Delivering Service.
Creating Solutions.
Building Success.
2011 ANNUAL REPORT
Corporate Profile
First National Financial Corporation (TSX: FN) wholly owns
First National Financial LP, a Canadian-based originator, underwriter
and servicer of predominantly prime residential (single-family and
multi-unit) and commercial mortgages. With almost $60 billion in
mortgages under administration, First National is Canada’s largest
non-bank originator and underwriter of mortgages, and ranks among
the top three in market share in the growing mortgage broker
distribution channel.
2011 Performance at a Glance
FUNDING SOURCES
(for the year ended December 31, 2011)
REVENUE SOURCES PRIOR
TO FAIR VALUE LOSSES
(for the year ended December 31, 2011)
MORTGAGES UNDER
ADMINISTRATION
(for the year ended December 31, 2011)
B
B
A
C
A
C
A
DE
D
B
CD
A 45% Institutional placements
A 39% Institutional placements
A 79% Insured
B 13% CMB dealers
C 32% NHA–MBS
D 8% ABCP
E 2% Internal company resources
B 23% Net interest –
securitized mortgages
C 28% Mortgage servicing
B 13% Multi-unit and commercial
C 7% Conventional single-family
residential
D 10% Investment income
D 1% Bridge loans/Alt-A
92% Insured or conventional
single-family residential
Investment Highlights
> Canada’s largest non-bank mortgage originator
> Leader in high-growth mortgage broker distribution channel
> High-quality mortgage portfolio
> Diverse revenue and funding sources
MORTGAGES UNDER
ADMINISTRATION
(in $ billions)
MORTGAGE
ORIGINATIONS
(in $ billions)
REVENUE
(in $ millions)
EBITDA
(in $ millions)
.
6
9
5
3
.
3
5
8
.
7
4
.
9
1
1
.
9
0
1
8
.
1
51
.
0
1
.
8
1
1
.
6
0
4
.
1
3
3
.
0
4
6
4
3
.
4
9
3
7
.
1
4
3
.
0
4
9
2
.
0
9
3
2
2
.
5
6
21
.
1
3
1
.
6
6
0
1
.
0
0
1
1
.
1
4
7
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
12%
Year-over-year growth
2010 to 2011
12%
Year-over-year growth
2010 to 2011
18%
Year-over-year growth
2010 to 2011
19%
Year-over-year decline
2010 to 2011
Note:
2007–2009 under Canadian GAAP;
2010–2011 under IFRS
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
1
Message from the President
Fellow Shareholders
For First National Financial Corporation, 2011 was a year characterized
by solid financial and operational performance across all of our divisional
segments. The Company continued to increase its value with strategic
investments in future growth throughout the year. In 2011, we fully
leveraged our distribution channels as our volume of originations and mortgages
under administration hit record levels. The Company also transitioned to International
Financial Reporting Standards (IFRS).
Throughout the year, the Canadian real estate market remained
Since First National was formed in 1988, the Company has
strong and First National was able to capitalize on these robust
earned a reputation as a high-quality ser vice provider and
conditions to originate and ser vice near-record levels of
market leader in the residential and commercial mor tgage
new mortgages in our residential, multi-unit and commercial
lending sectors. For more than 23 years, we have met the
segments. With a greater capital base resulting from our
mortgage needs of a growing number of Canadian property
preferred share issue early in the year, we took advantage of
owners by building strong relationships within the commercial
these increased origination levels by securitizing more than
real estate and residential broker communities. These strategic
$4 billion in mor tgages, which will continue to benefit the
relationships allow us to build our customer base, drive our
Company for the five- and 10-year terms of these transactions.
growth and profitability and further strengthen our leadership
The Company’s improved
financial performance in 2011
was due to our consistent
growth-oriented strategy, a high-
performing team and commitment
to operational excellence.
position in this increasingly competitive marketplace.
Record Financial Performance
In 2011, First National achieved strong financial and operational
results in the following key performance metrics:
• Mortgages under administration increased 12% year-over-
year to $59.6 billion;
• Revenue grew to $464.0 million from $394.3 million
in 2010, reflecting the increased interest revenue on
securitized mortgages;
•
Income before income taxes decreased 19% to $96.8 million
from $120.0 million in 2010;
2
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
• EBITDA decreased to $106.6 million in 2011 from
We are very pleased with origination volumes and mortgages
$131.2 million compared to the previous year; and
under administration levels reached in 2011, and anticipate overall
• The Company paid out dividends at $1.25 per share
volumes to remain at comparable levels in 2012 and beyond.
during the year, which represents an increase of 16% over
the tax-effected regular distribution of the Corporation’s
With a solid capital base and a strong balance sheet, First
predecessor (First National Financial Income Fund) in 2010.
National is well positioned to grow our market share and
Together with payments on account of income tax, the
increase profitability, allowing us to deliver solid and reliable
Company paid out $108.0 million in 2011, or $18.1 million
returns to our shareholders. We will continue to enhance
more than in 2010, on a tax-equivalent basis.
our operations, products and services while leveraging our
The First National Management Team
Left to right: Susan Biggar, General Counsel; Jason Ellis, Managing Director, Capital Markets; Jeremy Wedgbury, Managing Director,
Commercial Mortgage Origination; Stephen Smith, Chairman and President; Moray Tawse, Vice President, Mortgage Investments;
Robert Inglis, Chief Financial Officer; Lisa White, Vice President, Mortgage Administration; Scott McKenzie, Vice President,
Residential Mortgages
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
3
Message from the President
leadership position within the mor tgage broker distribution
Looking back over the history of our Company, a great deal
channel to better meet the needs of all of our stakeholders.
of our success can be attributed to the experience and
A Passion for Growth
First National’s success has been building for 23 years, and our
effectiveness of the management team. Each member is
committed to contributing to First National’s strong business
performance and future growth. Over the past several years,
focus is still on growth. The Company was founded in 1988
our team has played a key role in propelling us forward to
by Moray Tawse and myself when the securitization market
realize our vision and consolidate our position as the leading
was just developing. At that time, the mortgage broker channel
non-bank mortgage lender in the industry.
accounted for just 3% of the market. Today, brokers account for
approximately 30% of the mortgage financing in Canada.
We are most fortunate to have a dedicated group of employees
From the very beginning, we placed a high priority on service
building on its success and growing in the future. A number of
and a commitment to assist brokers in efficiently meeting the
our staff members have been part of the First National family
needs of clients. This was coupled with our strongly held belief
since we started this business more than 20 years ago, and both
that investing in leading-edge technology would enable us to
Moray and I take great pride in that they have remained with us.
who believe in this Company and who are committed to
deliver on this commitment. These two objectives were realized
together through the development of MERLIN, a proprietary
mortgage approval and tracking system.
Industry Developments
As a result of the market turmoil in 2011, the large Canadian
banks increased mortgage spreads in order to raise profitability
With the growth of Canada’s real estate markets and the
on these assets. This was most evident in the fourth quarter, as
accompanying need for mor tgages, First National expanded
floating-rate single-family mortgages that had been priced at a
its operations to meet the growing demand. The Company
0.70% discount to the prime rate in the summer were offered
opened an office in Vancouver in 1991, and subsequent offices
at no discount to prime. Similarly, fixed-rate mortgages were
in Calgary and Montreal, to establish a presence in Canada’s key
priced so as to increase spreads to a range of 1.75% to 2.00%.
regional markets. With our conservative, disciplined approach to
These increases enabled First National’s securitization activities
underwriting, our record of superior service and administrative
to be more profitable.
capabilities, large institutions started looking to us to originate
mortgage product.
First National’s consistent year-over-year growth has consolidated our
position as the market leader in non-bank mortgage lending.
4
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
In addition, Canada’s large banks also made the transition
These proven strategies will continue to deliver strong results
to IFRS this year. Together with increased capital requirements
and business growth, allowing First National to further extend
from Basel 3, there will be little incentive for the banks to
our solid record of returns to our shareholders as the Company
decrease spreads. First National has seen competitors exit
builds on its strengths and consolidates its position as a leading
the market or slow down origination in the face of higher
mortgage lender.
capital requirements for securitization, a direct consequence
of these changes.
Outlook
As we proceed through 2012, the Company forecasts that
I am proud of the financial and operational achievements we
recorded in 2011, and look forward to the further growth of our
business in 2012 and beyond. I’d like to thank our Board members
for their guidance throughout the year, our shareholders for their
mor tgages under administration will continue to grow and
continued support, the management team and our employees
produce higher income and cash flow. The wider mor tgage
once again for their hard work and contributions, as well as
spreads on our core products – prime mortgages – will give First
our customers for their loyalty and support. Going forward,
National the oppor tunity to continue to securitize directly,
First National will continue to grow our established brand and
retaining a large part of the economics of origination.
outperform the market by doing what we do best – delivering
service, creating solutions and building success.
With our large investment in the portfolio of mortgages under
securitization and servicing por tfolio at the end of this past
Sincerely,
year, First National expects increased cash flow and profitability
going forward.
Looking Ahead
First National will continue to operate according to our four
key strategies for ongoing success, including:
• Providing a full range of mortgage solutions;
• Growing assets under administration;
• Employing leading-edge technology to lower costs and
rationalize business processes; and
• Maintaining a conservative risk profile.
Stephen Smith
Chairman and President
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
5
Our philosophy is unique in its simplicity:
we deliver service, create solutions and
build success.
Through a combination of our innovative
mortgage solutions, MERLIN – our
industry-leading mortgage approval and
tracking system – and our team of experts,
First National has earned the trust of
mortgage brokers, commercial clients
as well as residential customers.
These strong relationships are thanks to
our unwavering commitment to delivering
excellent service – a commitment shared
by senior management and every
member of the First National team.
Delivering Service.
We are committed to providing industry-leading service
across all areas of our business. First National offers fast
turnaround times for mortgage applications. Commercial
clients often receive their mortgage commitment documents
in as little as seven days, while mortgage brokers often
receive responses to their submissions within four hours.
In independent surveys, First National is continually
ranked #1 by mortgage brokers for exceptional service.
“First National has a very flexible approach.
They look at each deal with a ‘can-do’ attitude
and creative thinking.”
– A.K., Senior Vice President, Finance
Additionally, homeowners have
access to our experienced team
of customer care agents and their
own personalized mortgage
management tool,
My Mortgage, online
or by phone.
“My needs have been met with awesome,
courteous, and seamless service. I received the
best customer service that I have had for as
long as I can remember.”
– K.P., Dartmouth, NS
6
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Creating Solutions.
Building Success.
At First National, we put all of our resources and expertise
behind the development, administration and servicing of
mortgage solutions.
Each commercial mortgage inquiry starts with a professional
mortgage consultation and analysis. A First National commercial
mortgage expert will analyze the client’s needs and develop a
customized proposal detailing the loan strategy, preferred terms,
best rate solution and optimum financing recommendation.
“First National’s product line-up provides us with flexible
financing solutions that allow us to focus on the
enhancement of our properties.”
– B.D., President and CEO
Residential mortgage brokers have access to a wide range
of mortgage solutions, flexible payment terms and prepayment
privileges to suit just about any lifestyle.
MERLIN, First National’s exclusive
industry-leading online mortgage
approval and tracking system, ensures
mortgage brokers stay connected to
the status of their deal, so they can exceed customers’
expectations and maximize their operational efficiencies.
“First National continues to be the industry standard
with their customer-driven technology – MERLIN.”
– J.S., Winnipeg, MB
For many Canadians, buying their first home is a dream.
Whether our homebuyers are new to Canada, self-employed
or making their first purchase, together with their mortgage
broker, we are all committed to helping them make this
dream come true as easily and worry-free as possible.
“I appreciate speaking with a real person. I also
find your staff courteous and helpful. You took
the time to explain my options, allowing me
to choose the best plan.”
– S.B., Ottawa, ON
Time and time again, mortgage brokers tell us that a key
component of excellent service is fast turnaround times so
that they can differentiate themselves from the competition.
First National responds to 90% of mortgage broker
submissions in less than four hours.
“Anyone looking to become a leader in the broker
industry should consider First National as their
lender of choice.”
– D.I., Toronto, ON
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
7
Financial Reporting
Table of Contents
Management’s Discussion and Analysis
Financial Statements
9 General Description of the Company
29 Management’s Responsibility for Financial Reporting
9 Basis of Presentation
30
Independent Auditors’ Report
10 Restatement of Comparative Figures
31 Consolidated Statements of Financial Position
13 2011 Results Summary
32 Consolidated Statements of Comprehensive Income
13 Outstanding Securities of the Corporation
and Retained Earnings
13 Selected Quarterly Information
33 Consolidated Statements of Changes in Shareholders’ Equity
14
Selected Annual Financial Information
34 Consolidated Statements of Cash Flows
for the Company’s Fiscal Year
35 Notes to Consolidated Financial Statements
15 Vision and Strategy
15 Key Performance Drivers
Growth in Portfolio of Mortgages under Administration
Growth in Origination of Higher Margin Mortgages
Lowering Costs of Operations
16 Employing Innovative Securitization Transactions
to Minimize Funding Costs
16 Key Performance Indicators
17 Determination of Adjusted Cash Flow and Payout Ratio
18 Revenues and Funding Sources
19 Results of Operations
22 Operating Segment Review
Residential Segment
Commercial Segment
23 Liquidity and Capital Resources
24 Financial Instruments and Risk Management
25 Capital Expenditures
25 Summary of Contractual Obligations
26 Critical Accounting Policies and Estimates
26 Future Accounting Changes
27 Risk and Uncertainties Affecting the Business
28 Forward-Looking Information
28 Outlook
8
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Management’s Discussion and Analysis
The following management’s discussion and analysis of financial condition
and results of operations is prepared as of February 28, 2012. This discus-
sion should be read in conjunction with the audited consolidated financial
statements of First National Financial Corporation (the “Company” or “Cor-
poration” or “First National”) as at and for the year ended December 31,
2011 and the notes thereto. This discussion should also be read in conjunc-
tion with the audited consolidated financial statements and notes thereto
of the Company’s predecessor, First National Financial Income Fund, and
First National Financial LP (“FNFLP”) for the year ended Decem ber 31,
2010. The audited consolidated financial statements of the Company have
been prepared in accordance with International Financial Reporting
Standards (“IFRS”).
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 infor-
mation and discussion below also refer to certain measures to assist in
assessing financial performance. These other measures such as “EBITDA”,
“Adjusted Cash Flow”, and “Adjusted Cash Flow per Unit” should not be
construed as alternatives to net income or loss or other comparable mea-
sures determined in accordance with IFRS as an indicator of performance
or as a measure of liquidity and cash flow. These measures do not have
standard meanings prescribed by IFRS and therefore may not be compa-
rable to similar measures presented by other issuers.
Unless otherwise noted, tabular amounts are in thousands of
Canadian dollars.
Additional information relating to the Corporation and FNFLP is avail-
able in the Corporation’s profile on the System for Electronic Data Analysis
and Retrieval (“SEDAR”) website at www.sedar.com.
General Description of the Company
First National Financial Corporation is the parent company of First
National Financial LP, a Canadian-based originator, underwriter and
servicer of predominantly prime residential (single family and multi-
unit) and commercial mortgages. With over $59 billion in mortgages
under administration (“MUA”), First National is Canada’s largest non-
bank originator and underwriter of mortgages and is among the top
three in market share in the growing mor tgage broker distribution
channel. Pursuant to a Plan of Arrangement (the “Arrangement”) and
an amalgamation (the “Amalgamation”) effective January 1, 2011, First
National Financial Corporation succeeded First National Financial
Income Fund (the “Fund”) as the public holding company invested
in FNFLP. The Arrangement and Amalgamation (together, the “Con-
version”) were used to convert the Fund into a corporate structure.
The most significant steps involved in the Conversion were:
• A new company, First National Financial Inc. (“FNFI”) was formed;
• Unitholders of the Fund exchanged their 12,681,113 units in the
Fund for shares in FNFI on a one-for-one basis;
• The pre-Arrangement shareholders of the Corporation (the
“Co-founders”) exchanged 47,286,316 shares in the Corporation
for 47,286,316 shares of FNFI with the result that the Corporation
became a wholly-owned subsidiary of FNFI;
• The Fund and First National Financial Operating Trust were wound
up; and
• The Corporation and FNFI were amalgamated and continued
under the name “First National Financial Corporation”.
Basis of Presentation
The financial statements of the Corporation are prepared in accor-
dance with IFRS. Effectively, the Conversion reorganized the ownership
interests in FNFLP such that all such interests are now consolidated
and held through the Corporation in the same ratio as previously held
by the Fund and by the Co-founders. Prior to the initial public offering
of the Fund (the “IPO”) in June 2006, the Corporation owned and
operated the business of First National. Concurrent with the IPO,
the business of First National was transferred from the Corporation
to FNFLP such that the Corporation then operated as a privately held
holding company which owned a direct interest of 80.03% in FNFLP.
At that time, the Fund indirectly held a 19.97% non-controlling inter-
est in FNFLP. Given that the Conversion does not involve any arm’s-
length transactions at fair market value, the Corporation has
accounted for these transactions under the concept of a pooling of
interests under common control. Accordingly, the Corporation’s finan-
cial statements reflect the combined activities of the Fund and the
Corporation prior to the Arrangement (including the consolidation of
FNFLP). Immediately prior to the Arrangement, residual assets and lia-
bilities of the Corporation were distributed and settled so that as of
the Arrangement date, the consolidated balance sheet of the Corpo-
ration substantially reflects the assets and liabilities of FNFLP at carry-
ing value, plus the intangible assets represented by the excess of the
purchase price paid by the Fund over the carrying value of its share of
the net assets of FNFLP at the IPO date and the deferred tax liabilities
related to temporary differences between the book and tax basis of
the carrying value of the Fund’s investment in FNFLP. In effect this
accounting treatment assumes, for comparative financial repor ting
purposes, that the Conversion occurred at the time of the IPO.
As all significant revenue earned by the Corporation in 2010 came
from its investment in FNFLP, the effect on the comparative earnings is
minimal; however, to the extent the Corporation earned revenue and
incurred expenses, these are recorded in the 2010 comparative fig-
ures. The Co-founders have provided indemnities to the Corporation
to protect the current shareholders of the Corporation from any
unrecorded liabilities incurred and unpaid by the Corporation in the
period between the IPO and January 1, 2011. Accordingly, the prior
year’s comparative figures have been restated to account for both the
Conversion and IFRS.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
9
Restatement of Comparative Figures
Conversion to a corporation
Prior to the Conversion, the Fund was the public entity with an invest-
ment in FNFLP, the operating entity. It accounted for its investment in
FNFLP using the equity method, effectively consolidating the results of
FNFLP in one line of equity pick up. Because of the limited usefulness of
this financial reporting, the Company made public the results of FNFLP
on a stand-alone basis ever y repor ting period. Now that FNFLP
is wholly-owned by the publicly traded corporation, its assets, liabilities
and results will be consolidated at the reporting issuer level, and pre-
sentation of separate financial information for FNFLP will no longer be
necessary. In order to present appropriate comparative information,
the Company will restate the 2010 results and year end balances for
FNFLP and the Fund as if FNFLP had been consolidated with the Fund
and the Corporation since the IPO. This restatement is summarized
below. The table takes the historical balance sheet of FNFLP as at
December 31, 2010 and the income statement for the year ended
December 31, 2010, and adjusts for values historically accounted for at
the Fund level and the financial position and results of operations of
the Corporation for the same periods. In particular, these adjustments
per tain to $65.0 million of intangible assets (ser vicing rights and
broker relationships) and $29.8 million of goodwill which the Fund re-
corded on the IPO, and deferred tax liabilities of $57.8 million related
to tax temporary differences embedded in the carrying value of the
Fund’s investment in FNFLP. As at December 31, 2010, the net book
value of the intangible assets was $32.5 million as these assets have
been amortized since the IPO.
Restatement of FNFLP’s 2010 financial results pursuant to the Conversion
($000s)
First National
Financial LP
as previously
presented
December 31
2010
$ 1,149,082
–
–
$ 1,149,082
$ 887,722
–
887,722
261,360
As restated for
First National
Financial Corporation
pursuant to the
Conversion
December 31
2010
$ 1,149,083
32,499
29,776
$ 1,211,358
$ 848,929
43,661
892,590
318,768
Conversion
adjustments
$
$
$
1
32,499
29,776
62,276
(38,793)
43,661
4,868
57,408
$ 1,149,082
$
62,276
$ 1,211,358
Year ended
December 31
2010
$ 343,214
(181,787)
–
161,427
–
Year ended
December 31
2010
$ 343,316
(183,230)
(9,468)
150,618
(30,040)
$
102
(1,443)
(9,468)
(10,809)
(30,040)
$ 161,427
$
(40,849)
$ 120,578
Balance sheet
Operating assets
Intangible assets
Goodwill
Total assets
Operating liabilities
Tax liabilities
Total liabilities
Equity
Total liabilities and equity
Income statement
Revenue
Expenses – operating
– amortization
Income before taxes
Provision for taxes
Net income for the period
10
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS
Transition to IFRS
In January 2006, the Canadian Accounting Standards Board announced
its decision requiring all publicly accountable entities to report under
IFRS. This decision established standards for financial reporting with in-
creased clarity and consistency in the global marketplace. These stan-
dards are effective for interim and annual financial statements relating
to fiscal years beginning on or after January 1, 2011 and are applicable
beginning with the Company’s first quarter of 2011. For the Company,
this has meant a significant change in its accounting policy regarding
revenue recognition, particularly in accounting for securitization trans-
actions. Under Canadian GAAP, the Company’s securitizations were
considered “true sales” for accounting purposes such that the Com-
pany recorded gains on securitization when these mor tgages were
sold to various securitization conduits. Under IFRS, these securitiza-
tions do not meet the definition of a “true sale” and instead are
accounted for as secured financings. Accordingly, the Company’s secu-
ritizations (through ABCP conduits, National Housing Act – Mortgage
Backed Securities (“NHA–MBS”) and direct Canada Mortgage Bonds
(“CMB”) issuance) do not qualify for sale accounting. Its deferred
placement transactions will continue to meet the criteria for off-
balance sheet treatment as the risks and rewards associated with the
ownership of these mor tgages have been transferred to an arm’s-
length institution.
The Company has restated its comparative 2010 financial state-
ments as if IFRS accounting standards had been applied retroactively.
This restatement eliminates all securitization receivables as at Decem-
ber 31, 2009, and puts these mortgages back on the Company’s bal-
ance sheet together with securitization debt related to these
transactions. The restated balance sheet under IFRS as at Decem-
ber 31, 2010 has a number of significant changes. As well as the rever-
sal of the securitization receivables, the balance sheet also features:
1) An increase in the amount of the Company’s mortgage assets by
approximately $7.2 billion; 2) An increase of $0.2 billion in restricted
cash representing principal received on these mortgages in December
2010 and held in trust until the subsequent month; 3) An increase of
the Company’s liabilities by an amount of $7.3 billion for notes payable
associated with the securitized assets; 4) A decrease in deferred tax
liabilities of $23.1 million, as the net tax-related temporary difference
associated with securitization receivables has been reduced; and 5) A
decrease in opening equity of $61.6 million, primarily reflecting the
after-tax effect of reversing previously recognized securitization gains.
The increase in mortgage assets also includes the addition of approxi-
mately $47 million of unamortized deferred origination costs, primarily
broker fees, which had been expensed under Canadian GAAP. The
deferred origination costs will be amortized against interest revenue
on the securitized mortgage portfolio over the term of the mortgages
on an effective yield basis.
The Company has also disclosed a restated statement of income
under IFRS for the third quarter of 2010. Generally this quarter fea-
tured large volumes of securitized mortgages and, accordingly, under
Canadian GAAP large gains on securitization were recorded. These rev-
enues are reversed under IFRS and are replaced with the net interest
margin from previously recorded securitization transactions.
In July 2010, the IFRS Interpretations Committee issued a staff
paper which described their discussion of cer tain 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 occur-
ring after January 1, 2004. The Committee recommended that 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 into IFRS with an effective
date of June 2011. The Company has chosen not to early adopt this
standard and has accounted for the transition with retroactive applica-
tion to January 1, 2004. The Company believes that to adopt this new
standard would result in inconsistent financial information being
presented, particularly on the balance sheet.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
11
MANAGEMENT’S DISCUSSION AND ANALYSIS
The table below restates the 2010 results, as restated above for the Conversion, under IFRS.
Restatement of FNFC’s 2010 financial results pursuant to IFRS
($000s)
Balance sheet
Mortgages pledged under securitization
Securitization receivable
Other operating assets
Intangible assets
Goodwill
Total assets
Debt related to securitized mortgages
Operating liabilities
Tax liabilities
Total liabilities
Equity
Total liabilities and equity
Income statement
Revenue – gain on securitization
– other
Expenses – operating
– amortization
Income before taxes
Provision for taxes
Net income for the period
As restated for
First National
Financial Corporation
pursuant to the
Conversion
December 31
2010
$
–
157,443
991,640
32,499
29,776
$ 1,211,358
$
–
848,929
43,661
892,590
318,768
IFRS
adjustments
$ 7,193,961
(157,443)
156,117
–
–
$ 7,192,635
$ 7,274,482
2,745
–
7,277,227
(84,592)
$ 1,211,358
$ 7,192,635
Year ended
December 31
2010
$
60,227
283,089
(183,230)
(9,468)
150,618
(30,040)
$
(60,227)
111,170
(81,604)
–
(30,661)
–
As restated for
First National
Financial Corporation
pursuant to
IFRS
December 31
2010
$ 7,193,961
–
1,147,757
32,499
29,776
$ 8,403,993
$ 7,274,482
851,674
43,661
8,169,817
234,176
$ 8,403,993
Year ended
December 31
2010
$
–
394,259
(264,834)
(9,468)
119,957
(30,040)
$ 120,578
$
(30,661)
$
89,917
12
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS
2011 Results Summary
The Company was pleased with its operational results for 2011, includ-
ing its transformation from an income trust to a dividend-paying cor-
poration and the adoption of IFRS. Although its financial results were
not as strong as the comparative results from 2010, the decrease in
profitability pertains primarily to adverse capital markets conditions
experienced in the third and fourth quarters. In 2011 First National
continued to build its portfolio of mortgages pledged under securitiza-
tion, increased overall origination volumes, and grew both net interest
margin and mortgage servicing revenue. Mortgages under administra-
tion continued to grow and the Company financed more mortgages
directly with the CMB program.
• MUA grew to $59.6 billion at December 31, 2011 from $53.3 bil-
lion at December 31, 2010, an annualized increase of 12%; the
growth from September 30, 2011, when mortgages under adminis-
tration were $58.0 billion, was 2.8%, an annualized increase of 11%;
• The Canadian single-family real estate market proved resilient
despite continued economic concerns and volatile capital markets.
In 2011 single-family mortgage originations for the Company in-
creased by 9% to $9.1 billion from $8.3 billion in 2010. The com-
mercial segment recorded even greater growth as volumes
increased by 23% to $2.7 billion from $2.2 billion in 2010;
• The Company securitized a significant por tion of its mor tgage
origination in the CMB program in the year : $498 million in the
10-year program and $1.2 billion in the five-year term programs;
• Revenue for the year ended December 31, 2011 increased to
$464.0 million from $394.3 million in 2010. The growth of 18% is
reflective of the increased interest revenue on securitized mort-
gages, particularly floating rate mortgages indexed to the prime
rate, which increased by 16% from an average of 2.58% in 2010 to
3.00% for 2011. Higher mor tgage servicing revenue, placement
fees and mor tgage investment income offset the large negative
charge recorded for losses on financial instruments;
• The Company’s hedging program, while appropriate, accounted
for $31.0 million of the net losses on financial instruments of
$18.5 million. From an economic perspective, these losses are
largely offset by higher values attributable to the hedged mortgages,
which will be recognized in earnings over the five- and 10-year
terms of the mortgages;
• Income before income taxes decreased by 19.3% from $120.0 mil-
lion in 2010 to $96.8 million in 2011. This decrease is due to vola-
tile debt markets in the year which negatively affected the
Company’s interest rate hedges. Despite this charge, the year pro-
duced steady and growing income from the Company’s securitized
mortgage and servicing portfolios;
• EBITDA decreased by 18.8% from $131.2 million in 2010 to
$106.6 million in 2011 due to the same factors cited above for
income before income taxes; and
• Dividends declared to common shareholders in 2011 increased
16% compared to tax-equivalent regular monthly distributions
declared by the Fund in 2010.
The Company celebrated its five-year anniversary as a public entity
after listing on the Toronto Stock Exchange (“TSX”) on June 15, 2006.
During those five and a half years to December 31, 2011, the Com-
pany paid out $459 million in distributions and dividends to unithold-
ers and shareholders. This represents a pre-tax return of 77% on the
IPO price of $10 per unit. With the appreciation of the value of the
Company since the IPO, original unitholders have earned a total pre-
tax return of over 150% (at the year-end share price) on the IPO
investment.
Outstanding Securities of the Corporation
At December 31, 2011 and February 28, 2012, the Corporation had
59,967,429 common shares, 4,000,000 Series 1, Class A preference
shares and 175,000 debentures outstanding.
Selected Quarterly Information
Quarterly results of First National Financial Corporation
($000s, except per share amounts)
Net
income
per
common
share
(unit)
Net
income
for the
period
Revenue
Total assets
2011
$ 118,121 $ 17,687 $ 0.27 $ 11,927,270
Fourth quarter
Third quarter
$ 115,522 $ 12,107 $ 0.18 $ 10,754,813
Second quarter $ 121,579 $ 20,197 $ 0.32 $ 9,948,118
$ 108,798 $ 20,500 $ 0.33 $ 9,261,178
First quarter
2010 (1)
Fourth quarter
Third quarter
Second quarter
First quarter
$ 116,011 $ 25,580 $ 0.43 $ 8,404,005
$ 105,238 $ 22,161 $ 0.37 $ 8,330,026
$ 90,411 $ 19,537 $ 0.32 $ 7,975,198
$ 82,599 $ 22,639 $ 0.38 $ 7,338,226
(1) 2010 figures have been restated to present comparative information to
account for the Conversion and IFRS.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
13
MANAGEMENT’S DISCUSSION AND ANALYSIS
Given First National’s large amount of MUA and portfolio of mort-
gages pledged under securitization, quar terly revenue under IFRS is
driven primarily by mortgage servicing revenue growth, and changing
mortgage interest rates on mortgages pledged under securitization.
Servicing will change as the portfolio of mortgages grows or contracts;
however, the gross interest on the mortgage portfolio is significantly
linked to the prime lending rate as the Company has pledged several
billion dollars of floating rate mortgages to the NHA–MBS program.
Prior to IFRS, revenue was more dependent on quarterly origination
volumes and one-time securitization gains. Revenue beginning in the
first quarter of 2010 onwards reflects the trend of the growing MUA
and prime lending rate hikes experienced throughout 2010. The prime
rate averaged 2.58% in 2010 but was 3.00% for all of 2011, an increase
of 16%. In the third quar ter of 2011, and to a lesser extent in the
four th quar ter, the Company was affected by volatile conditions in
the debt markets and its revenue was reduced by $17.4 million and
$8.4 million respectively, attributable to losses in the market value of
financial instruments related to its interest rate hedging program.
This issue also affected net income, which was decreased in aggregate
for the quarters by approximately $15.9 million on an after-tax basis.
During the eight quarters described above, except for the third and
fourth quarters of 2011, mortgage spreads tightened steadily as Cana-
dian capital markets returned to historical norms following the credit
turmoil of 2008. This trend is evident in net income figures except for
the fourth quarter of 2010, when the Company reduced the amount
of mor tgages originated for its securitization program and earned
increased upfront placement fee revenue, and in the third and fourth
quarters of 2011, when large mark-to-market adjustments on financial
instruments reduced earnings. Total assets have grown steadily as the
Company has taken advantage of securitization opportunities in order
to grow its mortgage assets pledged under securitization.
Selected Annual Financial Information for the Company’s Fiscal Year
($000s, except per share/unit amounts)
For the year then ended
Income statement highlights
Revenue
Interest expense – securitized mortgages
Brokerage fees
Other operating expenses
EBITDA (1)
Amortization of capital assets
Amortization of intangible assets
Provision for income taxes
Net Income
Dividends/distributions declared
Per share/unit highlights
Net income per unit/common share
Dividends/distributions declared per common share/unit
At year end
Balance sheet highlights
Total assets
Total long-term financial liabilities
December 31
2011
December 31
2010 (2)
December 31
2009 (2)
$
464,020
(184,291)
(81,480)
(91,642)
106,607
(1,856)
(7,968)
(26,292)
70,491
109,022
1.10
1.25
$
394,259
(112,530)
(70,718)
(81,586)
131,221
(1,796)
(9,468)
(30,040)
89,917
89,623
1.50
1.49
$ 341,716
–
(98,677)
(77,807)
165,232
(1,749)
–
–
163,483
86,953
2.73
1.45
11,927,270
8,403,993
$
184,689
$
178,849
1,067,690
$
–
(1) EBITDA is not a recognized earnings measure under IFRS and does not have a standardized meaning prescribed by IFRS. 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 IFRS 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.
(2) Information for 2010 has been restated to conform to presentation under IFRS and for the Conversion. Information for 2009 has been presented using
historical figures for FNFLP under Canadian GAAP.
14
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS
Vision and Strategy
Growth in Origination of
Higher Margin Mortgages
The Company provides mortgage financing solutions to virtually the
entire mortgage market in Canada. By offering a full range of mort-
gage products, with a focus on customer service and superior technol-
ogy, the Company believes that it is the leading non-bank mortgage
lender in the industry. Growth has been achieved while maintaining a
relatively conservative risk profile. The Company intends to continue
leveraging these strengths to lead the “non-bank” mortgage 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 administration;
employing leading-edge technology to lower costs and rationalize
business processes; and maintaining a conservative risk profile. An im-
portant element 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 bor-
rowers 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 mortgage. Through this relationship, the Com-
pany 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.
The Company’s main focus has always been on the prime single-family
mor tgage market. Prior to 2008, when the capital markets experi-
enced some significant turbulence, these mortgages had tight spreads
such that the Company’s strategy was to sell these mor tgages 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 2010, much of the turmoil in the capital markets had
waned and mor tgage spreads returned to modest premiums over
pre-crisis levels. This is most evident for five-year fixed rate single-family
mor tgage rates compared to similar-term Government of Canada
bonds. Prior to 2008, this comparison showed spreads of approxi-
mately 1.25%. With the credit crisis, these spreads reached as high as
3.00% in 2008. Between 2009 and mid 2011, spreads gradually tight-
ened as liquidity issues at financial institutions diminished and the com-
petition for mor tgages increased such that at June 30, 2011, these
mortgage spreads were at 1.46%. This changed with the United States
credit rating downgrade and continuing global economic turmoil. Risk-
free interest rates plummeted in the third quarter of 2011 and much
like 2008, as bond yields dropped, mortgage rates remained constant
such that the spread widened significantly. By the end of December
2011, the five-year spread was approximately 2.10%. In 2011, the
Company has chosen to securitize a larger portion of its originations,
both in the single-family and multi-family segments, to take advantage
of these higher spreads. For all of 2011, the Company originated for
securitization approximately $2.8 billion of single-family mortgages and
$1.2 billion of fixed multi-residential mor tgages in order to take
advantage of these wider spreads. In the year, the Company securi-
tized approximately $1.1 billion of floating rate single-family mortgages,
$833 million of fixed single-family mortgages and over $1 billion of
fixed multi-residential mortgages.
Growth in Portfolio of Mortgages
under Administration
Lowering Costs of Operations
Management considers the growth in MUA to be a key element of
the Company’s performance. The por tfolio grows in two ways:
through mortgages originated by the Company and through mortgage
servicing portfolios purchased from third parties. Mortgage origina-
tions not only drive placement and securitization revenues, but,
perhaps more importantly, longer term values such as servicing fees,
mortgage administration fees, renewal opportunities and growth in
customer base for marketing initiatives. As at December 31, 2011,
MUA totalled $59.6 billion, up from $53.3 billion at December 31,
2010, a rate of increase of 12%. This compares to $58.0 billion at
September 30, 2011, representing a quarter-over-quarter increase of
2.8% and an annualized increase of 11%.
Innovation of systems and technology
The Company has always used technology to provide for efficient and
effective operations. This is particularly true for its MERLIN underwrit-
ing system, Canada’s only web-based real-time broker information sys-
tem. By creating a paperless, 24/7-available commitment 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 Com-
pany issues that actually become closed mortgages).
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
15
MANAGEMENT’S DISCUSSION AND ANALYSIS
Preferred share issuance
On January 25, 2011, the Company issued 4,000,000 Series 1 Class A
preference shares for gross proceeds of $100 million. The Company
received net proceeds of $97.4 million after issuance costs net of de-
ferred tax assets of $0.9 million. 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 discretion 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 relevant
Government of Canada bond. While the investors in these shares
have an option on each five-year anniversary to convert their Series 1
holdings into Series 2 preference shares (which pay floating rate divi-
dends), there are no redemption options for these shareholders.
As such, the Company considers these shares to represent a perma-
nent source of capital and classifies the shares as equity on its balance
sheet. Management believes this capital will give the Company the
opportunity to pursue its strategy of increased securitization, which
requires upfront investment.
Employing Innovative Securitization
Transactions to Minimize Funding Costs
Approval as both an issuer of NHA–MBS and
seller to the Canada Mortgage Bonds program
The Company has been involved in the issuance of 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 Mortgage and Housing Corporation (“CMHC”) as an issuer
of NHA–MBS and as a seller into the CMB program. Issuer status has
provided the Company with a funding source that it can access inde-
pendently. Perhaps more importantly, seller status for the CMB gives
the Company direct access to the CMB. Generally, the demand for
high-quality fixed and floating rate investments increased significantly
with the turmoil in 2009. This demand has continued into 2011 and
allowed the Company to securitize almost $3 billion of mor tgages
through the NHA–MBS program during the year, including $872 million
in the fourth quarter.
Canada Mortgage Bonds program
The CMB program is an initiative sponsored by CMHC whereby the
Canada Housing Trust (“CHT”) issues securities to investors in the
form of semi-annual interest-yielding five- and 10-year bonds. The pro-
ceeds of these bonds are used to buy NHA–MBS. In previous years,
the Company entered into an agreement with a Canadian bank that
allowed the Company to indirectly sell a portion of the Com pany’s
residential mortgage origination into several CMB issuances. Subse-
quently, 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- and 10-year unamortizing terms and a federal government
guarantee), the CMB trades in the capital markets at a modest premi-
um to the yields on Government of Canada bonds. The 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
amortize 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 seller s for lar ger 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 quar ter. The Company is
also subject to these limitations.
Key Performance Indicators
The principal indicators used to measure the Company’s perfor-
mance are:
• Earnings before income taxes, depreciation and amor tization
(“EBITDA”); and
• Adjusted cash flow from operations (“Adjusted Cash Flow”).
EBITDA is not a recognized measure under IFRS. However, manage-
ment believes that EBITDA is a useful measure that provides investors
with an indication of cash income prior to capital expenditures.
EBITDA should not be construed as an alternative to net income de-
termined in accordance with IFRS or to cash flows from operating,
investing and financing activities. The Company’s method of calculating
EBITDA may differ from other issuers and, accordingly, EBITDA may
not be comparable to measures used by other issuers.
16
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS ($000s)
For the period
Revenue
Income before income taxes
EBITDA (1)
At period end
Total assets
Mortgages under administration
Quarter ended
Year ended
December 31
2011
December 31
2010 (2)
December 31
2011
December 31
2010 (2)
$ 118,121
24,287
26,347
$ 116,011
33,029
35,938
$ 464,020
96,783
106,607
$ 394,259
119,957
131,221
11,927,270
59,598,596
8,403,993
53,293,132
11,927,270
59,598,596
8,403,993
53,293,132
(1) This non-IFRS measure adjusts income before income taxes by adding back expenses for amortization of intangible and capital assets.
(2) December 2010 figures have been restated for the Conversion and transition to IFRS.
Adjusted Cash Flow is not a defined term under IFRS. Management
believes that net cash generated by the Company prior to investing
and financing activities is an important measure for investors to moni-
tor. Management 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 mortgage transactions. Adjusted Cash Flow is deter-
mined by the Company as cash provided from operating activities in-
creased/decreased by the change in mortgages accumulated for sale
or securitization in the period. Mortgages accumulated for sale or se-
curitization consist primarily of mortgages that the Company funds
ahead of securitization transactions. Normally during the month after
funding, the Company aggregates all relevant mortgages “warehoused”
to date and creates a pool to sell to the NHA–MBS market. As the
Company typically raises term debt through the securitization markets
on these mortgages in the months subsequent to the month of fund-
ing, there are large amounts of cash invested at quar ter ends. The
Company’s credit facilities provide full financing for the majority of
these mortgage loans. Accordingly, management believes the measure
of Adjusted Cash Flow is only meaningful if the change in mortgages
accumulated for sale between reporting periods is accounted for.
Determination of Adjusted Cash Flow and Payout Ratio
($000s)
Quarter ended
Year ended
For the period
Cash provided by (used in) operating activities
Add (deduct):
Cash provided (used) related to pre-amalgamation
shareholders of FNFC
Change in mortgages accumulated for sale or
securitization between periods
Adjusted cash flow (1)
Less: cash dividends on preference shares
December 31
2011
December 31
2010
December 31
2011
December 31
2010
$ (124,025)
$
77,834
$ (456,358)
$ 165,323
–
412
–
29,746
129,256
(36,293)
532,802
5,231
(1,163)
41,953
–
76,444
(3,154)
(64,723)
130,346
–
Adjusted cash flow available for common shareholders
$
4,068
$
41,953
$
73,290
$ 130,346
Adjusted cash flow per common share ($/share) (1)
Dividends/distributions declared on common shares/units
Dividends/distributions declared per common share/unit
($/share)/($/unit)
Payout ratio
0.07
18,740
0.31
443%
0.70
34,303
0.57
81%
1.22
74,960
1.25
102%
2.17
114,444
1.91
88%
(1) These non-IFRS measures adjust cash provided by (used in) operating activities by accounting for changes between periods in mortgages accumulated for
sale or securitization and mortgage securitization activity.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
17
MANAGEMENT’S DISCUSSION AND ANALYSIS
For the year ended December 31, 2011, the payout ratio was 102%. For
the year ended December 31, 2010, the payout ratio was 88%. The
increase in the payout ratio is a result of the higher dividend declared in
2011 compared to the tax-adjusted distributions made in 2010. The
Company paid dividends in 2011 based on an annual rate of $1.25 per
share. This rate is after provision for corporate income taxes and can
only be compared to the distributions of the Fund if the distributions
are adjusted on the same tax basis. The $1.50 annual distribution rate of
the Fund in 2010 represents approximately $1.08 on an after-tax basis.
Accordingly, the current dividend rate of $1.25 per share represents an
increase of 16% from the prior year. Together with payments on
account of income tax, the Company distributed $108.0 million in 2011
or $18.1 million more than in 2010, on a tax equivalent basis. If the
Company had chosen to distribute the same after-tax equivalent as in
2010, the payout ratio in 2011 would have been approximately 89%.
For the fourth quarter of 2011, the payout ratio was 443%. This
large ratio is reflective of the large unrealized losses on account of the
Company’s hedging progr am incur red in the third quar ter.
Although accrued for accounting purposes in the third quarter, these
losses became cash losses in the fourth quarter when the Company
closed out its hedge positions. Without these items, the payout ratio
for the quarter would have been 132%. The increase in the ratio from
the full year’s ratio of 102% is due to the Company’s increased invest-
ment in its prime ABCP program in the quarter.
Note that in the year, the Company reclassified its cash flow activi-
ties related to mortgage securitization. The reclassification effectively
increased cash used in investing activities by $1,752,800 for the year
ended December 31, 2010. The cash provided by financing activities
decreased by $1,857,460 for the year ended December 31, 2010. This
effected a decrease in operating cash flows of $14,712 for the year
ended December 31, 2010.
Revenues and Funding Sources
Mortgage origination
The Company derives a significant amount of its revenue from mort-
gage origination activities. The majority of mortgages originated are
funded by either placement with institutional investors or securitiza-
tion conduits, in each case with retained servicing. Depending upon
market conditions, either an institutional placement 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 provides the Company with servicing
fees to complement revenue earned through originations. For the
year ended December 31, 2011, origination volume increased from
$10.5 billion to $11.8 billion, or 12%, compared to 2010.
revenue recognition and instead are accounted for as secured financ-
ings. These mortgages remain as mortgage assets of the Company for
the full term and are funded with securitization-related debt. Of
the Company’s $11.8 billion of originations for the year ended
Decem ber 31, 2011, $4.0 billion was originated for securitization
through the NHA–MBS or ABCP markets. Approximately $980 million
of this origination is currently funded with ABCP-related debt.
Placement fees and gain on deferred placement fees
The Company recognizes revenue at the time that a mortgage is placed
with an institutional investor. Cash amounts received in excess of the
mortgage principal at the time of placement are recognized in revenue
as “placement fees”. The present value of additional amounts expected
to be received over the remaining life of the mortgage sold (excluding
normal market based servicing fees) is recorded as a “deferred place-
ment fee”. A deferred placement fee arises when mor tgages with
spreads in excess of “normalized” spreads are sold. Investors prefer
paying the Company over time as they earn net interest margin on
such transactions. Upon the recognition of a “deferred placement
fee”, the Company establishes a “deferred placement fee receivable”
that is amor tized as the fees are received by the Company. Of the
Company’s $11.8 billion of originations for the year ended Decem-
ber 31, 2011, $6.8 billion was placed with institutional investors and
$710 million was originated for institutional investors involved in the
issuance of NHA–MBS.
For all institutional placements and mortgages sold to institutional
investors for the NHA–MBS market, 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 mor tgage. This revenue is
received in cash at the time of placement. 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.
Mortgage servicing and administration
The Company services virtually all mortgages generated through its
mortgage origination activities on behalf of a wide range of institution-
al 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 reve-
nues, fees related to mortgage administration are earned by the Com-
pany throughout the mortgage term. Another aspect of servicing is
the administration of funds held in trust, including borrower’s property
tax escrow, reserve escrow and mortgage payments. As acknowledged
in the Company’s agreements, 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 banks that maintain the de-
posit accounts, which has resulted in significant interest revenue.
Securitization
The Company securitizes a portion of its origination through various
vehicles, including NHA–MBS, CMB and asset-backed commercial
paper. Although legally these transactions represent sales of mortgages,
for accounting purposes, they do not meet the requirements for
In addition to the interest income earned on securitized mortgages
and deferred placement fees receivable, the Company also earns inter-
est income on mortgage-related assets, including mortgages accumulat-
ed for sale or securitization, mor tgage and loan investments and
purchased mortgage servicing rights.
18
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS Results of Operations
The following table shows the volume of mortgages originated by First National and mortgages under administration for the periods indicated:
($ millions)
Mortgage originations by asset class
Single-family residential
Multi-unit residential and commercial
Total
Funding of mortgage originations by source
Institutional investors – residential
Institutional investors – multi-unit/commercial
NHA–MBS for institutional investors
NHA–MBS / CMB / ABCP securitization
Internal Company resources
Total
Mortgages under administration
Single-family residential
Multi-unit residential and commercial
Total
Total mortgage origination volumes increased in the year by 12% as
both multi-unit residential and single-family origination experienced a
strong year despite some unfavourable economic indicators. Total com-
mercial segment originations increased by 24% from 2010 as historically
low interest rates spurred real estate owners to enter into purchase
and refinance transactions, particularly for 10-year terms. Similar incen-
tives affected the single-family segment where volumes increased by
9% over 2010. Single-family volumes have also increased as some
smaller lenders have exited the market as tighter spreads and in-
creased capital requirements have made the returns from investing in
prime mortgages lower than in the previous three years. Origination
for direct securitization in the NHA–MBS, CMB and ABCP programs
increased from $3.0 billion in 2010 to about $4.0 billion in 2011. The
change represents an increase in multi-family origination of approxi-
mately $678 million and an increase of approximately $348 million in
single-family origination. This was the result of the Company’s decision
to securitize more of its own origination directly and use its capital
base efficiently. For the fourth quarter of 2011 overall origination in-
creased by 6% to $2.9 billion from $2.75 billion in 2010. This increase
reflects a 1% increase in single-family origination figures between the
periods and a 23% increase in the multi-unit residential and commer-
cial segment and is consistent with the trends experienced throughout
the year.
Quarter ended
Year ended
December 31
2011
December 31
2010
December 31
2011
December 31
2010
$
$
$
2,121
796
$
2,106
645
$
9,083
2,719
$
8,324
2,187
2,917
$
2,751
$
11,802
$
10,511
$
$
1,158
255
68
1,354
82
1,758
154
351
442
46
$
6,099
696
710
4,047
250
5,713
531
1,081
3,021
165
$
2,917
$
2,751
$
11,802
$
10,511
$
42,251
17,348
$
36,948
16,345
$
42,251
17,348
$
36,948
16,345
$
59,599
$
53,293
$
59,599
$
53,293
For the latter part of 2011, Canadian capital markets were volatile.
Continued global economic issues and a slowing recovery have meant
a movement of capital from the equity markets to bond markets, such
that bond prices were bid up and yields fell. The mor tgage market
moved in step with these indicators. For the Company, these condi-
tions had some significant impacts on its third quar ter 2011 results.
As an originator of mor tgages, the uncer tain economic conditions
made for a low rate environment, making it marginally easier for the
Company to originate mortgages. However, declining bond yields had a
negative impact on the Company’s hedging programs. The Company
puts interest rate hedges on the fixed rate mortgages that it intends to
finance through securitization. Those hedges are unwound as securiti-
zation-related debt is raised. Because bond yields decreased through
the quarter, the Company realized lower interest rates on these debts
compared to the related mortgage interest rates but incurred losses
on the hedges. Although these hedges were effective for the Company,
IFRS accounting requires such hedge losses to be recognized in the
period while the additional interest rate spread earned on the better
funding execution will be recognized over the five- and 10-year terms
of the mor tgages. As such the current year’s net income has been
negatively affected by such accounting.
Total revenues for the year ended December 31, 2011 increased by
about 18% compared to 2010, from $394.3 million to $464.0 million.
This increase resulted from the larger portfolio of mortgages pledged
under securitization and higher mortgage rates thereon.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
19
MANAGEMENT’S DISCUSSION AND ANALYSIS
Net interest – securitized mortgages
Comparing the year ended December 31, 2011 to the year ended
December 31, 2010, net interest – securitized mortgages increased
18% to $69.8 million from $59.0 million. The increase is due to a larger
portfolio of securitized mortgages offset by tighter weighted-average
spreads on the portfolio compared to those spreads a year ago. The
portfolio of mortgages funded by securitization grew from $5.5 billion
as at Januar y 1, 2010 to $7.2 billion as at December 31, 2010 to
$9.8 billion as at December 31, 2011. However, the market for prime
mortgages became more competitive during this period. At Decem-
ber 31, 2010, the Company’s securitized mortgage portfolio earned
gross spreads of approximately 1.37%. By December 31, 2011, as higher-
spread securitizations amortized down and new securitizations were
entered into at tighter spreads, the weighted average gross spread
decreased to 1.11%. Net interest is also affected by the amortization
of deferred origination costs that are capitalized on these mortgages
and the provision for credit losses. Credit losses were minimal in the
quarter as the Company’s exposure to uninsured mortgages is declin-
ing, par ticularly as the Alt-A and small conventional mor tgages
programs run off.
Placement fees
Placement fee revenue increased 3% to $110.0 million from $107.3 mil-
lion. This increase is due to the growth in origination volumes for insti-
tutional placement and the value of renewed mor tgages sold to
institutional investors. Total origination volumes which drive placement
fees, consisting of multi-unit residential mortgages for the third-party
MBS program together with mor tgages originated for institutional
investors, increased by 2% from 2010 to 2011. The Company also
earned $9.6 million of placement fees related to renewals in the year,
an increase of $6.2 million from 2010, accounting for an increase in
placement fees.
Gains on deferred placement fees
Gains on deferred placement fees revenue decreased 49% to
$6.7 million from $13.1 million. The decrease was due to lower vol-
umes and tighter mortgage spreads on multi-unit residential mortgages
originated for institutional MBS issuers. Volumes decreased from
$1.1 billion in 2010 to $710 million, or by 34%, and the margins on
these transactions narrowed from those realized in 2010.
Mortgage servicing income
Mor tgage ser vicing income increased 12% to $82.4 million from
$73.8 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. A significant portion of this growth in the past year has
been for mortgages pledged under securitization, particularly for the
Company’s NHA–MBS program. These mortgages earn net interest
spread for the Company such that there are no servicing fees earned
on these mor tgages. Despite the growth of this component of the
mortgage portfolio, the Company continued to earn administration
fees on these mortgages and comparatively more net interest income
on the trust funds it administers. These components of overall servic-
ing income have offset the slower growth experienced in the third-
party portfolio of mortgages under administration.
20
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Mortgage investment income
Mor tgage investment income increased 38% to $29.3 million from
$21.2 million. The change is due primarily to the Company’s larger se-
curitization program. As the Company elects to securitize more of its
origination, mortgages accumulated for sale or securitization increase
and earn the Company higher interest income in the warehouse period
prior to securitization. This is particularly true for the CMB, for which
the warehousing period is as long as four months. The remaining
change is a combination of offsetting factors, including different bond
yields than in the comparative quar ter (which affect the interest
earned on deferred placement fees receivable), rising prime lending
rates (which affect gross revenues on mortgage and loan investments),
and increased amounts of mortgage and loan investments held during
the comparative quarters.
Realized and unrealized gains (losses)
on financial instruments
For First National, this line item typically consists of two components:
(1) gains and losses related to the Company’s economic hedging activ-
ities, and (2) gains and losses related to holding term assets derived
using discounted cash flow methodology. Much like the short bonds
which the Company uses for hedging, 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
deferred placement fees receivable, mortgages designated as held for
trading (primarily those funded through ABCP) and some of its mort-
gage and loan investments).
The Company uses shor t Government of Canada bonds (pri-
marily CHT-issued bonds) together with repurchase agreements to
create forward interest rate contracts to hedge interest rate risk
associated with fixed rate mortgages originated for its own securitiza-
tion purposes. For accounting purposes, these do not qualify as valid in-
terest rate hedges as the bonds used are not “derivatives” but simple
cash-based financial instruments. In 2010 and prior periods, gains and
losses on such hedges were offset by higher or lower securitization
gains as both were recognized in the same period. Under IFRS, hedging
gains or losses are still recorded in the period in which the
securitization debt is taken on; however, the offsetting securitization
gains are not recorded. Instead, the resulting economic gain will be
reflected in wider or narrower spreads on the mortgages pledged for
securitization and will be realized in net interest margin over the terms
of the mortgages and the related debts. In the first quarter of 2011,
the Company recorded gains on these hedges of $2.3 million.
In the second quar ter of 2011, the Company recorded losses of
$7.5 million on these hedges. Because of the significant decline in bond
yields, in the third quarter of 2011 the Company recorded losses of
$17.4 million on these hedges. Bond yields continued downward in the
fourth quarter as issues on sovereign European debt chased Canadian
investors from the equity markets into the bond markets. Although not
as severe as experienced in the third quarter of 2011, the Company
recorded losses of $8.4 million on its hedging activity in the four th
quarter of 2011. Accordingly, the gross spread on the related portfolio
of securitized mortgages going forward will be relatively higher as the
Company’s testing indicates that the hedges were appropriate.
MANAGEMENT’S DISCUSSION AND ANALYSIS Uncer tainty about the global economy, par ticularly in the Euro-
pean Union and the US, led to a significant decrease in bond yields
in the year. Generally, five-year Government of Canada bond yields
declined significantly from approximately 2.6% at the beginning of the
year to 1.3% at the end of the year. Accordingly, the Company’s
deferred placement fees receivable and approximately $5 million of
mortgages in mortgage and loan investments are more valuable on a
comparative basis at year-end than at the end of 2010. The Company
recorded gains related to holding these assets of $2.2 million in the
year. Those portions of the Company’s mortgages which are held at
fair value (primarily those funded through ABCP), also benefited from
this change in yields. The fair value of these mortgages increased as
market mortgage rates decreased for similar term mortgages. Imbed-
ded credit losses in the Company’s pricing model improved and expo-
sures to credit losses lessened as the Alt-A program continued to run
off. In total for the year, the Company recorded gains in respect of
ABCP funded mortgages (net of unrealized losses on related interest
rate swaps) of $11.2 million.
The changes in fair value related to the Company’s interest rate
swaps, excluding those on the Company’s ABCP-funded mortgages,
had a negative impact on the Company’s results. The Company re-
corded net losses of about $0.8 million in the year. Generally, these
losses resulted from lower bond yields, which made the value of the
Company’s pay-fix swap positions less valuable than their market
value at the end of the previous year.
Brokerage fees expense
Brokerage fees expense increased 15% to $81.5 million from
$70.7 million. This increase is largely explained by the increase in sin-
gle-family origination between the years, which increased by 9%. The
Company’s securitization policy has also affected the increase of these
fees. In 2011, the Company capitalized $30.6 million of single-family bro-
ker fees to securitized mortgages. In 2010 this amount was $32.6 mil-
lion. By adding these amounts back to the amounts expensed above,
the Company’s total expenditure on broker fees grew by approxi-
mately 8.4% from 2010 to 2011 in line with the expected 9% growth
in origination volumes.
Salaries and benefits expense
Salaries and benefits expense increased 9% to $48.8 million from
$44.7 million. The increase is due primarily to employee costs associ-
ated with residential mortgage origination. The Company compensates
its sales staff with commissions based on origination volumes com-
pared to quotas. Because of the increased residential origination in the
year of 9%, this compensation increased by $2.6 million year-over-year.
The remaining increase is for increased requirements to administer a
larger portfolio of mortgages. As at December 31, 2011, the Company
had 574 employees, compared to 536 as at December 31, 2010. Man-
agement salaries were paid to the two senior executives (Co-found-
ers) who indirectly each own about 40% of FNFC’s common shares.
The current period’s expense is as a result of the compensation
arrangement executed on the closing of the initial public offering.
Interest expense
Interest expense increased 18% to $16.0 million from $13.6 million.
As discussed in the “Liquidity and cash resources” section of this analy-
sis, the Company warehouses a portion of the mortgages it originates
prior to settlement with the ultimate investor or funding with a securi-
tization vehicle. The Company uses a por tion of the debenture to-
gether with a credit facility with a syndicate of banks and 30-day
repurchase facilities to fund the mor tgages during this period. The
Company renewed the credit facility in May 2011 for a three-year
term and a total commitment of $125 million. The overall interest ex-
pense has increased from the prior period due to the increased use of
repurchase facilities to warehouse the larger amounts of mortgages
originated for the CMB. As at December 31, 2011, the Company
borrowed $664 million using these facilities, compared to $174 million
as at December 31, 2010. Generally, interest expenses would have
been greater but for the increased use of 30-day repurchase agree-
ments instead of bank debt, which has saved the Company approxi-
mately 0.95% in marginal interest rates. This expense has increased by
18% despite the increased use of warehouse borrowing facilities and
the increase of overnight base borrowing rates, which have risen from
an average of 0.71% for 2010 to 1.20% for 2011.
Other operating and amortization of intangibles expenses
These expenses increased 12% to $36.7 million from $32.8 million.
During 2011, the Company expensed $8.1 million of hedging costs
associated with the direct securitization of multi-unit residential and
single-family mor tgages into the NHA–MBS market. In 2010, these
costs amounted to $1.8 million as the Company securitized primarily
floating rate mortgages which do not require such hedging. In 2011
operating expenses include $8.0 million (2010 – $9.5 million) for the
amortization of intangible assets. In periods prior to 2011, this expense
was incurred at the Fund level. During 2010, the Company incurred
some one-time expenses totalling approximately $1.0 million related
to the issuance of the debenture and the conversion to a corporation.
The remaining change in these expenses represents the cost of
additional servicing requirements for a larger portfolio of mortgages
under administration.
Income before income taxes and EBITDA
Income before income taxes decreased 19% to $96.8 million from
$120.0 million. The decrease in earnings was mainly the result of the
$22.9 million of unfavourable losses related to the Company’s eco-
nomic hedging program. Without the impact of all gains and losses on
financial instruments, the Company’s financial results are approximate-
ly 2% better than those recorded in 2010. EBITDA decreased 19% to
$106.6 million from $131.2 million. The decrease was due to the same
factors described for income before income taxes.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
21
MANAGEMENT’S DISCUSSION AND ANALYSIS
Provision for income taxes
The provision for taxes decreased 12% to $26.3 million from
$30.0 million. The 2010 tax provision relates to deferred taxes which
the Company accrued while it operated as an income trust plus cur-
rent and deferred taxes accrued at the First National level, which are
included in the comparative figures. 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 unit holders such that it did not have any current tax liabilities. To
the extent that the Fund’s accounting income earned from FNFLP was
greater than the taxable income allocated to it by FNFLP, a deferred
tax provision was recorded. No deferred tax provision was recorded
for timing differences in accounting and taxable income scheduled to
reverse prior to January 1, 2011; however, First National was liable for
full tax on the portion of the par tnership’s income that would ulti-
mately be earned by it. Generally the tax provision is lower due to the
lower earnings recorded in 2011.
Operating Segment Review
The Company aggregates its business from two segments for financial reporting purposes: (i) Residential (which includes single-family residential
mortgages) and (ii) Commercial (which includes multi-unit residential and commercial mortgages), as summarized below.
Operating business segments
($000s, except percent amounts)
Quarter ended
Originations
Percentage change
Revenue
Percentage change
Income before income taxes
Percentage change
Period ended
Identifiable assets
Mortgages under administration
Residential
Commercial
December 31
2011
December 31
2010
December 31
2011
December 31
2010
$
$ 9,083,331
9.1%
351,497
17.9%
82,896
(7.4%)
$
$ 8,323,373
$
298,011
$
89,559
$
$ 2,719,100
24.3%
112,523
16.6%
13,887
(54.3%)
$
$ 2,187,410
$
$
96,248
30,398
December 31
2011
December 31
2010
December 31
2011
December 31
2010
$ 9,010,099
$ 42,251,220
$ 6,475,641
$ 36,948,100
$ 2,887,395
$ 17,347,376
$ 1,898,576
$ 16,345,032
Residential Segment
Commercial Segment
Residential revenues increased by about 18% although origination
increased by about 9% between 2011 and 2010. The higher revenue
relative to origination is attributable to higher interest revenue on
securitized mor tgages, which increased with the prime rate, which
increased by 16% over 2010. The decrease in net income before
income taxes is par tially due to gains in fair value of $6.6 million
earned in 2010. In 2011 the Company incurred $5.0 million of losses
in fair value. Eliminating the effect of such revenue, net income before
tax would have increased in 2011 by 6% from 2010, similar to the
growth in origination. Identifiable assets have increased from those at
December 31, 2010, as the Company added almost $2.0 billion of net
single-family mor tgages to mor tgages pledged under securitization.
The Company also increased the amount of securities purchased
under resale agreements by approximately $300 million to hedge the
larger pipeline of single-family fixed rate mortgages.
Commercial revenues increased by 17% from the prior year despite
the unfavourable mark to market on the Company’s hedging program
on the multi-unit residential CMB program, which reduced revenue by
approximately $13.5 million for the year. Eliminating the effect of such
gains, revenue would have increased in 2011 by 32% from 2010, in line
with the growth of origination volumes plus higher interest income on
securitized mor tgages, increased amounts from mor tgage servicing
and mortgage and loan investment interest revenue, which offset tighter
margins on placement activities. Net income before tax, excluding the
impact of fair value adjustments, fell by 8% or about $2.3 million from
2010 to 2011. The decrease was a result of the Company undertaking
to securitize more of its origination directly. Not only was revenue off-
set by larger interest expenses on higher amounts of securitization
debt, but hedging expenses increased by $3.9 million and warehouse
interest expense increased by almost $1 million. Identifiable assets
22
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS
have increased from those at December 31, 2010, as the Company
securitized approximately $1.0 million of multi-unit residential mort-
gages through the NHA–MBS market in 2011 and increased mortgages
pledged under securitization.
Liquidity and Capital Resources
The Company’s fundamental liquidity strategy has been to invest pri-
marily in prime Canadian mortgages. Management’s belief has always
been that these mortgages are considered “AAA” by investors and
will always be well bid and highly liquid. This strategy proved effective
during the turmoil experienced in 2007 through 2009 when capital
markets retreated and only the highest-quality assets were traded.
As the Company’s results have shown, First National had little, if any,
trouble finding investors to purchase its mortgage origination at prof-
itable margins. As a mortgage originator and securitizer, the Company
requires significant cash resources to purchase and hold mortgages
prior to selling to institutional investors or prior to arranging for term
debt through the securitization markets. For this purpose, the Com-
pany uses the combination of the $175 million debenture financing
and the Company’s revolving bank credit facility. This aggregate indebt-
edness is typically used to fund: (1) mortgages accumulated for sale or
securitization, (2) deferred placement fees receivable, (3) the origina-
tion costs associated with securitization, and (4) mortgage and loan in-
vestments. The Company has a credit facility with a syndicate of four
banks for a total credit of $125.0 million. This facility was renewed in
May 2011 for a three-year term. Bank indebtedness may also include
borrowings obtained through overdraft facilities. At December 31,
2011, the Company has entered into repurchase transactions with fi-
nancial institutions to borrow $664.4 million related to $688.3 million
of mortgages held in mortgages accumulated for sale or securitization
on the balance sheet.
At December 31, 2011, outstanding bank indebtedness at FNFLP
was $80.6 million (December 31, 2010 – $23.8 million). Together
with the debenture financing of $175 million (December 31, 2010 –
$175 million), this “combined debt” was used to fund $162.6 million
(December 31, 2010 – $139.5 million) of mortgages accumulated for
sale or securitization. At December 31, 2011, the Company’s other
interest-yielding assets included: (1) deferred placement fee receivable
of $58.5 million (December 31, 2010 – $77.4 million); and (2) mort-
gage and loan investments of $111.7 million (December 31, 2010 –
$70.9 million). The difference between “combined debt” and the
mortgages accumulated for sale or securitization funded by it, which
the Company considers a proxy for true leverage, has increased
between December 2010 and December 2011, and now stands at
$93.0 million (December 31, 2010 – $65.7 million). This represents a
debt-to-equity ratio of approximately 0.31 to 1, which the Company
believes is at a conservative level. This ratio has increased from 0.25 to
1.00 as at December 31, 2010 as the Company has fully invested the
proceeds of the preferred shares in $40.8 million in mor tgage and
loan investments, $19.2 million in cash held as collateral under secu-
ritization and approximately $30 million in net mor tgages pledged
under securitization.
The Company funds a large portion of its mortgage originations
for institutional placement on the same day as the advance of the re-
lated mortgage. The remaining originations are funded by the Com-
pany on behalf of institutional investors or pending securitization on
the day of the advance of the mortgage. On specified days, sometimes
daily, the Company aggregates all mortgages warehoused to date for
an institutional investor and transacts a settlement with that institu-
tional investor. A similar process occurs prior to arranging for term
funding through securitization. The Company uses a por tion of the
committed credit facility with the banking syndicate to fund the mort-
gages during this warehouse period. The credit facility is designed to
be able to fund the highest balance of warehoused mor tgages in a
month and is normally only partially drawn.
The Company also invests in short-term mortgages, usually for six-
to 18-month terms, to bridge existing borrowers in the interim period
between long-term financing solutions. The banking syndicate has
provided credit facilities to partially fund these investments. As these
investments return cash, it will be used to pay down this bank indebt-
edness. The syndicate has also provided credit to finance a portion of
the Company’s deferred placement fees receivable and the origination
costs associated with securitization as well as other miscellaneous
longer-term financing needs.
A portion of the Company’s capital has been employed to support
its ABCP and NHA–MBS programs, primarily to provide credit en-
hancements as required by rating agencies. In June 2011, CMHC issued
new regulations regarding the timing of mortgage title transfer to its
custodian. The notice requires that cash collateral be posted immedi-
ately on pool settlement with the custodian for all mortgages not regis-
tered with the custodian on a dollar-for-dollar basis. Due to the difficulty
in obtaining evidence from land registry offices on a timely basis, the
Company has posted collateral for the missing registrations. At Decem-
ber 31, 2011, $9.3 million (December 31, 2011 – $nil) of this collateral
was held by the custodian. The collateral will be repaid to the Company
as registration is subsequently evidenced to the custodian on these
mortgages. The other significant portion of cash collateral is the invest-
ment made on behalf of the Company’s ABCP programs. As at Decem-
ber 31, 2011, the investment in cash collateral was $47.6 million.
Although both the Alt-A and small commercial loan programs have
been discontinued, no further portion of the cash collateral for these
programs will be recovered by the Company until these programs ter-
minate fully in approximately two years, as the programs are subject to
minimum enhancement levels. As the Alt-A 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
rating agencies, the Company repaid face value debt from the Trust in
2011 of approximately $10.6 million related to defaulted mortgages.
The Company received $15.6 million (face value) on the liquidation of
previously repurchased mor tgages during the same period, experi-
encing credit losses at expected levels. At December 31, 2011, the
Company employs an assumption for the fair value of 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 pro-
gram will continue to require some level of liquidity from the Company
throughout its remaining term.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
23
MANAGEMENT’S DISCUSSION AND ANALYSIS
As demonstrated previously, the Company continues to see strong
demand for its mor tgage product from institutional investors and
liquidity from bank-sponsored commercial paper conduits. The Com-
pany’s strategy of using diverse funding sources has allowed the
Company to thrive, producing record profitability in 2009 and 2010.
By focusing on the prime mortgage market, the Company believes it
will continue to attract bids for mortgages as its institutional custom-
ers 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 origination volumes. Based on cash
flow received in the fourth quarter of 2011, the Company will receive
approximately $66 million of cash, on an annualized basis, from its ser-
vicing operations and $100 million of annualized cash flow from secu-
ritization transaction spread and deferred placement fees receivable.
Together, on an after-tax basis, this $120 million of annual cash flow
would be more than sufficient to support the indicated annual divi-
dends of $75 million on the common shares and the $4.65 million on
the preferred shares. Although this is a simplified analysis, it does high-
light the sustainability of the Company’s business model and dividend
policy through periods of economic weakness.
As described earlier, the Company issued 4,000,000 Series 1 pre-
ferred shares at a price of $25.00 per share for gross proceeds of
$100 million, before issue expenses. The net proceeds of $96.7 million
were invested in FNFLP as par tners’ capital. The issuance gives the
Company additional capital which will allow it to undertake greater
volumes of securitization transactions directly and reduce reliance on
institutional investors as a funding source.
The Company’s Board of Directors has elected to pay dividends,
when declared, on a monthly basis for the outstanding common
shares and on a quarterly basis for the outstanding preferred shares.
For purposes of the enhanced dividend tax credit rules contained in
the Income Tax Act (Canada) and any corresponding provincial and
territorial tax legislation, all dividends (and deemed dividends) paid by
us to Canadian residents on our common and preferred shares after
December 31, 2010 are designated as “eligible dividends”. Unless stated
otherwise, all dividends (and deemed dividends) paid by us hereafter
are designated as “eligible dividends” for the purposes of such rules.
For the preferred shares, the Company has elected to pay any tax
under Part VI.1 of the Income Tax Act, such that corporate holders of
the shares will not be required to pay tax under Par t VI.1 of the
Income Tax Act on dividends received on such shares.
Financial Instruments and Risk Management
The Company has elected to treat deferred placement fees receiv-
able, the portion of mortgages pledged under securitization sold to
ABCP conduits, and several mortgages within mortgage and loan in-
vestments as financial assets at “fair value through profit or loss” such
that changes in market value are recorded in the statement of income.
Effectively, these assets are treated much like bonds, earning the Com-
pany a coupon at the discount rates used by the Company. The dis-
count 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 asset’s residual cash flows. Accordingly, as rates in the bond market
change, so will the carrying value of these assets. These changes may
be significant (favourable and unfavourable) from quarter to quarter.
The Company enters into fixed for float swaps to manage the interest
rate exposure of fixed mortgages sold to ABCP conduits. These in-
struments will also be treated as fair value through profit or loss.
While the Company has attempted to exactly match the principal bal-
ances of the fixed mortgages over the next five-year period to the
notional swap values for the same period, there will be differences in
these amounts. Any favourable or unfavourable amounts will be
recorded in the statement of earnings each quarter.
The Company believes its hedging policies are suitably disciplined
such that the interest rate risk of holding mortgages prior to securiti-
zation is mitigated. From an accounting perspective, any gains or losses
on these instruments are recorded in the current period as the Com-
pany’s “hedging” strategy does not qualify as hedging for accounting
purposes. The Company uses bond forwards (consisting of bonds sold
short and bonds purchased under resale agreements) to manage in-
terest rate exposure between the time a mortgage rate is committed
to the borrower and the time the mortgage is transferred to the se-
curitization vehicle and the matched term debt is arranged. As interest
rates change, the value of these short bonds will vary inversely with
the value of the related mortgages. As interest rates increase, a gain
will be recorded on the bonds which should be offset by a tighter
interest rate spread between the interest rates on mor tgage and
the securitization debt. This spread will be earned over the term of
the related mortgages. For single-family mortgages, primarily mortgages
for the Company’s own securitization programs, only a portion of the
mortgage commitments issued by the Com pany eventually fund. The
Company must assign a probability of funding to each mortgage in the
pipeline and estimate how that probability changes as mor tgages
move through the various stages of the pipeline. 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, 2011, the Company
has $380.3 million of notional forward bond positions related to its
single-family programs. For multi-unit residential and commercial
mortgages, the Company assumes all mortgages committed will fund
and hedges each mortgage individually. This includes mortgages com-
mitted for the CMB program as well as mortgages for transfer to the
Company’s other securitization vehicles. As at December 31, 2011, the
Company had entered into $245.8 million in notional value forward
bond sales for this segment. The change in mark-to-market value to-
gether with realized losses totalled $31.0 million on the notional hedg-
es transacted in the period January 1, 2011 to December 31, 2011.
This amount 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 converts 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, five-year interest rates have
decreased pursuant to global economic issues and the value of
this swap has increased to $9.7 million as at December 31, 2011. The
24
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS Company has documented this swap as a hedge for accounting pur-
poses as the fixed leg of the swap exactly matches the cash flow obliga-
tions under the debenture. Effectively, the unrealized gain of $9.7 million
on the swap has been excluded from earnings and been applied to
increase the carrying value of the debenture note payable. The Com-
pany is also a party to four amortizing fix-for-float rate swaps that eco-
nomically hedge the interest rate exposure related to cer tain
mortgages held on the balance sheet that the Company has originated
as replacement assets for its CMB activities. As at December 31, 2011,
the aggregate notional value of these swaps was $48.6 million. Market
swap rates decreased during the year so the value of these swaps
decreased by approximately $0.8 million. The amortizing swaps mature
between September 2013 and December 2021.
As described above, the Company employs various strategies to
reduce interest rate risk. In the normal course of business, the Com-
pany takes some 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
mor tgages originated for the CMBS market in the spring of 2007.
These mor tgages were originated at credit spreads designed to be
profitable to the Company when sold to a bank-sponsored CMBS
conduit. Unfortunately for the Company, when these mortgages fund-
ed, 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 mortgage had moved wider. The Company adjusted
for market-suggested increases in credit spreads in 2007 and 2008, ad-
justing the value of the mortgages downward. In 2009, the economic
environment 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 relat-
ed to credit spread movement. Despite entering into effective eco-
nomic interest rate hedges, the Company’s exposure to credit spreads
remained. This risk is inherent in the Company’s business model and
cannot be economically hedged.
The same exposure to risk is inherent in the Company’s securitiza-
tion through ABCP. The Company is exposed to the risk that
30-day ABCP rates are greater than 30-day BA rates. Prior to the
financial crisis, 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. In 2008, 30-day ABCP traded at
approximately 1.10 percentage points over BAs but by the end of De-
cember 2011, it was priced at a discount to BAs. 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, 2011, the Company has various exposures to
changing credit spreads. The Company has $21 million of exposure re-
lated to commercial mor tgages originated originally for the CMBS
market. In mortgages accumulated for sale or securitization there are
$847 million of mor tgages that are susceptible to some degree of
changing credit spreads.
Capital Expenditures
A significant portion of First National’s business model consists of the
origination and placement or securitization of financial assets. General-
ly placement activities do not require much capital investment as the
Company acts primarily in the capacity of a broker. On the other
hand, the under taking of securitization transactions requires some-
times significant amounts of the Company’s own capital. This capital is
provided in the form of cash collateral, credit enhancements, and the
upfront funding of broker fees and other origination costs. These are
described more fully in the Liquidity and Capital Resources section
above. For fixed assets, the business requires capital expenditures on
technology (both software and hardware), leasehold improvements
and office furniture. During the year ended December 31, 2011, the
Company purchased new computers and office and communication
equipment to support primarily its single-family residential business.
Going forward, the Company expects capital expenditures on fixed
assets will be approximately $2.0 million annually.
Summary of Contractual Obligations
The Company’s long-term obligations include five- to 10-year premises
leases for its four offices across Canada, and its obligations for the on-
going ser vicing of mor tgages sold to securitization 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 principal and interest payments
on behalf of the conduits, including the management and collection of
mortgages in arrears.
($000s)
Payments due by period
Total
0–1 year
2–3 years
4–5 years
After 5 years
Lease obligations
Total contractual obligations
$ 17,552
$ 17,552
$ 3,758
$ 3,758
$ 6,661
$ 6,661
$ 5,894
$ 5,894
$ 1,239
$ 1,239
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
25
MANAGEMENT’S DISCUSSION AND ANALYSIS
Critical Accounting Policies and Estimates
The Company prepares its financial statements in accordance with
IFRS, which requires management to make estimates, judgments and
assumptions that management believes are reasonable based upon
the information available. These estimates, judgments and assumptions
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements,
and the repor ted amounts of revenue and expenses during the
reporting period. Management bases its estimates on historical experi-
ence and other assumptions which it believes to be reasonable under
the circumstances. Management also evaluates its estimates on an
ongoing basis.
The significant accounting policies of First National are described
in Note 2 to the Company’s audited financial statements as at De-
cember 31, 2011. 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 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 placed with institutions earning a deferred placement
fee. Under IFRS, valuing a gain on deferred placement requires the use
of estimates to determine the fair value of the retained interest (de-
rived from the present value of expected future cash flows) in the
mortgages. These retained interests are reflected on the Com pany’s
balance sheet as deferred placement fees receivable. The key assump-
tions used in the valuation of gains on deferred placement fees are
prepayment rates and the discount rate used to present value
future expected 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 approximately 15% for single-family mortgages.
The Company assumes there is virtually no prepayment on multi-resi-
dential fixed rate mortgages. Actual prepayment experience has been
consistent with these assumptions.
On a quarterly basis, the Company reviews the estimates used to
ensure their appropriateness and monitors the performance statistics
of the relevant mortgage portfolios to adjust and improve these esti-
mates. The estimates used reflect the expected performance of the
mortgage portfolio over the lives of the mortgages. The assumptions
underlying the estimates used for the year ended December 31, 2011,
continue to be consistent with those used for the year ended Decem-
ber 31, 2010 and the quarters ended September 30, 2011, June 30,
2011 and March 31, 2011.
The Company has elected to treat its financial assets and liabilities,
including deferred placement fees receivable, ABCP-funded mortgages,
some mortgage and loan investments and bonds sold short at fair value
through profit or loss. 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. Much like the valuation of deferred placement fees receivable
described above, the Company’s method of determining the fair value
of its mortgages funded by ABCP has a significant impact on earnings.
The Company uses different prepayment rates for its various programs
that average approximately 15% for single-family mortgages. The Com-
pany assumes there is vir tually no prepayment on multi-residential
fixed rate mortgages. Actual prepayment experience has been consis-
tent with these assumptions. It has also assumed discount rates based
on Government of Canada bond yields plus a spread that the Com-
pany believes would enable a third party to purchase the mortgages
and make a normal profit margin for the risk involved.
Future Accounting Changes
The Company has adopted IFRS as at January 1, 2010. The following
new IFRS pronouncements have been issued and although not yet ef-
fective, may have a future impact on the Company.
IFRS 9 – Financial Instruments
As of January 1, 2015, the Company will be required to adopt this
standard, which is the first phase of the International Accounting Stan-
dard Board’s (“IASB”) project to replace IAS 39 – Financial Instruments:
Recognition and Measurement. IFRS 9 provides new requirements for
how an entity should classify and measure financial assets and liabilities
that are in the scope of IAS 39. Management is currently evaluating
the potential impact that the adoption of IFRS 9 will have on the Com-
pany’s consolidated financial statements. Of potential relevance to the
Company is a revised section on hedge accounting designed to make
the reporting of hedging activity more straightforward. Among other
changes, the hedging standard will permit the use of a financial asset or
liability as a hedging instrument. The current standard requires that only
a derivative can be identified as a hedging instrument. As the Company
has historically used shor t bonds (a financial liability) as a hedging
instrument, the change could affect the nature of the Company’s
reporting in this respect.
IFRS 10 – Consolidated Financial Statements
As of January 1, 2013, the IASB introduced a single model for consoli-
dating subsidiaries using a control model. This standard addresses in
particular the control of special purpose entities. There will be little
impact to the Company as it currently consolidates its special purpose
entities fully.
IFRS 11 – Joint Arrangements
As of January 1, 2013, the IASB has expanded the definition of a joint
venture. The Company would be required to account for joint ventures
by the equity method as opposed to proportionate consolidation.
26
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS IFRS 12 – Disclosure of Interests in Other Entities
As of January 1, 2013, the Company will be required to make new dis-
closures on its off-balance sheet activities including those with special
purpose entities.
IFRS 13 – Fair Value Measurement
As of January 1, 2013, the Company will be required to adopt this
standard, which provides a framework for the application of fair value
to those assets and liabilities qualifying or permitted to be carried at
fair value. The Company believes its current measurement of fair value
is appropriate and there will be little impact.
IAS 27 – Separate Financial Statements
As of January 1, 2013, this standard will only prescribe the accounting
and disclosure requirements for investments in subsidiaries, joint
ventures and associates when an entity prepares separate financial
statements, and thus will have limited impact for the Company.
IAS 28 – Investments in Associates
As of January 1, 2013, this standard has been amended to correspond
to changes in IFRS 10, 11 and 12, listed above, providing guidance for
investments in associates. As described above, there should be little
effect on the Company.
Controls over financial reporting
Management is responsible for establishing and maintaining adequate
internal control over financial reporting. Internal control over financial
reporting is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial state-
ments for external purposes in accordance with reporting standards;
however, because of its inherent limitations, internal control over
financial repor ting may not prevent or detect misstatements on a
timely basis.
During the Company’s transition to IFRS and the Conversion to a
corporation, management identified and subsequently implemented
certain changes to accounting processes and procedures in order to
comply with IFRS. These changes were most significant for the follow-
ing financial statement components: reporting for mortgages pledged
under securitization; reporting for debt related to securitized mortgages;
reporting for both interest revenue – securitized mortgages and inter-
est expense – securitized mortgages; reporting for deferred income
taxes; reporting for consolidation of special purpose entities; and the
restatement of 2010 comparative figures to incorporate IFRS and the
conversion from an income trust structure. Because of these changes,
management revised existing internal controls and designed and imple-
mented new internal controls over financial reporting to provide rea-
sonable assurance that the risk of material misstatements in the
Company’s financial reporting has been mitigated. There were no other
changes made in the Company’s internal controls over financial report-
ing during the year ended December 31, 2011 that have materially
affected, or are reasonably likely to materially affect, the Company’s
internal controls over financial reporting.
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 re-
porting based on the criteria set forth in Internal Control over Financial
Reporting – Guidance for Smaller Public Companies issued by the Com-
mittee of Sponsoring Organizations of the Treadway Commission and,
based on that evaluation, concluded that the Company’s internal con-
trol over financial reporting was effective as of December 31, 2011 and
that there were no material weaknesses that have been identified in
the Company’s internal control over financial reporting as of Decem-
ber 31, 2011. No changes were made in the Company’s internal con-
trols over financial repor ting during the year ended December 31,
2011, except as described above related to IFRS and the Conversion,
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 Com-
pany are subject to a number of risks and uncertainties, and are affect-
ed by a number of factors outside the control of management of the
Company including: ability to sustain performance and growth, reliance
on sources of funding, concentration of institutional investors, reliance
on independent mor tgage brokers, changes in interest rates, repur-
chase obligations and breach of representations and warranties on
mortgage sales, risk of servicer termination events and trigger events
on cash collateral and retained interests, reliance on multi-unit residen-
tial and commercial mortgages, general economic conditions, govern-
ment regulation, competition, reliance on mortgage insurers, reliance
on key personnel, conduct and compensation of independent mort-
gage brokers, failure or unavailability of computer and data processing
systems and software, insufficient insurance coverage, change in or loss
of ratings, impact of natural disasters 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 include those related to the de-
pendence on FNFLP, leverage and restrictive covenants, dividends
which are not guaranteed and could fluctuate with FNFLP’s perfor-
mance, restrictions on potential growth, the market price of FNFC
shares, statutory remedies, control of the Company and contractual re-
strictions, and income tax matters. Risk and risk exposure are managed
through a combination of insurance, 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 ongoing servicing or spread income. For the single-
family residential segment, the Company relies on independent mort-
gage 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
Company’s business, reference should be made to the Annual Informa-
tion Form of the Company.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
27
MANAGEMENT’S DISCUSSION AND ANALYSIS
Forward-Looking Information
Outlook
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 historical facts. Forward-
looking information may relate to management’s future outlook and
anticipated events or results, and may include statements or informa-
tion regarding the future financial position, business strategy and stra-
tegic goals, product development activities, projected costs and capital
expenditures, financial results, risk management strategies, hedging
activities, geographic expansion, licensing plans, taxes and other plans
and objectives of or involving the Company. Particularly, information
regarding growth objectives, any increase in mortgages under adminis-
tration, future use of securitization vehicles, industry trends and future
revenues is forward-looking information. Forward-looking information
is based on certain factors and assumptions regarding, among other
things, interest rate changes and responses to such changes, the
demand for institutionally 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 informa-
tion should not be read as providing guarantees of future perfor-
mance 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 management 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 fac-
tors include reliance on sources of funding, concentration of institu-
tional investors, reliance on independent mor tgage brokers and
changes in interest rates outlined under ‘‘Risk and Uncer tainties
Affecting the Business’’. In evaluating this information, the reader
should specifically 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-looking
information. The forward-looking information contained in this discus-
sion represents management’s expectations as of February 28, 2012,
and is subject to change after such date. However, management and
the Company disclaim any intention or obligation to update or revise
any forward-looking information, whether as a result of new informa-
tion, future events or otherwise, except as required under applicable
securities regulations.
The global economic outlook turned negative during 2011. Epito-
mized perhaps by Standard & Poor’s downgrade of the United States
government’s credit rating in August, the latter half of the year fea-
tured increased recessionary pressures, global financial turmoil and
volatile equity markets. The interest rate environment, which began to
rise in the first quarter of 2011, reversed course in the second quar-
ter and then fell sharply in the third quarter as investors fled to the
safety of the bond markets, driving down bond yields. Yet the Canadi-
an real estate market remained strong throughout the year and the
Company was able to originate near record levels of new mortgages.
First National took advantage of this origination and its greater capital
base by securitizing more than $4 billion of mor tgages. Although
most of the origination costs for these mor tgages have been capi-
talized, the costs of internal underwriting, large hedge losses, and
significant fees paid to register the mortgages with the title custodian,
have all been expensed. The spread from this increased securitization
activity will benefit the Company for the five- and 10-year terms of
these transactions going forward.
Given the recent market turmoil, the large Canadian banks have
acted to increase mortgage spreads in order to maintain profitability
on these assets. This has been evidenced over the past quar ter as
floating-rate single-family mortgages that had been priced at a 0.70%
discount to prime in the summer are now being offered at no dis-
count to prime. Similarly, fixed-rate mor tgages have recently been
priced so as to increase spreads to a range of 1.75% to 2.00%. These
increases will enable the Company’s securitization activities to be
more profitable. The five large banks are also making the transition to
IFRS this year. While this may not have a large impact on their mort-
gage business, the Company has seen smaller competitors exit the
market or slow down origination in the face of higher capital require-
ments for securitization, which is a consequence of IFRS.
Management is very pleased with its volume of originations for
2011. For 2012, management sees overall origination volumes remain-
ing at levels comparable or slightly lower than 2011 origination as mar-
ket activity slows down. The Company forecasts that MUA, currently
at $59.6 billion, will continue to grow and produce higher income and
cash flow. The wider mortgage spreads on the Company’s core prod-
ucts, prime mortgages, will give the Company the opportunity to con-
tinue to pursue more direct securitization. Together with the large
investment in the portfolio of mortgages under securitization at the
end of December 31, 2011, First National expects increased cash flow
profitability in 2012.
28
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
MANAGEMENT’S DISCUSSION AND ANALYSIS Management’s Responsibility for Financial Reporting
The accompanying consolidated financial statements of First National Financial Corporation for the period from January 1, 2011 to December 31,
2011 and all information in this annual report are the responsibility of management.
The financial statements have been prepared by management in accordance with International Financial Reporting Standards. The preparation of
these financial statements requires management to make estimates and assumptions that affect certain reported 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 audi-
tors. 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 Corporation’s 2011 consolidated financial statements
in accordance with International Financial Repor ting Standards and has provided an independent audit opinion. The auditors have full and
unrestricted access to the Audit Committee to discuss the results of their audit.
Stephen J. R. Smith
Chairman and President
Robert A. Inglis
Chief Financial Officer
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
29
Independent Auditors’ Report
To the Shareholders of
First National Financial Corporation
We have audited the accompanying consolidated financial statements of First National Financial Corporation, which comprise the consolidated
statements of financial position as at December 31, 2011 and 2010, and January 1, 2010, and the consolidated statements of comprehensive
income and retained earnings, changes in shareholders’ equity and cash flows for the years ended December 31, 2011 and 2010, 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 International
Financial Reporting Standards, 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 accor-
dance 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 circum-
stances, 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 Corpora-
tion as at December 31, 2011 and 2010, and January 1, 2010, and its financial performance and its cash flows for the years ended December 31,
2011 and 2010 in accordance with International Financial Reporting Standards.
Toronto, Canada,
February 28, 2012
Chartered Accountants
Licensed Public Accountants
30
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
First National Financial Corporation
Consolidated Statements of Financial Position
($000s)
As at
ASSETS
Restricted cash
Accounts receivable and sundry
Securities purchased under resale agreements and owned
Mortgages accumulated for sale or securitization
Mortgages pledged under securitization
Deferred placement fees receivable
Cash held as collateral for securitization
Purchased mortgage servicing rights
Mortgage and loan investments
Income taxes recoverable
Other assets
Total assets
LIABILITIES AND EQUITY
Liabilities
Bank indebtedness
Obligations related to securities and mortgages
sold under repurchase agreements
Accounts payable and accrued liabilities
Securities sold under repurchase agreements and sold short
Debt related to securitized and participation mortgages
Debenture loan payable
Income taxes payable
Deferred tax liabilities
Total liabilities
Equity
Common shares
Preferred shares
Retained earnings
Total equity
Total liabilities and equity
See accompanying notes
Notes
December 31
2011
December 31
2010 [1]
January 1
2010 [1]
3
15
5
3
4
3
8
6
18
7
10
16
15
11
13
18
18
17
17
$
230,519
61,558
657,626
850,938
9,761,921
58,509
56,882
4,771
180,872
3,556
60,118
$
156,198
50,787
426,336
318,136
7,193,961
77,410
37,730
5,766
70,911
–
66,758
$
73,440
46,972
333,705
382,859
5,540,794
90,268
43,709
6,607
54,737
–
76,769
$ 11,927,270
$ 8,403,993
6,649,860
$
80,608
$
9,896
$
203,758
664,424
57,692
659,299
9,957,219
184,689
–
30,300
174,258
63,998
424,673
7,274,482
178,849
8,940
34,721
221,937
76,712
332,427
5,536,394
–
14,231
30,519
$ 11,634,231
$ 8,169,817
$ 6,415,978
$
122,671
97,394
72,974
293,039
$
122,671
–
111,505
234,176
$
122,671
–
111,211
233,882
$ 11,927,270
$ 8,403,993
$ 6,649,860
[1] The 2010 comparative figures have been restated to account for the Conversion. See notes 1 and 23.
John Brough
Robert Mitchell
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
31
First National Financial Corporation
Consolidated Statements of Comprehensive Income
and Retained Earnings
($000s, except earnings per unit)
Years ended December 31
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
Placement fees
Gains on deferred placement fees
Mortgage investment income
Mortgage servicing income
Realized and unrealized gains (losses) on financial instruments
EXPENSES
Brokerage fees
Salaries and benefits
Interest
Other operating
Amortization of intangible assets
Income before income taxes
Income tax expense
Net income and comprehensive income for the year
Retained earnings, beginning of year
Less: dividends/distributions declared
Retained earnings, end of year
Earnings per share
Basic
See accompanying notes
Notes
2011
2010 [1]
3
4
18
$
254,118
(184,291)
$
171,526
(112,530)
69,827
58,996
110,041
6,663
29,311
82,372
(18,485)
279,729
81,480
48,808
15,998
28,692
7,968
107,292
13,123
21,192
73,846
7,280
281,729
70,718
44,653
13,613
23,320
9,468
182,946
161,772
96,783
26,292
70,491
111,505
(109,022)
119,957
30,040
89,917
111,211
(89,623)
$
72,974
$
111,505
17
$ 1.10
$ 1.50
[1] The 2010 comparative figures have been restated to account for the Conversion. See notes 1 and 23.
32
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
First National Financial Corporation
Consolidated Statements of Changes in Shareholders’ Equity
($000s)
Balance at January 1, 2011 [1]
Comprehensive income
Issuance of preferred shares
Dividends paid or declared
Common
shares
Preferred
shares
Retained
earnings
Total
shareholders’
equity
$
122,671
–
–
–
$
–
–
97,394
–
$ 111,505
70,491
–
(109,022)
$
234,176
70,491
97,394
(109,022)
Balance at December 31, 2011
$
122,671
$
97,394
$
72,974
$
293,039
Balance at January 1, 2010 [1]
Comprehensive income
Distributions paid or declared
Balance at December 31, 2010
See accompanying notes
Common
shares
Preferred
shares
Retained
earnings
Total
shareholders’
equity
$
122,671
–
–
$
$
122,671
$
–
–
–
–
$
111,211
89,917
(89,623)
$
233,882
89,917
(89,623)
$
111,505
$
234,176
[1] The 2010 comparative figures have been restated to account for the Conversion. See notes 1 and 23.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
33
First National Financial Corporation
Consolidated Statements of Cash Flows
($000s)
Years ended December 31
OPERATING ACTIVITIES
Net income for the year
Add (deduct) items not affecting cash:
Deferred income tax expense
Non-cash portion of gains on deferred placement fees
Increase in restricted cash
Net investment in mortgages pledged under securitization
Net increase in debt related to securitized mortgages
Amortization of deferred placement fees receivable
Amortization of purchased mortgage servicing rights
Amortization of property, plant and equipment
Amortization of intangible assets
Unrealized gains on financial instruments
Net change in non-cash working capital balances related to operations
2011
2010 [1]
$
70,491
$
89,917
(3,508)
(4,720)
(74,321)
(2,569,632)
2,613,535
24,771
995
1,856
7,968
(3,846)
63,589
(519,947)
4,202
(9,566)
(82,758)
(1,670,042)
1,738,088
23,355
841
1,796
9,468
(6,698)
98,603
66,720
Cash provided by (used in) operating activities
$
(456,358)
$
165,323
INVESTING ACTIVITIES
Additions to property, plant and equipment
Investment of cash held as collateral under securitization
Investment in mortgage and loan investments
Repayment of mortgage and loan investments
Cash used in investing activities
FINANCING ACTIVITIES
Dividends/distributions paid
Issuance of preferred shares
Obligations related to securities and mortgages sold under repurchase agreements
Proceeds from debenture loan
Debt related to participation mortgages
Securities purchased under resale agreements and owned, net
Securities sold under repurchase agreements and sold short, net
Cash provided by financing activities
Net decrease (increase) in bank indebtedness during the year
Bank indebtedness, beginning of year
Bank indebtedness, end of year
Supplemental cash flow information
Interest received
Interest paid
Income taxes paid
See accompanying notes
[1] The 2010 comparative figures have been restated to account for the Conversion. See notes 1 and 23.
34
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
$
(3,184)
(19,152)
(238,476)
129,580
$
(1,253)
5,979
(67,170)
53,642
$
(131,232)
$
(8,802)
$
(133,600)
96,481
490,166
–
69,202
(231,290)
225,919
$
(89,623)
–
(47,679)
175,000
–
(92,631)
92,274
$
516,878
$
37,341
$
(70,712)
(9,896)
$
(80,608)
$
261,027
187,933
33,356
$
$
$
193,862
(203,758)
(9,896)
220,349
116,782
33,387
First National Financial Corporation
Notes to Consolidated Financial Statements
December 31, 2011 and 2010
($000s, except per unit amounts or unless otherwise noted)
Note 1
General Organization and Business
of First National Financial Corporation
First National Financial Corporation [the “Corporation” or “Com-
pany”] is the parent company of First National Financial LP [“FNFLP”],
a Canadian-based originator, underwriter and servicer of predomi-
nantly prime residential [single-family and multi-unit] and commercial
mortgages. With over $59 billion in mortgages under administration,
FNFLP is an originator and underwriter of mortgages and a significant
participant in the mortgage broker distribution channel. Pursuant to
a Plan of Arrangement [the “Arrangement”] and an amalgamation
[the “Amalgamation”] effective Januar y 1, 2011, the Corporation
succeeded First National Financial Income Fund [the “Fund”] as the
public holding company invested in FNFLP. The Arrangement and
Amalgamation [together the “Conversion”] were used to convert the
Fund into a corporate structure. The most significant steps involved in
the Conversion were:
• A new company, First National Financial Inc. [“FNFI”], was formed;
• Unitholders of the Fund exchanged their 12,681,113 Class A units
in the Fund for shares in FNFI on a one-for-one basis;
• The pre-Arrangement shareholders of the Corporation [the
“Co-founders”] exchanged 47,286,316 shares in the Corporation
for 47,286,316 shares of FNFI with the result that the Corporation
became a wholly-owned subsidiary of FNFI;
• The Fund and First National Financial Operating Trust were wound
up; and
• The Corporation and FNFI were amalgamated and continued
under the name “First National Financial Corporation”.
Effectively, the Conversion reorganized the ownership interests in
FNFLP such that all such interests are now consolidated and held
through the Corporation in the same ratio as previously held by the
Fund and by the Co-founders. Prior to the initial public offering of the
Fund [the “IPO”] in June 2006, the Corporation owned and operated
the business. Concurrent with the IPO, the business was transferred
from the Corporation to FNFLP such that the Corporation then
operated as a privately held holding company which owned a direct
interest of 80.03% in FNFLP. At that time, the Fund indirectly held the
non-controlling interest in FNFLP of 19.97%. Given the history of the
Corporation’s relationship with FNFLP and the non-arm’s length
nature of the Conversion, the Corporation has accounted for these
transactions as a business combination under common control using
the pooling of interests method. Accordingly, the Corporation’s con-
solidated financial statements reflect the combined activities of the
Fund and the Corporation prior to the Conversion [including the con-
solidation of FNFLP]. Immediately prior to the Conversion, residual
assets and liabilities of the Corporation were distributed and settled
so that as of the Conversion date, the consolidated statement of
financial position of the Corporation substantially reflects the assets
and liabilities of FNFLP at book value, plus the intangible assets repre-
sented by the excess of the purchase price paid by the Fund over the
carrying value of its share of the net assets of FNFLP at the IPO date
and deferred tax liabilities related to temporary differences between
the book value and tax basis of the carrying value of the Fund’s invest-
ment in FNFLP. In effect this accounting treatment assumes, for com-
parative financial reporting purposes, that the Conversion occurred at
the time of the IPO. The Co-founders have provided indemnities to
the Corporation to protect the current shareholders of the Corpora-
tion from any unrecorded liabilities incurred by the Corporation in the
period between the IPO and January 1, 2011.
The Corporation is incorporated under the laws of the Province of
Ontario, Canada and has its registered office and principal place of busi-
ness located at 100 University Avenue, Toronto, Ontario. The Corpora-
tion’s common and preferred shares are listed on the Toronto Stock
Exchange [“TSX”] under the symbols FN and FN.PR.A, respectively.
Note 2
Significant Accounting Policies
2.1 Basis of preparation
The consolidated financial statements have been prepared in accor-
dance with International Financial Repor ting Standards [“IFRS”] as
issued by the International Accounting Standards Board [the “IASB”]
[see note 23 for IFRS transition disclosures]. The consolidated financial
statements have been prepared on a historical cost basis, except for
derivative financial instruments and financial assets and financial liabili-
ties, which are recorded at fair value through profit or loss and mea-
sured at fair value. The carr ying values of recognized assets and
liabilities, that are hedged items in fair value hedges, and otherwise car-
ried at amor tized cost, are adjusted to record changes in fair value
attributable to the risks that are being hedged. The consolidated finan-
cial statements are presented in Canadian dollars and all values are
rounded to the nearest thousands, except when otherwise indicated.
The consolidated financial statements were authorized for issue by the
Board of Directors on February 28, 2012.
2.2 Basis of consolidation
The consolidated financial statements comprise the financial state-
ments of the Company and its subsidiaries, including FNFLP, First
National Financial GP Corporation [the general partner of FNFLP] and
FNFC Trust, a special purpose entity [“SPE”] which is used to manage
undivided co-ownership interests in mortgage assets and fund these
with Asset-Backed Commercial Paper [“ABCP”]. The consolidated
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
35
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
financial statements have been prepared using consistent accounting
policies for like transactions and other events in similar circumstances.
All inter-company balances and revenues and expenses have been
eliminated on consolidation.
2.3 Use of estimates
The preparation of financial statements in conformity with IFRS
requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, including contingencies,
at the date of the consolidated 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
estimates by management are those that require reporting of financial
assets and liabilities at fair value.
2.4 First-time application of IFRS
The Company has applied IFRS to its financial repor ting with effect
from January 1, 2010, the date of transition, in accordance with the
transitional provisions set out in IFRS 1, “First-time Adoption of Interna-
tional Financial Reporting Standards” [“IFRS 1”]. Previously, the Com-
pany had prepared its financial statements in conformity with Canadian
generally accepted accounting principles [“GAAP”]. The Company’s
consolidated financial statements for the year ended December 31,
2011 are the first annual financial statements that comply with IFRS.
IFRS 1 requires first-time adopters to retrospectively apply all effective
IFRS as of the first annual reporting date. IFRS 1 also provides certain
optional and mandatory exemptions for the first-time IFRS adopters.
The mandatory exemptions are as follows:
Mandatory exemptions
Derecognition of financial assets and financial liabilities The Company
has elected not to re-recognize any financial assets and financial liabili-
ties derecognized before January 1, 2004.
Hedge accounting Hedge accounting can only be applied prospectively
from the transition date of January 1, 2010 to transactions that satisfy
the hedge accounting criteria in IAS 39 at that date. Hedging relation-
ships cannot be designated retrospectively and the supporting docu-
mentation cannot be created retrospectively. As a result, only hedging
relationships that satisfied the hedge accounting criteria as of the tran-
sition date are reflected as hedges in the Company’s results under IFRS.
Estimates The estimates at January 1, 2010 and at December 31, 2010
are consistent with those made for the same dates in accordance with
Canadian GAAP, after adjustments to reflect any differences in
accounting policies.
2.5 Significant accounting policies
Revenue recognition
The Company earns revenue from placement, securitization and ser-
vicing activities related to its mortgage business. The majority of origi-
nated mor tgages are sold to institutional investors through the
placement of mor tgages or funded through securitization conduits.
The Company retains servicing rights on substantially all of the mort-
gages it originates, providing the Company with servicing fees.
Interest revenue and expense from mortgages pledged under securitiza-
tion The Company enters into securitization transactions to fund a por-
tion of its originated mortgages. Upon transfer of these mortgages to
securitization vehicles, the Company receives cash proceeds from the
transaction. These proceeds are accounted for as debt related to securi-
tized mortgages and the Company continues to hold the mortgages on
its consolidated statement of financial position, unless:
[i] substantially all the risks and rewards associated with the financial
instruments have been transferred, in which case the assets are
derecognized in full; or
[ii] a significant portion, but not all, of the risks and rewards have been
transferred. The asset is derecognized entirely if the transferee has
the ability to sell the financial asset; otherwise the asset continues
to be recognized to the extent of the Company’s continuing
involvement.
Where [i] or [ii] above applies to a fully proportionate share of all or
specifically identified cash flows, the relevant accounting treatment is
applied to that proportion of the mortgage.
For securitized mor tgages that do not meet the criteria for
derecognition, no gain or loss is recognized at the time of the transac-
tion. Instead, net interest revenue is recognized over the term of the
mortgages.
Interest revenue – securitized mor tgages represents interest
received and accrued on mortgage payments by borrowers and is net
of the amortization of capitalized origination fees.
Interest expense – securitized mor tgages represents financing
costs to fund these mortgages, net of the amortization of debt dis-
counts or premiums. Both capitalized origination fees and debt dis-
counts or premiums are amortized on an effective yield basis over the
term of the related mortgages/debt.
Derecognition A financial asset is derecognized when:
• The right to receive cash flows from the asset has expired;
•
The Company has transferred its rights to receive cash flows from
the assets or has assumed an obligation to pay the received cash
flows in full without material delay to a third party under a “pass-
through” arrangement; and either [a] the Company has transferred
substantially all the risks and rewards of the asset or [b] the Com-
pany has neither transferred nor retained substantially all of the risks
and rewards of the asset, but has transferred control of the asset.
36
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
When the Company has transferred its rights to receive cash flows
from an asset or has entered into a pass-through arrangement, and has
neither transferred nor retained substantially all of the risks and rewards
of the asset nor transferred control of the asset, the asset is recognized
to the extent of the Company’s continuing involvement in the asset.
In that case, the Company also recognizes an associated liability.
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.
Placement fees and deferred placement fees receivable The Company
enters into placement agreements with institutional investors to pur-
chase the mortgages it originates. When mortgages are placed with
institutional investors, the Company transfers the contractual right to
receive mortgage cash flows to the investors. Because it has transferred
substantially all of the risks and rewards of ownership of these mort-
gages, it has derecognized these assets. The Company retains a residual
interest, representing the rights and obligations associated with servic-
ing the mortgages. Placement fees are earned by the Company for its
origination and underwriting activities on a completed transaction basis
when the mortgage is funded. Amounts immediately collected or col-
lectible in excess of the mortgage principal are recognized as placement
fees. When placement fees and associated servicing fees are earned over
the term of the related mortgages, the Company determines the pres-
ent value of the future stream of placement fees and records a gain
on deferred placement fees and a deferred placement fees receivable.
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 prepayment rates and discount
rates commensurate with the risks involved.
Mortgage servicing income The Company services substantially all of
the mortgages that it originates whether the mortgage is placed with
an institutional investor or transferred to a securitization vehicle. In
addition, mortgages are serviced on behalf of third-party institutional
investors and securitization structures. For mortgages pledged under
securitizations, mortgages administered for investors or third parties, the
Company recognizes servicing income when services are rendered. For
mortgages placed under deferred placement arrangements, the Com-
pany retains the rights and obligations to service the mortgages. The
deferred placement fees receivable is the present value of the excess
retained cash flows over normal servicing fee rates and is reported as
deferred placement revenue at the time of placement. Servicing income
related to mortgages placed with institutional investors is recognized in
income over the life of the servicing obligation as payments are received
from mortgagors. Interest income earned by the Company from hold-
ing cash in trust related to servicing activities is classified as mortgage
servicing income.
Mortgage investment income The Company earns interest income from
its interest-bearing assets including deferred placement fees receiv-
able, mortgage and loan investments and mortgages accumulated for
sale or securitization. Mortgage investment income is recognized on an
accrual basis.
Mortgages pledged under securitization
Mortgages pledged under securitization are mortgages that the Com-
pany has originated and funded with debt raised through the securiti-
zation markets. The Company has a continuous involvement in these
mortgages, including the right to receive future cash flows arising from
these mortgages. Mortgages pledged under securitization [except for
mortgages funded with bank-sponsored ABCP programs] have been
classified as loans and receivables and are measured at their amortized
cost using the effective yield method. Mortgages funded under bank-
sponsored ABCP programs are classified as fair value through profit
or loss and recorded at fair value. Origination costs, such as brokerage
fees and timely payment guarantee fees that are directly attributable
to the acquisition of such assets, are deferred and amortized over the
term of the mortgages on an effective yield basis.
Debt related to securitized and participation mortgages
Debt related to securitized mortgages represents obligations related
to the financing of mortgages pledged under securitization. This debt
is measured at its amortized cost using the effective yield method. Any
discount/premium on the raising of these debts that is directly attribut-
able to the acquisition of such liabilities is deferred and amortized over
the term of the debt obligations.
Debt related to par ticipation mor tgages represents obligations
related to the financing of a portion of commercial mortgages included
in mor tgage and loan investments. These mor tgages are subject to
participation agreements with other financial institutions such that the
Company’s investment is subordinate to the other institution’s invest-
ment. The Company has retained various rights to the mortgages and
a proportionately larger share of the interest earned on these mort-
gages, such that the full mor tgage has been recorded on the Com-
pany’s statement of financial position with an offsetting debt. This debt
is recorded at face value and measured at its amortized cost.
Mortgages accumulated for sale or securitization
Mortgages accumulated for sale are mortgages funded for the pur-
pose of placing with investors and are classified as fair value through
profit or loss and are recorded at fair value. These mortgages are held
for terms usually not exceeding 90 days.
The Company classifies mor tgages that are funded for its own
securitization programs as loans and receivables and carries these
mortgages at amortized cost.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
37
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
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 origi-
nal seller at a specified price. The Company uses the combination of
bonds sold short and bonds purchased under resale agreements to
economically hedge its mor tgage commitments and the por tion of
mortgages that it intends to securitize.
Bonds sold short are classified as fair value through profit or loss
and are recorded at fair value. The accrued coupon on bonds sold
short is recorded as hedge expense. Bonds purchased under resale
agreements are carried at cost plus accrued interest, which approxi-
mates their market value. The difference between the cost of the pur-
chase and the predetermined proceeds to be received on a resale
agreement is recorded over the term of the hedged mortgages as an
offset to hedge expense. Transactions are recorded on a settlement
date basis.
Securities owned and securities sold
under repurchase agreements
The Company purchases bonds and enters into bond repurchase
agreements to close out economic hedging positions when mortgages
are sold to securitization vehicles or institutional investors.
These transactions are accounted for in a similar manner as the
transactions described for securities sold shor t and securities pur-
chased under resale agreements.
Mortgage and loan investments
Mortgage and loan investments are carried at their outstanding princi-
pal balances adjusted for unamortized premiums or discounts and are
net of specific provisions for credit losses, if any.
Mortgage and loan investments are recognized as being impaired
when the Company is no longer reasonably assured of the timely col-
lection 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.
Mortgage and loan investments are classified as loans and receiv-
ables, except for a por tfolio of long-term commercial mor tgages
which is designated as fair value through profit or loss and is recorded
at fair value.
Intangible assets
Intangible assets are comprised of broker relationships and customer
service contracts and arose in connection with the IPO in 2006. Intan-
gible assets are subject to annual impairment review if there are
events or changes in circumstances that indicate that the carrying
amount may not be recoverable.
Intangible assets with finite useful lives are amortized on a straight-
line basis over their estimated useful lives as follows:
Broker relationships
Investor servicing contracts
straight-line over 10 years
straight-line over 5 years
38
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Goodwill
Goodwill represents the price paid for the Corporation’s business in
excess of the fair value of the net tangible assets and identifiable intan-
gible assets acquired in connection with the IPO. Goodwill is reviewed
annually for impairment or more frequently when an event or change
in circumstance indicates that the asset might be impaired.
Property, plant and equipment
Property, plant and equipment are recorded at cost, less accumulated
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 a
computer license, which is straight-line
over 10 years
Property, plant and equipment are subject to an impairment review if
there are events or changes in circumstance which indicate that the
carrying amount may not be recoverable.
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 mortgage
servicing obligation. The fair value of such rights is determined on a
periodic basis to assess the continued recoverability of the unamor-
tized cost in relation to estimated future cash flows associated with
the underlying serviced assets. Any loss arising from an excess of the
unamor tized cost over the fair value is immediately recorded as a
charge to income.
Restricted cash
Restricted cash represents principal and interest for mor tgages
pledged under securitization held in trust awaiting the repayment of
debt related to these mortgages.
Bank indebtedness
Bank indebtedness consists of cash balances with banks and bank
indebtedness.
Cash held as collateral under securitization
Cash held as collateral under securitization is a cash-based credit
enhancement held by FNFC Trust.
Income taxes
The Company accounts for income taxes in accordance with the lia-
bility method of tax allocation. Under this method, the provision for
income taxes is calculated based on income tax laws and income tax
rates substantively enacted as at the date of the consolidated state-
ment of financial position. The income tax provision consists of cur-
rent income taxes and deferred income taxes. Current and deferred
taxes relating to items recognized directly in equity are recognized
directly in equity.
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Current income taxes are amounts expected to be payable or
recoverable as the result of operations in the current year and any
adjustment to tax payable/recoverable recorded in previous years.
Deferred income taxes arise on temporary differences between
the carrying amounts of assets and liabilities on the consolidated state-
ment of financial position and their tax bases. Deferred tax liabilities
are generally recognized for all taxable temporary differences and
deferred tax assets are recognized to the extent that future realization
of the tax benefit is probable. Deferred tax is calculated using the tax
rates expected to apply in the periods in which the assets will be real-
ized or the liabilities settled. Deferred tax assets and liabilities are
offset when they arise in the same tax reporting group and relate to
income taxes levied by the same taxation authority, and when a legal
right to offset exists in the entity.
Earnings per common share
The Company presents earnings per share [“EPS”] amounts for its
common shares. EPS is calculated by dividing the net earnings attribut-
able to common shareholders of the Company by the weighted aver-
age number of common shares outstanding during the year.
Financial assets and liabilities
The Company classifies its financial assets as either financial instru-
ments at fair value through profit or loss or loans and receivables.
Financial liabilities are classified as either held at fair value through
profit or loss or at amortized cost. Management determines the classi-
fication of financial assets and liabilities at initial recognition.
Financial assets and financial liabilities held at fair value through profit
or loss Financial instruments are classified in this category if they are
held for trading, or if they are designated by management at fair value
through profit or loss at inception.
Financial instruments are classified as held for trading if they are
acquired principally for the purpose of selling in the short term. Finan-
cial assets and financial liabilities may be designated at fair value
through profit or loss when:
[i] the designation eliminates or significantly reduces a measurement
or recognition inconsistency that would otherwise arise from mea-
suring assets or liabilities or recognizing the gains and losses on
them on a different basis; or
[ii] a group of financial assets and/or financial liabilities is managed and
its performance evaluated on a fair value basis.
The Company has elected to measure certain of its assets at fair value
through profit or loss. Most significant of these assets are: mortgages
pledged under securitization and funded with ABCP-related debt,
deferred placement fees receivable, cer tain long-term commercial
mortgages within mortgage and loan investments, and certain mort-
gages funded with MBS debt. The mortgages funded with MBS debt
were previously funded by ABCP debt and as such have retained their
classification as held for trading [together with ABCP-funded mort-
gages, “HFT mortgages”]. For the HFT mortgages, the Company has
entered into swaps to convert the mortgages from fixed rate to float-
ing rate in order to match the mortgages with the 30-day floating rate
funding provided by the ABCP notes. The swaps are derivatives and
are required by IFRS to be accounted for at fair value. This value can
change significantly with the passage of time as the interest rate envi-
ronment changes. In order to avoid a significant accounting mismatch,
the Company has measured the swapped mortgages at fair value as
well so that the asset and related liability values will move inversely as
interest rates change. The cash flows related to deferred placement
fees receivable are typically received over five- to 10-year terms.
These cash flows are subject to prepayment volatility as the mor t-
gages underlying the deferred placement fees receivable can experi-
ence unscheduled prepayments. As well, the bank syndicate bases a
portion of its loans to the Company on the carrying value of these
assets. Accordingly, the Company must manage these assets on a fair
value basis. The long-term commercial mor tgage investments are
being actively offered for sale by the Company. These mortgages are
priced off of benchmark Government of Canada bonds, such that fair
value is the most appropriate measurement in the circumstances.
Financial assets and financial liabilities held at fair value through profit
or loss are initially recognized at fair value. Subsequent gains and losses
arising from changes in fair value are recognized directly in the consoli-
dated statement of comprehensive income and retained earnings.
Held-for-trading non-derivative financial assets can only be trans-
ferred out of the held at fair value through profit or loss category in
the following circumstances: to the available-for-sale category, when, in
rare circumstances, they are no longer held for the purpose of selling
or repurchasing in the near term; or to the loans and receivables cate-
gor y, when they are no longer held for the purpose of selling or
repurchasing in the near term, would have met the definition of a
loan and receivable at the date of reclassification, and the Company
has the intent and ability to hold the assets for the foreseeable future
or until maturity.
Loans and receivables Loans and receivables are non-derivative financial
assets with fixed or determinable payments that are not quoted in an
active market and it is expected that substantially all of the initial invest-
ment will be recovered, other than because of credit deterioration.
Loans and receivables are initially recognized at cost, including
direct and incremental transaction costs. They are subsequently valued
at amortized cost.
Held-to-maturity Held-to-maturity assets are non-derivative financial
assets with fixed or determinable payments and fixed maturities that
the Company’s management has the positive intention and ability to
hold to maturity. These assets are initially recognized at cost, including
direct and incremental transaction costs. They are subsequently valued
at amortized cost using the effective interest method.
Held-to-maturity assets can be reclassified to the available-for-
sale category if the portfolio becomes tainted following the sale of
other than an insignificant amount of held-to-maturity assets prior to
their maturity.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
39
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Derivative financial instruments
Derivatives are categorized as trading unless they are designated as
hedging instruments. Derivative contracts are initially recognized at fair
value on the date on which a derivative contract is entered into and
are subsequently re-measured at their 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.
The Company enters into interest rate swaps to manage its inter-
est rate exposures associated with funding fixed rate receivables with
floating rate debt and to convert the fixed rate debenture into float-
ing rate debt. These contracts are negotiated over-the-counter. Inter-
est rate swaps require the periodic exchange of payments without the
exchange of the notional principal amount on which the payments are
based. The Company’s policy is not to utilize derivative financial instru-
ments for trading or speculative purposes.
Hedge accounting
At the inception of a hedging relationship, the Company documents
the relationship between the hedging instruments and the hedged
items, its risk management objective, its strategy for undertaking the
hedge, and its assessment of whether or not the hedging instruments
are highly effective in offsetting the changes attributable to the hedged
risks in the hedged items.
For fair value hedges, changes in the fair value of derivatives that are
designated and qualify as fair value hedging instruments are recorded in
the consolidated statement of comprehensive income and retained
earnings, together with any changes in the fair value of the hedged
asset or liability that are attributable to the hedged risk. The changes in
fair value attributable to the hedged risk are accounted for as basis
adjustment to the hedged item. If the hedge no longer meets the crite-
ria for hedge accounting, the adjustment to the carrying amount of a
hedged item for which the effective interest method is used is amor-
tized to the consolidated statement of comprehensive income and
retained earnings over the period to maturity or derecognition.
Note 3
Mortgages Pledged under Securitization
The Company securitizes residential and commercial mor tgages in
order to raise debt to fund these mortgages. Most of these securitiza-
tions consist of the transfer of fixed and floating rate mortgages into
securitization programs, such as ABCP, National Housing Act – Mort-
gage Backed Securities (“NHA–MBS”), and the Canada Mor tgage
Bonds [“CMB”] program. In these securitizations, the Company trans-
fers the assets to special purpose entities [“SPEs”] for cash, and incurs
interest-bearing obligations typically matched to the term of the mort-
gages. These securitizations do not qualify for derecognition, although
the SPEs and other securitization vehicles have no recourse to the
Company’s other assets for failure of the mor tgages to make pay-
ments when due.
As part of the ABCP transactions, the Company provides cash col-
lateral for credit enhancement purposes as required by the rating
agencies. Credit exposure to securitized mortgages is generally limited
to this cash collateral. The principal and interest payments on the
40
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
securitized mortgages are paid to the Company by the SPEs monthly
over the term of the mortgages. The full amount of the cash collateral
is recorded as an asset and the Company anticipates full recovery of
these amounts. NHA–MBS financings may also require cash collateral
in some circumstances. As at December 31, 2011, the cash held as
collateral under securitization was $56,882 [December 31, 2010 –
$37,730; January 1, 2010 – $43,709].
The following table compares the carrying amount of mortgages
pledged for securitization and the associated debt:
NHA–MBS and CMB programs
Bank-sponsored ABCP
Capitalized origination costs
Debt discounts
December 31, 2011
Carrying
amount of
securitized
mortgages
Carrying
amount of
associated
liabilities
$ 7,560,583
2,151,556
49,782
–
$ 7,634,173
2,258,368
–
(4,524)
9,761,921
9,888,017
Add: principal portion of payments
held in restricted cash
225,707
–
$ 9,987,628
$ 9,888,017
December 31, 2010
Carrying
amount of
securitized
mortgages
Carrying
amount of
associated
liabilities
$ 5,885,249
1,261,522
47,190
–
$ 6,008,854
1,271,262
–
(5,634)
7,193,961
7,274,482
NHA–MBS and CMB programs
Bank-sponsored ABCP
Capitalized origination costs
Debt discounts
Add: principal portion of payments
held in restricted cash
152,445
–
$ 7,346,406
$ 7,274,482
January 1, 2010
Carrying
amount of
securitized
mortgages
Carrying
amount of
associated
liabilities
$ 3,980,382
1,527,758
32,654
–
$ 3,995,080
1,554,248
–
(12,934)
5,540,794
5,536,394
NHA–MBS and CMB programs
Bank-sponsored ABCP
Capitalized origination costs
Debt discounts
Add: principal portion of payments
held in restricted cash
73,440
–
$ 5,614,234
$ 5,536,394
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The principal portion of payments held in restricted cash represents
payments on account of mor tgages pledged under securitization
which have been received at year end but have not been applied to
reduce the associated debt. This cash is applied to pay down the debt
in the month subsequent to year end. In order to compare all assets
funded by each category of securitization debt, this amount is added
to the carrying value of mortgages pledged under securitization in the
above table.
Except for approximately $521 million of securitized mor tgages
included in HFT mortgages, the mortgages securitized through NHA–
MBS and CMB programs have been classified as loans and receivables.
These mortgages are carried at par plus adjustment for unamortized
origination costs. Mor tgages in bank-sponsored ABCP programs
have been classified as fair value through profit or loss and are net of
specific provisions for credit losses.
The following table summarizes the mor tgages pledged under
Bank-sponsored ABCP mor tgages are net of valuation reserves
securitization that are past due:
Arrears days
31 to 60
61 to 90
Greater than 90
December 31
2011
December 31
2010
$
45,801
6,465
38,306
$
37,696
7,292
28,706
$
90,572
$
73,694
Interest revenue-securitized mortgages consists of $43,728 [2010 –
$38,244] of interest revenue related to ABCP funded mor tgages,
which are measured at fair value, and $210,390 [2010 – $133,282] of
interest revenue related to mortgages pledged under securitization
and securitized mortgages included in HFT mortgages.
related to credit losses of $5,293 [December 31, 2010 – $5,599].
The changes in capitalized origination costs for the year ended
December 31 are as follows:
2011
2010
Opening balance, January 1
Add: new origination costs
in the year
Less: amortization in the year
$
47,190
$
32,654
25,152
(22,560)
40,185
(25,649)
Ending balance, December 31
$
49,782
$
47,190
During the year ended December 31, 2011, the Company advanced
funds and transferred into the securitization vehicles $4,004,716
[2010 – $3,651,937] of new mortgages.
As at December 31, 2011, mortgages pledged under securitization
include $9,220,847 [December 31, 2010 – $6,556,644] of insured
mortgages and $496,584 [December 31, 2010 – $595,726] of unin-
sured mortgages.
The contractual maturity profile of the mortgages pledged under
securitization programs is as follows:
2012
2013
2014
2015
2016 and thereafter
Add: capitalized origination costs
fair value premium – HFT mortgages
$ 1,102,626
1,108,018
1,528,490
2,519,102
3,421,514
9,679,750
49,782
32,389
9,761,921
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
41
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 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], which might magnify or counteract the sensitivities.
Note 4
Deferred Placement Fees Receivable
The Company enters into transactions with institutional investors to
sell primarily fixed rate mor tgages in which placement fees are
received over time as well as at the time of the mortgage placement.
These mortgages are derecognized when substantially all of the risks
and rewards of ownership are transferred and the Company has mini-
mal exposure to the variability of future cash flows from these mort-
gages. The investors have no recourse to the Company’s other assets
for failure of mortgagors to pay when due.
During the year ended December 31, 2011, $1,012,743 [2010 –
$1,749,715] of mor tgages were placed with institutional investors,
which created gains on deferred placement fees of $6,663 [2010 –
$13,123]. Cash receipts on deferred placement fees receivable for the
year ended December 31, 2011 were $28,261 [2010 – $91,464].
The Company uses various assumptions to value the deferred
placement fees receivable, which are set out in the table below, includ-
ing the rate of unscheduled prepayments. Accordingly, the deferred
placement fees receivable are subject to measurement uncer tainty.
No assumption for credit loss was used, commensurate with the
credit quality of the investors. The effect of variations between actual
experience and assumptions will be recorded in future statements of
comprehensive income and retained earnings. 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:
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The Company uses various assumptions to value the HFT mort-
gages, which are set out in the tables below, including the rate of
unscheduled prepayment. Accordingly, HFT mortgages are subject to
measurement uncer tainty. The effect of variations between actual
experience and assumptions will be recorded in future statements of
comprehensive income. Key economic weighted average assumptions
and the sensitivities of the current carrying values to immediate 10%
and 20% adverse changes in those assumptions are as follows:
HFT mortgages
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
Discount rate [annual rate]
Impact on fair value of
10% adverse change
Impact on fair value of
20% adverse change
HFT mortgages
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
Discount rate [annual rate]
Impact on fair value of
10% adverse change
Impact on fair value of
20% adverse change
December 31, 2011
Commercial
mortgages
Residential
mortgages
$ 487,959
14
$ 2,161,550
44
12.7%
15.0%
$
$
74
145
2.3%
649
1,280
2.4%
2,011
$
10,867
4,005
$
21,629
$
$
$
$
December 31, 2010
Commercial
mortgages
Residential
mortgages
$ 523,477
14
$ 738,045
20
10.9%
15.1%
32
63
2.7%
1,786
3,560
$
$
$
$
191
381
3.4%
3,093
6,160
$
$
$
$
[1] The weighted-average life of prepayable assets in periods [for exam-
ple, months or years] can be calculated by multiplying the principal collec-
tions 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.
42
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
FIRST NATIONAL FINANCIAL CORPORATION
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 varia-
tion 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], which might
magnify or counteract the sensitivities.
The Company estimates that the expected cash flows from the
receipt of payments on the deferred placement fees receivable will be
as follows:
2012
2013
2014
2015
2016 and thereafter
$
23,882
16,045
6,639
3,430
8,513
$
58,509
Fair value of deferred placement
fees receivable
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 rate]
Impact on fair value of
10% adverse change
Impact on fair value of
20% adverse change
Fair value of deferred placement
fees receivable
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 rate]
Impact on fair value of
10% adverse change
Impact on fair value of
20% adverse change
December 31, 2011
Commercial
mortgages
Residential
mortgages
$
44,124
50
$
14,385
20
0.6%
15.0%
26
51
$
$
172
340
4.4%
4.1%
427
845
$
$
48
95
$
$
$
$
December 31, 2010
Commercial
mortgages
Residential
mortgages
$
51,468
56
$
25,942
30
0.7%
15.0%
$
$
$
$
52
102
5.3%
775
1,531
$
$
$
$
472
932
4.8%
144
287
[1] The weighted-average life of prepayable assets in periods [for exam-
ple, months or years] can be calculated by multiplying the principal collec-
tions 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 2011 ANNUAL REPORT
43
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 5
Mortgages Accumulated for Sale
or Securitization
Mortgages accumulated for sale or securitization consist of mortgages
the Company has originated for its own securitization programs or
mortgages funded for placement with other investors.
Mortgages accumulated for securitization
Mortgages accumulated for sale
Note 6
Mortgage and Loan Investments
Mortgages originated for the Company’s own securitization pro-
grams are classified as loans and receivables and are recorded at
amortized cost. Mortgages funded for placement with other investors
are designated as held for trading and recorded at fair value. The fair
values of mortgages held for trading approximate their carrying value
due to their short-term nature. The following table summarizes the
components of mortgages according to their classification:
December 31
2011
December 31
2010
January 1
2010
$ 846,694
4,244
$ 300,309
17,827
$ 374,695
8,164
$ 850,938
$ 318,136
$ 382,859
As at December 31, 2011, mortgage and loan investments consist primarily of commercial first and second mortgages held for various 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 fair value through profit or loss
December 31
2011
December 31
2010
January 1
2010
$ 175,071
5,801
$
60,555
10,356
$
45,133
9,604
$ 180,872
$
70,911
$
54,737
Mortgage and loan investments classified as loans and receivables are carried at outstanding principal balances adjusted for unamortized premiums
or discounts and are net of specific provisions for credit losses, if any.
The following table discloses the composition of the Company’s port-
folio of mor tgage and loan investments by geographic region as at
December 31, 2011:
[2010 – $70,388] of uninsured mortgage and loan investments as at
December 31, 2011.
The following table discloses the mortgages that are past due as at
Province
Alberta
British Columbia
Manitoba
New Brunswick
Newfoundland
Nova Scotia
Ontario
Quebec
Saskatchewan
Yukon
Portfolio
balance
Percentage
of portfolio
$
2,716
2,265
16,778
1,048
645
23,867
76,232
55,289
1,031
1,001
1.50
1.25
9.28
0.58
0.36
13.20
42.14
30.57
0.57
0.55
$ 180,872
100.00
These balances are net of discounts of $121 [2010 – $296] and pro-
visions for credit losses of $4,831 [2010 – $4,831]. The por tfolio
contains $1,001 [2010 – $523] of insured mortgages and $184,298
44
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
December 31:
Arrears days
31 to 60
61 to 90
Greater than 90
2011
2010
$
$
7,470
221
7,266
2,122
1,694
7,739
$
14,957
$
11,555
Of the above total amount, the Company considers $6,121 [2010 –
$5,968] as impaired, for which it has provided an allowance for poten-
tial loss of $4,831 [2010 – $4,831] as at December 31, 2011.
Due to loan-specific issues, the Company recorded credit losses of
$525 for the year ended December 31, 2010. These losses were
included in other operating expenses in the consolidated statement
of comprehensive income and retained earnings. The Company
re-assessed the credit risk of the mortgages at December 31, 2011,
and concluded that no additional accrual is required for 2011.
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The contractual repricing in the table below is based on the earlier of contractual repricing or maturity dates.
2012
2013
2014
2015
2016 and
thereafter
Book
value
2011
2010
Book
value
Residential
Commercial
$
3,904
130,301
$
–
30,242
$
–
6,660
$
$ 134,205
$ 30,242
$
6,660
$
100
–
100
$
1,178
8,487
$
5,182
175,690
$
3,039
67,872
$
9,665
$ 180,872
$ 70,911
Interest income for the year was $8,643 [2010 – $8,722] and is included in mortgage investment income on the consolidated statement of
comprehensive income and retained earnings.
Note 7
Other Assets
The components of other assets are as follows:
Property, plant and equipment, net
Intangible assets, net
Goodwill
December 31
2011
December 31
2010
January 1
2010
$
5,811
24,531
29,776
$
4,483
32,499
29,776
$
5,026
41,967
29,776
$ 60,118
$ 66,758
$ 76,769
The intangible assets have a remaining amor tization period of less
than five years.
For the purpose of testing goodwill for impairment, the cash-gen-
erating unit is considered to be the Corporation as a whole, since the
goodwill relates to the excess purchase price paid for the Corpora-
tion’s business in connection with the IPO. The recoverable amount of
the Corporation is calculated by reference to the Corporation’s
market capitalization, mor tgages under administration, origination
volume, and profitability. These factors indicate that the Corporation’s
recoverable amount exceeds the carrying value of its net assets and,
accordingly, goodwill is not impaired.
Note 8
Purchased Mortgage Servicing Rights
Purchased mortgage servicing rights consist of the following components:
2011
2010
Cost
Accumulated
amortization
Net book
value
Cost
Accumulated
amortization
Net book
value
Third-party commercial mortgage servicing rights
Commercial mortgage-backed securities primary
$
3,614
$
2,913
$
701
$
3,614
$
2,620
$
994
and master servicing rights
8,705
4,635
4,070
8,705
3,933
4,772
$ 12,319
$
7,548
$
4,771
$ 12,319
$
6,553
$
5,766
The Company did not purchase any new servicing rights during the years ended December 31, 2011 and 2010. Amortization charged to income
for the year ended December 31, 2011 was $995 [2010 – $841].
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
45
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 9
Mortgages under Administration
As at December 31, 2011, the Company had mortgages under admin-
istration of $59,598,596 [December 31, 2010 – $53,293,132], including
mortgages held on the Company’s consolidated statement of financial
position. Mor tgages under administration are serviced for financial
institutions such as banks, insurance companies, pension funds, mutual
funds, trust companies, credit unions and securitization vehicles. As at
December 31, 2011, the Company administered 193,250 mortgages
[December 31, 2010 – 174,483] for 92 institutional investors [Decem-
ber 31, 2010 – 95] with an average remaining term to maturity of
41 months [December 31, 2010 – 44 months].
Mortgages under administration are serviced as follows:
December 31
2011
December 31
2010
January 1
2010
Institutional investors
Mortgages accumulated for sale or securitization and mortgage and loan investments
Securitization vehicles, deferred placement investors
Mortgages pledged under securitization
CMBS conduits
$ 39,562,867 $ 36,678,521 $ 32,879,103
437,596
3,904,347
5,540,794
5,031,205
1,031,720
4,920,105
9,761,921
4,321,983
389,047
4,366,884
7,193,961
4,664,719
The Company’s exposure to credit loss is limited to mortgages under
administration totaling $619,165 [December 31, 2010 – $694,781], of
which $25,378 of mortgages have principal and interest payments out-
standing as at December 31, 2011 [December 31, 2010 – $38,435].
The Company incurred actual credit losses, net of recoveries, of $1,854
during the year ended December 31, 2011 [2010 – $3,689]. As at
December 31, 2011, the Company has $3,995 [December 31, 2010 –
$6,990] of uninsured non-performing mortgages [net of provisions for
credit losses] included in accounts receivable and sundry.
Note 10
Bank Indebtedness
Bank indebtedness includes a revolving line of credit of $125,000
[December 31, 2010 – $125,000] maturing in May 2014, of which
$66,403 [December 31, 2010 – $23,239] was drawn at December 31,
2011 and against which the following have been pledged as collateral:
[a] a general security agreement over all assets, other than real prop-
erty, 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 and bankers’ acceptance rates.
The terms of the revolving line of credit include negative cove-
nants customary for transactions of this kind. In February 2012, FNFLP
and its lenders amended the financial covenants associated with the
line of credit. The amendments are effective for the Corporation’s
fourth quarter 2011 reporting. The amendments resulted in changes
to the calculation of “Distributable Cash”. As a result, the Corporation
is in compliance with all revised financial covenants as amended and
restated as at December 31, 2011.
$ 59,598,596 $ 53,293,132 $ 47,793,045
Note 11
Debt Related to Securitized and
Participation Mortgages
Debt related to securitized mor tgages represents the funding for
mortgages pledged under the NHA–MBS, CMB and ABCP programs.
As at December 31, 2011, debt related to securitized mortgages was
$9,888,017 [December 31, 2010 – $7,274,482], net of unamortized
discounts of $4,524 [December 31, 2010 – $5,634]. A comparison of
the carrying amounts of the pledged mortgages and the related debt
is summarized in note 3.
As at December 31, 2011, debt related to participation mortgages
was $69,202 [December 31, 2010 – nil].
Debt related to securitized and participation mortgages is reduced
on a monthly basis when the principal payments received from the
mortgages are applied. Debt discounts and premiums are amortized
over the term of each debt on an effective yield basis.
Note 12
Swap Contracts
Swaps are over-the-counter contracts in which two counterpar ties
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 mortgages accumulated for sale held on the consolidated
statement of financial position. The swap agreement that the Com-
pany entered into was an interest rate swap where two counterpar-
ties exchange a series of payments based on different interest rates
applied to a notional amount in a single currency.
46
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
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, 2011 and 2010:
2011
Less than
3 years
3 to 5 years
6 to 10 years
Total
notional
amount
Fair value
Interest rate swap contract
$ 369,852
$ 915,712
$
16,112
$ 1,301,676
$
(1,009)
2010
Less than
3 years
3 to 5 years
6 to 10 years
Total
notional
amount
Fair value
Interest rate swap contract
$ 783,183
$ 292,255
$
–
$ 1,075,438
$
(15,263)
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 consolidated statement of financial position.
Note 13
Debenture Loan Payable
Note 14
Commitments, Guarantees and Contingencies
On May 7, 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. Pursuant to the Conversion, the Corporation assumed all liabili-
ties related to the debentures. The debentures are secured on a pari-
passu basis with the security under the one-year revolving line of
credit described in bank indebtedness on advance. The net proceeds
of the issuance were loaned to FNFLP at an interest rate of 5.1025%
per annum. 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 designated as a fair value hedge and matures on the due date of
the debenture loan. The Company has a full guarantee on the deben-
tures and the costs relating to the debenture issue have been borne
by the Company.
As at December 31, 2011, the Company has the following operating
lease commitments for its office premises:
2012
2013
2014
2015
2016 and after
$
3,758
3,398
3,263
3,164
3,969
$
17,552
Outstanding commitments for future advances on mor tgages with
terms of one to 10 years amounted to $1,814,084 as at Decem-
ber 31, 2011 [2010 – $2,166,166]. 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 commitments 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 vari-
ety 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 addi-
tion, contracts under which the Company may be required to make
payments if a third party fails to perform under the terms of the con-
tract [such as mortgage servicing contracts] are considered guaran-
tees. The Company has determined that the estimated potential loss
from these guarantees is insignificant.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
47
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 15
Securities Transactions under Repurchase
and Resale Transactions
Note 16
Obligations Related to Securities and Mortgages
Sold under Repurchase Agreements
The Company’s outstanding securities purchased under resale agree-
ments and securities sold under repurchase agreements have a
remaining term to maturity of less than one month.
The Company uses repurchase agreements to fund specific mor t-
gages included in mor tgages accumulated for sale or securitization.
The current contracts are with financial institutions based on bankers’
acceptance rates and mature on or before January 16, 2012. 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 17
Shareholders’ Equity
[a] Authorized
Unlimited number of common shares
Unlimited number of cumulative five-year rate reset preferred shares, Class A Series 1
Unlimited number of cumulative five-year rate reset preferred shares, Class A Series 2
[b] Capital stock activities
Balance, December 31, 2010
Issuance of preferred shares
Balance, December 31, 2011
[c] Preferred shares
On January 25, 2011, the Company 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 $3,519 related to the
issuance have been recorded against capital stock, net of deferred
income taxes recoverable of $913. The net proceeds of $96.5 million
from the issuance were paid down to FNFLP as a contribution of
partner capital.
Subject to declaration by the Board of Directors, holders of the
Series 1 Preferred Shares are entitled to receive a cumulative quar-
terly fixed dividend yielding 4.65% annually for the initial period ending
March 31, 2016. Thereafter, the dividend rate may be reset every five
years at a rate equal to the five-year Government of Canada yield
plus 2.07%, as and when approved by the Board of Directors.
Holders of Class A Series 1 Preferred Shares have the right, at
their option, to convert their shares into cumulative, floating rate Class
A Preferred Shares, Series 2 [“Series 2 Preferred Shares”], subject to
cer tain conditions, on March 31, 2016 and on March 31 every five
years thereafter. Holders of the Series 2 Preferred Shares will be enti-
tled to receive cumulative quarterly floating dividends at a rate equal
to the three-month Government of Canada treasury bill yield plus
2.07% as and when declared by the Board of Directors.
Preferred shares do not have voting rights. The par value per
preferred share is $25.
Common shares
Preferred shares
59,967,429 $
–
122,671
–
– $
4,000,000
59,967,429 $
122,671
4,000,000 $
–
97,394
97,394
[d] Common shares
Pursuant to the Conversion as described in note 1, on January 1, 2011,
unitholders of the Fund exchanged 12,681,113 Class A units in the
Fund for common shares in the Company on a one-for-one basis.
On the same date, the pre-Arrangement shareholders of FNFC
exchanged their shares in FNFLP for 47,286,316 common shares of
the Company.
Common shares have voting rights and do not have par value
per share.
[e] Earnings per share
Net income
Less: dividends declared on
preferred shares
Net earnings attributable to
common shareholders
2011
2010
$
70,491
$
89,917
(4,316)
–
$
66,175
$
89,917
Number of common shares
outstanding
Basic earnings per common share
59,967,429
1.10
$
59,967,429
1.50
$
48
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Note 18
Income Taxes
Prior to the Conversion on Januar y 1, 2011, 21.15% of FNFLP’s
income was allocated to the Fund and was not subject to current
income tax to the extent the Fund distributed its taxable income to
its unitholders. Following the Conversion, 100% of FNFLP’s income is
allocated to the Company and is subject to current income taxes in
the hands of the Company. For comparative reporting purposes, tax
provisions and balances reflect those of the Company’s predecessor
entities, the Fund and the Corporation.
The major components of deferred tax expense (recovery) for
the year ended December 31 are as follows:
2011
2010
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The effective income tax rate reported in the consolidated statements
of comprehensive income and retained earnings varies from the
Canadian tax rate of 28% for the year ended December 31, 2011
[2010 – 32%] for the following reasons:
Company’s statutory tax rate
Income before income taxes
Income tax at statutory tax rate
Increase (decrease) resulting from:
Tax obligation assumed by
unitholders of the Fund
Permanent differences
Differences in current and
future tax rates
Other
2011
2010
$
28.00%
96,783
27,099
32.00%
$ 119,957
38,386
–
585
(1,320)
(72)
(7,737)
–
(694)
85
Relates to origination and reversal
of timing differences
$
(3,508)
$
4,202
Income tax expense
$
26,292
$
30,040
The major components of current income tax expense for the year
ended December 31 are as follows:
Significant components of the Company’s deferred tax liabilities for
the year ended December 31 are as follows:
Income taxes relating to the year
$
29,800
$
25,838
2011
2010
Deferred placement fees receivable
Capitalized broker fees
Carrying values of mortgages
pledged under securitization
in excess of tax values
Intangible assets
Unamortized discount on debt
related to securitized mortgages
Cumulative eligible capital property
Losses on interest rate swaps
Loan loss reserves not deducted
for tax purposes
Debenture issuance costs
Share issuance costs
Other
2011
2010
$
15,008
12,704
$
20,809
12,746
8,391
6,257
1,156
(6,711)
(4,988)
(2,543)
(162)
(840)
2,028
5,352
8,492
1,522
(7,076)
(5,133)
(2,933)
–
(150)
1,092
Deferred tax liabilities
$
30,300
$
34,721
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
49
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The movement in significant components of the Company’s deferred tax liabilities and assets for the year ended December 31, 2011 is as follows:
As at
January 1
2011
Recognized
in income
Recognized
in equity
Deferred income tax liabilities
Deferred placement fees
Capitalized broker fees
Carrying values of mortgages pledged under securitization
in excess of tax values
Intangible assets
Unamortized discount on debt related to securitized mortgages
Other
$
20,809
12,746
$
(5,801)
(42)
$
5,352
8,492
1,522
1,092
3,039
(2,235)
(366)
936
Total deferred income tax liabilities
$
50,013
$
(4,469)
$
–
–
–
–
–
–
–
As at
January 1
2011
Recognized
in income
Recognized
in equity
As at
December 31
2011
$
15,008
12,704
8,391
6,257
1,156
2,028
$
45,544
As at
December 31
2011
Deferred income tax assets
Cumulative eligible capital property
Losses on interest rate swaps
Loan loss reserves not deducted for tax purposes
Debenture issuance costs
Share issuance costs
Total deferred income tax assets
$
$
(7,076)
(5,133)
(2,933)
–
(150)
$
365
145
390
(162)
223
$
–
–
–
–
(913)
(6,711)
(4,988)
(2,543)
(162)
(840)
$
(15,292)
$
961
$
(913)
$
(15,244)
Net deferred income tax liabilities
$
34,721
$
(3,508)
$
(913)
$
30,300
The calculation of taxable income of the Company is based on estimates and the interpretation of complex tax legislation. In the event that the
tax authorities take a different view from management, the Company may be required to change its provision for income taxes or deferred tax
balances and the change could be significant.
Note 19
Financial Instruments and Risk Management
Risk management
The various risks to which the Company is exposed and the Compa-
ny’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 interest rate
spreads from the point that a mortgage commitment is issued to the
transfer of the mortgage to the related securitization vehicle or sale to
an institutional investor. Primary among these strategies is the Com-
pany’s decision to sell mortgages at the time of commitment, passing on
interest rate risk that exists prior to funding to institutional investors.
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 mor tgage rate is committed to bor-
rowers and the time the mortgage is sold to a securitization vehicle and
the underlying cost of funding is fixed. As interest rates change, the val-
ues of these interest rate-dependent financial instruments vary inversely
with the values of the mortgage contracts. As interest rates increase, a
gain will be recorded on the economic hedge which will be offset by
the reduced future spread on mortgages pledged under securitization
as the mortgage rate committed to the borrower is fixed at the point
of commitment.
50
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
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 estimate
how that probability changes as mortgages move through the various
stages of the pipeline. The amount that is actually economically
hedged is the expected value of the mor tgages funding within the
future commitment period. The Company also hedges against interest
rate fluctuations by offsetting the exposure of the Company’s bank
indebtedness and funds held in trust. Bank indebtedness, obligations
related to debt and the debenture loan payable [after the effect of the
interest rate swap] are all floating rate obligations indexed to 30-day
CDOR; the funds held in trust earn the Company interest based on
the same floating rate basis. Because both the indebtedness and funds
held in trust have comparable values, with the liabilities at $745,032
[2010 – $363,003] at December 31, 2011 and the funds held in trust
at $503,294 [2010 – $527,624] on the same date, the Company con-
siders 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 shor t-term interest rates would have had on the net
income of the Company in 2011 and 2010.
100 basis point shift
Impact on net income and shareholders’ equity
200 basis point shift
Impact on net income and shareholders’ equity
Increase in interest rate
Decrease in interest rate
2011
2010
2011
2010
$
450
$
947
$
(449)
$
707
901
1,895
2,751
3,430
As at December 31, 2011, the Company administered $21,144 [2010 –
$50,553] of fixed rate commercial mortgages, of which it has a direct
face value interest of $5,281 [2010 – $10,903] included in mortgage
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 has exposure to the risk
that short-term interest rates increase, and credit losses as the Com-
pany has a first loss position. Accordingly, these mortgages are much
more sensitive to changes in interest rates and credit loss than the
Company’s typical mortgage and loan investments.
The Company’s accounts receivable and sundry, accounts payable
and accrued liabilities, and purchased mortgage servicing rights are not
exposed to interest rate risk.
The maximum credit exposures of the financial assets are their car-
rying values as reflected on the consolidated statement of financial posi-
tion. The Company does not have significant concentration of credit risk
within any particular geographic region or group of customers.
The Company is at risk that the underlying mortgages default and
the servicing cash flows cease. The large portfolio of individual mort-
gages that underlies these assets is diverse in terms of geographical
location, borrower exposure and the underlying type of real estate.
This and the priority ranking of the Company’s rights mitigate the
potential size of any single credit loss. Securities purchased under
resale agreements are transacted with large regulated Canadian insti-
tutions such that the risk of credit loss is very remote. Securities trans-
acted are all Government of Canada bonds and, as such, have virtually
no risk of credit loss.
Credit risk
Credit risk is the risk of loss associated with a counterparty’s inability
or unwillingness to fulfill its payment obligations. The Company’s credit
risk is mainly lending-related in the form of mor tgage default. The
Company uses stringent underwriting criteria and experienced adjudi-
cators 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. As at December 31,
2011, 94% [December 31, 2010 – 92%] of the pledged mor tgages
were insured mortgages. See details in note 3. The Company’s expo-
sure is fur ther mitigated by the relatively shor t period over which
a mortgage is held by the Company prior to securitization.
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 opera-
tions to fund longer-term assets. The Company’s credit facilities are
typically drawn to fund: [i] mortgages accumulated for sale or securiti-
zation, [ii] origination costs associated with mortgages pledged under
securitization, [iii] cash held as collateral under securitization, [iv] costs
associated with deferred placement fees receivable and [v] mortgage
and loan investments. The Company has a credit facility with a syndi-
cate of four banks which provides for a total of $125,000 in financing.
Bank indebtedness also includes borrowings obtained through out-
standing cheques and overdraft facilities.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
51
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The Company finances the majority of its mor tgages with debt
derived from the securitization markets, primarily NHA–MBS and
ABCP. These obligations reset monthly such that the receipts of princi-
pal on the mortgages are used to pay down the related debt within a
30-day period. Accordingly, these sources of financing amortize at the
same rate as the mortgages pledged thereunder, providing an almost
perfectly matched asset and liability relationship.
Valuation methods and assumptions
The Company uses valuation techniques to estimate fair values, includ-
ing reference to third-party valuation service providers, using proprie-
tary 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:
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.
Customer concentration risk
Placement fees, mor tgage servicing income and gains on deferred
placement fees revenue from three Canadian financial institutions rep-
resent approximately 47% [2010 – 43%] of the Company’s total reve-
nue. During the year ended December 31, 2011, the Company placed
51% [2010 – 54%] of all mortgages it originated with the same three
institutional investors.
Fair value measurement
The Company uses the following hierarchy for determining and dis-
closing fair value of financial instruments recorded at fair value in the
consolidated statement of financial position:
[a] HFT mortgages and certain mortgage and loan investments
The fair value of these mortgages is determined by discounting
projected cash flows using market industry pricing practices. Dis-
count rates used are determined by comparison to similar term
loans made to borrowers with similar credit. This methodology
will reflect changes in interest rates which have occurred since the
mortgages were originated. Impaired mortgages are recorded at
net realizable value.
[b] Deferred placement fees receivable
The fair value of deferred placement fees receivable is deter-
mined by internal valuation models consistent with industry prac-
tice using market data inputs, where possible. The fair value is
determined by discounting the expected future cash flows related
to the placed mortgages at market interest rates. The expected
future cash flows are estimated based on cer tain assumptions
which are not suppor ted by observable market data. Refer to
note 4, “Deferred placement fees receivable” for the key assump-
tions used and a sensitivity analysis.
Level 1 – quoted market price observed in active markets for identi-
cal instruments;
[c] Securities owned and sold short
Level 2 – quoted market price observed in active markets for similar
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.
The fair values of securities owned and sold shor t used by the
Company to hedge its interest rate exposure are determined by
quoted prices.
[d] Other financial assets and financial liabilities
The fair value of mortgage and loan investments classified as loans
and receivables, mortgages accumulated for sale or securitization,
cash held as collateral for securitization, restricted cash and bank
indebtedness corresponds to the respective outstanding amounts
due to their short-term maturity profiles.
52
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
The following table represents the Company’s financial instruments measured at fair value on a recurring basis:
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Financial assets
Mortgages accumulated for sale
HFT mortgages
Deferred placement fees receivable
Mortgage and loan investments
Interest rate swaps
Total financial assets
Financial liabilities
Securities sold under repurchase agreements and sold short
Interest rate swaps
Total financial liabilities
Financial assets
Mortgages accumulated for sale
HFT mortgages
Deferred placement fees receivable
Mortgage and loan investments
Interest rate swaps
Total financial assets
Financial liabilities
Securities sold under repurchase agreements and sold short
Interest rate swaps
December 31, 2011
Level 1
Level 2
Level 3
Total
$
$
– $
–
–
–
–
– $
4,244 $
–
–
–
9,689
– $
2,672,163
58,509
5,801
–
4,244
2,672,163
58,509
5,801
9,689
13,933 $ 2,736,473 $ 2,750,406
$
659,299 $
– $
–
10,698
– $
–
659,299
10,698
$
659,299 $
10,698 $
– $
669,997
December 31, 2010
Level 1
Level 2
Level 3
Total
$
$
$
– $
–
–
–
–
– $
17,827 $
–
–
–
3,849
– $
1,261,522
77,410
10,356
–
17,827
1,261,522 [1]
77,410
10,356
3,849
21,676 $ 1,349,288 $ 1,370,964
424,673 $
–
– $
19,112
– $
–
424,673
19,112
Total financial liabilities
$
424,673 $
19,112 $
– $
443,785
The following adjustments have been made to restate the December 31, 2010 comparatives under IFRS:
[1] Under IFRS, mortgages funded with bank-sponsored ABCP programs do not meet the derecognition criteria; the Company has chosen to classify these as
fair value through profit or loss and recorded at fair value. Cash held as collateral under securitization related to these mortgages is held at cost.
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 mar-
ket 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, 2011 that was estimated using a valuation technique
based on assumptions that are not fully suppor ted by observable
market prices or rates was a gain of approximately $3,846 [2010 –
$6,698]. Although the Company’s management believes that the esti-
mated fair values are appropriate as at the date of the consolidated
statement of financial position, those fair values may differ if other
reasonably possible alternative assumptions are used.
The following table presents changes in the fair values [including
realized losses of $16,824 [2010 – gains of $582]] of the Company’s
financial assets and financial liabilities for the years ended Decem-
ber 31, 2011 and 2010, all of which have been classified as fair value
through profit or loss:
HFT mortgages
Deferred placement fees receivable
Mortgage and loan investments
Securities owned and sold short
Interest rate swaps
2011
2010
$
$
(5,694)
1,150
1,066
(8,707)
(792)
$
(12,977)
$
2,978
931
3,229
27
115
7,280
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
53
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Movement in level 3 financial instruments measured at fair value
The following tables show the movement in level 3 financial instruments in the fair value hierarchy for the years ended December 31, 2011
and 2010. The Company classifies financial instruments to level 3 when there is reliance on at least one significant unobservable input in the
valuation models.
Financial assets
HFT mortgages
Deferred placement fees receivable
Mortgage and loan investments
Total financial assets
Financial assets
Bank-sponsored ABCP mortgages
Deferred placement fees receivable
Mortgage and loan investments
Total financial assets
Fair value
as at
January 1
2011
Investments
Unrealized
gain (loss)
recorded
in income
Payment and
amortization
Fair value
as at
December 31
2011
$ 1,261,522 $ 1,863,838 $
77,410
10,356
4,720
–
1,738 $
1,150
1,066
(454,935) $ 2,672,163
58,509
(24,771)
5,801
(5,621)
$ 1,349,288 $ 1,868,558 $
3,954 $
(485,327) $ 2,736,473
Fair value
as at
January 1
2010
Investments
Unrealized
gain (loss)
recorded
in income
Payment and
amortization
Fair value
as at
December 31
2010
$ 1,558,290 $
90,268
9,604
461,914 $
9,566
–
(16,875) $
931
3,230
(741,807) $ 1,261,522
77,410
(23,355)
10,356
(2,478)
$ 1,658,162 $
471,480 $
(12,714) $
(767,640) $ 1,349,288
Derivative financial instrument and hedge accounting
The Company entered into a swap agreement to hedge the deben-
ture loan payable against changes in fair value by converting the fixed
rate debt into a variable rate debt. The swap agreement has been
designated as a fair value hedge and the hedging relationship is for-
mally 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, as at December 31, 2011, accounts receivable
and sundry have been increased by $9,689 [December 31, 2010 –
$3,849] to account for the swap derivative, and the debenture loan
payable has been increased by the same amount.
54
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Note 20
Capital Management
The Company’s objective is to maintain a strong capital base so as to
maintain investor, creditor and market confidence and sustain future
development of the business. Management defines capital as the
Note 21
Earnings by Business Segment
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Company’s equity, long-term debt and retained earnings. The Company
has a minimum capital requirement as stipulated by its bank credit facility.
The agreement limits the debt under bank indebtedness together with
the debentures to four times FNFLP’s equity. As at December 31, 2011,
the ratio was 1.00:1.00 [December 31, 2010 – 0.80:1.00]. The Com-
pany was in compliance with the bank covenant throughout the year.
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. Identifiable assets are those used in the
operations of the segments.
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
Placement and servicing
Mortgage investment income
EXPENSES
Amortization
Interest
Other operating
2011
Residential
Commercial
Total
$
172,511 $
(119,199)
81,607 $
(65,092)
254,118
(184,291)
53,312
16,515
69,827
165,566
13,421
232,299
6,203
12,989
130,210
149,402
15,025
15,890
47,430
3,621
3,009
26,914
33,544
180,591
29,311
279,729
9,824
15,998
157,124
182,946
Income before income taxes
$
82,897 $
13,886 $
96,783
Identifiable assets
Goodwill
Total assets
Capital expenditures
$ 9,010,099 $ 2,887,395 $ 11,897,494
29,776
–
–
$ 11,927,270
$
2,228 $
956 $
3,184
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
55
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
Placement and servicing
Mortgage investment income
EXPENSES
Amortization
Interest
Other operating
2010
Residential
Commercial
Total
$
119,986 $
(78,106)
51,540 $
(34,424)
171,526
(112,530)
41,880
17,116
58,996
170,054
7,971
219,905
7,048
11,081
112,217
130,346
31,487
13,221
61,824
4,217
2,532
24,677
31,426
201,541
21,192
281,729
11,265
13,613
136,894
161,772
Income before income taxes
$
89,559 $
30,398 $
119,957
Identifiable assets
Goodwill
Total assets
Capital expenditures
$ 6,656,143 $ 1,718,074 $ 8,374,217
29,776
–
–
$ 8,403,993
$
877 $
376 $
1,253
Note 22
Related Party Transactions
For the past three years, several of the Company’s commercial bor-
rowers applied to the Company for mezzanine mortgage financing.
The amounts of the mor tgages requested were in excess of the
Company’s internal investment policies for investments of that nature;
however, a business controlled by a senior executive and shareholder
of the Company entered into agreements with the borrowers to fund
the mortgages. The Company serviced these mortgages during their
terms at market commercial servicing rates. The mortgages, which are
administered by the Company, have a balance of $33,781 as at
December 31, 2011 [December 31, 2010 – $21,627].
Company financed $15 million each of the mortgage while the Com-
pany financed $30 million. The Company is the servicer of the mort-
gage during the term. As at December 31, 2011, the mortgage had a
balance of $15 million, each party holding the same percentage as the
original funding. The mortgage was fully repaid in January 2012.
A senior executive and shareholder of the Company has a signifi-
cant investment in a mortgage default insurance company. In the ordi-
nary course of business, the insurance company provides insurance
policies to the Company’s borrowers at market rates. During the year,
the Company was engaged by the insurance company to service a
portfolio of $13.6 million of mortgages at market commercial servic-
ing rates. As at December 31, 2011, the por tfolio had a balance of
$13.4 million.
In April 2011, the Company syndicated a $60 million mezzanine
mortgage funding. As the full amount of the loan was in excess of the
Company’s internal investment policies, two senior executives of the
During the year ended December 31, 2011, the Company paid a
total compensation of $2,910 [2010 – $2,882] to senior management
and $216 [2010 – $195] to independent directors.
56
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Note 23
Transition to IFRS and the Conversion
Effective January 1, 2011, the Company adopted IFRS. The Company
retroactively applied IFRS to prior period financial reporting as if the
transition to IFRS occurred effective January 1, 2010. Accordingly, the
comparative financial results for 2010 have been presented to con-
form to the same accounting policies used in 2011 under IFRS. As
described in note 1, the comparative financial results have also been
restated pursuant to the Conversion. The presentation in these con-
solidated financial statements assumes that the Conversion occurred
immediately prior to the transition to IFRS.
In order for users of the financial statements to better understand
all of these changes, FNFLP’s consolidated statement of financial posi-
tion, consolidated statement of comprehensive income and retained
earnings and consolidated statement of cash flows have been recon-
ciled to the consolidated financial statements prepared under IFRS,
assuming the Conversion occurred at the date of the IPO. The follow-
ing reconciliations outline the impact of both IFRS and the Conversion:
[i] Reconciliation of the changes in equity as at:
• January 1, 2010
• December 31, 2010
[ii] Reconciliation of consolidated statement of comprehensive income
and retained earnings for:
• Year ended December 31, 2010
[iii] Reconciliation of consolidated statement of cash flows for:
• Year ended December 31, 2010
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Reconciliation of the changes in equity
The following table reconciles opening equity as at January 1, 2010
and December 31, 2010 to the comparative figures presented for
FNFLP to account for the Conversion and the transition to IFRS. The
largest adjustment relates to the purchase price discrepancies from
the proceeds of the IPO and the subsequent Distribution Re-Invest-
ment Plan [“DRIP”] in excess of the net book value of the net assets
of FNFLP. The following reconciliations provide details of the impact of
the Conversion on equity at January 1, 2010 and December 31, 2010:
Equity as at
January 1
2010
Equity as at
December 31
2010
Amounts as originally stated
for FNFLP
$ 214,377
$ 261,360
Add: fair value of capital raised on
IPO and DRIP in excess of
net book value [note [c]]
Less: amortization of intangible
assets [note [c]]
Less: deferred taxes related to
intangible assets [note [c]]
Less: deferred taxes related to
timing differences inherent in
FNFLP’s net assets [note [c]]
Less: adjustments related to
transition to IAS 39 and
consolidation of the Trust
[note [b]i and ii]
Elimination of inter-company
distributions and administration
expenses [note [c]]
Add: equity related to the
102,122
102,122
(30,379)
(39,847)
(8,600)
(8,600)
(21,919)
(26,121)
(47,408)
(84,591)
(37)
107
amalgamation of FNFC [note [c]]
25,726
29,746
As restated
$ 233,882
$ 234,176
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
57
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Reconciliation of consolidated statement of comprehensive income for the year ended December 31, 2010
Previous
GAAP
FNFLP
FNFC
Trust
[note [b]i]
MBS
[note [b]ii]
IFRS B/S
prior to
Conversion
Fund/FNFC
[note [c]]
IFRS
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
$
– $
–
–
– $
(2,637)
(2,637)
–
3,557
(4,514)
(512)
–
6,315
2,809
5,018
–
–
–
(2,637)
–
(2,637)
7,655
–
171,526 $
(109,893)
61,633
171,526 $
(112,530)
58,996
– $
–
–
171,526
(112,530)
58,996
3,703
–
(55,713)
(5,370)
–
(41,889)
(28,969)
(66,605)
(32,302)
–
(195)
4,208
–
(28,289)
(38,316)
–
107,292
13,123
–
21,090
73,846
–
7,280
281,627
70,718
44,653
13,613
21,877
–
–
–
–
102
–
–
–
102
–
–
–
1,443
9,468
107,292
13,123
–
21,192
73,846
–
7,280
281,729
70,718
44,653
13,613
23,320
9,468
150,861
10,911
161,772
130,766
–
(10,809)
30,040
119,957
30,040
103,589
9,566
60,227
26,972
73,846
35,574
33,440
343,214
103,020
44,653
13,808
20,306
–
181,787
161,427
–
Placement fees
Gains on deferred placement fees
Gain on securitization
Mortgage investment income
Mortgage servicing income
Residual securities income
Realized and unrealized gains (losses)
on financial instruments
EXPENSES
Brokerage fees
Salaries and benefits
Interest
Other operating
Amortization of intangible assets
Income before income taxes
Income tax expenses – current
Net income and comprehensive
income for the year
161,427
7,655
(38,316)
130,766
(40,849)
89,917
Retained earnings, beginning of year
Less distributions declared
117,087
(114,444)
42,966
–
–
–
160,053
(114,444)
(48,842)
24,821
111,211
(89,623)
Retained earnings, end of year
$
164,070 $
50,621 $
(38,316) $
176,375 $
(64,870) $
111,505
Earnings per share
Basic
$ 2.69
$ 0.13
$ (0.64)
$ 2.18
$ (0.34)
$ 1.50
58
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Reconciliation of consolidated statement of cash flows for the year ended December 31, 2010
OPERATING ACTIVITIES
Net income for the year
Add (deduct) items not affecting cash:
Deferred income taxes
Non-cash portion of gains on securitization and gains on
deferred placement fees
Non-cash portion of gains on deferred placement fees
Increase in restricted cash
Net investment in mortgages pledged under securitization
Net increase in debt related to securitized mortgages
Amortization of securitization receivable and deferred
placement fees receivable
Amortization of deferred placement fees receivable
Amortization of purchased mortgage servicing rights
Amortization of property, plant and equipment
Amortization of intangible assets
Unrealized (gains) losses on financial instruments
Amortization of servicing liability
Net change in non-cash working capital balances related to operations
Previous MBS and other
adjustments
[note [b]i and ii]
GAAP
FNFLP
Fund/FNFC
[note [c]]
IFRS
$
161,427 $
(30,661) $
(40,849) $
89,917
–
–
4,202
4,202
(80,868)
–
–
–
–
81,517
–
841
1,796
–
(32,857)
(7,024)
124,832
70,000
80,868
(9,566)
(82,758)
(1,670,042)
1,738,088
(81,517)
23,355
–
–
–
26,159
7,024
950
(3,736)
–
–
–
–
–
–
(9,566)
(82,758)
(1,670,042)
1,738,088
–
–
–
–
9,468
–
–
(27,179)
456
–
23,355
841
1,796
9,468
(6,698)
–
98,603
66,720
Cash provided by (used in) operating activities
$
194,832 $
(2,786) $
(26,723) $
165,323
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
(1,253)
5,118
(74,082)
60,554
–
861
6,912
(6,912)
–
–
–
–
(1,253)
5,979
(67,170)
53,642
Cash used in investing activities
$
(9,663) $
861 $
– $
(8,802)
FINANCING ACTIVITIES
Distributions paid
Obligations related to securities and mortgages
sold under repurchase agreements
Proceeds from debentures loan
Securities purchased under resale agreements and owned, net
Securities sold under repurchase agreements and sold short, net
$
(92,950) $
(4,118) $
7,445 $
(89,623)
(47,679)
175,000
(92,631)
92,274
–
–
–
–
–
–
–
–
(47,679)
175,000
(92,631)
92,274
Cash provided by financing activities
$
34,014 $
(4,118) $
7,445 $
37,341
Net decrease in bank indebtedness during the year
Bank indebtedness, beginning of year
$
219,183 $
(249,336)
(6,043) $
7,147
(19,278) $
38,431
193,862
(203,758)
Bank indebtedness, end of year
$
(30,153) $
1,104 $
19,153 $
(9,896)
Supplemental cash flow information
Interest received
Interest paid
Income taxes paid
$
– $
14,408
–
220,349 $
102,374
–
– $
–
33,387
220,349
116,782
33,387
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
59
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Notes to the reconciliations:
[a] Elections under IFRS 1
i.
ii.
iii.
The following exemptions are applicable to and have been
adopted by the Company at its transition date to IFRS, which is
January 1, 2010:
Estimates IFRS 1 requires estimates made under IFRS at the date
of transition to IFRS to be consistent with estimates made for the
same date under previous Canadian GAAP. The estimates previously
made by the Company under Canadian GAAP were not revised
for application of IFRS except where necessary to reflect any differ-
ences in accounting policies between Canadian GAAP and IFRS.
Designation of previously recognized financial instruments Financial
instrument designations are made on initial recognition. IFRS 1 per-
mits an “available for sale” designation or a “fair value through profit
or loss” designation to be made at the date of transition to IFRS. The
Company has elected to designate mortgages pledged under secu-
ritization in NHA–MBS and CMB programs as loans and receivables,
and for mortgages pledged under securitization in bank-sponsored
ABCP programs as fair value through profit or loss.
Derecognition of financial assets and financial liabilities This exemp-
tion allows IFRS first-time adopters to apply the IAS 39 derecogni-
tion requirements prospectively for transactions occurring on or
after January 1, 2004. The Company has elected to adopt this ex-
emption for mortgages pledged under securitization. As a result,
only gains on securitization recorded after 2003 which had been
recognized in the past under Canadian GAAP have been reversed
against opening equity. Previously reported securitization receiv-
ables and related servicing liability have been derecognized. Ac-
cordingly, both the mortgages and associated notes funding these
mortgages, which were off-balance sheet under Canadian GAAP,
are shown on the consolidated statement of financial position
under IFRS.
[b] IFRS revenue recognition – mortgages
pledged under securitization
Under previous Canadian GAAP, the Company’s securitizations
were considered “transfers of receivables” for accounting pur-
poses and were treated off-balance sheet. Gains on securitization
were recognized in income at such time as the Company trans-
ferred mor tgages to securitization vehicles and surrendered
control whereby the transferred assets had been isolated pre-
sumptively beyond the reach of the Company and its creditors.
When the Company securitized mortgages, it generally retained a
residual interest, presented in the balance sheets as a securitiza-
tion receivable, and the obligations associated with servicing the
mortgages as a servicing liability.
Under IAS 39, these securitized mortgages do not meet the
derecognition criteria, and instead are accounted for as a secured
financing and remain on the Company’s consolidated statement of
financial position. The proceeds from the securitization process
are recorded as interest-bearing notes under which the mor t-
gages act as collateral security.
i.
ii.
Mor tgages issued through bank-sponsored ABCP programs are
managed through FNFC Trust, a single-seller conduit, which includes
three siloed portfolios: small commercial loans, Alt-A mortgages
and prime mortgages. These mortgages are classified as fair value
through profit or loss and recorded at fair value. As well, the mark-
to-market adjustment on cash held as collateral under securitiza-
tion that serves as credit enhancement for these mortgages is no
longer required. The impact of these adjustments is shown on the
above reconciliations under the FNFC Trust column. The FNFC
Trust column is a direct reflection of the reported financial state-
ments of FNFC Trust, plus the elimination of inter-company trans-
actions and balances when consolidating with FNFLP.
For mortgages that were issued through NHA–MBS or CMB pro-
grams, the mor tgages were legally sold to funding vehicles and
cannot be traded at the Company’s discretion; as such, the Com-
pany classifies these mor tgages as loans and receivables, and
records them at amortized cost. Origination fees associated with
these mortgages have been capitalized and are amortized over
the terms of the mortgages on an effective yield basis. The impact
of these adjustments is shown in the above reconciliations under
the MBS/other adjustments column.
60
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
[c] Conversion
As described in note 1, the Company went through a series of
transactions on Januar y 1, 2011 and established First National
Financial Corporation [“FNFC”] as the repor ting entity. In sub-
stance, these transactions represent a combination of FNFLP,
FNFC and the Fund. In order for readers of the financial state-
ments to have meaningful comparative information, the 2010 con-
solidated financial statements have been restated as if the
combined entity reported the same way in 2010. Significant adjust-
ments related to the consolidation of the Fund and FNFC with
FNFLP are: the addition of goodwill and intangible assets from the
Fund, cash, current income taxes payable and equity from FNFC, as
well as the deferred tax liabilities that were previously recorded on
the financial statements of the Fund and FNFC. Under the new
laws enacted by the government in 2007 for taxation of “specified
investment flow-through”, the Fund accrued deferred tax liabilities
related to the differences between the carrying values and tax
base of its assets and liabilities star ting in 2007. The Fund also
accrued for its portion of the deferred tax liabilities for its 21.15%
ownership of FNFLP. As FNFLP is now wholly controlled by the
Corporation, the 2010 comparative numbers have been adjusted
for the full amount of deferred tax liabilities related to FNFLP. The
impact of these adjustments is shown in the above reconciliations
under the Fund/FNFC column.
[d] Impact of converting to IFRS
For the Company, this has meant a significant change in its
accounting policy regarding revenue recognition, par ticularly in
accounting for securitization transactions. Under Canadian GAAP,
the Company’s securitizations were considered “true sales” for
accounting purposes, such that the Company recorded gains on
securitization when these mortgages were sold to various securi-
tization conduits. Under current IFRS standards, these securitiza-
tions do not meet the criteria for derecognition and instead are
accounted for as a secured financing. Accordingly, the Company’s
securitizations [through ABCP conduits, NHA–MBS and direct
CMB issuance] do not qualify for sale accounting.
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
The Company has restated its comparative 2010 consolidated
financial statements as if IFRS accounting standards had been
applied for the past six years. This restatement eliminates all secu-
ritization receivables as at January 1, 2010, and puts these mort-
gages back on the Company’s balance sheet together with
securitization debt related to these transactions. The restated con-
solidated statements of financial position under IFRS as at Decem-
ber 31, 2010 have a number of significant changes. In addition to
the reversal of the securitization receivable of $157 million, the
consolidated statements of financial position also include these
changes: [1] an increase in the amount of the Company’s assets
by approximately $7.3 billion of mor tgages; [2] an increase of
$0.2 billion in restricted cash representing principal received on
these mor tgages in December 2010 and held in trust until the
subsequent month; [3] an increase in the Company’s liabilities by
an amount of $7.3 billion of debt related to securitized mortgages;
and [4] a decrease in opening equity of $19.5 million.
The reconciliations of equity balances from Canadian GAAP
to IFRS feature significant decreases representing the reversal of
previously recorded net securitization receivables. At January 1,
2010, these decreased equity by $104.0 million [December 31,
2010 – $157.4 million]. These decreases were offset by increases
resulting from the deferral of mortgage origination costs related
to mortgages pledged under securitization which the Company
had expensed under Canadian GAAP. These deferred costs
totaled $32.7 million at January 1, 2010 [December 31, 2010 –
$47.2 million].
The reconciliations of the consolidated statements of com-
prehensive income both show decreased gains on securitization
revenue as under IFRS these transactions do not meet the
derecognition tests. In their place, the Company will earn net inter-
est margin over the term of the pledged mortgages and related
debts. In both periods presented, income before income taxes has
decreased as gains on securitization exceeded the net interest
income for the periods.
The Company’s consolidated statement of cash flows is
similarly affected by the inflation of the Company’s assets under
IFRS. The investing in mortgages pledged under securitization and
the net increase in debt related to securitized mortgages are new
significant cash flows under IFRS that were not disclosed under
Canadian GAAP. In prior year disclosures, these cash flows were
effectively described on a net basis in operating activities related
to securitization.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
61
FIRST NATIONAL FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 24
Future Accounting Changes
The Company has adopted IFRS as at January 1, 2010. The following
new IFRS pronouncements have been issued and, although not yet
effective, may have a future impact on the Company:
IFRS 9 – Financial Instruments
As of January 1, 2013, the Company will be required to adopt this
standard, which is the first phase of the IASB project to replace IAS 39,
“Financial Instruments: Recognition and Measurement”. IFRS 9 provides
new requirements for how an entity should classify and measure finan-
cial assets and financial liabilities that are in the scope of IAS 39. Man-
agement is currently evaluating the potential impact that the adoption
of IFRS 9 will have on the Company’s consolidated financial statements.
IFRS 10 – Consolidated Financial Statements
As of January 1, 2013, IFRS 10 – “Consolidated Financial Statements”
will replace portions of IAS 27, “Consolidated and Separate Financial
Statements” and interpretation SIC – 12, “Consolidation – Special Pur-
pose Entities”. The IASB introduced a single model for consolidating
subsidiaries using a control model. In particular this standard addresses
the control of SPEs. There will be little impact to the Company as it
currently consolidates its SPEs fully.
IFRS 11 – Joint Arrangements
As of January 1, 2013, the IASB will expand the definition of a joint ven-
ture. The Company would be required to account for joint ventures by
the equity method as opposed to proportionate consolidation.
IFRS 12 – Disclosure of Interests in Other Entities
As of January 1, 2013, the Company will be required to make new dis-
closures on its off-balance sheet activities including those with SPEs.
IFRS 13 – Fair Value Measurements
As of January 1, 2013, the Company will be required to adopt this
standard, which provides a framework for the application of fair value
to those assets and liabilities qualifying or permitted to be carried at
fair value. The Company believes its current measurement of fair value
is appropriate and there will be little impact.
IAS 27 – Separate Financial Statements
As of January 1, 2013, this standard will only prescribe the accounting
and disclosure requirements for investments in subsidiaries, joint
ventures and associates when an entity prepares separate financial
statements, and thus will have limited impact for the Company.
IAS 28 – Investments in Associates
As of January 1, 2013, this standard has been amended to correspond
to changes in IFRS 10, 11 and 12 listed above, providing guidance for
investments in associates. As described above, there should be little
effect on the Company.
62
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Corporate Governance
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,
transparency, compliance and discipline. These standards define
the relationships among all of our stakeholders – Board, management
and shareholders – and are the basis for building these values
and nur turing a culture of accountability and responsibility across
the organization.
Policies
The Board super vises and evaluates the management of the
Company and oversees matters related to our strategic direction
and assesses results relative to our 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 Whistleblower 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.
The Audit Committee consists of three independent directors, all
of whom are considered financially literate for the purposes of the
Canadian Securities Administrators’ Multilateral 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 Committee’s
responsibilities include:
• Making recommendations concerning the compensation of the
Company’s senior executive officers and the remuneration of the
Board of Directors;
• Developing the Company’s approach to corporate governance
issues and compliance with applicable laws, regulations, rules,
policies and orders with respect to such issues;
• Advising the Board of Directors on filling director vacancies;
• Periodically reviewing the composition and effectiveness of the
directors and the contributions of individual directors, and
• Adopting and periodically reviewing and updating the Company’s
written Disclosure Policy.
Committees
The Board of Directors has established an Audit Committee and a
Compensation, Governance and Nominating Committee to assist in the
efficient functioning of the Company’s corporate governance strategy.
The Compensation, Governance and Nominating Committee consists
of three independent directors for the purposes of the Canadian
Securities Administrators’ Multilateral Instrument 58 -10 – Disclosure
of Corporate Governance Practices.
Committee Members:
Stanley Beck (Chair), Duncan Jackman and Peter Copestake
Audit Committee
The Audit Committee’s responsibilities include:
• Management of the relationship with the external auditor including
the oversight and super vision of the audit of the Company’s
financial statements;
• Oversight and super vision of the quality and integrity of the
Company’s financial statements; and
• Oversight and super vision of the adequacy of the Company’s
internal accounting controls and procedures, as well as its financial
reporting practices.
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
63
Board Members
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.
Robert Mitchell has been President of
Dixon Mitchell Investment Counsel Inc.,
a Vancouver-based investment management
company since 2000. Prior to that, Mr. Mitchell
was Vice President, Investments at Seaboard
Life Insurance Company. Mr. Mitchell is a
director and chairs the audit committee for
Discovery Parks Holdings Ltd., trustee for Dis-
covery Parks Trust. Discovery Parks Trust was
established to suppor t the high technology
and research industries in British Columbia
through the development of its real estate
assets. Mr. Mitchell has a MBA from University
of Western Ontario, a Bachelor of Commerce
(Finance) from University of Calgary, and is a
CFA charterholder.
Peter Copestake currently serves as a cor-
porate director and as a consultant to business,
academic and government organizations. Over
the past 30 years he has held senior financial
and management positions at federally regu-
lated financial institutions and in the federal
government. From 1999 to 2007 he was Se-
nior Vice President and Treasurer of Manulife
Financial Corporation. He currently serves as
the Chairman Emeritus of the Association for
Financial Professionals of Canada, Chair Emeri-
tus of the Society of Canadian Treasurers, as
a member of the Investment Committee of
the Board of Trustees of Queen’s University,
as a member of the Board of Directors of
the Canadian Derivatives Clearing Corpora-
tion, the Chairman of the Independent Review
Committee of First Trust Por tfolios Canada
and member of the Board of Directors of
Manulife Bank. He is also currently serving as
the Executive in Residence at the Queen’s
University School of Business.
Stephen Smith is President of the Corpo-
ration, President of First National Financial LP
and co-founder of First National. Mr. Smith
has been an innovator in the development
and utilization of various securitization tech-
niques to finance mor tgage assets and is a
regular speaker at securitization conferences.
Prior to co-founding First National in 1988,
Mr. Smith held various positions including
Assistant Director, Corporate Planning,
Hawker Siddeley Canada and Research Ana-
lyst, Canadian Pacific Limited. Mr. Smith has
a Master of Science (Economics) from the
London School of Economics and Political
Science, a Bachelor of Science (Honours)
in Electrical Engineering, Queen’s University,
and is a member of the Association of Profes-
sional Engineers of Ontario. He is currently
the vice-chairman of Metrolinx, a director of
The Dominion of Canada General Insurance
Company, the Empire Life Insurance Com-
pany and is Chair of The Historica-Dominion
Institute. Mr. Smith is a graduate of the Di-
rectors Education Program at the University
of Toronto, Rotman School of Management.
Moray Tawse is Vice President and Secre-
tary of the Corporation, Vice President, Mort-
gage Investments of First National Financial LP
and co-founder of First National. In addition
to directing the operations of all of First
National’s commercial mortgage origination
activities, he is one of Canada’s leading ex-
perts 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 Guaranty Trust
Company of Canada from 1983 until 1988.
Stanley Beck, Q.C. has been President
of Granville Arbitrations Limited (an arbi-
tration and mediation firm) for more than
five years. He was previously a Professor of
Law and Dean at Osgoode Hall Law School,
Toronto. From 1985 to 1990, Mr. Beck served
as Chairman of the Ontario Securities Com-
mission. Mr. Beck acts as a consultant on
securities and corporate matters. In addition,
Mr. Beck is the chairman of 407 International
Inc. and GMP Capital Trust and ser ves on
the board as a director of Scotia Utility Corp.
and Scotia NewGrowth Corp.
John Brough served as President of both
Wittington Proper ties Limited (Canada)
and Torwest, Inc. (United States) real es-
tate development companies from 1998 to
2007. From 1974 until 1996 he was with
Markborough Properties, Inc., where he was
Senior Vice President and Chief Financial
Officer from 1986 until 1996. Mr. Brough
is a Director of Kinross Gold Corporation,
Silver Wheaton Corp., Canadian Real Estate
Investment Trust and Transglobe Apartment
Real Estate Investment Trust. Mr. Brough
has a Bachelor of Arts (Economics) degree
from the University of Toronto, as well as a
Chartered Accountant degree. Mr. Brough is
a graduate of the Directors Education Pro-
gram at the University of Toronto, Rotman
School of Management, and a member of the
Institute of Corporate Directors.
Duncan Jackman is the Chairman, Presi-
dent and Chief Executive Officer of E-L
Financial Corporation Limited, an invest-
ment holding company and has held simi-
lar positions with E-L Financial since 2003.
Mr. Jackman is the Chairman and President
of Economic Investment Trust Limited and
United Corporations Limited, both closed-
end investment corporations, and has acted
in a similar capacity with these corporations
since 2001. Prior to this, Mr. Jackman held a
variety of positions including portfolio man-
ager at Cassels Blaikie and investment analyst
at RBC Dominion Securities Inc. Mr. Jackman
holds a Bachelor of Ar ts in Literature from
McGill University.
64
FIRST NATIONAL FINANCIAL CORPORATION 2011 ANNUAL REPORT
Shareholder Information
Corporate Address
Senior Executives of
First National Financial LP
Investor Relations
Contacts
First National Financial Corporation
100 University Avenue
North Tower, Suite 700
Toronto, Ontario M5J 1V6
Phone: 416.593.1100
416.593.1900
Fax:
Stephen Smith
Co-founder, Chairman and President
Moray Tawse
Co-founder and Vice President,
Mortgage Investments
Robert Inglis
Chief Financial Officer
Robert Inglis
Chief Financial Officer
rob.inglis@firstnational.ca
Steve Wallace
Vice President
Barnes Communications Inc.
swallace@barnesir.com
Scott McKenzie
Vice President, Residential Mortgages
Investor Relations Website
www.firstnational.ca
Jason Ellis
Managing Director, Capital Markets
Jeremy Wedgbury
Managing Director,
Commercial Mortgage Origination
Registrar and Transfer Agent
Computershare Investor Services Inc.
Toronto, Ontario
1.800.564.6253
Lisa White
Vice President, Mortgage Administration
Exchange Listing and Symbol
TSX: FN
Susan Biggar
General Counsel
Legal Counsel
Stikeman Elliott LLP
Toronto, Ontario
Auditors
Ernst & Young LLP
Toronto, Ontario
Annual Meeting
May 3, 2012, 10 a.m. EDT
TMX Broadcast Centre
The Gallery
The Exchange Tower
130 King Street West
Toronto, Ontario
VANCOUVER • CALGARY • TORONTO • MONTREAL • HALIFAX