A N N U A L R E P O R T 2 0 1 0
S e r v i c e . I n n o v a t i o n . R e s u l t s .
TABLE OF CONTENTS
P R O F I L E
1
Investment Highlights /
Our 2010 Performance at a Glance
2
Letter from the President
4
Corporate Governance
5
Board Members
6
Management’s Discussion and Analysis
29
First National Financial Income Fund
Consolidated Financial Statements
34
First National Financial Income Fund
Notes to Consolidated Financial
Statements
38
First National Financial LP
Financial Statements
42
First National Financial LP
Notes to Financial Statements
1BC Investor Information
First National Financial Corporation (TSX:FN) is the successor
to First National Financial Income Fund, and its wholly-owned
subsidiary, First National Financial LP, is a Canadian-based
origi nator, underwriter and servicer of predominantly prime
residential (single-family and multi-unit) and commercial mort-
gages. With over $53 billion in mortgages under administration,
First National is Canada’s largest non-bank originator and under-
writer of mortgages and is among the top three in market share
in the growing mortgage broker distribution channel.
• Canada’s largest non-bank
mortgage originator
• Leader in mortgage broker
distribution channel
• High-quality mortgage portfolio
• Diverse revenue and funding sources
I N V E S T M E N T H I G H L I G H T S
FUNDING SOURCES
REVENUE SOURCES*
(Year ended December 31, 2010)
(Year ended December 31, 2010)
F
E
D
A
C
B
A
C
B
MORTGAGES UNDER
ADMINISTRATION
(As at December 31, 2010)
D
C
B
A
A. 59% Institutional placements
B. 4% Securitization and internal
company sources
C. 37% NHA-MBS
A. 33% Institutional placements
B. 17% Gain on securitization
C. 22% Mortgage servicing
D. 8% Investment income
E. 10% Residual securitization
F. 10% Gain on financial instruments
* Based on gross revenue
A. 79% Insured
B. 13% Multi-unit and commercial
C. 7% Conventional and
single-family residential
D. 1% Bridge loans/Alt-A
86% Insured or conventional
single-family residential
O U R 2 0 1 0 P E R F O R M A N C E AT A G L A N C E
MORTGAGE ORIGINATIONS
(In $ Billions)
REVENUE
(In $ Millions)
EBITDA
(In $ Millions)
MORTGAGES UNDER
ADMINISTRATION
(In $ Billions)
.
3
3
5
.
8
7
4
.
6
0
4
.
1
3
3
.
4
4
2
.
9
1
1
.
8
1
1
.
9
0
1
.
5
0
1
*
3
7
.
.
7
1
4
3
.
2
3
4
3
.
0
4
9
2
.
0
9
3
2
.
*
9
3
9
1
06
07
08
09
10
06
07
08
09
10
06
07
08
09
10
11.5%
Year-over-year growth
2009 to 2010
(11%)
Year-over-year growth
2009 to 2010
0.4%
Year-over-year growth
2009 to 2010
* 2006 figures reflect the operations of First National Financial Corporation from January 1, 2006 to June 14, 2006
combined with the operations of First National Financial LP from June 15, 2006 to December 31, 2006.
.
2
5
6
1
.
2
3
6
1
.
0
0
1
1
.
1
4
7
.
*
2
8
6
06
07
08
09
10
(1%)
Year-over-year growth
2009 to 2010
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 1
L E T T E R F R O M T H E P R E S I D E N T
FELLOW SHAREHOLDERS,
This past year was a time of significant accomplishment for
First National Financial Corporation. During 2010, the Com-
pany successfully transitioned from an income trust structure
to a dividend-paying corporation, while maintaining its posi-
tive trend of strong financial results. Additionally, in the second
quarter, mortgages under administration reached $50 billion, a
significant milestone in the Company’s history. These achieve-
ments reflect the fundamental strengths of our business strat-
egy and our leadership position within the mortgage broker
distribution channel.
DELIVERING SOLID RESULTS
• Mortgages under administration reached $53.3 billion at
year-end, growing by 11.5% from the $47.8 billion estab-
lished at the end of 2009.
• Revenue increased to $343.2 million from $341.7 mil-
lion in 2009, reflecting the increased valuation of floating
rate securitization transactions and higher mortgage ser-
vicing revenue.
• Net income and EBITDA both decreased by 1%; net
income from $163.5 million in 2009 to $161.4 million and
EBITDA from $165.2 million in 2009 to $163.2 million.
The declines were a result of tighter mortgage spreads
on mortgages originated for securitization offset by gains
recognized on improving capital markets. Earnings were
also decreased by marginally higher mortgage brokerage
expenses.
• The Company paid out distributions of $1.50 per unit dur-
ing the year and declared a one-time special distribution
in December of $0.40, rewarding unitholders with the sur-
plus cash flow generated from the business.
• In 2010, management initiated a conversion to a cor po-
ration, which was completed effective January 1, 2011, and
set the initial annual dividend payment in the amount of
$1.25 per common share, payable on a monthly basis.
In 2010, First National maintained its market share and pro-
duced solid results, despite a slowing real estate market and
increased competition from other lenders. Despite relatively
tight spreads on new mortgage origination, we continued to
grow the number of mortgages under administration, achiev-
ing a record year-end level of $53 billion. Our ability to grow
in such uncertain economic conditions confirms our position
as Canada’s leading non-bank mortgage lender and demon-
strates the success of our business strategy.
First National achieved strong financial performance in 2010,
almost matching the record results of 2009, which repre-
sented a period of wide spreads and reduced competition.
The high demand for prime insured mortgages and profit-
able spreads on much of our origination recorded in the
first three months of the year receded in both the second
and third quarters. The resulting decline in Canada’s housing
market translated into lower revenue and net income than
was recorded in the previous year. However, seasonal mort-
gage commitments returned to 2009 levels in the fourth
quarter. The relative strength of our domestic economy and
the widening of mortgage spreads to pre-crisis levels helps
ensure that First National will continue to grow and profit
in this environment.
Another key achievement this year was the Company’s
successful transition from an income trust to a corporate
entity. The intention to convert to a dividend-paying corpo-
ration was first announced on March 25, 2010 and was
overwhelmingly approved by First National Financial Income
Fund’s unitholders at a special meeting held on May 4, 2010.
We are confident that this strategic change will facilitate a
more attractive environment for First National’s securities
while broadening the potential investor base for the Company
and positioning us for greater profitability and future growth.
2 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
INDUSTRY DEVELOPMENTS
Recessionary market conditions persisted throughout 2010.
A slower domestic housing market, tighter spreads and
increased competition continued to create sustained but
slower growth and increased cash flow for First National.
Following a record-breaking 2009, there were fewer real
estate transactions available to finance in 2010, leading to
reduced mortgage origination levels in both the single-family
and multi-unit residential and commercial segments.
Although the demand for prime insured mortgages contin-
ued to be strong, supply fell off as economic pressures slowed
down both the number of home purchases and house prices.
Capital markets, which had improved markedly in the first
quarter of 2010, fell back in the second and third quarters,
while the fourth quarter showed more strength as we en-
tered 2011. Although these and other domestic issues slowed
the Canadian real estate market, competition for mortgage
products was strong. Unlike 2009, when the Company’s com-
petitors operated tentatively, 2010 has evidenced a re-emer-
gence of robust competition such that the Company now
operates in a normalized market environment.
OUTLOOK
In a year characterized by continuing global economic weak-
ness and fragile market conditions, First National achieved
a record level of mortgages under administration and suc-
cess fully completed its corporate conversion, the next logical
growth step in the history of the Company. Although origi-
nation levels were lower than those experienced in 2009,
going forward we anticipate increased cash flows and sus-
tained growth in mortgages under management. And while
the effects of the recession are still notable, we are confident
in our Company’s potential to continue growing.
LOOKING AHEAD
Going forward, First National will continue to operate accord-
ing to our four key strategies for ongoing success:
• Minimizing funding costs by employing diverse and innova-
tive funding sources;
• Growing mortgages under administration;
• Maintaining our steadfast commitment to excellence in
service; and
• Lowering operating costs through our systems and
technology.
These proven strategies will continue to produce strong
results and growth, allowing First National to drive solid
returns to shareholders as the Company grows and prospers.
Our success continues to be dependent on the guidance of
our Board, the dedication and support of our shareholders
and employees, as well as the loyalty of our customers.
I would like to express my appreciation and gratitude to each
of these groups for their confidence and continued support.
Through our collective efforts, First National continues to
per form despite the unsettled nature of the current economic
environment. We are confident that by taking advantage
of our new corporate structure and strictly adhering to a
prudent business plan, First National is in a good position to
achieve sustained future growth and success.
Sincerely,
Stephen Smith
Chairman and President
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 3
C O R P O R AT E G O V E R N A N C E
First National’s Board of Directors and management team fully acknowledge the importance of their duty
to serve the long-term interests of shareholders.
Sound corporate governance is fundamental for maintaining
the confidence of investors and increasing shareholder value.
As such, First National is committed to the highest standards
of integrity to ensure transparency, compliance and discipline.
It defines the relationships among all of our stakeholders –
Board, management and shareholders – and is the basis for
building these values and nurturing a culture of accountability
and responsibility across the organization.
POLICIES
The Board supervises and evaluates the management of the
Company and oversees matters related to our strategic direc-
tion and assessing results relative to its goals and objectives.
As such, the Board has adopted several policies that reflect
best practices in governance and disclosure. These include
a Disclosure Policy, a Code of Business Conduct, a Whistle-
blower Policy and an Insider Trading Policy. These policies are
compliant with the corporate governance guidelines of the
Canadian Securities Administrators. As a public company, First
National’s Board continues to update, develop and implement
appropriate governance policies and practices as it sees fit.
COMMITTEES
The Board of Directors has established an Audit Committee
and a Compensation, Governance and Nominating Commit-
tee to assist in the efficient functioning of the Company’s cor-
porate governance strategy.
Audit Committee
The Audit Committee’s responsibilities include:
• Management of the relationship with the external auditors,
including the oversight and supervision of the audit of the
Company’s financial statements;
• Oversight and supervision of the quality and integrity of
the Company’s financial statements; and
• Oversight and supervision of the adequacy of the Com-
pany’s internal accounting controls and procedures, as well
as its financial reporting practices.
The Audit Committee consists of three independent direc-
tors, all of whom are considered financially literate for the
purposes of the Canadian Securities Administrators’ Multi-
lateral Instrument 52–110 – Audit Committees.
Committee Members: John Brough (Chair), Peter Copestake
and Robert Mitchell
Compensation, Governance and Nominating Committee
The Compensation, Governance and Nominating Commit-
tee’s responsibilities include:
• Making recommendations concerning compensation of
the Company’s senior executive officers and the remu-
neration of the Board of Directors;
• Developing the Company’s approach to corporate gover-
nance issues and compliance with applicable laws, regula-
tions, rules, policies and orders with respect to such issues;
• Advising the Board of Directors on filling director va cancies;
• Periodically reviewing the composition and effectiveness of
the directors and the contributions of individual directors;
and
• Adopting and periodically reviewing and updating First
National’s written Disclosure Policy.
The Compensation, Governance and Nominating Committee
consists of three independent directors for the purposes of
the Canadian Securities Administrators’ Multilateral Instrument
58 – 101 – Disclosure of Corporate Governance Practices.
Committee Members: Stanley Beck (Chair), Duncan Jackman
and Peter Copestake
4 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
B O A R D M E M B E R S
Collectively, the Board of Directors has extensive experience in mortgage lending, real estate, strategic
planning, law and finance. The Board consists of seven members, five of whom are independent.
Stephen Smith (Chairman) is President and Co-founder
of First National. He has been an innovator in the devel-
opment and utilization of various securitization techniques
to finance mortgage assets throughout his career. He is the
Vice Chairman of GO Transit, a member of the board of
directors of The Dominion of Canada General Insurance
Company and The Empire Life Insurance Company and Chair
of The Historica-Dominion Institute. Mr. Smith has a M.Sc.
(Econ.) from the London School of Economics and Political
Science and a B.Sc. (Hons.) in Electrical Engineering from
Queen’s University.
Moray Tawse is Vice President, Mortgage Investments and Co-
founder of First National. In addition to directing the operations
of all the Company’s commercial mortgage origination activi -
ties, he is one of Canada’s leading experts on commercial real
estate and is often called upon to deliver keynote addresses
at national real estate symposiums. Prior to co-founding First
National, Mr. Tawse was Manager of Mortgages for the Guar-
anty Trust Company of Canada from 1983 until 1988.
Stanley Beck, Q.C. is the President of Granville Arbitrations
Limited. He was previously a Professor of Law and Dean at
Osgoode Hall Law School. From 1985 to 1990, he served as
Chairman of the Ontario Securities Commission. Mr. Beck is
also the Chairman of 407 International Inc. and GMP Capital
Trust and serves as a director on the boards of Scotia Utility
Corp. and Scotia NewGrowth Corp.
John Brough served as President of both Wittington Prop-
erties Limited and Torwest Inc. from 1998 to 2007. From
1996 to 1998, he was Executive Vice President and Chief
Financial Officer of iStar Internet, Inc. From 1974 until 1996,
he was with Markborough Properties, Inc., where for the
last ten years he served as Senior Vice President and Chief
Financial Officer.
He is a director of Kinross Gold Corporation, Silver Wheaton
Corp., Canadian REIT and Transglobe Apartment REIT. He
has a B.A. (Economics) degree from the University of Toronto
and is a Chartered Accountant.
Peter Copestake serves as a corporate director and con-
sultant to business, academic and government organizations
globally and most recently served in the role of Senior Vice
President and Treasurer of Manulife Financial. He is currently
Chairman Emeritus of the Association for Financial Profes-
sionals of Canada, Chair Emeritus of the Society of Canadian
Treasurers, Chairman of the Independent Review Committee
for the Board of First Trust Portfolios and a member of the
Board of Directors of Manulife Bank and Canadian Deriva-
tives Clearing Corporation. Mr. Copestake has a Master of
Business Administration in Finance from Dalhousie University
and a Bachelor of Arts from Queen’s University.
Duncan Jackman is the Chairman, President and Chief
Executive Officer of E-L Financial Corporation Ltd. and the
Chairman and President of Economic Investment Trust Ltd.
and United Corporations Ltd. Prior to this, he was a portfolio
manager at Cassels Blaikie and an investment analyst at RBC
Dominion Securities Inc. Mr. Jackman has a Bachelor of Arts in
Literature from McGill University.
Robert Mitchell has been the President of Dixon Mitchell
Investment Counsel Inc. since 2000. Prior to that, he was
Vice President, Investments at Seaboard Life Insurance Com-
pany. He is currently a director and audit committee chair for
Discovery Parks Holdings Ltd. and a trustee for Discovery
Parks Trust. Mr. Mitchell has a Master of Business Adminis-
tration degree from the University of Western Ontario, a
B.Comm. (Finance) from the University of Calgary and is a
CFA charterholder.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 5
Management’s Discussion and Analysis
The following management’s discussion and analysis of financial conditions and results of operations is prepared as of March 1, 2011. This discus-
sion should be read in conjunction with the audited consolidated financial statements of First National Financial Income Fund (the “Fund”) and
First National Financial LP (“FNFLP”) as at and for the year (the “period”) ended December 31, 2010 (as applicable) and the notes thereto. This
discussion should also be read in conjunction with the audited consolidated financial statements and notes thereto of the Fund and FNFLP for the
year ended December 31, 2009. The audited consolidated financial statements of the Fund and FNFLP have been prepared in accordance with
Canadian Generally Accepted Accounting Principles (“GAAP”).
The Fund earns income from its 21.15% interest in FNFLP. The Fund accounts for its investment in FNFLP using the equity method and
therefore does not consolidate the results of operations of FNFLP. As a result, financial statements with accompanying notes thereon have been
presented for both the Fund and FNFLP. In addition, the following management’s discussion and analysis (“MD&A”) presents a discussion of the
financial condition and results of operations for both the Fund and FNFLP.
This MD&A contains forward-looking information. Please see “Forward-Looking Information” for a discussion of the risks, uncertainties and
assumptions relating to these statements. The selected financial information and discussion below also refer to certain measures to assist in assess-
ing financial performance. These “non-GAAP measures” such as “EBITDA”, “Distributable Cash”, and “Distributable Cash per Unit” should not be
construed as alternatives to net income or loss or other comparable measures determined in accordance with GAAP as an indicator of performance
or as a measure of liquidity and cash flow. Non-GAAP measures do not have standard meanings prescribed by GAAP and therefore may not be
comparable to similar measures presented by other issuers.
The Fund is entirely dependent upon the operations and financial condition of FNFLP. The earnings and cash flows of FNFLP are affected by
certain risks. For a description of those risks, please refer to the “Risk and Uncertainties Affecting the Business” section.
Unless otherwise noted, tabular amounts are in thousands of Canadian dollars.
Additional information relating to the Fund and FNFLP is available in the Fund’s profile on the System for Electronic Data Analysis and Retrieval
(“SEDAR”) website at www.sedar.com.
GENERAL DESCRIPTION OF THE FUND
AND FIRST NATIONAL FINANCIAL LP
Pursuant to an underwriting agreement dated June 6, 2006, and
initial public offering (“IPO”), the Fund sold 10,600,000 units of
the Fund (“Fund Units”, “Units” or “Unit”), at a price of $10.00 per
Unit for proceeds totalling $106 million. The proceeds of the offer-
ing were used to par tially fund the indirect acquisition (through
the Fund’s wholly-owned subsidiary, First National Financial Oper-
ating Trust) by the Fund of a 17.94% interest in FNFLP. In turn,
FNFLP purchased the net business assets of First National Financial
Corporation (“FNFC”), as predecessor to FNFLP. Subsequently,
with the issue of Units pursuant to an over-allotment option and
its Distribution Reinvestment Plan (“DRIP”), the Fund now indi-
rectly holds a 21.15% interest in FNFLP and FNFC holds a 78.85%
controlling interest in FNFLP.
First National Financial Income Fund
The Fund is an unincorporated, open-ended trust established under
the laws of the Province of Ontario on April 19, 2006, pursuant to
a Declaration of Trust. The Fund was established to acquire and
hold, through a newly constituted wholly-owned trust, First National
Financial Operating Trust (the “Trust”), investments in the outstand-
ing limited partnership units of FNFLP. Each unitholder participates
pro rata in any distribution from the Fund. Income tax obligations
related to the distributions of the Fund are the obligations of the
unitholders. The Fund effectively commenced operations through
its indirect investment in FNFLP on June 15, 2006, and the income
reported by the Fund commenced on that date. Effective January 1,
2011, the Fund was wound up pursuant to a plan of arrangement
as First National restructured from an income trust to a corporate
structure (“the Conversion”).
6 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
SELECTED QUARTERLY INFORMATION
Quarterly Results of First National Financial Income Fund
(in $000s, except for per Unit amounts)
Net Income
for the
period
Revenue
Net
Income
per Unit
Total Assets
2010
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2009
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
$ 9,980 $ 4,170
$ 5,256 $ 3,456
$ 9,565 $ 7,465
$ 5,714 $ 4,364
$ 0.33 $ 300,683
$ 0.27 $ 303,479
$ 0.59 $ 300,743
$ 0.34 $ 119,620
$ 7,100 $ 6,950
$ 7,092 $ 5,192
$ 6,413 $ 5,463
$ 4,498 $ 4,048
$ 0.55 $ 119,296
$ 0.41 $ 116,951
$ 0.43 $ 114,138
$ 0.32 $ 112,005
INVESTMENTS
At December 31, 2010, the Fund had an investment in 12,681,113
units (21.15%) of First National Financial LP at a cost of $122,670.
Under Canadian GAAP, the Fund is required to account for
the investment in units using the equity method. During the year
ended December 31, 2010, the Fund’s equity earnings from FNFLP
were $34.2 million, amor tization of identifiable assets inherent
in the investment was $9.5 million and the carrying value of this
investment at December 31, 2010 was $117.5 million. The Fund
has also invested $175,000 in FNFLP by way of an interest bearing
note receivable.
STATEMENT OF DISTRIBUTABLE CASH
(in $000s, except where noted)
DISTRIBUTIONS
The IPO described above closed on June 15, 2006, and begin-
ning on this date, the Fund began making monthly distributions
at the rate of $0.07917 per unit on or around the 15th of each
month. Subsequently, the Fund increased the monthly distribu-
tion each year : to $0.10417 per unit in 2007, $0.1125 per unit in
2008 and $0.125 per unit beginning with the distribution paid on
October 15, 2009. The Fund also announced special distributions
in December of the past four years. In 2010, the amount was $0.40
per unit; in the prior three years the amount was between $0.05
per unit and $0.07 per unit. For the year, the Fund’s distributions of
approximately $24.1 million were based on the distributions that
the Fund received from FNFLP. The amount of regular monthly
distributions declared in 2010 represents a 58% increase from the
distribution rate contemplated at the time of the IPO. The following
table shows the payout ratio based on the Fund’s pro rata share of
distributable cash earned by FNFLP.
For the quar ter ended December 31, 2010, the payout ratio
was 79%. For the year ended December 31, 2010, the payout ratio
was 88%. These figures reflect the receipt of increased cash flows
received on securitization transactions. In the third and four th
quarters of 2010, the Company chose to securitize a much smaller
portion of its origination. Instead, more mortgages were placed with
institutional investors and cash was received upfront. As a result,
the Company had the benefit of large receipts of cash from its
previous securitization transactions with much lower cash invest-
ment needed on new securitizations. Despite the large special
distribution declared in December, the payout ratio in the fourth
quarter is less than 100%. The ratio of distributions to net income
at the FNFLP level, which management believes is an impor tant
ratio, was 71% for the year.
First National Financial LP
Distributable Cash from First National Financial LP (1)
First National Financial Income Fund
Weighted Average Share of Distributable
Cash from First National Financial LP (1)
Distributable Cash per Unit ($/Unit) (1)
Distributions Declared
Distributions Declared per Unit ($/Unit)
Payout Ratio
For the quarter ended
For the year ended
December 31
2010
December 31
2009
December 31
2010
December 31
2009
$
59,225
$
30,252
$
128,856
$
76,907
12,526
0.99
9,828
0.78
79%
6,399
0.50
5,390
0.42
84%
27,253
2.15
24,094
1.90
88%
16,266
1.28
18,388
1.45
113%
(1) Distributable cash and distributable cash per unit are non-GAAP measures generally used by Canadian open-ended trusts as an indicator of financial performance. They are
considered key measures as they demonstrate the cash available for distribution to unitholders. See the FNFLP section in this MD&A for their determination.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 7
MANAGEMENT’S DISCUSSION AND ANALYSIS
INCOME TAXES
In 2010, the Fund was a mutual fund trust for income tax purposes.
As such, the Fund was only taxed on any amount of taxable income
not distributed to unitholders. While it existed, the Fund distributed
substantially all of its taxable income to its unitholders and complied
with the provisions of the Income Tax Act (Canada) that permitted,
among other items, the deduction of distributions to unitholders
from the Fund’s income for tax purposes.
As described in the Fund’s financial statements and the “Income
Tax Matters” section later in this MD&A, on June 22, 2007, the
federal government enacted previously announced legislation that
would have had the effect of imposing additional income taxes
on the Fund commencing January 1, 2011. Accordingly, the Fund’s
financial statements have been affected in two ways: (1) a future tax
liability has been accrued based upon the net book value of the
intangible assets inherent in the carrying value of the Fund’s invest-
ment in FNFLP; and (2) a future tax liability has been accrued related
to differences between the net book value of assets and liabilities
in FNFLP and their tax cost base.
ACCRUED FUTURE TAX LIABILITY
ON INTANGIBLE ASSETS
The first issue relates to the intangible assets described in
Note 2 to the financial statements. Due to a difference between
the accounting carrying value of these assets and their underly-
ing tax carrying value, GAAP requires that a future tax liability be
accrued. This was effectively accrued at the time of the IPO based
on the then current effective tax rate for income trusts, which
was a rate of Nil. Under the new laws enacted on June 22, 2007,
together with the general tax changes announced subsequently, the
effective tax rate for the Fund as at January 1, 2011 was changed
to approximately 29%. Based on this new rate, the Fund accrued
a future tax liability related to these assets of $8.2 million in June
2007. In the interim three years, the DRIP and lower provincial tax
rates have had offsetting impacts on the liability, increasing it by
$0.1 million. The combined liability of $8.6 million is expected to be
drawn down beginning on January 1, 2011, as the Fund’s successor
continues to amor tize the related intangible assets until 2016.
This future tax liability is an accounting convention and has no effect
on the distributable cash of the Fund.
ACCRUED FUTURE TAX LIABILITY
ON INVESTMENT IN FNFLP
Similar to the discussion above, there are also differences between
the accounting and tax carrying values of certain assets and liabili-
ties in FNFLP. Because there is no tax levied at the partnership level,
these differences are temporary and require tax accounting at the
Fund level. In the reporting periods ended prior to June 22, 2007,
these differences had been accounted for using a tax rate of Nil.
As the new rules have been enacted, the Fund has accounted for
these differences with the applicable higher tax rates. As at Decem-
ber 31, 2010, these differences were such that the Fund recorded
a future tax liability of $10.4 million. This tax liability represents
the Fund’s estimated pro rata share of tax liabilities that FNFLP
will incur in the periods subsequent to December 31, 2010 and
is based on timing differences related to the period from June 15,
2006 (the IPO date) to December 31, 2010. Up until June 22, 2007,
the Fund had been applying tax rates to temporary differences
in FNFLP at a Nil tax rate. This was based on the assumption that
the Fund would make sufficient tax deductible cash distributions
to unitholders such that the Fund’s taxable income would be Nil
for the foreseeable future. The new legislation enacted on June 22,
2007, imposes a tax on certain income distributed to unitholders
such that income taxes may become payable in the future. For the
year ended December 31, 2010, the Fund recorded a provision for
future taxes on these differences of $5.25 million.
The Fund has estimated both of these future income tax accru-
als based on its best estimates of the results of operations, current
tax legislation and future cash distributions, assuming no material
change to the Fund’s current organizational structure. The Fund’s
estimate of future income taxes will vary as the Fund’s assumptions
vary in accordance with the factors above, and such variations may
be material.
OUTSTANDING SECURITIES OF THE FUND
At December 31, 2010, the Fund had 12,681,113 units and 175,000
debentures outstanding. On January 1, 2011 the Fund was wound
up as par t of the Conversion. The continuing public entity, First
National Financial Corporation, had 59,967,429 shares and 175,000
debentures outstanding as at March 1, 2011.
As at December 31, 2010, FNFC held 47,286,316 exchange-
able Class B LP units of FNFLP, each of which was exchangeable
into one Fund Unit at no cost at any time at the option of FNFC,
and each of which carried a Special Voting Right that entitled the
holder to receive notice of, attend and vote at all meetings of
unitholders of the Fund. Subsequent to year end, pursuant to the
Conversion, these securities were cancelled and effectively replaced
with 47,286,316 Class A public common shares of First National
Financial Corporation.
CRITICAL ACCOUNTING ESTIMATES
Management makes estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of con-
tingent assets and liabilities at the date of the Consolidated Finan-
cial Statements, and revenues and expenses during the reporting
period. Management reviews these estimates on an ongoing basis,
including those related to securitization accounting and future
income taxes. Changes in facts and circumstances may result in
revised estimates and actual results may differ from these estimates.
8 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
BUSINESS RISKS
The Fund is entirely dependent upon the operations and financial
condition of FNFLP. The earnings and cash flows of FNFLP are
affected by cer tain risks. For a description of those risks, please
refer to the “Risk and Uncertainties Affecting the Business” section
in this MD&A.
2010 RESULTS SUMMARY
• Mor tgages under administration grew to $53.3 billion at
December 31, 2010 from $47.8 billion at December 31, 2009,
an annualized increase of 11.5%; the growth from September 30,
2010, when mortgages under administration were $52.0 billion,
was 2.5%, an annualized increase of 10%;
GUARANTEE
At December 31, 2010, the Fund’s wholly-owned subsidiary, First
National Financial Operating Trust, had provided guarantees to
and subordinated their rights to receive payments from FNFLP in
respect of FNFLP’s $125 million bank credit facility. Pursuant to the
Conversion, this guarantee was removed and replaced with a guar-
antee from First National Financial Corporation.
First National Financial LP
BASIS OF PRESENTATION
The financial statements of First National Financial LP (“FNFLP” or
the “Company”) are prepared in accordance with Canadian Gener-
ally Accepted Accounting Principles (“GAAP”). FNFLP is considered
to be a continuation of FNFC’s business following the continuity of
interest method of accounting. Under this method of accounting,
FNFLP’s acquisition of the FNFC business is recorded at the net
book value of FNFC’s business assets and liabilities on June 14, 2006
and the equity of FNFLP represents the equity of the FNFC busi-
ness at that date.
EXECUTIVE SUMMARY
The Company’s financial results for 2010 were similar to those
recorded in the 2009 comparative year. Lower volumes associated
with a slowing real estate market together with relatively tighter
spreads on prime mor tgages, negatively affected revenues. 2010
featured continued growth in mor tgages under administration,
revenue and net income consistent with that recorded in the
prior year. The demand for prime insured mor tgages was strong
throughout the year ; however, supply was volatile as economic
news and government monetary policy affected the normal season-
ality of mortgage consumers. Capital markets, which had improved
markedly in the first quarter of 2010, suffered in both the second
and third quarter as global economic indicators became decidedly
more negative. Although these fears and other domestic issues
slowed the Canadian real estate market, competition for mortgage
products was strong. Unlike 2009, when the Company’s competi-
tors operated tentatively, 2010 evidenced a re-emergence of robust
competition such that the Company operated in a normalized
market by the end of the year.
• The Canadian single-family real estate market proved resilient
despite continued recessionary pressures and global economic
worries. Total 2010 single-family mor tgage originations for
the Company decreased by 2% from $8.5 billion in 2009 to
$8.3 billion for 2010. For the commercial segment, the year
reflected a slower market, as the robust activity in 2009 mod-
erated and, together with increased competition, volumes
decreased 33% from $3.3 billion to $2.2 billion;
• Revenue for the year ended December 31, 2010 increased to
$343.2 million from $341.7 million in 2009. The small growth
of 0.4% is reflective of the increased valuation of floating rate
securitization transactions and higher mortgage servicing reve-
nue offset by the effect of lower origination volumes and tighter
securitization spreads;
• Net income decreased by 1% from $163.5 million in 2009 to
$161.4 million in 2010. This decrease is consistent with the
change in revenues offset by marginally higher mortgage broker-
age expenses;
• EBITDA decreased by 1% from $165.2 million in 2009 to
$163.2 million in 2010 due to the same factors cited above for
net income; and
• The Company paid out $1.50 per unit of distributions during
the year and declared a one-time special distribution in Decem-
ber of $0.40, rewarding unitholders with the surplus cash flow
generated from the business.
SELECTED QUARTERLY INFORMATION FOR
RESULTS OF FNFLP
Net Income
for the
period
Revenue
Net
Income
($/Unit)
Total Assets
2010
Fourth Quarter $ 75,504 $ 30,844 $ 0.51 $ 1,149,082
Third Quarter $ 87,549 $ 35,982 $ 0.60 $ 982,627
Second Quarter $ 104,620 $ 56,389 $ 0.94 $ 1,095,097
$ 75,541 $ 38,212 $ 0.64 $ 1,074,461
First Quarter
2009
Fourth Quarter $ 88,280 $ 44,768 $ 0.75 $ 1,067,690
$ 96,161 $ 44,730 $ 0.75 $ 1,122,651
Third Quarter
Second Quarter $ 91,570 $ 41,519 $ 0.69 $ 919,300
905,774
First Quarter
$ 65,705 $ 32,466 $ 0.54 $
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 9
MANAGEMENT’S DISCUSSION AND ANALYSIS
First National’s quar terly revenue can be divided into two cat-
egories: (1) seasonally affected revenues; and (2) those which
are steadily earned throughout its fiscal year. Mor tgage ser vic-
ing income, mor tgage investment income interest and, generally,
residual securitization income accrue to the Company each quarter
and will reflect the trend of the changing portfolio of mortgages
under administration. Alternatively, origination (including placement
and securitization) activities are more seasonal in nature. This is
particularly true for single-family residential origination for which
volumes follow the purchasing patterns of single-family home
buyers: origination activity is generally slower in the first quarter of
each year, increases in the second quarter, peaks in the third quarter
and gradually retreats in the last quarter of the year. Single-family
origination has the effect of “smoothing out” net income fluctuations
because the large amount of revenue generated from this category
does not generally result in significant income due to the high
percentage of related brokerage fees.
Both the seasonal and income smoothing trends are apparent
in the information presented above except for the second quarter
of 2010, in which the Company recognized large gains from hold-
ing securitization assets, including a one-time gain of $21.9 million
related to the change in the Company’s estimate of ongoing Prime-
BA spreads as described in detail subsequently in the MD&A.
If this adjustment is added back, revenue and net income for these
quarters would have been in line with seasonal expectations and
a growing business. During this two-year period mortgage spreads
tightened steadily throughout the quar ters as Canadian capital
markets returned to historical norms following the credit turmoil
of 2007 and 2008. This trend is evident in both revenue and net
income figures.
Total assets fluctuated between $0.9 billion and $1.2 billion over
the past eight quarters due primarily to movements between the
periods in the amount of securities purchased under resale agree-
ments which are used for hedging purposes.
SELECTED ANNUAL FINANCIAL INFORMATION FOR THE COMPANY’S FISCAL YEAR ENDED
($000s, except per Unit amounts)
For the Period
Income Statement Highlights
Revenue
Brokerage fees
Other operating expenses
EBITDA (1)
Amortization of capital assets
Provision for income taxes
Net income
Distributions declared
Per Unit Highlights
Net income per Unit
Distributions declared per Unit
At Period End
Balance Sheet Highlights
Total assets
Total long-term financial liabilities
December 31
2010
December 31
2009
December 31
2008
$
343,214
(103,020)
(76,971)
163,223
(1,796)
–
161,427
114,444
2.69
1.91
$
341,716
(98,677)
(77,807)
165,232
(1,749)
–
163,483
86,953
2.73
1.45
$
293,959
(105,757)
(78,527)
109,675
(1,654)
–
108,021
81,233
1.81
1.36
1,149,082
178,849
$
1,067,690
–
$
737,065
–
$
(1) EBITDA is not a recognized earnings measure under GAAP and does not have a standardized meaning prescribed by GAAP. Therefore, EBITDA may not be comparable to
similar measures presented by other issuers. Investors are cautioned that EBITDA should not be construed as an alternative to net income or loss determined in accordance with
GAAP as an indicator of the Company’s performance or as an alternative to cash flows from operating, investing and financing activities as a measure of liquidity and cash flows.
10 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
GROWTH IN ORIGINATION OF HIGHER
MARGIN MORTGAGES
The Company’s main focus has always been on the prime single-
family mor tgage market. Prior to the credit issues which have
affected the market in the last three years, these mor tgages had
tight spreads such that the Company’s strategy was to sell these
mortgages on commitment to institutional investors and retain the
servicing. This strategy changed with the challenges in the credit
environment and the Company was able to take a larger portion
of the spread for itself. By the end of 2009, mortgage spreads on
fixed rate single-family mortgages had returned to pre-crisis levels;
however, floating rate single-family mor tgages continued to be
priced at historically wide spreads. In 2007, such mortgages were
priced at a discount to prime (a discount that reached a high of
0.90 percentage points that year). In 2009, these mortgages began
the year priced at prime plus 0.80 percentage points as liquidity
issues affected the funding costs for the large banks. As the liquid-
ity issues were resolved, pricing gradually narrowed during the year
such that by year end these mor tgages were being originated at
slight discounts to prime. Throughout 2010 competition increased
and the discount grew to 0.70 percentage points below prime.
The Company chose to securitize much of this origination as it was
able to earn a higher return than on an institutional placement. For
the 2010 year, the Company originated for securitization approxi-
mately $2.7 billion of floating rate single family mortgages in order
to take advantage of these wider spreads. Although the bid from
the NHA-MBS market for this product has remained consistent, the
profitability of securitization at these spreads has decreased to a
level that is comparable to that of an institutional placement. During
the third quarter of 2010, the Company elected to securitize lower
volumes of this product than what was securitized in the first two
quarters of 2010. Instead, more of these mortgages will be sold to
institutional investors. Management believes this strategy will reduce
the risk to the Company of increased credit spread tightening, and
provide the Company with more cash flow with only a marginal
reduction to revenue. In the fourth quarter of 2010, the Company
began a program to securitize fixed rate single-family mor tgages
through sales to the NHA-MBS market. The Company originated
approximately $95 million of mortgages for the program and securi-
tized one pool of $42 million late in the year.
VISION AND STRATEGY
The Company provides mortgage financing solutions to virtually
the entire mortgage market in Canada. By offering a full range of
mortgage products, with a focus on customer service and superior
technology, the Company believes that it is the leading non-bank
mortgage lender in the industry. Growth has been achieved while
maintaining a relatively conser vative risk profile. The Company
intends to continue leveraging these strengths to lead the “non-
bank” mor tgage lending industry in Canada, while appropriately
managing risk.
The Company’s strategy is built on four cornerstones: providing
a full range of mortgage solutions; growing assets under adminis-
tration; employing leading-edge technology to lower costs and
rationalize business processes; and maintaining a conservative risk
profile. An impor tant consequence of the Company’s strategy is
its direct relationship with the mortgage borrower. Although the
Company places most of its originations with third parties, FNFLP
is perceived by all of its borrowers as the mortgage lender. This is
a critical distinction. It allows the Company to communicate with
each borrower directly throughout the term of the related mort-
gage. Through this relationship, the Company can negotiate new
transactions and pursue marketing initiatives. Management believes
this strategy will provide long-term profitability and sustainable
brand recognition for the Company.
KEY PERFORMANCE DRIVERS
The Company’s success is driven by the following factors:
• Growth in the portfolio of mortgages under administration;
• Growth in the origination of higher margin mortgages;
• Lowering the costs of operations through the innovation of
systems and technology; and
• Employing innovative securitization transactions to minimize
funding costs.
GROWTH IN PORTFOLIO OF MORTGAGES
UNDER ADMINISTRATION
Management considers the growth in mortgages under administra-
tion (“MUA”) to be a key element of the Company’s performance.
The portfolio grows in two ways: through mortgages originated
by the Company and through mortgage servicing portfolios pur-
chased from third par ties. Mor tgage originations not only drive
placement and securitization revenues, but perhaps more impor-
tantly, longer term values such as servicing fees, mortgage admin-
istration fees, renewal opportunities and growth in customer base
for marketing initiatives. As at December 31, 2010, mor tgages
under administration totalled $53.3 billion, up from $47.8 billion at
December 31, 2009, a rate of increase of 11.5%. This compares to
$52.0 billion at September 30, 2010, representing a quarter-over-
quarter increase of 2.5% and an annualized increase of 10%.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 11
MANAGEMENT’S DISCUSSION AND ANALYSIS
LOWERING COSTS OF OPERATIONS
Innovation of Systems and Technology
The Company has always used technology to provide for efficient
and effective operations. This is par ticularly true for its MERLIN
underwriting system, Canada’s only web-based real-time broker
information system. By creating a paperless, 24/7 available commit-
ment management platform for mortgage brokers, the Company
is now ranked among the top three lenders by market share in
the broker channel. This has translated into increased single-family
origination volumes and higher closing ratios (the percentage of
mortgage commitments the Company issues that actually become
closed mortgages).
Debenture Issuance
In the second quar ter of 2010, the Fund issued $175 million of
five-year term senior secured debentures with an interest rate of
5.07% maturing on May 7, 2015. The Fund subsequently loaned the
proceeds of the issuance through the Trust to FNFLP, which in turn
repaid $175 million of its bank indebtedness under the existing
bank credit facility. Simultaneously with the issuance, the Company
entered into a swap agreement to receive the 5.07% fixed coupon
semi-annually and to pay a floating rate on a monthly basis, effec-
tively converting the fixed rate debenture into a floating rate debt.
Through these transactions the Company has maintained its overall
maximum debt at $300 million and has not increased its leverage.
The Company has elected to undertake this initiative for a number
of reasons: (1) the swapped floating rate on the debenture is signif-
icantly better than the spreads currently being offered by the Com-
pany’s bank syndicate; (2) the debenture provides the Company
with five years of certainty on a large portion of its interest costs,
enabling management to better plan and make decisions about
future investment opportunities and insulate the Company from
credit market volatility during the five-year term; (3) strategically,
the Company considers the ability to access such debt markets
valuable – the debentures give the Fund a history as an issuer; and
(4) the transaction allowed the Company to partially pay down the
existing bank credit facility, giving the Company more borrowing
capacity in the future while diversifying its sources of debt capital.
Preferred Share Issuance
Subsequent to year end, the Company, through FNFC (the new
public corporation), issued 4,000,000 Series 1 Class A Preference
shares for gross proceeds of $100 million. The Company received
net proceeds of $96.7 million after issuance costs on January 25,
2011. These shares are rate reset preferred shares having a stated
4.65% annual dividend rate, subject to Board of Director approval,
and a par of $25 per share. The rate reset feature is at the discre-
tion of the Company such that after the initial five-year term, the
Company can choose to extend the shares for another five-year
term at a fixed spread (2.07%) over the yield of the then rele-
vant risk-free Government of Canada bond. While the investors in
these shares have an option on each five-year anniversary to con-
vert their Series 1 holdings into Series 2 preference shares (which
pay floating rate dividends), there are no redemption options for
these shareholders. As such, the Company considers these shares
to represent a permanent source of capital and will classify the
shares as equity on its balance sheet. Management believes this
capital will give the Company the opportunity to pursue a strategy
of increased securitization, which requires upfront investment.
EMPLOYING INNOVATIVE SECURITIZATION
TRANSACTIONS TO MINIMIZE FUNDING COSTS
Normalization of the Asset-Backed Commercial Paper
(“ABCP”) Market
As described in prior years’ MD&A, ABCP funded by third-party
sponsored ABCP conduits became frozen in August 2007 due to
liquidity and credit concerns. Similar issues affected bank-sponsored
ABCP conduits. The Company has continued to fund a portion of
its assets (approximately $1.2 billion of the $53.3 billion of MUA
as at December 31, 2010) with bank-sponsored ABCP. Although
bank-sponsored ABCP is now trading efficiently in the marketplace,
its cost has varied greatly in the past few years due to uncertainty
surrounding both the quality of the underlying assets and the bank’s
ability to suppor t the paper’s continued liquidity. During 2009,
ABCP spreads were volatile, beginning the year at 1.10 percentage
points in excess of historical levels and then tightening during the
year such that they ended at historical levels. The Company consid-
ers historical levels to be when ABCP traded at the same rates as
Bankers’ Acceptances rates (“BA”). In 2010, although global credit
markets worsened, Canadian banks remained profitable and liquid
such that their covenant underlying the value of bank-sponsored
ABCP was perceived as strong. Accordingly, 30-day AAA-rated
ABCP continued to trade at rates comparable to BA.
The Company is required to mark-to-market its securitization
receivables at the end of each reporting period. A significant por-
tion of those receivables is calculated using assumptions about the
cost of funding arranged through the ABCP market. At the end of
2010, the Company had approximately $1.2 billion of mortgages
under administration funded with ABCP, including all of its Alt-A
mor tgages. The Company’s exposure to ABCP at December 31,
2010 (which excludes mor tgages having mor tgage rates linked
to the Company’s cost of ABCP) was approximately $1.0 billion.
As described above, adver tised ABCP spreads narrowed during
the course of the year. Management believes that much of the
uncer tainty in this market has now disappeared. The Company
changed its assumption each quar ter in 2010 to recognize this
return to historical norms such that by year end its models assumed
that ABCP will trade at rates comparable to BA. For 2010, the
Company recorded unrealized gains of $3.9 million with respect to
the changing fair value of the Company’s securitization receivables
involving ABCP.
12 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Permanent widening of the Prime lending rate (“Prime”) –
Bankers’ Acceptances (“BA”) spread
Since the Company began securitizing floating rate mor tgages
indexed to Prime, it took on the risk of the spread between Prime
and BA. As these floating rate mortgages are funded primarily with
BA-based funding, the Company must make an assumption of this
spread in its securitization models. To the extent that this assump-
tion is not appropriate, the Company’s earnings will be subject
to volatility. Historically this spread was 160 bps (if the BA rate
was 0.50%, then Prime would have been approximately 2.10%).
This spread is determined by the large chartered banks which set
both Prime and BA rates and is set, ultimately, so that the banks
can earn enough spread to earn sufficient profits to pay for their
weighted average cost of capital and give shareholders a rate of
return commensurate with the investment risk taken. The banks
have typically priced BA at a relatively fixed spread to the Bank
of Canada’s overnight rates; however, on December 9, 2008, the
Bank of Canada lowered the rate at which it lends to banks on
eligible assets by approximately 0.75%. The banks lowered their BA
settings accordingly but only lowered Prime by 0.50%. The result was
a higher spread between the two indices (approximately 1.85%).
The Company believed this elevated spread was only a temporary
measure to address the credit crisis, which peaked in the four th
quar ter of 2008. Accordingly, by the end of the first quar ter of
2009, the Company’s models assumed that the Prime – BA spread
would revert to the historical norm of 1.60%.
Since December 2008, the Bank of Canada lowered its over-
night rates several times. On each occasion the chartered banks left
the Prime – BA spread at 1.85%. As time passed, it became more
apparent that this spread would not change as the banks were
faced with higher costs due to regulatory requirements for addi-
tional capital. At the same time, this period featured an uncertain
economy and volatile credit markets. For the Company, the true
test on the longevity of this “new” spread was the banks’ reaction
to the Bank of Canada’s announced increase of its overnight rate
on June 1, 2010. This increase of 0.25% was addressed by each of
the five large Canadian banks with a commensurate increase in
their Prime to 2.50%. Accordingly, as at June 1, 2010, the Company
changed its assumption in its models to increase the Prime – BA
spread to 1.85% and recorded an unrealized gain of $21.9 million
in the second quar ter of 2010. This spread continued to be the
norm through the rest of 2010 until the four th quar ter, when
markets began pricing in the likelihood of another Bank of Canada
increase as inflation and currency issues became more prevalent.
Consequently, at December 31, 2010, Prime was 3.00% and CDOR
was 1.20%. The Company believes that over a five-year horizon this
spread will average approximately 1.85% and has used this spread
in its models.
Approval as both an Issuer of NHA-MBS and Seller
to the Canada Mortgage Bond Program
The Company has been involved in the issuance of National Housing
Act-Mor tgage Backed Securities (“NHA-MBS”) since 1995. This
program has been very successful, with over $5 billion of NHA-
MBS issued. In December 2007, the Company was approved by
Canada Mor tgage and Housing Corporation (“CMHC”) as an
issuer of NHA-MBS and as a seller into the Canada Mortgage Bond
(“CMB”) program, one of the first non-OSFI regulated companies
in Canada to be so approved. Issuer status will provide the Com-
pany with another funding source that it will be able to access inde-
pendently. Perhaps more importantly, seller status for the CMB will
give the Company direct access to the CMB. This status has also
allowed the Company to participate in the federal government’s
NHA-MBS reverse auction and has provided the Company with
an additional, albeit temporary, source of liquidity. In addition, the
demand for high-quality fixed income and floating rate investments
increased significantly in 2009. The demand has continued into 2010
and allowed the Company to issue $2.7 billion of floating rate single-
family NHA-MBS pools during the year.
Canada Mortgage Bond (CMB) Program
The CMB program is an initiative introduced by CMHC whereby
the Canada Housing Trust (“CHT”) issues securities to investors in
the form of semi-annual interest-yielding five and ten-year bonds.
The proceeds of these bonds are used to buy NHA-MBS. In previ-
ous years, the Company entered into an agreement with a Cana-
dian bank which allowed the Company to indirectly sell a portion
of the Company’s residential mor tgage origination into several
CMB issuances. Subsequently, pursuant to the Company’s approval
as a seller into the CMB, the Company was able to make direct
sales into the program. Because of the similarities to a traditional
Government of Canada bond (both have five/ten-year unamortizing
terms with a federal government guarantee), the CMB trades in the
capital markets at a modest premium to the yields on Government
of Canada bonds. The Company’s ability to sell into the CMB has
given the Company access to lower costs of funds on both single-
family and multi-family mor tgage securitizations. Because these
funding structures do not amortize, the Company can fund future
mortgages through this channel as the original mortgages amor-
tize or pay out. The Company also enjoys significant demand for
mortgages from investment dealers who sell directly into the CMB.
Because of the effectiveness of the CMB, there have been requests
from approved CMB sellers for larger issuances. CHT has indicated
that it will not unduly increase the size of its issuances, and has
created guidelines through CMHC that limit the amount that can
be sold by each seller into the CMB each quarter. The Company is
also subject to these limitations.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 13
MANAGEMENT’S DISCUSSION AND ANALYSIS
KEY PERFORMANCE INDICATORS
The principal indicators used to measure FNFLP’s performance are:
• Earnings before income taxes, depreciation and amor tization
(“EBITDA”); and
• Distributable cash.
EBITDA is not a recognized measure under GAAP. However, man-
agement believes that EBITDA is a useful measure that provides
investors with an indication of cash available for distribution prior
to capital expenditures. EBITDA should not be construed as an
alternative to net income determined in accordance with GAAP
or to cash flows from operating, investing and financing activities.
FNFLP’s method of calculating EBITDA may differ from other issu-
ers and, accordingly, EBITDA may not be comparable to measures
used by other issuers.
($000s)
Quarter ended
Year ended
For the Period
Revenue
Net income
EBITDA (1)
At Period End
Total assets
Mortgages under administration
December 31
2010
December 31
2009
December 31
2010
December 31
2009
$
$
75,504
30,844
31,386
88,280
44,768
45,247
$
343,214
161,427
163,223
$
341,716
163,483
165,232
1,149,082
53,293,132
1,067,690
47,793,045
1,149,082
53,293,132
1,067,690
47,793,045
(1) This non-GAAP measure adjusts income before income taxes by adding back expenses for amortization of capital assets.
Distributable cash is not a defined term under GAAP. Manage-
ment believes that net cash generated by FNFLP prior to distri-
bution is an important measure for investors to monitor. Manage-
ment cautions investors that due to the Company’s nature as a
mortgage seller and securitizer, there will be significant variations
in this measure from quarter to quarter as the Company collects
and invests cash from mor tgage transactions. Distributable cash
is determined by the Company as cash provided from operating
activities increased/decreased by the change in mortgages accumu-
lated for sale in the period and reduced by capital expenditures.
Mortgages accumulated for sale consist primarily of mortgage loans
that the Company funds ahead of securitization sales. Normally the
month after funding, the Company aggregates all relevant mor t-
gages “warehoused” to date and creates a pool to sell to the NHA-
MBS market. As the majority of mortgages are advanced in the last
few days of a month, there are large amounts of cash invested at
quarter ends by the Company that are typically received in the first
two weeks of the subsequent month. The Company’s credit facili-
ties provide full financing for the majority of these mortgage loans.
Accordingly, management believes the measure of distributable cash
is only meaningful if the change in mortgages accumulated for sale
between reporting periods is accounted for.
14 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
DETERMINATION OF DISTRIBUTABLE CASH
($000s)
Quarter ended
Year ended
For the Period
Cash provided by (used in) operating activities
Add (deduct):
Change in mortgages accumulated
for sale between periods
Less:
Capital expenditures
Distributable cash (1)
December 31
2010
December 31
2009
December 31
2010
December 31
2009
$
78,865
$
(91,838)
$
194,832
$
(83,549)
(19,409)
122,302
(64,723)
161,966
(231)
(212)
(1,253)
(1,510)
$
59,225
$
30,252
$
128,856
$
76,907
(1) This non-GAAP measure adjusts cash provided by (used in) operating activities by accounting for changes between periods in mortgages accumulated for sale and deducting
maintenance capital expenditures.
REVENUES AND FUNDING SOURCES
Mortgage Origination
The Company derives a significant amount of its revenue from
mor tgage origination activities. The majority of mor tgages origi-
nated are funded by either placement with institutional investors or
sale to securitization conduits, in each case with retained servicing.
Depending upon market conditions, either an institutional place-
ment or a securitization conduit may be the most cost-effective
means for the Company to fund individual mortgages. In general,
originations are allocated from one funding source to another
depending on market conditions and strategic considerations
related to maintaining diversified funding sources. The Company
retains servicing rights on virtually all of the mortgages it originates,
which provide the Company with servicing fees to complement
revenue earned through originations. For the year ended Decem-
ber 31, 2010, origination volume decreased from $11.8 billion to
$10.5 billion, or 11%, from the prior year.
Placement Fees, Gain on Securitization and
Gain on Deferred Placement Fees
The Company recognizes revenue at the time that a mor tgage
is placed with an institutional investor or sold to a securitization
conduit. Cash amounts received in excess of the mortgage princi-
pal at the time of placement are recognized in revenue as “Place-
ment fees”. Prior to 2009, the present value of additional amounts
(excess spread) expected to be received over the remaining life of
the mortgages sold (net of servicing and other costs) was included
with “Gain on securitization”. The excess spread on a mortgage is
the difference between the interest rate on the mortgage and the
yield earned by the investor after accounting for all anticipated pre-
payment provisions, servicing obligations and other costs. For Alt-A
and small conventional multi-unit residential and commercial mort-
gages, the excess spread also includes assumptions for credit losses.
The Company separates this revenue into two components:
“Gain on deferred placement fees” and “Gain on securitization”.
This distinction acknowledges the nature of the future payments
being received. At the time of the IPO, these future payments
represented primarily the present value of future payments from
direct securitization by the Company where the Company was
the principal risk taker. This included securitizations through ABCP,
NHA-MBS and the CMB program. At that time, the Company also
entered into transactions with institutional investors in which addi-
tional placement fees were received over time instead of just at the
time of the mortgage sale. In these cases the Company applied the
same accounting methodology as it had with the direct securitiza-
tion transactions; future expected cash flows were discounted to
present and a gain on securitization was recorded. While arguably
a different type of revenue, the Company determined it was insig-
nificant to disclose it separately from regular “Gain on securitiza-
tion” revenue. As described in previous discussions, the Company
began to enter into more placement transactions that attracted
larger deferred placement fees starting in the third quarter of 2007.
During 2008, a significant portion of the Company’s direct secu-
ritization business ceased, particularly with the discontinuance of
the uninsured Alt-A program. Accordingly, deferred gains related
to placement activity became a larger component of the “Gain
on securitization” revenue line. The Company believes that such
revenue is better described as “Gain on deferred placement fees”
as the Company is not directly securitizing these mor tgages but
placing them with institutional investors.
Upon the recognition of a “Gain on securitization”, the Company
establishes a “Securitization receivable” which is amor tized as
spread income is received by the Company. In addition, the Com-
pany is also required to establish a “servicing liability”, which rep-
resents the future cost of servicing the securitized mortgages. As
spread income is received by the Company, both the securitization
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 15
MANAGEMENT’S DISCUSSION AND ANALYSIS
receivable and the ser vicing liability are amor tized accordingly.
Residual securitization income consists of two components: (a) the
difference between the spread income received over time and the
spread income assumed in the Company’s derivation of securitiza-
tion receivable at the time of sale; and b) the amortization of the
servicing liability. The excess is attributable to better than expected
cash flows being earned by the securitization compared to those
anticipated when gain on sale assumptions regarding prepay-
ments, cost of funds and credit losses were originally forecasted.
All mortgages securitized through the Company’s ABCP programs
or directly sold as NHA-MBS or CMB produce “Gain on securitiza-
tion” revenue. Of the Company’s $10.5 billion of originations for
the year ended December 31, 2010, $374 million was originated
for ABCP conduits and other securitization vehicles and $2.8 billion
for direct sale to the NHA-MBS market, both generating “Gain on
securitization” revenue.
For all institutional placements and most mortgages securitized
through the NHA-MBS program, the Company earns “Placement
fees”. Revenues based on these originations are equal to either
(1) the present value of the excess spread, or (2) an origination
fee based on the outstanding principal amount of the mortgage.
This revenue is received in cash at the time of placement. Of the
Company’s $10.5 billion of originations for the year ended Decem-
ber 31, 2010, $6.2 billion was placed with institutional investors and
$1.1 billion was originated for institutional investors involved in
the issuance of NHA-MBS. In addition, under certain circumstances,
additional revenue from institutional placements and NHA-MBS
may be recognized as “Gain on deferred placement fees” as
described above. Upon the recognition of a “Gain on deferred
placement fee”, the Company establishes a “Deferred placement
fee receivable” which is amortized as spread income is received by
the Company with similar accounting, as described in the previous
paragraph for a “Securitization receivable”.
In the past several years, the Company has experienced
significant growth in mor tgages funded through its securitiza-
tion programs and deferred placement fee activities. As a result,
revenues from “Gain on securitization” and “Gain on deferred
placement fees” have increased accordingly. Since cash flows
received from these assets are received over the life of the mort-
gages involved, and the revenue is recognized upon securitization,
there will be a timing difference between the recognition of rev-
enue and the receipt of cash. The financial effect of the timing
difference between the recognition of revenue and the receipt of
cash is effectively equal to the sum of “Gain on securitization” and
“Gain on deferred placement fees” less the “Amortization of secu-
ritization and deferred placement fees receivable” (net of “Amor-
tization of servicing liability”) for any given period. For 2010, the
volume of mortgages funded through NHA-MBS and institutional
placements that earn either “Gain on securitization” or “Gain
on deferred placement fees” revenue increased marginally. This
timing difference required working capital funding of approxi-
mately $6.4 million for the year ($79.3 million for the year ended
December 31, 2009). To the extent that gains on securitization and
deferred placement fees do not increase for a number of years, the
effects of the timing difference would be neutralized, as new securi-
tization and deferred placement receivables would be offset by the
collection of existing receivables.
Mortgage Servicing and Administration
The Company services virtually all mortgages generated through
its mor tgage origination activities on behalf of a wide range of
institutional investors. Mortgage servicing and administration is a
key component of the Company’s overall business strategy and a
significant source of continuing income and cash flow. In addition
to pure servicing revenues, fees related to mortgage administra-
tion are earned by the Company throughout the mortgage term.
Another aspect of servicing is the administration of funds held in
trust, including: borrower’s property tax escrow, reserve escrows,
and mortgage payments. As acknowledged in the Company’s agree-
ments, any interest earned on these funds accrues to the Company
as partial compensation for administration services provided. The
Company has negotiated favourable interest rates on these funds
with the chartered bank that maintains the deposit account, which
has resulted in significant interest revenue.
In addition to the interest income earned on securitization and
deferred placement fees receivable, the Company also earns inter-
est income on mortgage-related assets, including mortgages accu-
mulated for sale, mor tgage and loan investments and purchased
mortgage servicing rights.
16 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
RESULTS OF OPERATIONS
The following table shows the volume of mortgages originated by First National and mortgages under administration for the periods indicated:
($ millions)
Quarter ended
Year ended
Mortgage Originations by Asset Class
Single-family residential
Multi-unit residential and commercial
Total
Funding of Mortgage Originations by Source
Institutional investors
NHA-MBS for institutional investors
NHA-MBS securitized by the Company
Securitization and internal resources (1)
Total
Mortgages Under Administration
Single-family residential
Multi-unit residential and commercial
Total
December 31
2010
December 31
2009
December 31
2010
December 31
2009
$
$
2,106
645
2,751
1,912
351
369
119
2,751
36,948
16,345
53,293
2,018
841
2,859
1,101
629
1,170
(41)
2,859
31,880
15,913
47,793
$
$
8,324
2,187
10,511
8,468
3,319
11,787
6,244
1,081
2,812
374
6,519
2,609
2,208
451
10,511
11,787
36,948
16,345
53,293
31,880
15,913
47,793
(1) The negative amount of $41 million in the fourth quarter of 2009 results from $103 million of mortgages securitized in the first and second quarters of 2009 with an
institutional investor. In the fourth quarter of 2009 this transaction was repackaged in the form of a First National issued MBS.
Total mortgage origination volumes decreased in the year by 11%
as multi-unit residential origination slowed down from a very strong
2009 market. Total commercial segment originations decreased
by 34% from 2009. This is in comparison to the single-family seg-
ment, which declined a moderate 2% year over year. For the com-
mercial segment, the Company experienced a slower market and
more competition in 2010. With a record 2009 behind it, there
were fewer real estate transactions available to finance in 2010. As
well, competition, primarily from “schedule one” banks, re-entered
this marketplace. Single-family volumes are slightly lower than the
levels experienced in 2009 due to a resilient housing market and
the Company’s strong presence in the mortgage broker channel.
Although this market was affected by stricter lending guidelines,
a difficult economic environment and higher mortgage rates, the
Company was able to leverage its broker relationships and produce
solid origination figures. Origination for direct securitization in the
NHA-MBS and CMB markets increased from $2.2 billion in 2009
to $2.8 billion in 2010. This was the result of the Company’s deci-
sion to securitize most of its floating rate single-family origination
as opposed to selling it to institutional investors. For the four th
quarter of 2010 overall origination decreased by 4% to $2.8 billion
from $2.9 billion in 2009. This decrease reflects a 4% increase in sin-
gle-family origination figures between the periods together with a
23% decrease in the multi-unit residential and commercial segment
and is consistent with the trends experienced throughout the year.
In the first quar ter of 2010, Canadian capital markets saw
improvement from a challenging 2009. This sentiment reversed in
the second and third quarters as economic indicators, particularly
in global markets, became more negative. Despite these challenges,
the Bank of Canada’s monetary policy acted to slow government
stimulus and “re-establish the normal functioning of the overnight
rate”. Accordingly, the Bank of Canada raised its overnight target
lending rate from 0.25% at the end of the first quarter to 1.00%
by the end of the third quarter of 2010. Although economic indi-
cators turned more positive in the four th quar ter of the year,
worries about the speed of the recovery in Canada led the Bank
of Canada to slow down the pace of increasing interest rates.
The bond and mortgage markets moved in step with these indi-
cators. For the Company, these conditions had significant impacts
on its 2010 results. Most significantly, as described earlier in
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 17
MANAGEMENT’S DISCUSSION AND ANALYSIS
this MD&A, the Company concluded that these rate increases,
together with the ensuing increase in the banks’ prime lending rates,
demonstrated a permanent increase in the Prime – BA spread.
The Company adjusted its models accordingly and recognized
higher per unit gains on securitization on the mor tgages securi-
tized than in previous periods (all other assumptions being equal).
Given the Bank of Canada’s reticence in raising interest rates,
2010 represented a year of historically low mortgage rates. As an
originator of mortgages, this low rate environment made it easier
for the Company to originate mortgages. The Company continued
to see demand for mortgages and funding costs for 30-day ABCP
normalized. Mor tgage spreads that narrowed throughout 2009
grew somewhat wider in the latter part of the year as the banks’
raised mortgage rates despite falling bond yields. However, the very
large spreads that existed at the beginning of 2009 disappeared and
for most of 2010 prime mortgage spreads were closer to the levels
seen prior to the credit crisis in mid-2007 than those seen in the
past two years.
The Company continued to profit from a stabilizing ABCP
market. At December 31, 2009, the Company had adjusted the
fair value of its retained interests in ABCP conduits to assume the
highest grade of ABCP would trade at a spread of 0.25 percent-
age points in excess of BA. By the end of December 2010, posted
ABCP rates had come down such that quoted ABCP spreads were
in fact lower than BA rates. More relevant is the cost of funds cur-
rently being charged by bank-sponsored ABCP conduits to the
Company. This cost is now being invoiced at comparable levels
to BA rates. The Company revised its assumption for ABCP costs
such that its models assume 30-day ABCP will trade equivalent to
30-day BA rates in its calculation of the fair value of its securiti-
zation receivable. This resulted in an unrealized fair value gain of
$3.9 million recorded in the 2010 year.
Total revenues for the year ended December 31, 2010 increased
by about 1% compared to the 2009 year, from $341.7 million to
$343.2 million. This increase resulted from the positive gain earned
from the Prime – BA spread adjustment described earlier in the
MD&A, offset by the tighter securitization margins and lower vol-
umes of commercial mortgage origination in the year compared to
those experienced in 2009.
Placement Fees
Comparing the year ended December 31, 2010 to the year ended
December 31, 2009, placement fee revenue decreased by 16%
to $103.6 million from $123.9 million. This was largely due to the
Company’s strategy with respect to single-family floating rate mort-
gages. Beginning in the middle of the second quarter of 2009, these
mortgages were originated for securitization as opposed to insti-
tutional placement. In the following 12-month period, the Com-
pany continued this strategy. During the third quarter of 2010, the
profitability of these securitizations decreased with tighter mort-
gage spreads and the Company began to place a large share of
such mortgages with institutions. For the whole year, the volume
of residential origination for institutional placement decreased from
$6.1 billion to $5.7 billion or 7%. The Company also saw decreased
origination of multi-unit residential mortgages for the MBS program,
which had volumes of $1.1 billion in 2010 as the period evidenced
a slowdown in real estate transactions in the marketplace. This
compares to $2.6 billion in 2009. Together with mortgages origi-
nated for institutional investors, origination volumes, which drive
placement fees, decreased by 20% from 2009 to 2010. Per unit
placements fees increased as a larger proportion of higher yielding
ten-year term multi-unit mortgages were placed in 2010 compared
to 2009.
Gains on Deferred Placement Fees
Gains on deferred placement fees revenue decreased 81% to
$9.6 million from $51.8 million. The decrease was due primarily to
decreased volumes of multi-unit residential mortgages originated
for institutional MBS issuers. These volumes fell from $2.6 billion in
2009 to $1.1 billion or 58% and the margins realized in 2010 nar-
rowed as competition for this product resurfaced. The Company
also chose to directly securitize more of this type of origination
in 2010 than in 2009. From these MBS programs, the Company
recognized both a placement fee (described above) and ongoing
interest-only strips on these mortgages. The Company has valued
these strips at $9.2 million, which is reflected in gains on deferred
placement fees revenue. In 2009, the Company recorded $37.7 mil-
lion in revenue from these and similar programs. Gains were also
lower on deferred placement fees from mortgages sold to insti-
tutional investors for the CMB program. As previously described,
the Company sells a portion of its residential origination volume
to institutional investors. In some cases, the Company earns addi-
tional revenue over the term of the sold mor tgages based on
those investors’ current funding rates. The Company benefited from
the increased mortgage spreads resulting from the turmoil in the
credit markets in early 2009. By the end of 2009 these spreads had
returned to historical levels. On these mor tgages, the Company
recorded reduced gains on deferred placement fees of $13.7 million
for 2010 compared to 2009.
18 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Gain on Securitization
Gain on securitization revenue increased 9% to $60.2 million from
$55.4 million. The increase is due to increased volumes of float-
ing rate single-family mortgages as described earlier in this MD&A.
In 2010, the Company originated $2.8 billion of single-family mort-
gages for inclusion in NHA-MBS pools. In 2009, the Company
securitized $2.1 billion of this product. Due to historically high
spreads offered on these mortgages relative to funding costs, the
Company was able to execute securitizations at favourable terms.
For 2010, these spreads tightened throughout the year so that
despite increased volume, the Company recognized approximately
$38.5 million in gains on securitization for such transactions. In 2009,
the Company recorded $53.8 million related to the securitiza-
tion of such floating rate mortgages. As demand in the institutional
markets increased, the Company also originated for direct secu-
ritization $339 million (2009 – $146 million) of fixed rate multi-
unit MBS pools for gains of approximately $17.4 million (2009 –
$6.7 million). Revenue for 2009 was also decreased by $4.3 million
as the credit loss assumption for the Alt-A program was increased
to account for poor economic conditions.
Mortgage Servicing Income
Mortgage servicing income increased 15% to $73.8 million from
$64.4 million. This was primarily due to the growth in the amount
of the mor tgage por tfolio under administration, which grew by
12% year-over-year. The residential component grew by 16% and
has a larger impact on ser vicing revenue than the commercial
component (the price per unit is much higher on the residential
than on the commercial por tfolio). The Company also earned
more net interest income on the trust funds it administers for its
borrowers and investors. These funds earn the Company interest
based on 30-day CDOR rates. These rates rose by approximately
0.75% during 2010.
Mortgage Investment Income
Mor tgage investment income increased 15% to $27.0 million
from $23.4 million. The change is due primarily to the increase of
$4.6 million of additional interest earned on securitization receiv-
able and deferred placement fees receivable as these assets grew
by 20% from December 31, 2009 to December 31, 2010. The
remaining change is a combination of offsetting factors, including:
different bond yields than in the comparative year (which affect
the interest earned on these receivables), rising prime lending rates
(which affect gross revenues on mortgage and loan investments)
and increased amounts of mor tgage and loan investments held
during the year.
Residual Securitization Income
Residual securitization income increased 55% to $35.6 million
from $22.9 million. The recurring source of this revenue is the
amortization of the servicing liability, which represents the servicing
portion of the spread received from past securitization transactions.
This revenue has increased from $5.7 million to $7.0 million com-
paring the two periods as the Company has increased the size of
its directly securitized portfolio. The other source is the excess of
any cash flows received above the expected cash flows assumed
in the Company’s calculation of the securitization and deferred
placement fee receivables. The increase in 2010 is a result of the
conservatism inherent in the Company’s securitization models. The
Company seeks to use realistic values for spread, prepayment and
credit losses assumptions in these models. Faced with a choice, the
Company tends to use conservative assumptions to record its gain
on securitization revenue. If actual receipts in a period exceed the
Company’s assumed cash flows for that same period, the amount
is recognized as residual securitization income in the period. This
extra spread relates to various factors including lower ABCP costs
of funding, lower prepayment speeds, receipts of interest penalties
on prepayment and the general normalization of credit markets
in the year.
Realized and Unrealized Gains (Losses)
on Financial Instruments
For First National, this line item typically consists of two compo-
nents: (1) gains and losses related to holding term assets derived
using discounted cash flow methodology; and (2) those related to
the Company’s economic hedging activities. The term assets are
affected by changes in credit markets and Government of Canada
bond yields (which form the risk-free benchmarks used to price the
Company’s assets, including the Company’s investment in securiti-
zation and deferred placement fees receivable, cash collateral and
subordinate notes held by securitization trusts). The Company does
not attempt to hedge these assets and accordingly will experience
potentially significant unrealized gains and losses as credit spreads
change and bond yields fluctuate.
The largest increase in the year per tained to the Company’s
decision to change the assumption of the Prime – BA spread in its
securitization models. As described earlier in this MD&A, the Com-
pany believes that the Prime – BA spread will be wider for the
foreseeable future and recorded an unrealized gain of $21.9 million
in the second quarter of 2010.
Despite the Bank of Canada’s increases to its target overnight
lending rate in mid-2010, global credit issues sent bond yields
lower over the course of the year. Generally, five-year Govern-
ment of Canada bond yields decreased from approximately
2.9% at the beginning of the year to 2.3% at the end of the year.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 19
MANAGEMENT’S DISCUSSION AND ANALYSIS
Accordingly, the Company’s on-balance sheet mortgages, securiti-
zation receivables and deferred placement receivables are more
valuable on a comparative basis at year end than at the end of
2009. The Company has recorded unrealized gains related to hold-
ing these assets of $1.9 million in 2010.
The decreased assumption for ABCP from 0.25 percentage
points over BA to BA flat, as described earlier in this MD&A, has
created an unrealized gain of $3.9 million for the year. The Com-
pany also recognized a $2.6 million gain in the year related to the
change in value of $13.5 million of mortgage investments catego-
rized as held for trading and priced off of seven-year Government
of Canada bonds. The lower bond yields made the value of these
fixed rate mor tgages more valuable. The changes in fair value
related to the Company’s interest rate swaps, securities sold short,
mortgages accumulated for sale and mortgage commitments had
offsetting, but primarily positive effects, such that the Company
recorded additional net gains of about $2.6 million in the year. Gen-
erally, this net gain results from normalizing credit markets which
increased the value of higher spread mortgages held over time.
Brokerage Fees Expense
Brokerage fees expense increased 4% to $103.0 million from
$98.7 million. The increase is the result of lower origination vol-
umes of single-family mortgages offset by the reversal of deferred
brokerage fees from previous periods. While single-family mor t-
gage origination volume was down just 2% from the prior year, the
timing of warehousing and securitizing significant volumes of float-
ing rate mortgages and higher per unit broker fees increased the
expense from 2009. At the end of 2009, the Company had deferred
$3.9 million of broker fees on mortgages that were securitized in 2010.
By the end of 2010, the amount of mortgages accumulated for sale
to be securitized was lower, and only $2.2 million of broker fees
were deferred. This had the effect of decreasing 2009 expenses by
$3.4 million and increasing 2010 expenses by $1.7 million. Without
these movements, brokerage fees expense would have decreased
by 1%. The remaining increase is due to higher per unit brokerage
fees. Due to increased competition for a dwindling supply of mort-
gages during the summer months, the Company increased broker
compensation programs to match other lenders’ practices, particu-
larly its loyalty management programs.
Salaries and Benefits Expense
Salaries and benefits expense decreased 10% to $43.2 million from
$48.2 million. The decrease is due to employee costs associated with
commercial mortgage origination. The Company compensates its
sales staff with a significant portion of the fees earned by the Com-
pany. Because of the decreased origination in the year, particularly
with respect to placement fees, this compensation decreased by
$5.2 million year-over-year. Excluding these amounts, the core sala-
ries and benefits expense remained flat year-over-year, generally in
line with a slower increase in headcount and lower sales bonuses.
As at December 31, 2010, the Company had 536 employees, com-
pared to 519 as at December 31, 2009. Management salaries were
paid to the two senior executives who indirectly own the Class B LP
units. The current year’s expense is as a result of the compensation
arrangement executed on the closing of the IPO.
Interest Expense
Interest expense increased 3% to $13.8 million from $13.4 million.
As discussed in the “Liquidity and cash resources” section of this
MD&A, the Company warehouses a por tion of the mor tgages it
originates prior to settlement with the ultimate investor or sale to
a securitization vehicle. The Company uses a portion of the deben-
ture loan together with a credit facility with a syndicate of banks
and 30-day repurchase facilities to fund the mortgages during this
period. The Company renewed the credit facility in May 2010 to
coincide with the debenture issuance so that by the end the year the
Company had a total commitment from this facility of $125 million.
The overall interest expense has increased from the prior year due
to a more extensive securitization program which required the Com-
pany to fund mortgages for longer periods prior to securitization.
These costs would have been higher but for two cost-saving measures:
1) the replacement of more expensive bank debt with cheaper inter-
est from the debenture, which has saved the Company as much as
1.2% in marginal interest rates; and 2) the increased use of 30-day
repurchase agreements instead of bank debt, which has saved the
Company as much as 2.5% in marginal interest rates.
Other Operating Expense
Other operating expense increased 24% to $20.3 million from
$16.4 million. During 2010, the Company expensed $1.4 million
of hedging costs associated with the direct securitization of multi-
unit residential mor tgages in the NHA-MBS market. These costs
were not significant in 2009. In 2010, the Company recorded provi-
sions for credit losses of $0.6 million; in 2009 these provisions were
$1.3 million. The remaining change to this expense consists of vari-
ous items including: $0.6 million for professional fees related to the
issuance of the debenture; $0.3 million for conversion costs to a
corporate structure; and $0.5 million for higher insurance costs.
The other $1.0 million increase in these expenses represents a 6%
growth rate and is due to additional servicing requirements of a
larger portfolio of mortgages under administration.
Net Income and EBITDA
Net income decreased 1% to $161.4 million from $163.5 million.
The decrease in earnings was a result of tighter mortgage spreads
on mor tgages originated for securitization offset by gains recog-
nized on improving capital markets. EBITDA decreased 1% to
$163.2 million from $165.2 million. The decrease was due to the
same factors described for net income.
20 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
OPERATING SEGMENT REVIEW
The Company aggregates its business from two segments for financial reporting purposes: (i) Residential (which includes single-fam-
ily residential mortgages) and (ii) Commercial (which includes multi-unit residential and commercial mortgages), as summarized below.
Operating Business Segments
($000s except percent amounts)
Residential
Commercial
Year ended
Originations
Percentage change
Revenue
Percentage change
Income before income taxes and
corporate non-allocated expenses
Percentage change
Period ended
Identifiable assets
Mortgages under administration
December 31
2010
December 31
2009
December 31
2010
December 31
2009
$ 8,323,373
(1.7%)
268,402
11.7%
$
$
114,308
21.8%
$ 8,468,296
$
240,263
$ 2,187,410
(34.1%)
74,812
(26.3%)
$
$ 3,318,925
$
101,453
$
93,863
$
48,619
(31.6%)
$
71,120
December 31
2010
December 31
2009
December 31
2010
December 31
2009
608,305
$
$ 36,948,100
530,908
$
$ 31,879,946
540,777
$
$ 16,345,032
536,782
$
$ 15,913,099
RESIDENTIAL SEGMENT
Residential revenues increased by 11.7% although origination
decreased 1.7% between 2010 and 2009. The higher revenue rela-
tive to the drop in origination is attributable to the large gain asso-
ciated with the change in the assumption of the Prime – BA spread,
which increased revenue by about $22 million. The Company also
earned $14 million of residual securitization income in 2010 for this
segment. These positive influences were offset by tighter margins
on the Company’s deferred placement fees and floating rate secu-
ritizations. Income before income taxes increased by 21.8% as the
increased revenue flowed through to the bottom line. Identifiable
assets have increased from those at December 31, 2009, due to an
increase in hedging requirements of $98 million needed at the end
of 2010.
COMMERCIAL SEGMENT
Commercial revenues decreased by 26.3% from the prior year
due to lower origination volumes and narrower mortgage spreads.
These negative issues were offset by higher mortgage investment
returns, more residual securitization income and an increase of
$2.7 million in unrealized gains on financial instruments as capital
markets normalized. The decreased revenue affected the bottom
line directly as only some operating costs decreased in step with
revenue. Identifiable assets for the commercial sector remained
consistent year-over-year as the Company’s hedging requirements
remained similar at the end of 2009 and 2010.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s liquidity strategy has been to use debt to fund
working capital requirements and to use cash flow from opera-
tions to fund longer-term assets, providing a relatively low lever-
aged balance sheet. The combination of the $175 million debenture
financing and the Company’s revolving bank credit facility are typi-
cally used to fund: (1) mortgages accumulated for sale; (2) deferred
placement fees receivable; (3) securitization receivables; and
(4) mortgage and loan investments. The Company has a credit facil-
ity with a syndicate of four banks for a total credit of $125.0 mil-
lion (2009 – $378.3 million). This facility was renewed in May 2010
for a 364-day term. Bank indebtedness also includes borrowings
obtained through securitization transactions, outstanding cheques
and overdraft facilities. At December 31, 2010, the Company has
entered into repurchase transactions with financial institutions to
borrow $174.3 million related to $179.3 million of mortgages and
NHA-MBS securities held in mortgages accumulated for sale on the
balance sheet.
At December 31, 2010, outstanding bank indebtedness was
$30.2 million (December 31, 2009 – $249.3 million). Together with
the debenture financing of $175 million (December 31, 2009 –
$Nil), this “combined debt” was used to fund $139.5 million
(December 31, 2009 – $159.8 million) of mortgages accumulated
for sale. At December 31, 2010, the Company’s other interest-
yielding assets included: (1) deferred placement fees receivable of
$85.2 million (December 31, 2009 – $98.1 million); (2) securitization
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 21
MANAGEMENT’S DISCUSSION AND ANALYSIS
receivables of $157.4 million (December 31, 2009 – $104.0 million);
and (3) mortgage and loan investments of $70.9 million (Decem-
ber 31, 2009 – $54.7 million). The difference between “combined
debt” and the mortgages accumulated for sale funded with it, which
the Company considers a proxy for true leverage, has decreased
between December 2009 and December 2010 and now stands
at $65.7 million (December 31, 2009 – $89.5 million). This repre-
sents a debt-to-equity ratio of approximately 0.25 to 1, which the
Company believes is at a conservative level. This ratio has decreased
from 0.42 to 1 as at December 31, 2009 as the Company has
increased equity through retained earnings.
The Company funds a portion of its mortgage originations with
institutional placements and sales to securitization vehicles on the
same day as the advance of the related mortgage. The remaining
originations, primarily residential, are funded by the Company on
behalf of institutional investors or securitization vehicles on the day
of the advance of the mortgage. On specified days, typically daily,
the Company aggregates all mortgages “warehoused” to date for
an institutional investor and transacts a settlement with that insti-
tutional investor. A similar process occurs for sales to securitization
vehicles, although the Company can dictate the date of sale into
the vehicle at its discretion. The Company uses a por tion of the
committed credit facility with the banking syndicate to fund the
mor tgages during this “warehouse” period. The credit facility is
designed to be able to fund the highest balance of warehoused
mortgages in a month and is normally only partially drawn.
The Company also invests in short-term mortgages, usually for
six to eighteen month terms, to bridge existing borrowers in the
interim period between long-term financing solutions. The bank-
ing syndicate has provided credit facilities to par tially fund these
investments. As these investments return cash, it will be used to
pay down this bank indebtedness. The syndicate has also provided
credit to finance a portion of the Company’s deferred placement
fees and securitization receivables and other miscellaneous longer
term financing needs.
A portion of the Company’s capital has been employed to sup-
port its ABCP programs, primarily to provide credit enhancements
as required by rating agencies. The largest part of this investment
was made on behalf of the Alt-A program. As at December 31,
2010, this investment was $17.2 million. Now that this program has
been discontinued, this investment will be repaid to the Company
(less any losses in excess of the Company’s credit loss assump-
tions) over the term of the related mortgages. Since June 30, 2008,
when FNFLP stopped offering the Alt-A product, the Company has
received repayment of approximately $25.2 million of this collateral.
The cash flow associated with this return of collateral will provide
more liquidity to the Company in future periods. This positive cash
flow has been offset with the need for additional liquidity to man-
age the administration of defaulted mortgages in the Alt-A program.
As this program has paid down, the ratio of defaulted mortgages to
the total mortgages in the program has become skewed. In order
to keep these ratios at an acceptable level for the Trust, the Com-
pany repurchased from the Trust approximately $65.6 million of
defaulted mortgages over the past two years. Most of these mort-
gages were in the midst of the foreclosure process such that the
Company liquidated $56.8 million (face value) of these mortgages
during the same period, experiencing credit losses at expected lev-
els. In 2010, the Company repurchased $24.7 million of defaulted
mor tgages from the program and liquidated $27.3 million (face
value) of such mortgages repurchased over the two-year period.
At December 31, 2010, the Company employs an assumption for
credit losses in the Alt-A program of 0.70% per annum. To date, this
assumption has been more than enough to absorb all actual losses
experienced in the program. The Company believes that prudent
management of this program will continue to require some level of
liquidity from the Company throughout its term.
As demonstrated previously, the Company continues to see
strong demand for its mortgage product from institutional inves-
tors and liquidity from bank-sponsored commercial paper conduits.
The Company’s strategy of using diverse funding sources has
allowed the Company to thrive, maintaining its profitability through
2009 into 2010. By focusing on the prime mortgage market, the
Company believes it will continue to attract bids for mor tgages
as its institutional customers seek government-insured assets for
investment purposes. The Company also believes it can manage any
liquidity issues that would arise from a year-long slowdown in origi-
nation volumes. Based on cash flow received in the fourth quarter
of 2010, the Company received approximately $60 million of cash
on an annualized basis from its servicing operations and $83 million
of cash flow from previously recorded securitization and deferred
placement fees receivables. Together, on an after tax basis, this
$101 million of annual cash flow would be more than sufficient to
support the almost $75 million of annual dividends at the currently
indicated rate of $1.25 per share. Although a simplified analysis, it
does highlight the sustainability of the Company’s business model
and distribution policy through periods of economic weakness.
As described earlier in this MD&A, the Fund’s successor (FNFC)
filed a prospectus and then issued 4 million Series 1 Preferred
Shares at a price of $25.00 per share for gross proceeds of
$100,000, before issue expenses. The net proceeds of $96.7 million
were invested in FNFLP as partners’ capital. The issuance gives the
Company additional capital, which will allow it to undertake greater
volumes of securitization transactions directly and ultimately to
reduce its reliance on institutional investors for funding.
22 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
FINANCIAL INSTRUMENTS
AND RISK MANAGEMENT
The Company has elected to treat deferred placement fees and
securitization receivables together with the cash collateral and
subordinate short-term notes held by securitization trusts as held-
for-trading such that changes in market value are recorded in the
statement of income. By electing to classify these assets as available-
for-sale, the Company would have been required to allocate mark-
to-market amounts between “normal” income and comprehensive
income. Management believes this would needlessly increase the
complexity of the financial statements. Effectively, these assets will
now be treated much like bonds, earning the Company a coupon
at the different discount rates used by the Company. The discount
rates used represent the interest rate associated with a risk-free
bond of the same duration plus a premium for the risk/uncertainty
of the securitization’s residual cash flows. As such, as rates in the
bond market change, so will the recorded value of the Company’s
securitization-related assets. These changes may be significant
(favourable and unfavourable) from quarter to quarter. The Com-
pany has no intention of attempting to hedge this exposure due to
the cost and complexity required to do so. Further, the Company
does not intend to sell these assets before maturity. This election
has no impact on distributable cash.
The Company believes its hedging policies are suitably disci-
plined such that the related mark-to-market adjustments will be
insignificant; however, in the event that effective economic hedg-
ing does not occur, the resulting gains and losses will be included
in the current period’s income. The Company uses bond forwards
(consisting of bonds sold short and bonds purchased under resale
agreements) to manage interest rate exposure between the time
a mortgage rate is committed to the borrower and the time the
mortgage is sold to securitization trusts and the underlying cost of
funding is fixed. As interest rates change, the value of these inter-
est rate hedges varies inversely with the value of the mor tgage
contract. As interest rates increase, a gain will be recorded on the
hedge, which should be offset by a loss on the sale of the mortgage
to the purchaser as the mortgage rate committed to the borrower
is fixed at the point of commitment. For residential mor tgages,
primarily mor tgages for the Company’s own inventor y, only a
por tion of the mor tgage commitments issued by the Company
eventually fund. The Company must assign a probability of funding
to each mortgage in the pipeline and estimate how that probability
changes as mortgages move through the various stages of the pipe-
line. The amount that is actually hedged is the expected value of
mortgages funding within the next 120 days (120 days being the
standard maximum rate hold period available for the mortgages).
As at December 31, 2010, the Company has $98 million of notional
forward bond positions related to its residential programs. For
multi-unit residential and commercial mor tgages, the Company
assumes all mortgages committed will fund and hedges each mort-
gage individually. This includes mortgages committed for the CMB
program as well as mortgages for sale to the Company’s own secu-
ritization vehicles. As at December 31, 2010, the Company had
entered into $335.5 million in notional value forward bond sales.
The change in mark-to-market value of the total $433.5 million of
notional hedges from January 1, 2010 to December 31, 2010 has
been expensed through the statement of income.
Upon the settlement of the debenture issuance, the Company
entered into a float for fix swap. The swap requires the Company
to pay CDOR+2.134% on a notional amount of $175 million and
to receive the debenture interest coupon (5.07%) semi-annually.
This effectively conver ts the fixed rate semi-annual debenture-
based loan payable into a floating rate monthly resetting note
payable. Since the date when this swap was entered into, credit
spreads have widened pursuant to poor domestic and global
economic indicators and the value of this swap has increased to
$3.8 million as at December 31, 2010. The Company has docu-
mented this swap as a hedge for accounting purposes as the fixed
leg of the swap matches the cash flow obligations under the deben-
ture. Effectively, the unrealized gain of $3.8 million on the swap has
been excluded from earnings and been applied to increase the car-
rying value of the debenture note payable. The Company is also a
party to two amortizing fix for float rate swaps that economically
hedge the interest rate exposure related to certain mortgages held
on balance sheet, which the Company has originated as replace-
ment assets for its CMB activities. As at December 31, 2010, the
notional value of these swaps are $17.0 million and $4.2 million.
Market swap rates increased during the year such that the value of
these swaps increased by approximately $0.1 million. The amortiz-
ing swaps mature in September 2013 and July 2015.
As described above, the Company uses various strategies to
reduce interest rate risk. The financial statements also disclose the
sensitivity which the deferred placement fees and securitization
receivable have to changing discount rates. In the normal course of
business, the Company also takes credit spread risk. This is the risk
that the credit spread at which a mortgage is originated changes
between the date of commitment of that mortgage and the date
of sale or securitization. This can be illustrated by the Company’s
experience with commercial mortgages originated for the CMBS
market in the spring of 2007. These mortgages were originated at
credit spreads designed to be profitable to the Company when
sold to a bank-sponsored CMBS conduit. Unfor tunately for the
Company, when these mortgages funded, the CMBS market had
shut down. The alternative to this channel was more expensive
as credit spreads elsewhere in the marketplace for this type of
mor tgage had moved wider. The Company adjusted for market
suggested increases in credit spreads in 2007 and 2008, adjusting
the value of the mortgages downward. In 2009, the economic envi-
ronment remained weak but did not worsen from what it was at
the end of 2008. Overall credit spreads stopped widening such that
the Company applied the same spreads to these mortgages, and the
Company did not record any additional unrealized loss or gains
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 23
MANAGEMENT’S DISCUSSION AND ANALYSIS
related to credit spread movement. Despite the fact that the
Company had entered into effective economic interest rate hedges,
the exposure to credit spreads remained. This risk is inherent in
the Company’s business model and cannot be hedged economi-
cally. Although the Company has recorded these losses in its past
financial results, the mortgages themselves are all in good stand-
ing and continue to pay monthly principal and interest payments
at the contracted terms of the mortgages. If scheduled repayment
continues for the full term of the mortgages, the Company will earn
higher mortgage investment income equivalent to the amount of
the cumulative losses recorded.
The same exposure to risk has also been described in the
valuation of the Company’s securitization receivable through ABCP
conduits. The Company is exposed to the risk that 30-day ABCP
rates are greater than 30-day BA rates. Initially it considered this
a low risk given the quality of the assets securitized, the amount
of credit enhancements provided by the Company and the strong
covenant of the bank-sponsored conduits with which the Company
transacted. As described earlier in this discussion, 30-day ABCP
traded at approximately 1.10 percentage points over BA at its
worst in 2008 but by the end of December 2010 were priced at a
discount to BA. At the same time the Company has leveraged on
changing credit spreads. This has been demonstrated through the
increase in volume and profitability of the NHA-MBS program and
significant increases in gains on deferred placement fees from the
sale of prime insured mortgages.
As at December 31, 2010, the Company has various expo-
sures to changing credit spreads. The Company has $51 million of
exposure related to commercial mor tgages originated originally
for the CMBS market. As described earlier, there are $1.0 billion
of mor tgages in securitization conduits that are exposed to
BA – ABCP spread risk. In mortgages accumulated for sale there
are $300 million of mortgages that are susceptible to some degree
of changing credit spreads.
CAPITAL EXPENDITURES
First National’s business is not a capital-intensive business. Histori-
cally, capital expenditures have included technology software and
hardware, facility improvements and office furniture. During the
quarter ended September 30, 2010, the Company purchased new
computers and office and communication equipment primarily to
support its single-family residential business.
Going forward, the Company expects capital expenditures will
be approximately $1.5 million annually and primarily relate to tech-
nology (software and hardware). Capital expenditures are expected
to be funded from operating cash flow.
SUMMARY OF CONTRACTUAL OBLIGATIONS
The Company’s long-term obligations include five-to-ten year
premises leases for its four offices across Canada, and its obliga-
tions for the ongoing servicing of mor tgages sold to securitiza-
tion conduits and mortgages related to purchased servicing rights.
The Company sells its mortgages to securitization conduits on a
fully-serviced basis, and is responsible for the collection of the prin-
cipal and interest payments on behalf of the conduits, including the
management and collection of mortgages in arrears.
Payments Due By Period
(in $000s)
Total
0-1 Year
1-3 Years
4-5 Years
After 5 Years
Lease Obligations
Servicing Liability
Total Contractual Obligations
$
$
$
18,553
25,709
44,262
$
$
$
3,399
9,638
13,037
$
$
$
6,691
10,876
17,567
$
$
$
5,967
3,674
9,641
$
$
$
2,496
1,521
4,017
GUARANTEES
First National Financial Operating Trust (the “Trust”) and First
National Financial GP Corporation (FNFLP’s general partner, the
“GP”) have entered into postponement of claim and guarantees
with respect to FNFLP’s borrowings under its credit facility. The
guarantee is supported by first ranking security over all the pres-
ent and future assets of the Trust, including a first ranking pledge
of all securities held by the Trust in FNFLP and the GP. The Deben-
tures issued by the Fund are unconditionally guaranteed, jointly and
severally, on a secured basis by each of the Trust, FNFLP and the GP.
CRITICAL ACCOUNTING POLICIES
AND ESTIMATES
FNFLP prepares its financial statements in accordance with GAAP,
which requires management to make estimates, judgments and
assumptions that management believes are reasonable based upon
the information available. These estimates, judgments and assump-
tions affect the reported amounts of assets and liabilities and dis-
closure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses
during the reporting period. Management bases its estimates on
historical experience and other assumptions, which it believes to be
reasonable under the circumstances. Management also evaluates its
estimates on an ongoing basis.
24 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
The significant accounting policies of First National are
described in Note 2 to the audited financial statements prepared
as at December 31, 2010. The policies which First National believes
are the most critical to aid in fully understanding and evaluating its
reported financial results include the determination of the gains on
securitization and deferred placement fees and the impact of fair
value accounting on financial instruments.
The Company uses estimates in valuing its gain or loss on the
sale of its mortgages to special purpose entities (“Trusts”) through
securitizations as well as its gains or losses on those mor tgages
placed with institutions earning a deferred fee. Under GAAP,
valuing a gain on sale requires the use of estimates to determine
the fair value of the retained interest (derived from the present
value of expected future net cash flows) in the mortgages. These
retained interests are reflected on the Company’s balance sheet as
securitization receivable and deferred placement fees receivable.
The key assumptions used in the valuation of gains on securitiza-
tion and deferred placement fees are spread, prepayment rates,
the annual expected credit losses and the discount rate used to
present value future expected residual cash flows. The annual rate
of unscheduled principal payments is determined by reviewing
portfolio prepayment experience on a monthly basis. The Company
uses different rates for its various programs that average approxi-
mately 23% for residential mor tgages and 35% for commercial
floating rate mor tgages. The Company assumes there is vir tually
no prepayment on commercial fixed rate mortgages. Actual pre-
payment experience has been consistent with these assumptions.
Credit losses are also reviewed on a monthly basis, in the context
of the type of mor tgages securitized. For the largest por tion of
the Company’s securitizations, the mortgages are either insured or
low ratio mortgages for which the Company does not provide for
the event of a credit loss.
On a quarterly basis, the Company reviews the estimates used
to ensure their appropriateness and monitors the performance sta-
tistics of the relevant mortgage portfolios to adjust and improve
these estimates. The estimates used reflect the expected perfor-
mance of the mortgage portfolio over the life of the mortgages.
The assumptions underlying the estimates used for the year ended
December 31, 2010 continue to be consistent with those used
for the year ended December 31, 2009 and the quarters ended
March 31, 2010, June 30, 2010 and September 30, 2010, with the
exception of the Prime – BA spread assumption described previ-
ously in this MD&A and assumptions for prepayment and credit
losses related to specific securitization programs. For adjustable rate
insured single-family residential mortgages, the Company increased
the assumption for annual prepayment from 16% to 20.6% in the
third quarter of 2009 and from 20.6% to 25.6% in the fourth quar-
ter of 2009. This change was the result of an anticipated trend of
higher rates of conversion to fixed rate mortgages identified dur-
ing each quar ter. For the securitization of Alt-A mor tgages, the
Company currently assumes a credit loss rate of 0.70% per annum.
The Company increased this assumption in 2009 from 0.35% used
prior to March 31, 2009 as the loss rates on this portfolio increased.
For the securitization of small multi-unit residential and commer-
cial mortgages, the Company used a credit loss rate of 0.25% per
annum. Both these rates have been greater than the actual rates
experienced by the Company to date, but which management feels
are appropriate estimates of losses that will average over the life of
the mortgages being securitized.
Inherent in the determination of the Company’s securitization
receivable is also an assumption about the relationship of short-
term interest rates, specifically the spread between one-month BA
and one-month high-quality ABCP. Historically, the Company built
its financial models with the assumption that the spread between
these two rates would always be quite narrow. As described pre-
viously in this discussion, this relationship deviated from historical
norms beginning in 2007 and then moved even wider in 2008
before narrowing during the course of 2009 such that the spread
between these instruments is insignificant as at December 31, 2010.
As described previously, the Company has adjusted its securitization
receivable to account for this change in circumstances. Currently
the Company has assumed that ABCP spreads are consistent with
one-month BA rates. The Company must also estimate the spread
between Prime and BA for the securitization of various Prime-
based mortgages. As described earlier in this MD&A, the Company
has changed its estimate of this spread effective June 1, 2010 to
1.85% from 1.60%.
The Company has elected to treat its financial assets and lia-
bilities, including deferred placement fees receivable, securitization
receivables, mor tgages accumulated for sale, cash collateral and
short-term subordinated loans, and bonds sold short, as held-for-
trading. Essentially, this policy requires the Company to record
changes in the fair value of these instruments in the current period’s
earnings. The Company’s assets and liabilities are such that the
Company must use valuation techniques based on assumptions
that are not fully supported by observable market prices or rates
in most cases.
FUTURE ACCOUNTING CHANGES
International Financial Reporting Standards (IFRS)
In Januar y 2006, the Canadian Accounting Standards Board
announced its decision requiring all publicly accountable entities to
report under International Financial Reporting Standards (IFRS). This
decision establishes standards for financial reporting with increased
clarity and consistency in the global marketplace. These standards
are effective for interim and annual financial statements relating to
fiscal years beginning on or after January 1, 2011 and will be appli-
cable for the Company’s first quarter of 2011. For the Company,
besides more detailed disclosure, there will be a significant change
in its accounting policy regarding revenue recognition, particularly
in accounting for securitization transactions. Under current GAAP,
the Company’s securitizations are all considered “true sales” for
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 25
MANAGEMENT’S DISCUSSION AND ANALYSIS
accounting purposes such that the Company has recorded gains on
securitization when these mortgages were sold to various securiti-
zation conduits. Under current IFRS standards, these securitizations
will likely not meet the definition of a “true sale” and instead will
be accounted for as a secured financing. Accordingly, the Company
believes that all of its securitizations (through ABCP conduits, NHA-
MBS and direct CMB issuance) will not qualify for sale account-
ing; however, it believes that its deferred placement transactions
will continue to meet the criteria for off-balance sheet treatment.
As described in the Revenue and Funding Sources of this MD&A,
the Company differentiates revenue earned from transactions that
provide the Company future cash flow streams. The Company dis-
closes such transactions as either gains on securitization or gains
on deferred placement fees. This change in presentation will assist
stakeholders with the transition to IFRS as the Company believes
that the mor tgages related to deferred placement fees receiv-
able will likely receive off-balance sheet treatment and the current
accounting treatment will continue to be appropriate under IFRS.
The securitization receivable consists primarily of direct securitiza-
tions through ABCP, NHA-MBS and the CMB. In these cases the
Company believes that for most, if not all, of these transactions, off-
balance sheet treatment will not be permitted under current IFRS
and these receivables will be effectively reversed against opening
equity as at January 1, 2011.
In 2010, the Company’s project team completed its initial impact
assessment and made system changes to gather financial infor-
mation that will be required for the transition. The Company has
involved its external auditors in the assessment of the impact of
the new standards and produced the requisite documentation to
support its position in adopting the new international accounting
standards under IFRS so as to prepare an unaudited balance sheet
as at December 31, 2009 under IFRS rules. While the treatment of
most of the Company’s securitization transactions now seems clear,
there is still some discussion about the “derecognition” of NHA-MBS
transactions. The Company’s analysis indicates that the Company
has retained the majority of the risk and reward, and accordingly,
that these mortgages would remain on the balance sheet. How-
ever, the five big Canadian banks are also affected by this standard.
Because the banks have significant influence on the accounting prin-
ciples used in the Canadian financial industry and do not convert
to IFRS until November 2011, the Canadian interpretation for the
accounting for NHA-MBS under IFRS may be subject to change.
The Company has prepared its comparative 2010 financial state-
ments as if NHA-MBS remains on the balance sheet when sold to
the market. The balance sheets under IFRS as at December 31, 2010
and 2009 have a number of significant changes: 1) an increase in the
amount of the Company’s assets by approximately $7.2 billion of
mortgages (2009 – $5.5 billion); 2) an increase in the Company’s
liabilities by an amount of $7.3 billion (2009 – $5.6 billion), which
will consist primarily of 30-day resetting notes payable indexed to
30-day CDOR and ABCP rates set by the Company’s counterpar-
ties; and 3) as described above, opening equity will be reduced by
the extent of securitization receivable as at December 31, 2010
net of the reduction of the related servicing liability and deferred
origination costs which had been expensed under Canadian GAAP.
The Company has estimated the net securitization receivable
to be approximately $132 million (2009 – $87 million) and the
deferred origination costs to total $44 million (2009 – $30 million).
If the Company’s models underlying the securitization receivable
were appropriate at December 31, 2010, the amount related to
securitization will be earned by the Company over the next five
to ten years as mor tgage interest spread is received. The reduc-
tion in opening equity will be offset by an upward adjustment
to the carrying value of the newly recorded $7.2 billion (2009 –
$5.5 billion) of mortgage assets. Currently these assets are effectively
held at par (excluding the effect of gain on securitization account-
ing). Under IFRS the Company will elect to treat the mor tgages
in ABCP conduits as held-for-trading, marking these to market at
the end of each reporting period. The mortgages funded through
NHA-MBS and CMB will be treated as loans and receivable. Accord-
ingly, a por tion of the costs of origination will be capitalized and
amortized into earnings over their effective terms. The Company
estimates these adjustments will increase opening equity by approxi-
mately $44 million (2009 – $30 million), such that in total opening
equity at December 31, 2010 will be reduced by about $88 million
(2009 – $57 million).
The Company has also prepared draft statements of income
under IFRS for each quarter of 2010. These figures will be the basis
for presentation of comparative financial information when IFRS is
implemented in 2011. Generally the first three quarters featured
large volumes of securitized mortgages and, accordingly, large gains
on securitization. These revenues will be eliminated under IFRS and
will be replaced with net interest margin from previously recorded
securitization transactions. Because the Company has grown in
the last five years and significantly increased the extent of its own
securitization por tfolio, the reversal of the gain on securitization
revenue in these quar ters is larger than the net interest income
now recorded such that the restated net income under IFRS is
lower than what was repor ted under Canadian GAAP in 2010.
In the fourth quarter, the Company securitized lower volumes of
its origination so that the net interest margin received under IFRS
exceeds the value of the gain on securitization revenue recorded in
that quarter.
In July 2010, the IFRS Interpretations Committee issued a staff
paper which described their discussion of certain transition issues
for “derecognition” accounting under IFRS. In particular, the extent
of retroactive application of these standards for new adopters was
debated. Currently the standard requires retroactive treatment
for application of this accounting change, but only for transactions
occurring after January 1, 2004. The Committee recommended that
26 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
instead of this fixed date, the date should be defined as the date
of transition to IFRS (or January 1, 2010 for Canadian issuers). The
Committee’s recommendation has now been adopted in IFRS with
an effective date of June 2011. The Company has chosen not to
early adopt this standard and will account for the transition with
retroactive application to January 1, 2004. The Company believes
that to adopt this new standard would result in inconsistent finan-
cial information, particularly on the balance sheet. First National will
continue to evaluate the impact of these new standards and report
thereon in future MD&A.
Controls over Financial Reporting
Management is responsible for establishing and maintaining ade-
quate internal control over financial reporting. Internal control over
financial repor ting is designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with
GAAP. However, because of its inherent limitations, internal control
over financial reporting may not prevent or detect misstatements
on a timely basis.
Management evaluated, under the supervision of and with the
par ticipation of the Chairman and President, and Chief Financial
Officer, the effectiveness of the Company’s internal control over
financial repor ting based on the criteria set for th in the Internal
Control over Financial Reporting – Guidance for Smaller Public Compa-
nies issued by the Committee of Sponsoring Organizations of the
Treadway Commission and, based on that evaluation, concluded
that the Company’s internal control over financial reporting was
effective as of December 31, 2010 and that there were no mate-
rial weaknesses that have been identified in the Company’s inter-
nal control over financial reporting as of December 31, 2010. No
changes were made in the Company’s internal controls over finan-
cial reporting during the year ended December 31, 2010 that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal controls over financial reporting.
RISK AND UNCERTAINTIES AFFECTING
THE BUSINESS
The business, financial condition and results of operations of the
Company are subject to a number of risks and uncertainties, and
are affected by a number of factors outside the control of manage-
ment of the Company including: ability to sustain performance and
growth, reliance on sources of funding, concentration of institutional
investors, reliance on independent mortgage brokers, changes in
interest rates, repurchase obligations and breach of representations
and warranties on mortgage sales, risk of servicer termination events
and trigger events, cash collateral and retained interest, reliance on
multi-unit residential and commercial mortgages, general economic
conditions, government regulation, competition, reliance on mort-
gage insurers, reliance on key personnel, conduct and compensation
of independent mortgage brokers, failure or unavailability of com-
puter and data processing systems and software, insufficient insur-
ance coverage, change in or loss of ratings, impact of natural disas-
ters and other events, environmental liability and risk related to
Alt-A mortgages, which experience higher arrears rates and credit
losses than prime mortgages. In addition, risks associated with the
structure of FNFC (the public entity as at January 1, 2011) include
those related to the dependence on FNFLP, leverage and restrictive
covenants, dividends which are not guaranteed and could fluctuate
with FNFLP’s performance, restrictions on potential growth, the
market price of FNFC shares, statutory remedies, control of the
Company and contractual restrictions and income tax matters. Risk
and risk exposure are managed through a combination of insur-
ance, a system of internal controls and sound operating practices.
The Company’s key business model is to originate primarily prime
mortgages and find funding through various channels to earn ongo-
ing servicing or spread income. For the single-family residential
segment, the Company relies on independent mortgage brokers
for origination and several large institutional investors for sources
of funding. These relationships are critical to the Company’s success.
For a more complete discussion of the risks affecting the Com pany’s
business, reference should be made to the Annual Information
Form of the Fund and its successor (FNFC).
Income Tax Matters and Conversion to a Corporation
Amendments to the Tax Act enacted June 22, 2007 affect the taxa-
tion of cer tain publicly traded trusts and their beneficiaries (the
“SIFT Rules”). The Fund benefited from the transitional period, and
would otherwise have been subject to the SIFT Rules in January 2011
had management not converted to a corporate structure on Janu-
ary 1, 2011. As a result of the enactment of the SIFT Rules, the Fund
has been required to account for future income taxes under the
asset and liability method whereby future income tax assets and lia-
bilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Future
income tax assets and liabilities are measured using enacted or sub-
stantively enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled. The effect on future income tax assets and lia-
bilities of a change in tax rates is recognized in income in the period
that includes the enactment date. See the description above under
“Accrued Future Tax Liability on Intangible Assets” and “Accrued
Future Tax Liability on Investment in FNFLP”.
The Company believed that to remain a trust after the SIFT
Rules came into effect in 2011 would not be in the best interest of
unitholders. Although the rates of taxation applicable to the Com-
pany’s earnings would be similar, these taxes would be marginally
higher if the Fund were to remain as a mutual fund trust. Addition-
ally, any earnings not distributed by the Fund would be taxed at the
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 27
MANAGEMENT’S DISCUSSION AND ANALYSIS
highest marginal personal tax rates. In order to provide the Com-
pany with the most flexibility, management initiated a conversion
to a corporation, which was completed effective January 1, 2011.
The plan used tax-free rollover provisions to reorganize the trust
structure as described in the Management Information Circular
filed on April 8, 2010. The plan of rearrangement was approved
by the Board of Directors on March 25, 2010, and the Fund’s unit-
holders at the Company’s special and annual general meeting on
May 4, 2010. Subsequently, final court approval was obtained. Effec-
tive January 1, 2011, the Fund dissolved and the unitholders became
shareholders of First National Financial Corporation.
FORWARD-LOOKING INFORMATION
Forward-looking information is included in this MD&A. In some
cases, forward-looking information can be identified by the use of
terms such as ‘‘may’’, ‘‘will, ‘‘should’’, ‘‘expect’’, ‘‘plan’’, ‘‘anticipate’’,
‘‘believe’’, ‘‘intend’’, ‘‘estimate’’, ‘‘predict’’, ‘‘potential’’, ‘‘continue’’ or
other similar expressions concerning matters that are not histori-
cal facts. Forward-looking information may relate to management’s
future outlook and anticipated events or results, and may include
statements or information regarding the future financial position,
business strategy and strategic goals, product development activities,
projected costs and capital expenditures, financial results, risk man-
agement strategies, hedging activities, geographic expansion, licens-
ing plans, taxes and other plans and objectives of or involving the
Company. Particularly, information regarding growth objectives, any
increase in mortgages under administration, future use of securitiza-
tion vehicles, industry trends and future revenues is forward-looking
information. Forward-looking information is based on certain fac-
tors and assumptions regarding, among other things, interest rate
changes and responses to such changes, the demand for institution-
ally placed and securitized mortgages, the status of the applicable
regulatory regime and the use of mortgage brokers for single-family
residential mortgages. This forward-looking information should not
be read as providing guarantees of future performance or results,
and will not necessarily be an accurate indication of whether or not,
or the times by which, those results will be achieved. While man-
agement considers these assumptions to be reasonable based on
information currently available to it, they may prove to be incorrect.
Forward-looking information is subject to certain factors, including
risks and uncertainties, which could cause actual results to differ
materially from what management currently expects. These factors
include reliance on sources of funding, concentration of institutional
investors, reliance on independent mortgage brokers and changes
in interest rates outlined under ‘‘Risk and Uncertainties Affecting
the Business’’. In evaluating this information, the reader should spe-
cifically consider various factors, including the risks outlined under
‘‘Risk and Uncertainties Affecting the Business’’, which may cause
actual events or results to differ materially from any forward-look-
ing information. The forward-looking information contained in this
MD&A represents management’s expectations as of March 1, 2011,
and is subject to change after such date. However, management and
the Fund disclaim any intention or obligation to update or revise
any forward-looking information, whether as a result of new infor-
mation, future events or otherwise, except as required under appli-
cable securities regulations.
OUTLOOK
The global economy is still somewhat unsettled but sentiment
seems to point to slow improvement and recovery in 2011. For the
mortgage industry, there are a number of significant issues which
affect the clarity of management’s outlook. 2011 will feature the
transition to IFRS, which combined with new capital regulations for
federally regulated banks and trust companies may have a signifi-
cant impact on competitors of the Company and overall mortgage
spreads. It is also unclear how quickly the Bank of Canada will act to
slow inflation and move interest rates back to a more normalized
environment. Recently, the Minister of Finance announced changes
to mortgages regulations, generally introducing tighter lending crite-
ria for insured mortgages. These measures will affect the volume of
originations, but any reduction in origination volumes is anticipated
to be marginal.
Generally, the Company sees overall origination volumes to
be similar to 2010 as lower per unit mor tgages will be offset by
increased market share as competitors exit the market or slow
down origination so as to maintain regulated capital ratios. The
Company believes spreads, which tightened throughout 2010, will
stabilize and will remain at these levels or widen to reflect higher
costs of capital among the Company’s competitors. Together with a
more stable and efficient capital market, the Company sees oppor-
tunity for more direct securitization. The new issue of rate reset
preferred shares, which the Company closed on January 25, 2011,
provides the Company additional capital to pursue this strategy.
Lastly, management forecasts that the portfolio of mortgages under
administration, currently at approximately $53 billion, will continue
to grow and produce higher income and cash flow.
As described earlier, the Company restructured from an income
trust structure and became a corporation on Januar y 1, 2011.
Beginning in 2011, the Company will replace its distributions with
payments of after-tax dividends. In the fourth quarter, the Company
reviewed its forecast for both earnings and cash flow going into
2011. Given management’s view of increasing cash flows, the Com-
pany set the estimate of the annual dividend as a corporation at
$1.25 per annum. Management believes this dividend policy will be
sustainable and will allow the Company to continue to pursue its
growth objectives.
28 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Management’s Responsibility for Financial Reporting
The accompanying consolidated financial statements of First National Financial Income Fund for the period from January 1, 2010 to
December 31, 2010 and the financial statements of First National Financial LP for the period January 1, 2010 to December 31, 2010 and all
information in this annual report are the responsibility of management.
The financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles.
The preparation of these financial statements requires management to make estimates and assumptions that affect certain repor ted
amounts which management believes are reasonable.
The Audit Committee of the Board of Directors has reviewed in detail the financial statements with management and the independent
auditors. The Board of Directors has approved the financial statements on the recommendation of the Audit Committee.
Ernst & Young LLP, an independent auditing firm, has audited First National Financial Income Fund’s 2010 consolidated financial
statements and First National Financial LP’s 2010 financial statements in accordance with Canadian generally accepted auditing standards
and has provided independent audit opinions. The auditors have full and unrestricted access to the Audit Committee to discuss the results
of their audits.
Stephen J. R. Smith
Chairman and President
Robert A. Inglis
Chief Financial Officer
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 29
Independent Auditors’ Report
To the Unitholders of First National Financial Income Fund
We have audited the accompanying consolidated financial statements of First National Financial Income Fund, which comprise the
consolidated balance sheets as at December 31, 2010 and 2009, and the consolidated statements of income and unitholders’ equity and
cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information.
Management’s responsibility for the consolidated financial statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with Canadian
generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of
consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits
in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements
and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial
statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of
the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control
relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.
An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of First National Financial
Income Fund as at December 31, 2010 and 2009 and the results of its operations and its cash flows for the years then ended in accordance
with Canadian generally accepted accounting principles.
Toronto, Canada,
March 1, 2011
Chartered Accountants
Licensed Public Accountants
30 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
FIRST NATIONAL FINANCIAL INCOME FUND
CONSOLIDATED BALANCE SHEETS
(in $000s)
As at December 31
2010
2009
ASSETS
Distributions receivable
Interest receivable (note 9)
Investment in First National Financial LP (note 4)
LIABILITIES AND EQUITY
Liabilities
Distributions payable
Accounts payable and accrued liabilities
Debentures (note 9)
Future income taxes (note 6)
Total liabilities
Equity
Unitholders’ equity
See accompanying notes
Approved by the Trustees:
Trustee
John Brough
Trustee
Robert Mitchell
$
6,765
1,374
292,544
$
2,219
–
117,077
300,683
119,296
6,658
1,374
175,000
19,000
202,032
2,219
37
–
13,750
16,006
98,651
103,290
$
300,683
$
119,296
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 31
FIRST NATIONAL FINANCIAL INCOME FUND
CONSOLIDATED STATEMENTS OF INCOME AND UNITHOLDERS’ EQUITY
(in $000s, except per Unit amounts and number of Units)
Years ended December 31
2010
2009
REVENUE
Equity income from investment in First National Financial LP
Interest income (note 9)
EXPENSES
Interest (note 9)
Income before income taxes
Provision for future income taxes (note 6)
Net income for the year
Unitholders’ equity, beginning of year
Distributions (note 5)
Unitholders’ equity, end of year
Average number of Units outstanding during the year
Earnings per Unit (note 8)
Basic
See accompanying notes
$
$
24,668
5,847
30,515
5,810
24,705
5,250
25,103
–
25,103
–
25,103
3,450
$
19,455
$
21,653
103,290
(24,094)
100,024
(18,387)
$
98,651
$
103,290
12,681,113
12,681,113
$ 1.53
$ 1.71
32 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
FIRST NATIONAL FINANCIAL INCOME FUND
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in $000s)
Years ended December 31
2010
2009
OPERATING ACTIVITIES
Net income for the year
Add (deduct) items not involving cash
Provision for future income taxes
Equity income from investment in First National Financial LP
Distributions received from First National Financial LP
Net change in non-cash working capital balances related to operations
Cash provided by operating activities
INVESTING ACTIVITIES
Loan to First National Financial LP
Cash used in investing activities
FINANCING ACTIVITIES
Debentures issued
Distributions paid
Cash provided by (used in) financing activities
Net change in cash during the year and cash equivalents, end of year
See accompanying notes
$
19,455
$
21,653
5,250
(24,668)
19,655
(37)
3,450
(25,103)
18,482
–
19,655
18,482
$
(175,000)
$
(175,000)
–
–
175,000
(19,655)
$
–
(18,482)
155,345
(18,482)
–
$
–
$
$
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 33
FIRST NATIONAL FINANCIAL INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
(in $000s, except per Unit amounts)
NOTE 1
ORGANIZATION AND BUSINESS OF THE FUND
First National Financial Income Fund [the “Fund”] is an unincorpo-
rated, open-ended trust established under the laws of the Province
of Ontario on April 19, 2006, pursuant to a Declaration of Trust. The
Fund was established to acquire and hold, through a newly consti-
tuted wholly-owned trust, First National Financial Operating Trust
[the “Trust”], investments in the outstanding limited par tnership
units of First National Financial LP [“FNFLP”]. Pursuant to an under-
writing agreement dated June 6, 2006 and initial public offering
and over-allotment option in June 2006, the Fund sold 11,800,000
units of the Fund [“Fund Units”, “Units” or “Unit”], at a price of
$10.00 per Unit for proceeds totalling $118,000. The proceeds
of the offering, net of underwriters’ fees of $7,080, were used to
par tially fund the indirect acquisition [through the Trust] by
the Fund of a 19.97% interest in FNFLP, through the issuance of
11,800,000 Class A LP Units by FNFLP.
Concurrent with the initial public offering and as par t of the
acquisition agreement between the Fund, FNFLP and First National
Financial Corporation [“FNFC”], on June 15, 2006, FNFLP pur-
chased all of FNFC’s assets and assumed its liabilities, except for
future income tax liabilities. Par t of the consideration for this
purchase [after provision for the over-allotment option] was
the issuance of 47,286,316 exchangeable Class B LP Units. The
exchangeable Class B LP Units retained by FNFC are exchange-
able on a one-for-one basis for Units of the Fund at any time at the
option of FNFC. FNFLP is managed by First National Financial GP
Corporation [the “GP”], the general partner, which holds a 0.01%
interest in FNFLP. As at December 31, 2010, the Fund indirectly
holds a 21.15% [2009 – 21.15%] interest in FNFLP and FNFC holds
a 78.85% [2009 – 78.85%] controlling interest in FNFLP.
The Class A LP Unitholders and the exchangeable Class B LP
Unitholders of FNFLP are entitled to one vote for each Unit held
at all meetings of holders of the LP Units and have economic rights
that are equivalent in all material respects, except that exchange-
able Class B LP Units are exchangeable, directly or indirectly, on a
one-for-one basis [subject to customary anti-dilution provisions]
for Fund Units at the option of the holder at any time. Additionally,
exchangeable Class B LP Units have special voting rights that entitle
the holder to receive notice of, attend and vote at all meetings of
Unitholders of the Fund.
The Fund effectively commenced operations through its indirect
investment in FNFLP on June 15, 2006. The excess of the Fund’s
cost of its investments in Units of FNFLP over the carrying value of
the underlying net assets has been assigned to goodwill and finite-
life intangible assets. Income reported by the Fund commenced on
the acquisition date.
NOTE 2
BASIS OF PRESENTATION AND
SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
These consolidated financial statements have been prepared in
accordance with Canadian generally accepted accounting principles.
Income taxes
Accounting for income taxes is reflected in these consoli-
dated financial statements on the assumption that the Fund will
qualify as a “mutual fund trust” as defined in the Income Tax Act
(Canada) [the “Tax Act”], including its establishment and
maintenance as a trust for the benefit of Canadian residents.
Consequently, these consolidated financial statements do not
reflect any provision for current income taxes as the Fund intends
to distribute to its Unitholders substantially all of its taxable income
and the Fund intends to comply with the provisions of the Tax Act
that permit, amongst other items, the deduction of distributions
to Unitholders from the Fund’s taxable income.
The Fund accounts for income taxes in accordance with the
liability method. Under this method, future income tax assets and
liabilities are determined based on temporary differences between
the carrying amounts and tax bases of assets and liabilities, and
measured using the substantively enacted tax rates and laws that
are expected to be in effect when the differences are expected
to reverse. The effect on future income taxes of a change in tax
rates is recognized in income in the period that includes the date of
substantive enactment. A valuation allowance is established, if neces-
sary, to reduce future income tax assets to the amount that is more
likely than not to be realized.
34 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Fund Units are redeemable at any time on demand by the Unit-
holder. The redemption price per Unit is equal to the lesser of:
• 90% of the weighted average trading price per Unit during the
last 10 days on the principal exchange on which the Units are
listed; or
• An amount equal to:
• the closing price of the Units on the date on which the
Units were tendered for redemption on the principal stock
exchange on which the Units are listed, if there was a trade
on the specified date and the applicable market or exchange
provides a closing price; or
• the average of the highest and lowest prices of the Units
on the date on which the Units were tendered for redemp-
tion on the principal stock exchange on which the Units are
listed, if there was trading on the date on which the Units
were tendered for redemption and the exchange or other
market provides only the highest and lowest trade prices of
the Units traded on a particular day; or
• the average of the last bid and ask prices quoted in respect
of the Units on the principal stock exchange on which the
Units are listed, if there was no trading on the date on which
the Units were tendered for redemption.
Since the initial public offering, no Units have been redeemed.
Investments in FNFLP and First National
Financial GP Corporation
The Fund accounts for its investments in FNFLP and First National
Financial GP Corporation using the equity method. Under this
method, the cost of the investment is increased by the Fund’s
proportionate share of FNFLP’s earnings and reduced by any distri-
bution paid to the Fund by FNFLP and amortization of the portion
of the purchase price discrepancy, consisting of intangible assets.
The excess of the Fund’s cost of its investment in Units over
the carrying value of the underlying net assets has been allocated
notionally to FNFLP’s servicing rights, broker and borrower relation-
ships and goodwill. The excess related to servicing rights is being
amortized over the average term of the related mortgages and the
excess related to broker and borrower relationships over the esti-
mated useful term of 5 and 10 years of the relationships. The good-
will component of the purchase price discrepancy is not amortized.
The value of the investments is tested annually for impairment.
NOTE 3
FUND UNITS
The Fund may issue an unlimited number of Units for consideration
and on the terms and conditions as determined by the Fund’s trust-
ees. Each Fund Unit is transferable and represents an equal, undi-
vided beneficial interest in any distribution from the Fund. All Fund
Units are of the same class and have equal rights and privileges.
Under the terms of the Exchange, Voting and Registration Rights
Agreement dated June 15, 2006, the exchangeable Class B LP Units
held by FNFC are exchangeable for Fund Units on a one-for-one
basis. After exercise of the over-allotment options, the Fund has
reserved 47,286,316 Units for the exchange of the exchangeable
Class B LP Units.
The following Units are outstanding as at December 31:
Balance of Units outstanding, December 31
12,681,113
$
120,171
12,681,113
$
120,171
2010
Number
of Units
Amount
2009
Number
of Units
Amount
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 35
FIRST NATIONAL FINANCIAL INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4
INVESTMENT IN FIRST NATIONAL FINANCIAL LP
NOTE 6
INCOME TAXES
Investment in First National Financial LP consists of the following:
Units outstanding
Note receivable (note 9)
Equity accounting adjustments
Made prior to beginning
of year
Equity earnings of FNFLP
2010
2009
$
123,671
175,000
$
123,671
–
(6,594)
(13,310)
for the year
34,136
34,571
Amortization of purchase
price discrepancy
Distributions received
in the year
(9,468)
(9,468)
(24,201)
(18,387)
$
292,544
$
117,077
NOTE 5
DISTRIBUTIONS TO UNITHOLDERS
The Fund is entirely dependent on distributions from FNFLP to
make its own distributions. The Fund pays monthly distributions to
its Unitholders of record on the last business day of each month
approximately 15 days after the end of each month. The table
below outlines the cumulative distributions to the Unitholders:
Distributions paid
2009 regular distribution
2009 special distribution
January 2010
February 2010
March 2010
April 2010
May 2010
June 2010
July 2010
August 2010
September 2010
October 2010
November 2010
Distributions payable
December 2010
regular distribution
2010 special distribution
$
Per Unit
Amount
$
0.125
0.050
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.125
0.400
1,585
634
1,585
1,586
1,585
1,585
1,585
1,585
1,585
1,585
1,585
1,585
1,585
1,586
5,072
$
26,313
In June 2007, the Government of Canada enacted new legislation
imposing additional income taxes upon publicly traded income
trusts, including the Fund, effective January 1, 2011. Prior to June
2007, the Trust estimated the future income taxes on cer tain
temporary differences between amounts recorded on its consoli-
dated balance sheets for book and tax purposes at a nil effective
tax rate. Under the legislation and general federal and provincial
corporate rate reductions, the Trust now estimates the effective
tax rate on the post-2010 reversal of these temporary differences
to be 28.25% for 2011, 26.25% for 2012, 25.50% for 2013 and
25.00% for 2014. Temporary differences reversing before 2011 will
still give rise to nil future income taxes.
The change in future tax rates has had two consequences for
the Fund’s consolidated financial statements: [i] the Fund has pro-
vided for a future income tax liability on the anticipated net book
value and tax carrying cost difference as at January 1, 2011 related
to the servicing rights and broker and borrower relationships listed
in note 2, and [ii] the Fund has accounted for temporary tax differ-
ences implicit in its investment in FNFLP.
On the first issue, because there is a difference between the
accounting carrying value of these intangible assets and their under-
lying tax carrying value, Canadian generally accepted accounting
principles require a future income tax liability to be accrued. This
was accrued on the initial public offering based on tax rates for
income trusts, which at that time was a rate of nil. With new
rates being enacted in 2009, the effective tax rate was changed
to 28.25% for 2011, 26.25% for 2012, 25.50% for 2013 and 25.00%
for 2014. Based on these new tax rates, the Fund accrued a future
income tax liability of $8,600 as at December 31, 2010 [2009 –
$8,600]. This liability will remain at this amount until January 1, 2011,
when it will be drawn down every quarter as the Fund continues
to amortize the related intangible assets until 2016.
In June 2007, based on the assets and liabilities of FNFLP, the
Fund began estimating its por tion of the amount of the tempo-
rary differences which were previously not subject to tax and has
estimated the periods in which these differences will reverse. The
Fund estimates that as at December 31, 2010, FNFLP has a net
taxable temporary difference per taining to the Fund which will
reverse after January 1, 2011, such that an accrual of $10,400 of
future income taxes is required at year end. The temporary differ-
ences relate principally to the difference of net tax carrying values
of the securitization receivable, servicing liability, purchased mort-
gage servicing rights and intangible assets recorded in the financial
statements of FNFLP over the net book value of those assets.
As described in note 10, the Fund will be wound up effective
January 1, 2011. The tax liabilities above will be assumed by its suc-
cessor, First National Financial Corporation [the “Corporation”].
36 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
The calculation of taxable income of the Fund is based on esti-
mates and the interpretations of tax legislation. In the event that the
tax authorities take a different view, the balances of future income
taxes could change and the change could be significant.
NOTE 7
GUARANTEE
The Fund’s wholly-owned subsidiar y, the Trust, has provided
guarantees to and subordinated its rights to receive payments
from FNFLP in respect of FNFLP’s bank credit facility that had an
outstanding amount at December 31, 2010 of $23,239 [2009 –
$240,704] and an authorized limit of $125,000 [2009 – $378,330].
No fee is charged for this guarantee.
NOTE 8
EARNINGS PER UNIT
Earnings per Unit are calculated using net income for the year
divided by the equivalent number of Fund Units outstanding during
the year.
NOTE 9
DEBENTURES
On May 7, 2010, the Fund issued $175,000 Series 1 senior secured
debentures bearing interest at a rate of 5.07% per annum, pay-
able semi-annually. The debentures mature on May 7, 2015 and are
guaranteed, jointly and severally, by the Trust, FNFLP and the GP.
The Fund loaned the full proceeds to the Trust at a rate of 5.09%
per annum. The Trust loaned these proceeds to FNFLP at a rate of
5.1025% per annum. Both intercompany loans are payable on the
same dates as the interest and principal payments on the deben-
tures. FNFLP used the full proceeds of the loan to repay a portion
of its bank indebtedness under its current credit facility. The costs
relating to the debenture issuance have been borne by FNFLP.
NOTE 10
SUBSEQUENT EVENTS
Reorganization
Subsequent to year end, pursuant to a Plan of Arrangement
[the “Arrangement”] and an amalgamation [the “Amalgamation”]
effective January 1, 2011, the structure of the Fund and its invest-
ment in FNFLP was reorganized as follows:
• A new company [First National Financial Inc. [“FNFI”]] was
formed;
• Unitholders of the Fund exchanged 12,681,113 Units in the
Fund for Class A shares in FNFI on a one-for-one basis;
• The pre-Arrangement shareholders of the Corporation
exchanged their shares in the Corporation for 48,077,950
shares of FNFI with the result that the Corporation became a
wholly-owned subsidiary of FNFI;
• The Fund and the Trust were wound up; and
• The Corporation and FNFI were amalgamated and continued
under the name “First National Financial Corporation”.
Effectively, the Arrangement and the Amalgamation reorganized
the ownership interests in FNFLP such that all such interests will
be consolidated and held through the Corporation in the same
ratio as previously held by the Fund and the Corporation, respec-
tively. The continuing publicly traded entity will be First National
Financial Corporation.
Issuance of preferred shares
On January 25, 2011, the Corporation issued 4 million Class A
Series 1 Preferred Shares at a price of $25.00 per share for gross
proceeds of $100,000, before issue expenses. Expenses of $2,470
related to the issuance have been recorded in capital stock, which
is net of income taxes recoverable of $868. The net proceeds of
$96.7 million from the issuance were paid down to the FNFLP as a
contribution of partner capital.
Holders of the Series I Preferred Shares are entitled to receive a
cumulative quarterly fixed dividend yielding 4.65% annually for the
initial term ending March 31, 2016. Thereafter, the dividend rate will
be reset every five years at a rate equal to the 5-year Government
of Canada yield plus 2.07%.
Holdings of Series I Preferred Shares have the right, at their
option, to conver t their shares into cumulative, floating rate
Class A Preference Shares, Series 2 [“Series 2 Preferred Shares”],
subject to certain conditions, on March 31, 2016 and on March 31
every five years thereafter. Holders of the Series 2 Preferred Shares
will be entitled to receive cumulative quarterly floating dividends at
a rate equal to the 3-month Government of Canada Treasury Bill
yield plus 2.07%.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 37
Independent Auditors’ Report
To the Partners of First National Financial LP
We have audited the accompanying financial statements of First National Financial LP, which comprise the balance sheets as at
December 31, 2010 and 2009, and the statements of income and retained earnings and cash flows for the years then ended, and a
summary of significant accounting policies and other explanatory information.
Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with Canadian generally
accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of financial
statements that are free from material misstatement, whether due to fraud or error.
Auditors’ responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with
Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements.
The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s
preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating
the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating
the overall presentation of the financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements present fairly, in all material respects, the financial position of First National Financial LP as at
December 31, 2010 and 2009 and the results of its operations and its cash flows for the years then ended in accordance with Canadian
generally accepted accounting principles.
Toronto, Canada,
March 1, 2011
Chartered Accountants
Licensed Public Accountants
38 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
FIRST NATIONAL FINANCIAL LP
BALANCE SHEETS
(in $000s)
As at December 31
2010
2009
ASSETS
Accounts receivable and sundry (notes 8 and 14)
Mortgages accumulated for sale
Securitization receivable (note 3)
Deferred placement fees receivable (note 3)
Cash collateral and short-term notes held by securitization trusts (note 3)
Mortgage and loan investments (note 4)
Purchased mortgage servicing rights (note 5)
Securities purchased under resale agreements and owned (note 11)
Property, plant and equipment, net (note 6)
Total assets
LIABILITIES AND EQUITY
Liabilities
Bank indebtedness (note 7)
Obligations related to securities and mortgages sold under repurchase agreements (note 12)
Accounts payable and accrued liabilities (notes 8 and 14)
Distributions payable
Servicing liability (note 3)
Securities sold under repurchase agreements and sold short (note 11)
Debenture loan payable (notes 9, 14 and 15)
Total liabilities
Commitments and guarantees (note 10)
Equity
GP units (notes 1 and 19)
Class A LP units (notes 1 and 19)
Exchangeable Class B LP units (notes 1 and 19)
Retained earnings
Total equity
Total liabilities and equity
See accompanying notes
On behalf of the Board:
Director
Stephen Smith
Director
Moray Tawse
$
$
39,485
318,791
157,443
85,181
40,686
70,911
5,766
426,336
4,483
$
37,161
383,257
103,964
98,121
45,112
54,737
6,607
333,705
5,026
1,149,082
1,067,690
30,153
174,258
22,092
31,988
25,709
424,673
178,849
$
249,336
221,937
18,097
10,494
21,022
332,427
–
887,722
853,313
59
120,171
(22,940)
164,070
59
120,171
(22,940)
117,087
261,360
214,377
$ 1,149,082
$ 1,067,690
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 39
FIRST NATIONAL FINANCIAL LP
STATEMENTS OF INCOME AND RETAINED EARNINGS
(in $000s, except earnings per unit)
Years ended December 31
2010
2009
REVENUE
Placement fees
Gains on deferred placement fees (note 3)
Gains on securitization (note 3)
Mortgage investment income (note 4)
Mortgage servicing income
Residual securitization income (note 3)
Realized and unrealized losses on financial instruments (notes 2 and 14)
EXPENSES
Brokerage fees
Salaries and benefits
Interest
Management salaries
Other operating (note 4)
Net income for the year
Retained earnings, beginning of year
Less distributions declared
Retained earnings, end of year
Earnings per unit (note 17)
Basic
See accompanying notes
$
$
103,589
9,566
60,227
26,972
73,846
35,574
33,440
$
123,882
51,805
55,417
23,428
64,440
22,853
(109)
343,214
341,716
$
103,020
43,153
13,808
1,500
20,306
98,677
48,204
13,439
1,500
16,413
181,787
178,233
$
161,427
$
163,483
117,087
(114,444)
40,557
(86,953)
$
164,070
$
117,087
$ 2.69
$ 2.73
40 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
FIRST NATIONAL FINANCIAL LP
STATEMENTS OF CASH FLOWS
(in $000s)
Years ended December 31
2010
2009
OPERATING ACTIVITIES
Net income for the year
Add (deduct) items not affecting cash
Non-cash portion of gains on securitization and gains on deferred placement fees
Amortization of securitization receivable and deferred placement fees receivable
Amortization of purchased mortgage servicing rights
Amortization of property, plant and equipment
Unrealized (gains) losses on financial instruments
Amortization of servicing liability
Net change in non-cash working capital balances related to operations (note 13)
$
161,427
$
163,483
(80,868)
81,517
841
1,796
(32,857)
(7,024)
124,832
70,000
(121,565)
48,019
2,024
1,749
32
(5,743)
87,999
(171,548)
Cash provided by (used in) operating activities
194,832
(83,549)
INVESTING ACTIVITIES
Additions to property, plant and equipment
Repayment of cash collateral and short-term notes, net
Investment in mortgage and loan investments
Repayment of mortgage and loan investments
Cash provided by (used in) investing activities
FINANCING ACTIVITIES
Distributions paid
Obligations related to securities and mortgages sold under repurchase agreements
Proceeds from debenture loan
Securities purchased under resale agreements and owned, net
Securities sold under repurchase agreements and sold short, net
Cash provided by financing activities
Net decrease in bank indebtedness during the year
Bank indebtedness, beginning of year
Bank indebtedness, end of year
Supplemental cash flow information
Interest paid
See accompanying notes
$
$
(1,253)
5,118
(74,082)
60,554
$
(1,510)
8,614
(82,924)
101,063
(9,663)
25,243
(92,950)
(47,679)
175,000
(92,631)
92,274
$
(87,403)
221,937
–
(106,401)
111,840
34,014
139,973
219,183
(249,336)
81,667
(331,003)
$
(30,153)
$
(249,336)
$
14,408
$
13,330
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 41
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
December 31, 2010 and 2009
(in $000s, except per unit amounts or unless otherwise noted)
NOTE 1
GENERAL ORGANIZATION AND BUSINESS
OF FIRST NATIONAL FINANCIAL LP
First National Financial LP [the “Company” or “FNFLP”], a limited
partnership established under the laws of Ontario, is a Canadian-
based originator, underwriter and servicer of predominantly prime
single-family residential and multi-unit residential and commercial
mortgages.
As a Canada Mor tgage and Housing Corporation approved
lender, the Company is active in the single-family residential and
commercial mor tgage markets. As at December 31, 2010, the
Company had mor tgages under administration of $53,293,132
[2009 – $47,793,045] and cash held in trust of $527,624 [2009 –
$435,358]. Mortgages under administration are serviced for finan-
cial institutions such as banks, insurance companies, pension funds,
mutual funds, trust companies, credit unions and special purpose
entities [including trusts], also referred to as securitization vehicles.
As at December 31, 2010, the Company administered 174,483
mortgages [2009 – 155,401] for 95 institutional investors [2009 –
98] with an average remaining term to maturity of 44 months
[2009 – 47 months].
Pursuant to the Limited Par tnership Agreement between
FNFLP, First National Financial Operating Trust [the “Trust”] and
First National Financial Corporation [“FNFC”] dated June 15, 2006,
First National Financial GP Corporation, as general partner, has full
power and exclusive authority to employ all persons necessary for
the conduct of the partnership, to enter into an agreement and to
incur any obligation related to the affairs of the partnership and is
entitled to full reimbursement of all costs and expenses incurred
on behalf of the partnership. As general and administrative costs
incurred by First National Financial GP Corporation are on behalf
of the partnership, these costs have been reflected in the financial
statements of FNFLP.
NOTE 2
SIGNIFICANT ACCOUNTING POLICIES
Use of estimates
The preparation of financial statements in conformity with Cana-
dian generally accepted accounting principles [“GAAP”] requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, including contingencies,
at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results
may differ from those estimates. Major areas requiring use of esti-
mates by management are the securitization receivable and the fair
values of financial assets and liabilities.
Adoptions of new accounting standards
2010
No significant new accounting policies were adopted during 2010.
2009
Credit risk and the fair value of financial assets
and financial liabilities
In January 2009, the Emerging Issues Committee of the Canadian
Institute of Char tered Accountants [“CICA”] issued Abstract
EIC-173, “Credit Risk and the Fair Value of Financial Assets and
Financial Liabilities”, which establishes guidance requiring an entity
to consider its own credit and the credit risk of the counterparty
when determining the fair value of financial assets and financial
liabilities, including derivative instruments. EIC-173 should be applied
retroactively, without restatement of prior periods. The adoption of
this abstract did not have a significant impact on the Company’s
financial statements.
Financial instruments – disclosures
In June 2009, the CICA amended Handbook Section 3862, “Finan-
cial Instruments – Disclosures”, to enhance disclosures about fair
value measurements and the liquidity risk of financial instruments.
All financial instruments recognized at fair value on the balance
sheets must be classified into three fair value hierarchy levels, which
are as follows:
Level 1 – valuation based on quoted prices [unadjusted] observed
in active markets for identical assets or liabilities;
Level 2 – valuation techniques based on inputs that are quoted
prices of similar instruments in active markets; quoted prices
for identical or similar instruments in markets that are not active;
inputs other than quoted prices used in a valuation model that
are observable for that instrument; and inputs that are derived
principally from or corroborated by observable market data by
correlation or other means; and
Level 3 – valuation techniques with significant unobser vable
market inputs.
The amendments have no impact on how the Company deter-
mines the fair value of financial instruments; however, they require
additional disclosures, which details are provided in note 14.
42 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Impairment of financial assets
In August 2009, the CICA amended Handbook Section 3855,
“Financial Instruments – Recognition and Measurement”. The
amendments apply to annual financial statements relating to
fiscal year s beginning on or after November 1, 2008 with
retroactive application to the beginning of the fiscal year. The
amendments allow certain debt securities not quoted in an active
market to be classified as loans and receivables and measured at
amortized cost, with impairment being measured using the incurred
credit loss model of Section 3025, “Impaired Loans”. Loans and
receivables that an entity intends to sell immediately or in the near
term must be classified as held-for-trading, and loans and receiv-
ables for which the holder may not recover substantially all of its
initial investment, other than because of credit deterioration, must
be classified as available-for-sale. Impairment losses recognized
in income relating to an available-for-sale debt security must be
reversed in income when, in a subsequent period, the fair value of
the security increases, and the increase can be objectively related
to an event occurring after the loss was recognized. The initial
application of these amendments had no significant impact on the
Company’s financial statements, primarily because the Company
has not classified any assets as available-for-sale.
Revenue recognition
The Company earns revenue from placement, securitization and
servicing activities related to its mortgage business. The majority
of originated mortgages are funded either by placement of mort-
gages with institutional investors or the sale of mor tgages to
securitization conduits. The Company retains ser vicing rights
on substantially all of the mor tgages it originates, providing the
Company with servicing fees.
The Company complies with CICA Accounting Guideline 12,
“Transfers of Receivables”. Accordingly, gains on securitization
are recognized in income at such time as the Company transfers
mortgages to securitization vehicles and surrenders control whereby
the transferred assets have been isolated presumptively beyond
the reach of the Company and its creditors, even in bankruptcy
or other receivership. When the Company securitizes mortgages,
it generally retains a residual interest, presented in the balance
sheets as securitization receivable, and the rights and obliga-
tions associated with servicing the mortgages. The measurement
of gains or losses recognized on the sale of mor tgages depends
in part on the previous carrying amount of the transferred mort-
gages, as allocated between the assets sold and the interests that
are retained by the Company as the seller, based on the relative fair
value of the assets and the retained interest at the date of transfer.
To obtain fair values, quoted market prices are used where available.
Since quoted prices are generally not available for retained interests,
the Company estimates fair value based on the net present value
of future expected cash flows, calculated using management’s best
estimates of key assumptions related to expected credit loss expe-
rience, prepayment rates and discount rates commensurate with
the risks involved.
Placement fees are earned by the Company for its origination
and underwriting activities on a completed transaction basis when
the mortgage is funded. Amounts collected or collectible in excess
of the mortgage principal are recognized as placement fees. When
placement fees are earned over the term of the related mortgages,
the Company determines the present value of the ongoing place-
ment fees. This amount is recorded in income as gains on deferred
placement fees. The same accounting methodology is applied as
described above for gains on securitization.
Residual securitization income represents primarily the differ-
ence between the actual cash flows received on securitized mort-
gages and the assumed cash flows, and is recognized in income as
received. It also includes the difference between the actual cash
flows received on mor tgages sold under deferred placement
arrangements and the assumed cash flows. Fur ther, subsequent
to securitization/placement, the fair value of retained interests is
measured quarterly and compared to the receivables at the bal-
ance sheet dates. Should the carrying value of the receivables differ
from the fair value of the retained interests determined by refer-
ence to the underlying remaining expected cash flows, unrealized
gains or losses on financial instruments are recorded in the state-
ments of income and retained earnings to adjust the carrying value
of the receivables.
The Company services substantially all of the mortgages that it
originates whether the mortgage is placed with institutional inves-
tors or transferred to a securitization vehicle. In addition, mortgages
are serviced on behalf of third-par ty institutional investors and
securitization structures. Servicing revenue is recognized in income
on an accrual basis and is collected on a monthly basis from insti-
tutional investors. For securitized mortgages, the Company retains
the rights and obligations to service the mortgages and records a
liability for future servicing and a reduction to gains on securitiza-
tion revenue at the time of transfer. Servicing income related to
securitized mor tgages is accreted to income over the life of the
servicing obligation and included in residual securitization income.
Interest income earned by the Company related to servicing activi-
ties is classified as mortgage servicing income.
In addition to the foregoing sources of revenue, the Com-
pany earns interest income, which is recorded on an accrual basis
from its interest-bearing assets including securitization receivable,
deferred placement fees receivable, mortgage and loan investments
and mortgages accumulated for sale. Prior to placement or transfer,
funded mor tgages are presented in the balance sheets as mor t-
gages accumulated for sale which are typically held for a period of
less than 90 days and are carried at fair value.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 43
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
Brokerage fees
Brokerage fees relating to the mortgages recorded at fair value are
expensed as incurred and brokerage fees relating to mor tgages
recorded at amortized cost are deferred and amortized over the
term of the mortgages.
Cash collateral and short-term notes
Cash collateral and short-term notes held by securitization trusts
are classified as held-for-trading under the Fair Value Option
[“FVO”] and recorded at fair value.
Mortgage and loan investments
Mor tgage and loan investments are carried at their outstanding
principal balances, adjusted for unamortized premiums or discounts,
and are net of specific provisions for credit losses, if any.
Mor tgage and loan investments are recognized as being
impaired when the Company is no longer reasonably assured of
the timely collection of the full amount of principal and interest. An
allowance for loan losses is established for mortgages and loans that
are known to be uncollectible. When management considers there
to be no probability of collection, the investments are written off.
Mortgages accumulated for sale
Mortgages accumulated for sale are mortgages funded on behalf
of the Company’s investors. These mortgages are held for terms
usually not exceeding 90 days. These mor tgages are classified as
held-for-trading under the FVO and recorded at fair value.
Purchased mortgage servicing rights
The Company purchases the rights to service mortgages from third
parties. Purchased mortgage servicing rights are initially recorded at
cost and charged to income over the life of the underlying mort-
gage servicing obligation. The fair value of such rights is determined
on a periodic basis to assess the continued recoverability of the
unamortized cost in relation to estimated future cash flows associ-
ated with the underlying serviced assets. Any loss arising from an
excess of the unamortized cost over the fair value is immediately
recorded as a charge to income.
Property, plant and equipment
Property, plant and equipment are recorded at cost, less accumu-
lated amortization, at the following annual rates and bases:
Computer equipment
Office equipment
Leasehold improvements
Computer software
30% declining balance
20% declining balance
straight-line over the term of the lease
30% declining balance except for
computer license, which is straight-
line over 10 years
Securities sold short and securities purchased
under resale agreements
Securities sold short consist of the short sale of a bond. Bonds pur-
chased under resale agreements consist of the purchase of a bond
with the commitment by the Company to resell the bond to the
original seller at a specified price. The Company uses combinations
of bonds sold short and bonds purchased under resale agreements
to economically hedge its mortgage commitments and the portion
of mortgages accumulated for sale that it intends to sell.
Bonds sold shor t are classified as held-for-trading under the
FVO and recorded at fair value. The accrued coupon on bonds
sold short is recorded as interest expense. Bonds purchased under
resale agreements are carried at cost plus accrued interest, which
approximates market value. The difference between the cost of
the purchase and the predetermined proceeds to be received on
a resale agreement is recorded over the term of the hedged mort-
gages as an offset to interest expense. Transactions are recorded on
a settlement date basis.
Securities sold under repurchase agreements
The Company purchases bonds and enters into bond repurchase
agreements to close out economic hedging positions when mort-
gages are sold to institutional investors or securitization vehicles.
These transactions are accounted for in a similar manner as
the transactions described for securities sold short and securities
purchased under resale agreements.
Income taxes
These financial statements are those of the Company and do not
reflect the assets, liabilities, revenues and expenses of its partners.
FNFLP is a partnership carrying on business in Canada, and conse-
quently is not directly subject to federal or provincial income taxes.
The income or loss for income tax purposes of the Company is
required to be allocated to FNFLP’s partners.
The calculation of taxable income of the Company is based on
estimates and the interpretations of tax legislation. In the event that
the tax authorities take a different view, income for tax purposes of
the Company as allocated to FNLP partners could change and the
change could be significant.
Cash and cash equivalents
Cash and cash equivalents consist of cash balances with banks and
bank indebtedness.
Derivative instruments
Derivative instruments are marked-to-market and recorded at fair
value with the changes in fair value recognized in income as they
occur. Positive values are recorded as assets and negative values are
recorded as liabilities.
44 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Financial instruments – disclosures and presentation
Effective January 1, 2008, the Company adopted CICA Handbook
Sections 3862, “Financial Instruments – Disclosures”, and 3863,
“Financial Instruments – Presentation”. These sections require the
disclosure of information with regard to the significance of financial
instruments for the Company’s financial position and performance
and the nature and extent of risks arising from financial instruments
to which the Company is exposed during the period and at the
balance sheet dates, and how the Company manages those risks.
In 2009, Section 3862 was amended to enhance the disclosure
requirements regarding the liquidity risk of financial instruments.
As these are disclosure items, they had no measurement effect on
the Company’s financial statements.
Financial instrument classification is as follows:
Accounts receivable and sundry
Securities purchased under resale agreements
Securitization receivable
Deferred placement fees receivable
Mortgages accumulated for sale
Cash collateral and short-term notes held by securitization trusts
Mortgage commitments
Securities owned and sold short
Obligations related to securities and mortgages sold under repurchase agreements
Mortgage and loan investments, except for long-term commercial mortgages
Accounts payable and bank indebtedness
Long-term commercial mortgages included in mortgage and loan investments
Loans and receivables
Loans and receivables
Held-for-trading
Held-for-trading
Held-for-trading
Held-for-trading
Held-for-trading
Held-for-trading
Other liabilities
Loans and receivables
Other liabilities
Held-for-trading
Variable interest entities
The Company applies the guidance in CICA Accounting Guide-
line 15, “Consolidation of Variable Interest Entities”, [“AcG-15”]
when preparing its financial statements. AcG-15 provides a frame-
work for identifying a variable interest entity [“VIE”] and requires
a primary beneficiary to consolidate a VIE. A primary beneficiary
is the enterprise that absorbs the majority of the VIE’s expected
losses or receives a majority of the VIE’s residual returns, or both.
The Company has interests in VIEs that are not consolidated
because the Company is not considered the primary beneficiary.
NOTE 3
SECURITIZATION AND DEFERRED PLACEMENT
FEES RECEIVABLE
The Company enters into various sale transactions that provide
it with an ongoing stream of cash flow based on the value of the
mortgages sold or placed. The value of these streams is calculated
and revenue is recorded on the transaction date. The Company
separates this revenue into “Gains on deferred placement fees” and
“Gains on securitization”, and the resultant assets between “Secu-
ritization receivable” and “Deferred placement fees receivable”.
This distinction acknowledges the nature of the future payments
being received. When these future payments represent primarily
the present value of future payments from direct securitization by
the Company, where the Company is the principal risk taker, a gain
on securitization is recorded. This includes securitizations through
Asset-Backed Commercial Paper [“ABCP”], NHA-MBS and the
Canada Mor tgage Bonds [“CMB”] program. The Company also
enters into transactions with institutional investors in which place-
ment fees are received over time instead of only at the time of
the mortgage sale. In these cases, the Company applies the same
accounting methodology as it does with the direct securitization
transactions; future expected cash flows are discounted to present
value and a gain on deferred placement fee is recorded.
The Company securitizes residential and commercial mortgage
loans. In all of these securitizations, the Company retains servicing
responsibilities and subordinate interests. Most of these securitiza-
tions consist of sales of fixed and floating rate mortgages to spe-
cial purpose entities [including direct sales into the CMB program].
In these cases, the Company does not receive an explicit servicing
fee; instead, the Company receives subordinated interests consist-
ing of rights to future cash flows arising after the investors in the
special purpose entities have received the return for which they
contracted, and provides credit enhancement to the special pur-
pose entity in the form of cash collateral accounts and short-term
notes. The special purpose entities and other securitization vehicles
have no recourse to the Company’s other assets for failure of debt-
ors to pay when due. The Company’s retained interests are sub-
ject to credit, prepayment and interest rate risks on the transferred
receivables. The Company also places residential and commercial
mortgages with institutions and earns fees which are collected over
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 45
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
future periods. These placement fees result from sales of fixed and
floating rate mortgages to institutional investors. The investors have
no recourse to the Company’s other assets for failure of debtors to
pay when due. The Company’s deferred placement fees receivable
are subject primarily to prepayment risk on the mor tgages sold.
During the year ended December 31, 2010, the Company
securitized $3,651,937 [2009 – $2,543,505] of mor tgage loans
to special purpose entities and other securitization vehicles, recog-
nizing gains on securitization of $60,227 [2009 – $55,417]. Gains
on securitization are net of securitization transactions costs of
$11,075 [2009 – $9,638]. During the year ended December 31,
2010, the Company sold $1,749,715 [2009 – $4,606,051] of mort-
gage loans to institutional investors which created placement fees
receivable in future periods, recognizing gains on deferred place-
ment fees of $9,566 [2009 – $51,805]. These gains are net of losses
from interest rate hedging of nil [2009 – losses of $4,705].
The liability for implicit servicing on securitization was $25,709
as at December 31, 2010 [2009 – $21,022]. In the absence of
quoted market rates for servicing securitized assets, management
has estimated, based on industry exper tise, that the fair market
value of this liability approximates its carrying value. Amortization
of the servicing liability during the year ended December 31, 2010
amounted to $7,024 [2009 – $5,743] and is included in residual
securitization income.
As par t of its securitization activities, the Company provides
cash collateral and invests in short-term notes for credit enhance-
ment purposes as required by the rating agency. Credit exposure
to securitized mortgages is limited to the securitization receivable,
cash collateral and amounts invested in the notes. The securitization
receivable is paid to the Company by the special purpose entity
over the term of the mor tgages, as monthly net spread income.
The full amount of the cash collateral and the notes held by the
securitization trusts, and accrued interest thereon, is also recorded
as a receivable and the Company anticipates full recover y of
these amounts. As at December 31, 2010, the cash collateral was
$29,767 [2009 – $32,178] and the short-term notes were $10,919
[2009 – $12,934].
The key weighted average assumptions used in determining
gains on deferred placement fees and securitization were as follows:
Prepayment rate
Discount rate
2010
15%
5.1%
2009
13.5%
5.4%
No credit loss assumption was used for insured mortgages as no
loss is expected. For uninsured mortgages, the expected weighted
average credit loss assumption used was 0.56% [2009 – 0.51%].
Cash flows received from securitization vehicles for the years
ended December 31 are as follows:
2010
2009
Proceeds from new
securitizations and
deferred placements
Receipts on securitization
and deferred placement
fees receivable
$ 5,401,652
$ 7,149,556
$
120,663
$
71,126
The Company uses various assumptions to value the securitiza-
tion receivable and deferred placement fee receivable [excluding
cash collateral and shor t-term notes held by the securitization
trusts], which are set out in the tables below, including the rate
of unscheduled prepayments. Accordingly, the securitization
receivable is subject to measurement uncer tainty. The effect of
variations between actual experience and assumptions will be
recorded in future statements of income and retained earnings.
46 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Key economic weighted average assumptions and the sensitivity of the current carrying value of residual cash flows to immediate 10% and
20% adverse changes in those assumptions are as follows:
2010
Fair value of securitization receivable and
deferred placement fees receivable (FVO)
Average life (in months) (1)
Prepayment speed assumption (annual rate)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Residual cash flows discount rate (annual)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Expected credit losses
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Spread assumption
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
2009
Fair value of securitization receivable and
deferred placement fees receivable (FVO)
Average life (in months) (1)
Prepayment speed assumption (annual rate)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Residual cash flows discount rate (annual)
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Expected credit losses
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Spread assumption
Impact on fair value of 10% adverse change
Impact on fair value of 20% adverse change
Commercial
mortgage loans
Fixed
rate
88,113
56
0.4%
54
107
5.3%
1,109
2,191
0.0%
31
62
0.5%
8,858
17,717
$
$
$
$
$
$
$
$
$
Commercial
mortgage loans
Fixed
rate
78,012
56
0.6%
88
173
5.6%
1,029
2,033
0.0%
65
129
0.5%
7,847
15,693
$
$
$
$
$
$
$
$
$
Adjustable
1,760
19
38.4%
64
124
4.6%
7
14
0.0%
1
2
1.0%
176
352
Adjustable
958
11
33.7%
28
54
3.7%
3
6
0.1%
3
7
0.7%
96
191
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Residential
mortgage loans
Fixed
rate
Adjustable
36,632
29
15.3%
667
1,316
4.8%
209
417
0.0%
206
413
0.6%
3,840
7,680
$
$
$
$
$
$
$
$
$
Residential
mortgage loans
Fixed
rate
48,399
39
15.2%
1,091
2,144
5.1%
378
751
0.0%
423
847
0.6%
5,161
10,323
$
$
$
$
$
$
$
$
$
116,119
43
25.5%
4,180
8,129
5.1%
851
1,691
0.0%
101
203
1.2%
11,585
23,170
Adjustable
74,716
43
25.5%
2,854
5,537
5.3%
607
1,205
0.0%
177
353
1.0%
7,435
14,869
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
(1) The weighted-average life of prepayable assets in periods [for example, months or years] can be calculated by multiplying the principal collections expected in each future period
by the number of periods until that future period, summing those products, and dividing the sum by the initial principal balance.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 47
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
These sensitivities are hypothetical and should be used with caution.
As the figures indicate, changes in carrying value based on a 10%
or 20% variation in assumptions generally cannot be extrapolated
because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in these tables, the effect of a
variation in a particular assumption on the fair value of the retained
interest is calculated without changing any other assumption;
in reality, changes in one factor may result in changes in another
[for example, increases in market interest rates may result in lower
prepayments and increased credit losses], which might magnify or
counteract the sensitivities.
The sensitivity for spread assumptions disclosed above includes
the sensitivity of securitization receivables to changes in ABCP
spreads. The securitization receivable assumes ABCP will trade
at par with Bankers’ Acceptances rates. If this spread increased by
0.10 percentage points, the related fair value of the securitization
receivable would be decreased by approximately $1,531.
The Company estimates that the expected cash flows of the
securitization receivable and the deferred placement fees receivable
will be as follows:
2011
2012
2013
2014
2015 and thereafter
$
94,562
67,162
42,114
22,169
16,617
NOTE 4
MORTGAGE AND LOAN INVESTMENTS
As at December 31, 2010, mortgage and loan investments consist
primarily of commercial first and second mortgages held for vari-
ous terms, the majority of which mature within one year.
Mortgage and loan investments consist of the following:
Mortgage loans classified
as loans and receivables
Mortgage loans designated
as held-for-trading
Subordinated note
2010
2009
$
60,555
$
44,133
10,356
–
9,604
1,000
$
70,911
$
54,737
Mortgage and loan investments classified as loans and receivables
are carried at outstanding principal balances, adjusted for unamor-
tized premiums or discounts, and are net of specific provisions for
credit losses, if any.
The subordinated note was issued by a securitization trust not
related to the Company. The note matured in November 2010.
The following table discloses the composition of the Company’s
portfolio of mortgage and loan investments by geographic region
as at December 31, 2010:
$
242,624
Province
Mortgages under administration are serviced as follows:
Institutional investors
Securitization vehicles
CMBS conduits
2010
2009
$ 37,067,568
11,560,845
4,664,719
$ 33,316,698
9,445,142
5,031,205
$ 53,293,132
$ 47,793,045
Alberta
British Columbia
Manitoba
Newfoundland
Nova Scotia
Ontario
Quebec
Saskatchewan
Yukon
$
Portfolio
balance
4,158
4,669
11,428
104
2,030
36,698
11,201
100
523
Percentage
of portfolio
5.86
6.58
16.12
0.15
2.86
51.75
15.80
0.14
0.74
$
70,911
100.00
These balances are net of discounts of $296 [2009 – $674] and
provisions for credit losses of $4,831 [2009 – $4,306]. The portfo-
lio contains $523 [2009 – $869] of insured mortgages and $70,388
[2009 – $53,868] of uninsured mortgage and loan investments as
at December 31, 2010.
The Company’s exposure to credit loss is limited to mor tgages
under administration totalling $694,781 [2009 – $858,023], of
which mor tgages of $38,435 have principal and interest pay-
ments outstanding as at December 31, 2010 [2009 – $60,928].
The Company incurred actual credit losses, net of recoveries, of
$3,689 during the year ended December 31, 2010 [2009 – $3,736].
As at December 31, 2010, the Company has $6,990 [2009 –
$9,296] of uninsured non-performing mortgages [net of provisions
for credit losses] included in accounts receivable and sundry related
to defaulted mortgages purchased from securitization trusts.
48 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
The following table discloses the mortgages that are past due
as at December 31:
Days
31 to 60
61 to 90
Greater than 90
$
2010
2,122
1,694
7,739
$
$
11,555
$
2009
400
–
5,956
6,356
Of the above total amount, the Company considers $5,968 [2009 –
$5,956] as impaired for which it has provided an allowance for
potential loss of $4,831 [2009 – $4,306] as at December 31, 2010.
Allowance for loan losses
The following table discloses credit losses which the Company has
provided for impaired mortgage and loan investments:
2010
2009
Balance, beginning of year
Provisions for credit losses
Write-offs
$
$
4,306
525
–
3,437
1,313
(444)
Balance, end of year
$
4,831
$
4,306
Due to loan specific issues, the Company has experienced credit
losses of $525 for the year ended December 31, 2010 [2009 –
$1,313]. These losses are included in other operating expenses in
the statements of income and retained earnings.
The contractual repricing on the table below is based on the
earlier of contractual repricing or maturity dates.
Within
1 year
Over
1 to 3
years
2010
Over
3 to 5
years
Over
5 years
Book
value
2009
Book
value
Residential
Commercial
$
2,376
44,628
$
631
11,286
$
32
3,197
$
–
8,761
$
3,039
67,872
$
5,524
49,213
$
70,911
$
54,737
The maturity profile of mortgage and loan investments is as follows:
2011
2012
2013
2014
2015 and thereafter
$
47,004
10,598
1,319
3,229
8,761
$
70,911
Interest income for the year was $8,722 [2009 – $9,626] and is
included in mor tgage investment income on the statements of
income and retained earnings.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 49
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
NOTE 5
PURCHASED MORTGAGE SERVICING RIGHTS
Purchased mortgage servicing rights consist of the following components:
2010
Accumulated
amortization
Cost
Net
book value
Cost
2009
Accumulated
amortization
Net
book value
3,614
$
2,620
$
994
$
3,614
$
2,462
$
1,152
Third-party commercial
mortgage servicing rights $
Commercial mortgage backed
securities primary and
master servicing rights
8,705
3,933
4,772
8,705
3,250
$
12,319
$
6,553
$
5,766
$
12,319
$
5,712
$
5,455
6,607
The Company did not purchase any new servicing rights during the years ended December 31, 2010 and 2009. Amortization, including
impairment, charged to income for the year ended December 31, 2010 was $841 [2009 – $2,024].
During the year ended December 31, 2009, management performed an impairment test on these assets and concluded that the
Company’s unamortized cost exceeded the fair market value and, as a result, the Company recorded an impairment charge of $1,194.
No impairment was recorded in 2010.
NOTE 6
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
2010
Accumulated
amortization
Net
book value
$
$
4,578
2,215
1,577
2,030
$
2,530
805
729
419
2009
Accumulated
amortization
Net
book value
$
$
3,662
2,016
1,259
1,668
2,665
990
610
761
Cost
6,327
3,006
1,869
2,429
Cost
7,108
3,020
2,306
2,449
Computer equipment
Office equipment
Computer software
Leasehold improvements
$
$
14,883
$
10,400
$
4,483
$
13,631
$
8,605
$
5,026
50 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
NOTE 7
BANK INDEBTEDNESS
NOTE 8
SWAP CONTRACTS
Bank indebtedness includes a one-year revolving line of credit
of $125,000 [2009 – $378,330] maturing in May 2011, of which
$23,239 [2009 – $240,704] was drawn at December 31, 2010 and
against which the following have been pledged as collateral:
[a] a general security agreement over all assets, other than real
property, of the Company; and
[b] a general assignment of all mortgages owned by the Company.
The revolving line of credit bears a variable rate of interest based
on prime or bankers’ acceptance rates.
Swaps are over-the-counter contracts in which two counterparties
exchange a series of cash flows based on agreed upon rates to
a notional amount. The Company used an interest rate swap to
manage interest rate exposure relating to variability of interest
earned on a portion of mor tgages accumulated for sale held on
the balance sheets. The swap agreement that the Company entered
into was an interest rate swap where two counterparties exchange
a series of payments based on different interest rates applied to
a notional amount in a single currency.
The following tables present, by remaining term to maturity, the
notional amounts and fair values of the swap contract that do not
qualify for hedge accounting as at December 31, 2010 and 2009:
Less than
3 years
3 to 5 years
Total
notional amount
2010
Fair value
Interest rate swap contract
$
17,000
$
4,243
$
21,243
$
(93)
2009
Less than
3 years
3 to 5 years
Total
notional amount
Fair value
Interest rate swap contract
$
–
$
33,000
$
33,000
$
(209)
Positive fair values of the interest rate swap contracts are included in accounts receivable and sundry and negative fair values are included
in accounts payable and accrued liabilities on the balance sheets.
NOTE 9
DEBENTURE LOAN PAYABLE
On May 7, 2010, First National Financial Income Fund [the “Fund”]
issued $175 million of five-year term senior secured debentures
with an interest rate of 5.07%, maturing on May 7, 2015. The deben-
ture is secured on a pari-passu basis with the security under the
one-year revolving line of credit described in bank indebtedness.
The Fund loaned the net proceeds of the issuance through the Trust
to FNFLP at an interest rate of 5.1025% per annum. The Company
has fully guaranteed the debentures on behalf of the Fund. The
Company used the proceeds of the debenture loan to repay a por-
tion of its bank indebtedness under its existing bank credit facility.
On the same date, the Company entered into a swap agreement
to receive a 5.07% fixed coupon and pay monthly CDOR+2.134%,
effectively protecting the Company against changes in fair value due
to changes in interest rates. The swap agreement has been desig-
nated as a fair value hedge and matures on the due date of the
debenture loan. The costs relating to the debenture issue have been
borne by the Company.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 51
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
NOTE 10
COMMITMENTS, GUARANTEES
AND CONTINGENCIES
NOTE 11
SECURITIES TRANSACTIONS UNDER
REPURCHASE AND RESALE TRANSACTIONS
As at December 31, 2010, the Company has the following oper-
ating lease commitments for its office premises:
The Company’s outstanding securities purchased under resale
agreements and securities sold under repurchase agreements have
a remaining term to maturity of less than one month.
2011
2012
2013
2014
2015 and thereafter
$
3,399
3,523
3,168
3,033
5,430
$
18,553
Outstanding commitments for future advances on mortgages with
terms of one to 10 years amounted to $2,166,166 as at Decem-
ber 31, 2010 [2009 – $1,835,674]. The commitments generally
remain open for a period of up to 90 days. These commitments
have credit and interest rate risk profiles similar to those mortgages
which are currently under administration. Certain of these com-
mitments have been sold to institutional investors while others will
expire before being drawn down. Accordingly, these amounts do
not necessarily represent future cash requirements of the Company.
In the normal course of business, the Company enters into a
variety of guarantees. Guarantees include contracts where the
Company may be required to make payments to a third party, based
on changes in the value of an asset or liability that the third party
holds. In addition, contracts under which the Company may be
required to make payments if a third party fails to perform under
the terms of the contract [such as mortgage servicing contracts]
are considered guarantees. The Company has determined that the
estimated potential loss from these guarantees is insignificant.
The Company is a named defendant in several legal actions
involving matters that arise in the ordinary course of its business
activities. Management believes that any liability that may ultimately
result from the resolution of these matters will not have a material
adverse effect on the financial position or operating results of the
Company and, accordingly, no provision has been recorded.
NOTE 12
OBLIGATIONS RELATED TO SECURITIES
AND MORTGAGES SOLD UNDER
REPURCHASE AGREEMENTS
The Company uses repurchase agreements to fund specific mort-
gages included in mor tgages accumulated for sale. The current
contracts are with financial institutions and have a weighted average
interest rate of 1.4% and mature on or before January 17, 2011.
This liability includes $81,300 [2009 – $62,500] for repo transac-
tions related to mortgages carried by the Company in the form of
NHA-MBS, and $93,000 [2009 – $159,500] related to the sale of
whole loan mortgages. The sale is entered into concurrently with
a total return swap, which with the mortgage sale is the economic
equivalent of a repurchase agreement.
NOTE 13
STATEMENTS OF CASH FLOWS
The net change in non-cash working capital balances related to
operations consists of the following:
Accounts receivable
and sundry
Mortgages accumulated
for sale
Accounts payable and
accrued liabilities
Distributions payable
2010
2009
$
1,641
$
(10,068)
64,723
(161,966)
(17,858)
21,494
936
(450)
$
70,000
$
(171,548)
52 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
NOTE 14
FINANCIAL INSTRUMENTS
AND RISK MANAGEMENT
Risk management
The various risks to which the Company is exposed and the
Company’s policies and processes to measure and manage them
individually are set out below:
Interest rate risk
Interest rate risk arises when changes in interest rates will affect the
fair value of financial instruments.
The Company uses various strategies to reduce interest rate
risk. The Company’s risk management objective is to maintain inter-
est rate spreads from the point that a mor tgage commitment is
issued to the sale of the mor tgage to the related securitization
vehicle or institutional investor. Primary among these strategies is
the Company’s decision to sell mortgages at the time of commit-
ment, passing on to institutional investors the interest rate risk that
exists prior to funding. The Company uses bond forwards [consist-
ing of bonds sold short and bonds purchased under resale agree-
ments] to manage any fixed interest rate exposure between the
time a mortgage rate is committed to borrowers and the time the
mortgage is sold to a securitization vehicle. As interest rates change,
the values of these interest rate-dependent financial instruments
vary inversely with the values of the mortgage contracts. As inter-
est rates increase, a gain will be recorded on the economic hedge
which will be offset by the loss on the sale of the mortgage to the
securitization vehicle or institutional investor as the mortgage rate
committed to the borrower is fixed at the point of commitment.
For single-family mortgages, only a portion of the commitments
issued by the Company eventually fund. The Company must assign
a probability of funding to each mortgage in the pipeline and esti-
mate how that probability changes as mortgages move through the
various stages of the pipeline. The amount that is actually economi-
cally hedged is the expected value of the mortgages funding within
the future commitment period. The Company also hedges against
interest rate fluctuations by offsetting the exposure of the Com-
pany’s bank indebtedness and funds held in trust. Bank indebted-
ness, obligations related to debt and the debenture loan payable
are all floating rate obligations indexed to 30-day CDOR; the funds
held in trust earn the Company interest based on the same float-
ing rate basis. Because both the indebtedness and funds held in
trust have comparable values, with the liabilities being $383,260
[2009 – $471,273] at December 31, 2010 and funds held in trust
being $527,624 [2009 – $435,358] on the same date, the Company
considers the arrangement to be a natural hedge against shor t-
term interest rate fluctuations.
The table below provides the financial impact that an immediate and sustained 100 basis point and 200 basis point increase and decrease
in short-term interest rates would have had on the net income of the Company in 2010 and 2009.
Increase in interest rate
Decrease in interest rate
2010
2009
2010
2009
100 basis point shift
Impact on net income and unitholders’ equity
200 basis point shift
Impact on net income and unitholders’ equity
$
$
1,398
2,797
$
$
1,024
2,049
$
$
256
2,528
$
$
1,802
4,417
Interest revenue earned on funds held in trust is included in mort-
gage servicing income on the statements of income and retained
earnings. These funds are administered by the Company and include
borrowers’ property tax escrow. For the year ended December 31,
2010, this revenue was $2,639 [2009 – $1,260].
The Company has exposure to the risk that shor t-term interest
rates increase, which represents a first loss position. Accordingly,
these mortgages are much more sensitive to changes in interest
rates and credit loss than the Company’s typical mor tgage and
loan investments.
As at December 31, 2010, the Company administered $50,553
[2009 – $68,025] of fixed rate commercial mor tgages, of which
it has a direct face value interest of $10,903 [2009 – $13,719]
included in mor tgage and loan investments. The other interests
in these mor tgages are owned by an arm’s-length investor and
are subject to par ticipation agreements such that this investor
receives a floating rate of return on its portion of these mortgages.
The Company’s accounts receivable and sundr y, accounts
payable and accrued liabilities, distributions payable, purchased
mor tgage servicing rights and servicing liability are not exposed
to interest rate risk. The Company’s floating rate interest bearing
assets and liabilities, such as mor tgage and loan investments and
bank indebtedness, are subject to liquidity risk.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 53
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
Credit risk
Credit risk is the risk of loss associated with a counterparty’s inabil-
ity or unwillingness to fulfill its payment obligations. The Company’s
credit risk is mainly lending-related in the form of mortgage default.
The Company uses stringent underwriting criteria and experi-
enced adjudicators to mitigate this risk. The Company’s approach
to managing credit risk is based on the consistent application of
a detailed set of credit policies and prudent arrears management.
The Company’s exposure is also mitigated by the short period over
which a mortgage is held by the Company prior to securitization.
The maximum credit exposures of the financial assets are their
carrying values as reflected on the balance sheets. The Company
does not have significant concentration of credit risk within any
particular geographic region or group of customers.
Mortgages accumulated for sale consist primarily of $318,791
prime mortgages, of which 88% are insured, 2% are uninsured but
sold on commitment to institutional investors, and the remainder
are low loan-to-value conventional. Securitization receivables, cash
collateral and short-term notes held by securitization trusts repre-
sent the Company’s retained interest in various securitizations, as
described in note 3. Mor tgage and loan investments are primar-
ily first and second mortgage charges on commercial properties
with an average loan to value of 47% and average yield of 7.9%,
as described in detail in note 4. These mor tgages are primarily
bridge financing for the Company’s borrowers and have a higher
exposure to credit risk than the Company’s primary commercial
mortgage products. The majority of purchased mortgage servicing
rights are investments in the servicing component of CMBS secu-
ritizations. The Company is at risk that the underlying mortgages
default and the servicing cash flows cease. The large portfolio of
individual mortgages that underlies these assets is diverse in terms
of geographical locations, borrower exposure and underlying type
of real estate. This and the priority ranking of the Company’s rights
mitigate the potential size of any credit losses. Securities purchased
under resale agreements are transacted with large regulated Cana-
dian institutions such that the risk of credit loss is very remote.
Securities owned are all Government of Canada bonds, and, as
such, have virtually no risk of credit loss.
Liquidity risk and capital resources
Liquidity risk is the risk that the Company will be unable to meet its
financial obligations as they come due.
The Company’s liquidity strategy has been to use bank credit to
fund working capital requirements and to use cash flow from oper-
ations to fund longer-term assets, providing relatively low-leveraged
balance sheets. The Company’s credit facilities are typically drawn
to fund: [i] mortgages accumulated for sale, [ii] securitization receiv-
able, [iii] deferred placement fees receivable and [iv] mortgage and
loan investments. The Company has a credit facility with a syndicate
of four banks which provides for a total of $125,000 in financing.
Bank indebtedness also includes borrowings obtained through secu-
ritization transactions, outstanding cheques and overdraft facilities.
54 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Market risk
Market risk is the risk of loss that may arise from changes in market
factors such as interest rates and credit spreads. The level of market
risk to which the Company is exposed varies depending on market
conditions, expectations of future interest rates and credit spreads.
Fair value measurement
The Company uses the following hierarchy for determining and
disclosing fair value of financial instruments recorded at fair value in
the balance sheets:
Level 1 – quoted market price observed in active markets for iden-
tical instruments;
Level 2 – quoted market price observed in active markets for simi-
lar instruments or other valuation techniques for which
all significant inputs are based on observable market data;
and
Level 3 – valuation techniques in which one or more significant
inputs are unobservable.
Valuation methods and assumptions
The Company uses valuation techniques to estimate fair values,
including reference to third-party valuation service providers using
proprietary pricing models and internal valuation models such as
discounted cash flow analysis. The valuation methods and key
assumptions used in determining fair values for the financial assets
and financial liabilities are as follows:
[a] Mortgages accumulated for sale and mortgage and
loan investments
The fair value of these mor tgages is determined by discounting
projected cash flows using market industry pricing practices for dis-
count rates at which similar loans made to borrowers with similar
credit profiles and maturities would be discounted and, therefore,
reflects changes in interest rates which have occurred since the
mortgages were originated. Impaired mortgages are recorded at
net realizable value.
[b] Securitization receivable and deferred placement fees receivable
The fair values of securitization receivable and deferred place-
ment fees receivable are determined by internal valuation models
consistent with industry practice, using market data inputs, where
possible. The fair value is determined by discounting the expected
future cash flows related to the mortgages securitized and placed
at market interest rates. The expected future cash flows are esti-
mated based on cer tain assumptions which are not suppor ted
by observable market data. Refer to note 3, “Securitization and
deferred placement fees receivable”, for the key assumptions used
and sensitivity analysis.
[c] Cash collateral and short-term notes held by securitization trusts
The fair value is determined by discounting the expected cash
flows related to these assets at estimated market interest rates.
These rates are determined based on the amount of variability,
mitigated by the assumptions inherent in the calculation of the
securitization receivable.
[d] Securities owned and sold short
The fair value of securities owned and sold shor t used by the
Company to hedge its interest rate exposure is determined by
quoted prices.
[e] Mortgage commitments
The fair value reflects changes in interest rates which have occurred
since the mortgage commitments were issued and is determined
using standard industry pricing practices.
[f] Other financial assets and liabilities
The fair value of mortgage and loan investments classified as loans
and receivables and bank indebtedness corresponds to the respec-
tive outstanding amounts due to their short-term maturity profiles.
The following table represents the Company’s financial instruments measured at fair value on a recurring basis:
Total financial liabilities
$
424,673
$
423
$
Financial assets
Mortgages accumulated for sale
Securitization receivable
Deferred placement fees receivable
Cash collateral and short-term notes
held by securitization trusts
Mortgage and loan investments
Interest rate swaps
Total financial assets
Financial liabilities
Securities sold under repurchase agreements and sold short
Mortgage commitments
Interest rate swaps
$
$
$
Financial assets
Mortgages accumulated for sale
Securitization receivable
Deferred placement fees receivable
Cash collateral and short-term notes
held by securitization trusts
Mortgage and loan investments
Total financial assets
Financial liabilities
Securities sold under repurchase agreements and sold short
Mortgage commitments
Interest rate swaps
$
$
$
Level 1
Level 2
Level 3
Total
2010
–
–
–
–
–
–
–
$
318,791
–
–
$
–
157,443
85,181
$
318,791
157,443
85,181
–
–
3,849
40,686
10,356
–
40,686
10,356
3,849
$
322,640
$
293,666
$
616,306
$
424,673
–
–
$
–
330
93
–
–
–
–
$
424,673
330
93
$
425,096
Level 1
Level 2
Level 3
Total
2009
–
–
–
–
–
–
$
383,257
–
–
$
–
103,964
98,121
$
–
–
45,112
9,604
383,257
103,964
98,121
45,112
9,604
$
383,257
$
256,801
$
640,058
$
332,427
–
–
$
–
(29)
209
–
–
–
–
$
332,427
(29)
209
$
332,607
Total financial liabilities
$
332,427
$
180
$
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 55
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
In estimating the fair value of financial assets and financial liabilities
using valuation techniques or pricing models, certain assumptions
are used including those that are not fully supported by observable
market prices or rates [Level 3]. The amount of the change in fair
value recognized by the Company in net income for the year ended
December 31, 2010 that was estimated using a valuation technique
based on assumptions that are not fully supported by observable
market prices or rates was a gain of approximately $32,817 [2009 –
loss of $656]. Although the Company’s management believes that
the estimated fair values are appropriate at the balance sheet dates,
those fair values may differ if other reasonably possible alternative
assumptions are used.
The following table presents changes in the fair values [including
realized gains of $583 [2009 – losses of $77]] of the Company’s
financial assets and financial liabilities for the years ended Decem-
ber 31, 2010 and 2009, all of which have been designated as held-
for-trading under the FVO except for the interest rate swaps, which
are required to be classified as held-for-trading:
Mortgages accumulated for sale $
Securitization receivable
Deferred placement fees
receivable
Cash collateral and
short-term notes held
by securitization trusts
Mortgage and loan investments
Securities owned and sold short
Mortgage commitments
Interest rate swaps
2010
2009
257
28,547
$
(3,279)
4,048
931
(1,658)
692
3,230
27
(359)
115
(472)
(2,651)
4,294
(919)
528
$
33,440
$
(109)
Movement in Level 3 financial instruments measured at fair value
The following table shows the movement in Level 3 financial instruments in the fair value hierarchy for the year ended December 31,
2010. The Company classifies financial instruments to Level 3 when there is reliance on at least one significant unobservable input in the
valuation models.
Fair value
as at
January 1
2010
Realized and
unrealized gain
(loss) recorded
in income
Repayments
and
amortization
Fair value
as at
December 31
2010
Investments
Financial assets
Securitization receivable
Deferred placement fees receivable
Cash collateral and short-term notes
held by securitization trusts
Mortgage and loan investments
$
103,964
98,121
$
81,476
11,102
$
28,547
931
$
(56,544)
(24,973)
$
157,443
85,181
45,112
9,604
3,186
–
692
3,230
(8,304)
(2,478)
40,686
10,356
Total financial assets
$
256,801
$
95,764
$
33,400
$
(92,299)
$
293,666
Financial assets
Securitization receivable
Deferred placement fees receivable
Cash collateral and short-term notes
held by securitization trusts
Mortgage and loan investments
Fair value
as at
January 1
2009
51,104
63,977
54,198
12,389
$
Realized and
unrealized gain
(loss) recorded
in income
Repayments
and
amortization
Fair value
as at
December 31
2009
Investments
$
73,424
59,209
$
4,048
(1,658)
$
(24,612)
(23,407)
$
103,964
98,121
2,758
–
(472)
(2,651)
(11,372)
(134)
45,112
9,604
Total financial assets
$
181,668
$
135,391
$
(733)
$
(59,525)
$
256,801
56 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
Note 3 provides detailed sensitivity analysis of the securitization
receivable and deferred placement fees receivable, using various
assumptions. The following table shows the potential impact on fair
values of the remaining Level 3 financial instruments by changing
key assumptions. The sensitivity analysis is calculated based on a
10% change in discount rates and spread over risk free rates for
cash collateral and short-term notes held by securitization trusts
and mortgage and loan investments.
Increase in
fair value
2010
Decrease in
fair value
2010
Financial assets
Cash collateral and
short-term notes held
by securitization trusts
$
Mortgage and loan investments
$
236
820
(236)
(820)
Total
$
1,056
$
(1,056)
Increase in
fair value
2009
Decrease in
fair value
2009
Financial assets
Cash collateral and
short-term notes held
by securitization trusts
$
Mortgage and loan investments
NOTE 15
CAPITAL MANAGEMENT
The Company’s objective is to maintain a strong capital base so
as to maintain investor, creditor and market confidence and sus-
tain future development of the business. Management defines capi-
tal as the Company’s equity, long-term debt and retained earnings.
The Company’s liquidity strategy has been to use debt to fund
working capital requirements and to use cash flow from opera-
tions to fund longer-term assets, providing a relatively low leveraged
balance sheet. Net income generated from operations is available
for reinvestment in the Company or distribution to the unitholders.
The Board of Directors does not establish quantitative return on
capital criteria for management, but rather promotes year-over-year
sustainable profit growth. The Board of Directors also reviews on
a quarterly basis the level of distributions paid to the unitholders.
During the year, the Fund issued $175 million of five-year term
debentures at an interest rate of 5.07% per annum and the proceeds
were used by the Company to reduce its revolving bank credit facility.
The debentures were effectively hedged against CDOR+2.134%,
reducing the future interest rate risk arising from bank credit facility
spread. The Company has a minimum capital requirement as stipu-
lated by its bank credit facility. The agreement requires a debt to
equity ratio of 4:1. As at December 31, 2010, the ratio was 0.80:1
[2009 – 2.20:1]. The Company was in compliance with the bank
agreement throughout the year.
545
1,218
$
(545)
(1,218)
NOTE 16
INFORMATION ABOUT MAJOR CUSTOMERS
Total
$
1,763
$
(1,763)
Derivative financial instrument and hedge accounting
The Company entered into a swap agreement to hedge the loan
payable against changes in fair value by converting the fixed rate
debt into a variable rate debt. The swap agreement has been desig-
nated as a fair value hedge and the hedging relationship is formally
documented, including the risk management objective and mea-
surement of effectiveness. The swap agreement is recorded at fair
value with the changes in fair value recognized in income. Changes
in fair value attributed to the hedged risk are accounted for as basis
adjustments to the debenture loan payable and are recognized in
income. Accordingly, accounts receivable and sundry have been
increased by $3,849 to account for the swap derivative, and the
debenture loan payable has been increased by the same amount.
Placement fees, mortgage servicing income and gains on deferred
placement fees revenue from three Canadian financial institutions
represent approximately 35% [2009 – 41%] of the Company’s total
revenue. During the year ended December 31, 2010, the Company
placed 54% [2009 – 51%] of all mortgages it originated with the
same three institutional investors.
NOTE 17
EARNINGS PER UNIT
Earnings per unit are calculated as follows:
2010
2009
Net income for the year
available to unitholders
$
161,427
$
163,483
Number of equivalent
unitholders [Class A
and B (000s)]
Basic earnings per unit
59,967
$ 2.69
59,967
$ 2.73
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 57
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
NOTE 18
EARNINGS BY BUSINESS SEGMENT
The Company operates principally in two business segments, Residential and Commercial. These segments are organized by mortgage
type and contain revenue and expenses related to origination, underwriting, securitization and servicing activities. Expenses not allocated to
segments relate to compensation paid to senior management. Identifiable assets are those used in the operations of the segments.
2010
Residential
Commercial
Total
$
$
255,879
12,523
268,402
60,362
14,450
74,812
$
316,241
26,973
343,214
1,367
11,197
141,530
–
154,094
114,308
608,305
429
2,611
23,153
–
26,193
48,619
1,796
13,808
164,683
1,500
181,787
161,427
540,777
1,149,082
$
878
$
375
$
1,253
2009
Residential
Commercial
Total
$
229,096
11,167
240,263
$
89,192
12,261
101,453
$
318,288
23,428
341,716
1,353
10,333
134,714
–
146,400
93,863
396
3,106
26,831
–
30,333
71,120
1,749
13,439
161,545
1,500
178,233
163,483
530,908
536,782
1,067,690
$
1,056
$
454
$
1,510
REVENUE
Placement, securitization and servicing
Mortgage investment income
EXPENSES
Amortization
Interest
Other operating
Corporate non-allocated expenses
Net income for the year
Identifiable assets
Capital expenditures
REVENUE
Placement, securitization and servicing
Mortgage investment income
EXPENSES
Amortization
Interest
Other operating
Corporate non-allocated expenses
Net income for the year
Identifiable assets
Capital expenditures
58 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
NOTE 19
UNITHOLDERS’ EQUITY
NOTE 21
FUTURE ACCOUNTING CHANGES
The following units are issued and outstanding:
Number of units
Amount
GP units
Units outstanding,
January 1, 2010 and 2009
1
$
Units outstanding,
December 31, 2010 and 2009
1
$
59
59
Class A LP units
Units outstanding,
January 1, 2010 and 2009
12,681,113
$
120,171
Units outstanding,
December 31, 2010
and 2009
12,681,113
$
120,171
Class B LP units
Units outstanding,
January 1, 2010 and 2009
47,286,316
$
(22,940)
Units outstanding,
December 31, 2010
and 2009
47,286,316
$
(22,940)
The Company is authorized to issue an unlimited number of GP
units, Class A LP units and Class B LP units. The Class B LP units are
exchangeable for units of the Fund at the option of the holder sub-
ject to certain conditions.
NOTE 20
RELATED PARTY TRANSACTIONS
For the past few years, several of the Company’s borrowers ten-
dered oppor tunities to invest in large commercial mezzanine
mor tgages. The amounts of the mor tgages were in excess of
the Company’s internal investment policies for investments of that
nature; however, a business controlled by a senior executive of
the Company entered into agreements with the borrowers to fund
the mor tgages. The Company serviced these mor tgages during
their terms at normal commercial servicing rates. The mortgages
are administered by the Company at market rates and have a
balance of $21,627 as at December 31, 2010 [2009 – $5,483].
International Financial Reporting Standards [“IFRS”]
In February 2008, the Canadian Accounting Standards Board con-
firmed that all publicly accountable enterprises would be required
to report under IFRS for fiscal years beginning on or after January 1,
2011. These standards are effective for interim and annual financial
statements relating to fiscal years beginning on or after January 1,
2011 and will be applicable for the Company’s first quarter of 2011.
In preparation for the changeover to IFRS, the Company has
developed an IFRS transition plan consisting of three phases:
1. Scoping and Diagnostic Phase,
2. Impact Analysis and Design Phase, and
3. Implementation and Review Phase
Pursuant to the plan, an initial diagnostic impact assessment has
been completed to identify the IFRS standards that represent key
accounting differences from Canadian GAAP for the Company.
A number of differences have been identified with respect to the
recognition and measurement of certain balance sheet items. Based
on the preliminary analysis of IFRS 1, “First time Adoption of Inter-
national Financial Reporting Standards”, the Company has identified
the following significant exemptions that it expects to apply:
[i] IFRS 1 – Designation of previously recognized financial instru-
ments. This exemption provides the opportunity for the Com-
pany to designate some of the mor tgage pools out of the
held-for-trading category to loans and receivables, and offset
the income statement impact of the movement as a result of
changes in the fair value of their assets.
[ii] IFRS 1 – Derecognition of financial assets and financial liabili-
ties. This exemption is mainly applicable to the securitized assets
and allows the Company to apply the IAS 39 derecognition
requirements prospectively for transactions occurring on or
after January 1, 2004. That is, for any derecognized non-deriv-
ative financial assets and liabilities under the existing Canadian
GAAP before January 1, 2004, the Company will not have to
recognize these items under IFRS.
The Company has finished its detailed analysis of the impact of
the significant areas identified in phase one and phase two and has
made system changes to produce the financial information under
IFRS. The Company has also drafted the opening balance sheet
under IFRS as at December 31, 2009 and the comparative state-
ments of income and retained earnings and balance sheets for each
quarter of 2010.
FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT 59
Effectively, the Arrangement and the Amalgamation reorganized
the ownership interests in FNFLP such that all such interests will
be consolidated and held through the Corporation in the same
ratio as previously held by the Fund and FNFC, respectively.
The continuing publicly traded entity will be First National Financial
Corporation.
Issuance of preferred shares
On January 25, 2011, the Corporation issued 4 million Class A
Series 1 Preferred Shares at a price of $25.00 per share for gross
proceeds of $100,000, before issue expenses. Expenses of $2,470
related to the issuance have been recorded in capital stock, net of
income taxes recoverable of $868. The net proceeds of $96.7 mil-
lion from the issuance were paid down to FNFLP as a contribution
of partner capital.
Holders of the Series 1 Preferred Shares are entitled to receive
a cumulative quarterly fixed dividend yielding 4.65% annually for
the initial term ending March 31, 2016. Thereafter, the dividend rate
will be reset every five years at a rate equal to the 5-year Govern-
ment of Canada yield plus 2.07%.
Holders of Series 1 Preferred Shares have the right, at their
option, to convert their shares into Cumulative, Floating Rate Class
A Preference Shares, Series 2 [“Series 2 Preferred Shares”], subject
to certain conditions, on March 31, 2016 and on March 31 every
five years thereafter. Holders of the Series 2 Preferred Shares will
be entitled to receive cumulative quar terly floating dividends at
a rate equal to the 3-month Government of Canada Treasury Bill
yield plus 2.07%.
FIRST NATIONAL FINANCIAL LP
NOTES TO FINANCIAL STATEMENTS
The most significant change in accounting policy for the
Company is regarding revenue recognition, particularly for secu-
ritization transactions. Recently, the International Accounting
Standards Board has finalized its amended IFRS 1 that requires first-
time adopters to apply the derecognition requirements of IFRS
prospectively from the date of transition, rather than from January 1,
2004, unless certain conditions are met. The amendment is effective
from annual periods beginning on or after July 1, 2011. Accordingly,
the Company has decided to apply the “derecognition” account-
ing retrospectively to January 1, 2004. Depending on the volumes
of securitization transactions, the impact from the “derecognition”
varies from quarter to quarter. Generally, the first three quarters
featured large volumes of securitized mortgages and, accordingly,
large gains on securitization. These revenues will be eliminated
under IFRS and will be replaced with net interest rate spread
from previously recorded securitization transactions. Because the
Company has grown in the last five years and significantly increased
the extent of its own securitization, the reversal of the gain on
securitization revenue in these quarters is larger than the net inter-
est income now recorded such that net income under IFRS will
be lower. In the four th quar ter, the Company securitized lower
volumes of its origination so that IFRS will have a smaller effect on
that quarter’s restated net income.
NOTE 22
SUBSEQUENT EVENTS
Reorganization
Subsequent to year end, pursuant to a Plan of Arrangement
[the “Arrangement”] and an amalgamation [the “Amalgamation”]
effective January 1, 2011, the Fund was wound up and its invest-
ment in FNFLP was reorganized as follows:
• A new company [First National Financial Inc. [“FNFI”]] was
formed;
• Unitholders of the Fund exchanged 12,681,113 Units in the
Fund for Class A shares in FNFI on a one-for-one basis;
• The pre-Arrangement shareholders of FNFC exchanged their
shares in FNFC for 48,077,950 shares of FNFI with the result
that FNFC became a wholly-owned subsidiary of FNFI;
• The Fund and the Trust were wound up; and
• FNFC and FNFI were amalgamated and continued under the
name “First National Financial Corporation” [the “Corporation”].
60 FIRST NATIONAL FINANCIAL CORPORATION 2010 ANNUAL REPORT
I N V E S T O R I N F O R M AT I O N
CORPORATE
ADDRESS
SENIOR EXECUTIVES OF
FIRST NATIONAL FINANCIAL LP
INVESTOR RELATIONS CONTACTS
100 University Avenue
North Tower, Suite 700
Toronto, Ontario M5J 1V6
Phone: 416.593.1100
416.593.1900
Fax:
Robert Inglis
Chief Financial Officer
rob.inglis@firstnational.ca
Steve Wallace
Vice President
BarnesMcInerney Inc.
swallace@barnesmcinerney.com
INVESTOR RELATIONS WEBSITE
www.firstnational.ca
REGISTRAR AND TRANSFER AGENT
Computershare Investor Services Inc.
Toronto, Ontario
1.800.564.6253
EXCHANGE LISTING AND SYMBOL
TSX: FN
ANNUAL MEETING
May 4, 2011, 9 a.m. ET
TMX Broadcast & Conference Centre
The Gallery
The Exchange Tower
130 King Street West
Toronto, Ontario
Stephen Smith
Co-founder, Chairman & President
Moray Tawse
Co-founder & Vice President,
Mortgage Investments
Robert Inglis
Chief Financial Officer
Scott McKenzie
Vice President, Residential Mortgages
Jason Ellis
Managing Director, Capital Markets
Jeremy Wedgbury
Managing Director,
Commercial Mortgage Origination
Lisa White
Vice President, Mortgage Administration
Susan Biggar
General Counsel
LEGAL COUNSEL
Stikeman Elliott LLP
Toronto, Ontario
AUDITORS
Ernst & Young LLP
Toronto, Ontario
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