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CORPORATE
PROFILE
First National Financial is Canada’s largest non-bank lender,
originating and servicing both residential and commercial
mortgages since 1988. Our broad range of mortgage
solutions and unwavering commitment to innovative
customer service has made First National a preferred choice
for hundreds of thousands of borrowers and independent
mortgage brokers from coast to coast. Our common shares
trade on The Toronto Stock Exchange under the symbol FN,
and our preferred shares trade under the symbols FN.PR.A
and FN.PR.B.
Shareholders can find current and historical financial
data and information on our business segments at
www.firstnational.ca.
1
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
THE YEAR
IN NUMBERS
2
OVER
300,000
Borrowers served by First National in 2018 across
Canada.
$106.2
BILLION
$1.2
BILLION
$166.4
MILLION
37%
$171.4
MILLION
$1.6
BILLION
Mortgages Under Administration (MUA) – the
source of most of the Company’s earnings –
reached this all-time record at year-end 2018.
Revenue in 2018 grew 10% to a new annual
record as strong productivity was assisted by the
rising interest rate environment.
Net income in 2018 ($2.73 per share) reflected
good execution despite tighter mortgage
spreads and higher securitization activity, which
reduced earnings from 2017 levels by 9%.
The after-tax, Pre-Fair Market Value1 return on
shareholders’ equity in 2018, a demonstration of
the efficiency of the Company’s business model.
Value of common share dividends declared in
2018, bringing the cumulative total to almost
$1.3 billion since the Company’s IPO in 2006.
The Company’s market capitalization at
December 31, 2018.
1 Non-IFRS Measure. See MD&A for more details.
3
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT OUR
MANAGEMENT
TEAM
STEPHEN SMITH
Co-founder, Chairman and
Chief Executive Officer
MORAY TAWSE
Co-founder and
Executive Vice President
JASON ELLIS
Chief Operating Officer
HILDA WONG
Senior Vice President and
General Counsel
JEREMY WEDGBURY
Senior Vice President,
Commercial Mortgages
LISA WHITE
Senior Vice President,
Mortgage Operations
ROBERT INGLIS
Chief Financial Officer
SCOTT MCKENZIE
Senior Vice President,
Residential Mortgages
4
OUR MANAGEMENT TEAM
MESSAGE TO
SHAREHOLDERS
Fellow Shareholders:
It seems like just yesterday that First National was conceived as an
ambitious start-up on a mission to originate, fund and service mortgages.
Yesterday is now 31 years ago and the time has passed quickly for those of
us who were here at incorporation on March 31, 1988.
Moray and I are often asked whether we envisioned a day when this
Company would become the largest non-bank mortgage lender in Canada.
The truthful answer is no. We simply saw an opportunity and together with
a small, highly talented team, vigorously pursued it.
In so doing, we were the beneficiaries of good timing. Our start up
coincided with the emergence of the independent mortgage broker
channel as a competitive force and the rise of the securitization market.
However, the steady growth First National has achieved since – including in
2018 – is not happenstance. It is the result of building honest and trusting
relationships with customers and partners over time and never sacrificing
our principles in order to make short-term gains.
While I could extol the virtues of First National’s business model, capital
allocation strategies and risk-management systems, and certainly
these attributes play a role in the Company’s success, it is our caring,
entrepreneurial culture that is the single most significant contributor to
long-term performance and stability.
Culture is, of course, not static. It changes and grows with every new
individual who joins our team, and with every new market situation we
encounter and learn from in the course of each year. By the same token,
culture cannot be taken for granted. It must be shaped and nurtured. We
appreciate this and do so by maintaining a flat organizational structure
void of cumbersome bureaucracy, promoting from within whenever
possible, spending to develop our capabilities and talents and maintaining a
consistent set of management priorities.
First National’s first priority is to serve our customers. “Serve” has become
a generic term, so to be more specific, we encourage our team to put
responsiveness at the centre of their daily activities, we invest in time-
saving, customer-facing technology embodied in MERLIN™ (for brokers)
and MyMortgage (for residential borrowers), and we offer our commercial
customers full access to our knowledge base to enhance their investment
decision making.
Our principles-based approach delivered good results in 2018.
5
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT “It is our caring, entrepreneurial
culture that is the single most
significant contributor to long-
term performance and stability.”
6
2018 IN REVIEW
Mortgages Under Administration (MUA) increased to $106.2 billion at
December 31, 2018, 5% above the previous record set a year ago. This figure
represents our investment, alone and in partnership with other institutions,
in thousands of homes and commercial businesses in Canada. Single-family
MUA reached $79.2 billion, while Commercial MUA of $27.0 billion was also
record-setting.
By virtue of this performance, which was assisted by solid originations and
mortgage renewals, First National added to its status as Canada’s largest
non-bank mortgage lender, and largest commercial mortgage lender. The
bottom line results for our shareholders were also favourable.
On revenue of $1.2 billion, net income was $166.4 million or $2.73 per share.
While earnings were lower than in 2017 due to tighter mortgage spreads
and higher securitization activity, which delays the earnings process,
profitability was solid.
During 2018, First National paid $171.4 million or $2.86 per common share of
dividends. These figures include the payment of a special dividend of $1.00
per share in December. As a lender and as a publicly traded corporation,
consistency and longevity matter, so we are pleased to note that this was
First National’s 30th consecutive year of profitable operations and the
12th consecutive year (since our initial public offering) of common share
dividend increases. Since the IPO, almost $1.3 billion in total dividends and
distributions have been paid to holders of our common equity. On a per
share basis, First National has delivered $20.92 per share of dividends and
distributions to common shareholders who purchased ownership at the IPO
for $10 per unit. Combined with share price appreciation, we calculate the
total return to IPO investors was 484% to December 31, 2018.
As a result of our efficient business model, 2018 after-tax Pre-Fair Market
Value1 return on shareholders’ equity was 37%.
THE MARKETPLACE
Government policy interventions in the housing market have been
significant over the past few years. In the fall of 2016, the Department of
Finance introduced a stress test for borrowers of five-year, fixed-rate, high-
ratio mortgages and eliminated insurability on single-family refinancing
transactions. In early 2017, the Office of the Superintendent of Financial
Institutions introduced new minimum capital adequacy standards for
mortgage default insurers and, in early 2018, the Department of Finance
amended Guideline B-20 – Residential Mortgage Underwriting Practices and
Procedures to require users of conventional mortgages to qualify at interest
rates higher than the actual rate offered by lenders.
Coupled with the implementation of foreign buyers’ taxes in B.C. and Ontario,
these fundamental changes made it harder for first-time borrowers to qualify
for a mortgage, harder for those with a mortgage to switch to another
financial institution, and harder to be an off-shore real estate speculator.
7
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT SINGLE-FAMILY SOLUTIONS
As a lender, we are supportive of policies that
reduce excessive risk in the housing market,
First National’s single-family team efficiently embraced each policy change.
This allowed the Company to remain highly customer-focused throughout
which, left unchecked, could spur an economic
both 2017 and 2018. Working side-by-side with mortgage brokers, we
recession and result in significant personal
hardship for many Canadians. With the
reduction in home prices and re-sale volumes
that we saw in the latter part of 2018, these
maintained our response times to new origination opportunities and
helped thousands of first-time buyers make the move into the market as
prime borrowers. We also paid close attention to renewal opportunities,
which grew as a result of First National’s origination activities over the past
policies appear to have hit their mark, especially
few years.
because they were accompanied by three
separate increases in the Bank of Canada’s
overnight rate during 2018.
While it is unclear at the time of writing if
more interventions will be forthcoming in 2019,
what is clear is that First National still has
significant presence in the Canadian mortgage
Recognizing an opportunity to expand our suite of mortgage solutions for
our broker and borrower clients, the Company re-introduced its Excalibur
branded mortgage program. Excalibur features expanded underwriting
criteria designed to serve self-employed and other credit-worthy borrowers
who may fall just outside traditional guidelines. Although we have initially
limited the Excalibur program to the Ontario market, volumes surpassed
our expectations as did positive product reviews from our partners and
market and will continue to play a constructive
customers.
role in helping our customers adjust to the
changing environment.
COMMERCIAL OPPORTUNITIES
For the commercial lending team, 2018 was highly productive with new
records set for annual originations. While clearly benefitting from strong
market activity, First National has steadily improved its opportunity
pipeline in recent years by developing deeper, more meaningful customer
relationships. We’ve done this partly by sharing more of our knowledge
to assist borrowers at the very earliest stages of their investment
deliberation processes – an approach we call being “more than a lender”
– so that they can stress-test their assumptions and easily investigate
financing alternatives.
As Canada’s largest commercial mortgage lender, First National participates
across numerous commercial asset classes and with financing at every
project stage – raw land acquisition, construction, term and property
repositioning. The breadth of our offering and ability to make the right
underwriting decisions decisively position us as a customer-focused
commercial lender to borrowers who value responsiveness and choice.
8
MESSAGE TO SHAREHOLDERS
MORTGAGES UNDER
ADMINISTRATION ($ Billions)
MUA BY ASSET TYPE
120
100
80
60
40
20
120
0
100
80
60
40
1200
20
1000
2014
2015
2016
2017
2018
120
0
800
REVENUE
2014
100
($ Millions)
600
2015
2016
2017
2018
80
400
60
200
40
1200
0
20
1000
0
800
600
300
400
250
200
200
1200
0
150
1000
100
800
50
600
300
0
400
250
200
200
0
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
150
NET INCOME
100
($ Millions)
50
300
0
250
200
150
100
50
0
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
5%
2014 - 85.9
2015 - 93.8
2016 - 99.4
2017 - 101.6
2018 - 106.2
5-year compound
annual growth
2014 - 85.9
2015 - 93.8
2016 - 99.4
2017 - 101.6
2018 - 106.2
2014 - 803.1
2015 - 915.3
2016 - 1049.8
2014 - 85.9
2017 - 1078.8
2015 - 93.8
2018 - 1181.5
2016 - 99.4
2017 - 101.6
2018 - 106.2
2014 - 803.1
2015 - 915.3
2016 - 1049.8
2017 - 1078.8
2018 - 1181.5
014 - 183.1
5-year compound
2015 - 209.9
annual growth
2016 - 253.5
2014 - 803.1
2017 - 234.3
2015 - 915.3
2018 - 225.2
2016 - 1049.8
2017 - 1078.8
2018 - 1181.5
014 - 183.1
2015 - 209.9
2016 - 253.5
2017 - 234.3
2018 - 225.2
10%
014 - 183.1
2015 - 209.9
2016 - 253.5
2017 - 234.3
2018 - 225.2
5%
5-year compound
annual growth
C
B
A 79% Insured
B 15% Multi-unit Residential
and Commercial
C 6% Conventional Single
Family Residential
A
2018 REVENUE SOURCES PRIOR
TO FAIR VALUE GAINS/LOSSES
D
C
A
B
A 29% Institutional Placements
B 27% Net Interest –
Securitized Mortgages
C 27% Mortgage Servicing
D 17% Investment Income
2018 FUNDING SOURCES
C
B
A 57% Institutional Investors
B 40% Securitization
C 3% Internal
A
9
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
FUNDING PARTNERSHIPS
LOOKING AHEAD
Unlike traditional balance-sheet lenders who
Our outlook is published within Management’s Discussion and Analysis. To
match their mortgage activities with customer
preface this section, I would say that when it comes to forecasts, the best
deposits, First National has always used an
perspective is a balanced perspective that takes into account positives
institutional funding model. This unique approach
(such as immigration and employment levels, both of which are drivers of
means we deploy our own substantial balance
the housing market) and potential negatives (such as economic concerns
sheet (over $36 billion of assets at year end),
that arose in November and were reflected in the capital markets).
while also selectively partnering with other
institutional investors to provide flexible, large-
scale mortgage financing options to borrowers.
Whatever comes our way in 2019, First National will operate with customers
at the epicentre of its thinking. We will seek new customers, strive to
capture every renewal opportunity, and work hard to give our customers
Thirty years of experience tells us that partnering
and partners the industry’s best service. As our long-term financial results
with other institutional investors gives us
have demonstrated, this thinking is beneficial to our fellow shareholders,
much greater flexibility to cater to borrowers,
whose interests are best served when customers are loyal to the First
irrespective of deal size and timing and at
National franchise because they value our approach.
various points across the risk-return spectrum.
First National’s funding system is one of our
greatest advantages and one we will continue to
nurture by presenting outstanding investment
opportunities to our partners and by expertly
servicing each loan through its duration. I am
pleased to say that our funding partnerships
have never been stronger. The Company’s
long-standing status as an NHA-MBS issuer,
approved CMHC lender and seller into the CMB
program complements our institutional funding
relationships by providing additional channels to
access reliable, low-cost funding.
To live our customer mission, we will continue to invest in our most
important assets: our employees and the proprietary First National “fintech”
that we use to serve the market. Recognizing that many members of our
team are young and value career advancement, we will provide in-class and
on-line training, as well as mentoring, and use the results of our bi-annual
employee survey to shape and enhance our workforce programs. We will
also remain open to new employee-led ideas and innovations aimed at
improving the business for all stakeholders.
The Canadian mortgage market is a dynamic environment full of challenges
and opportunity. We look forward to taking on those challenges and remain
highly motivated to realize on future opportunities.
GIVING THANKS
I thank our dedicated Board of Directors for their wise counsel, our
managers for leading with integrity, energy and intelligence and our
employees for doing the incredibly hard work that goes into meeting
customer needs and setting new performance records in competitive
mortgage markets. Most especially, I thank our customers, partners and
shareholders for choosing First National. We hope to reward each of you
for your trust in us in 2019.
Yours sincerely,
Stephen Smith
Chairman and Chief Executive Officer
10
MESSAGE TO SHAREHOLDERS
MANAGEMENT’S
DISCUSSION
AND ANALYSIS
The following management’s discussion and
This MD&A contains forward-looking information. Please see “Forward-
analysis (“MD&A”) of financial condition and
Looking Information” for a discussion of the risks, uncertainties and
results of operations is prepared as of February
assumptions relating to these statements. The selected financial information
25, 2019. This discussion should be read in
and discussion below also refer to certain measures to assist in assessing
conjunction with the audited consolidated
financial performance. These other measures such as “Pre-FMV EBITDA”
financial statements and accompanying
and “After-tax Pre-FMV Dividend Payout Ratio” should not be construed as
notes of First National Financial Corporation
alternatives to net income or loss or other comparable measures determined
(the “Company” or “Corporation” or “First
in accordance with IFRS as an indicator of performance or as a measure
National”) as at and for the year ended
of liquidity and cash flow. These measures do not have standard meanings
December 31, 2018. The audited consolidated
prescribed by IFRS and therefore may not be comparable to similar measures
financial statements of the Company have
presented by other issuers.
been prepared in accordance with International
Financial Reporting Standards (“IFRS”).
Unless otherwise noted, tabular amounts are in thousands of Canadian dollars.
Additional information relating to the Company is available in First National
Financial Corporation’s profile on the System for Electronic Data Analysis
and Retrieval (“SEDAR”) website at www.sedar.com.
11
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT GENERAL DESCRIPTION OF
THE COMPANY
2018 RESULTS SUMMARY
First National Financial Corporation is the
Management is pleased with the results of 2018. Despite new mortgage
parent company of First National Financial
insurance rules announced in late 2016 and tighter underwriting rules
LP (“FNFLP”), a Canadian-based originator,
on uninsured mortgages required under OSFI’s revised B-20 guidelines
underwriter and servicer of predominantly prime
introduced in 2018, which the Company has adopted, single family
residential (single-family and multi-unit) and
origination increased 10% year over year in 2018. Combined with
commercial mortgages. With over $106 billion in
commercial segment origination and steady renewals, First National
mortgages under administration (“MUA”), First
increased its total origination by 11% in the year compared to 2017.
National is Canada’s largest non-bank originator
Despite this growth, tighter mortgage spreads and a trend toward
and underwriter of mortgages and is among the
increased securitization reduced normalized earnings by 9%.
top three in market share in the mortgage broker
distribution channel.
12
MANAGEMENT’S DISCUSSION AND ANALYSIS
• MUA grew to $106.2 billion at December 31, 2018 from $101.6 billion at
December 31, 2017, an increase of 5%; the growth from September 30,
2018, when MUA was $105.0 billion, was also 5% on an annualized basis;
• Total new single-family mortgage origination was $12.2 billion in 2018
compared to $11.1 billion in 2017, an increase of 10%. The Company
attributes this to the relaunch of its alternative lending product, Excalibur,
and strong growth in the Toronto and Montreal regions. The commercial
segment had a strong year with origination up 8% as volumes increased to
$6.2 billion in 2018 from $5.8 billion in 2017. The Company attributes this to
the continued development of its expertise in real estate across the
country which increases the value proposition of its financial products to
borrowers and investors alike. Overall new origination increased by 9% in
the year;
• The Company took advantage of opportunities in the year to renew
$6.1 billion of single-family mortgages. In 2017, the Company renewed
$5.2 billion of single-family mortgages. For the commercial segment,
renewals increased to $1.3 billion from $1.1 billion;
• Revenue for 2018 increased by 10% to $1.2 billion
• The Company’s earnings before income taxes, depreciation and
from $1.1 billion in 2017. The increase is related
amortization and gains and losses on financial instruments (“Pre-FMV
to the rising interest rate environment offset
EBITDA”) for the year decreased by 4%, from $234.3 million to
by lower revenue from gains on financial
$225.2 million in 2018. This measure was lower in 2018 largely due to
instruments. Because of higher interest rates,
tighter securitization margins and lower placement fee revenue both
interest revenue on securitized mortgages
of which are the result of tightening mortgage spreads. Although the
increased by $131 million as the portfolio
Company set a new record for overall origination, including renewal
composition transitioned to mortgages with
volume, in 2018, most of the additional origination was securitized.
higher interest rate coupons. Higher interest
Securitization, while perhaps economically superior, delays the recognition
rates also impacted mortgage investment
of earnings when compared to a placement transaction; and
• Net income was $166.4 million (2.73 per common share) in 2018, compared
to $209.7 million (3.42 per common share) in 2017. This was the Company’s
30th consecutive year of profitable operations.
income which was higher by $20 million.
However because of changing interest rates
and the adoption of hedge accounting in 2018,
gains of financial instruments were lower by
$53 million year over year. Without this
component of revenue, revenue increased
by 15%;
• Income before income taxes decreased from
$285.4 million in 2017 to $227.4 million in 2018
because of changing capital markets conditions
and the way new hedge accounting rules
adopted in 2018 accounted for the related
gains and losses on financial instruments. In
aggregate, the impact from financial
instruments decreased this measure by
$53.1 million comparing 2017 to 2018;
13
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT SELECTED QUARTERLY INFORMATION
Quarterly Results of First National Financial Corporation
($000s, except per share amounts)
2018
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2017
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Revenue
Net Income
for the period
Pre-FMV
EBITDA for
the period (1)
Net Income per
Common Share
Total Assets
$312,039
$321,835
$290,935
$256,701
$270,015
$284,315
$292,200
$232,238
$32,220
$51,958
$46,347
$35,902
$45,948
$58,809
$68,768
$36,127
$55,780
$62,989
$56,048
$50,368
$61,093
$51,826
$68,275
$53,084
$0.53
$36,037,127
$0.85
$35,597,827
$0.76
$35,794,066
$0.59
$33,846,283
$0.75
$0.96
$32,776,278
$31,548,130
$1.13
$30,832,883
$0.58
$29,901,289
(1) This non-IFRS measure adjusts income before income taxes by adding back expenses for amortization of intangible and capital assets but it also eliminates the impact
of changes in fair value by adding back losses on the valuation of financial instruments (except those on mortgage investments) and deducting gains on the valuation of
financial instruments.
With First National’s large portfolio of mortgages
Generally, in the years after the credit crisis in 2008, the Company grew
pledged under securitization, quarterly revenue
its origination volumes which provided larger servicing and securitization
is driven primarily by the gross interest earned
portfolios. To the extent the Company employed securitization strategies,
on the mortgages pledged under securitization.
net interest margins were locked in for five and ten year terms. These
The gross interest on the mortgage portfolio
margins were wide in 2008 as financial institutions maintained mortgage
is dependent both on the size of the portfolio
rates despite a significant drop in the cost of funds. Since 2008, such
of mortgages pledged under securitization as
margins have steadily declined with competitive pressures and new
well as mortgage rates. Because mortgage rates
securitizations are at much tighter spreads. For the Company this has
and MUA have both increased, revenue has also
meant that as high spread securitization transactions have matured and
increased. Net income is partially dependent on
been replaced with new securitizations, profitability has decreased. This
conditions in bond markets, which affect the
trend is evident in the Pre-FMV EBITDA figures above. In the third quarter
value of gains and losses on financial instruments
2017, Pre-FMV EBITDA was lower than expected as placement fees were
arising from the Company’s interest rate hedging
negatively affected by a rising interest rate environment. The Company
program. Accordingly, the movement of this
earned $14.4 million as a gain on holding short bonds in the second quarter
measurement between quarters is related to
2017. Consistent with the Company’s reporting practice, this amount was
factors external to the Company’s core business.
deducted from earnings to determine Pre-FMV EBITDA. However this gain
By removing this volatility and analyzing Pre-FMV
reduced the value of the hedged mortgages and when these were placed in
EBITDA, management believes a more
the third quarter 2017, earnings were negatively affected. Using normalized
appropriate measurement of the Company’s
earnings, third quarter 2018 earnings were 5% lower compared to those in
performance can be assessed.
the third quarter of 2017. The decrease was due to tighter mortgage spreads
and more securitization which delays the earning’s process in comparison to
placement fees which are earned in the same period as origination. Fourth
quarter 2018 earnings were lower by 9% for the same reasons.
14
MANAGEMENT’S DISCUSSION AND ANALYSIS
OUTSTANDING SECURITIES OF THE CORPORATION
At December 31, 2018 and February 25, 2019, the Corporation had 59,967,429 common shares; 2,887,147 Class A preference shares,
Series 1; 1,112,853 Class A preference shares, Series 2; and 175,000 April 2020 senior unsecured notes outstanding.
SELECTED ANNUAL FINANCIAL INFORMATION AND RECONCILIATION TO PRE-FMV EBITDA(1)
2018
2017
2016
For the Year ended December 31,
INCOME STATEMENT HIGHLIGHTS
Revenue
Interest expense – securitized mortgages
Brokerage fees
Salaries, interest and other operating expenses
Deduct: realized and unrealized gains on financial instruments
Deduct: unrealized losses regarding mortgage investments
Pre-FMV EBITDA(1)
Amortization of intangible and capital assets
Add: realized and unrealized gains on financial instruments
excluding those on mortgage investments
Provision for income taxes
Net income
Common share dividends declared
PER SHARE HIGHLIGHTS
Net income per common share
Dividends per common share
At Year End
BALANCE SHEET HIGHLIGHTS
Total assets
1,181,510
(646,069)
(75,354)
(227,739)
(3,162)
(4,000)
225,186
(4,931)
7,162
(60,990)
166,427
171,407
2.73
2.86
1,078,768
1,049,818
(511,939)
(495,681)
(83,260)
(193,032)
(56,259)
—
234,278
(5,135)
(103,719)
(169,129)
(27,750)
—
253,539
(7,160)
56,259
27,750
(75,750)
(72,300)
209,652
184,400
3.42
3.08
201,829
98,946
3.28
1.65
$36,037,127
$32,776,278
$30,394,465
Total long-term financial liabilities
$174,829
$174,693
$174,556
Notes:
(1) Pre-FMV EBITDA is not a recognized earnings measure under IFRS and does not have a standardized meaning prescribed by IFRS. Therefore, Pre-FMV EBITDA may not
be comparable to similar measures presented by other issuers. Investors are cautioned that Pre-FMV 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.
15
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT VISION AND STRATEGY
GROWTH IN PORTFOLIO OF MORTGAGES
UNDER ADMINISTRATION
The Company provides mortgage financing
Management considers the growth in MUA to be a key element of the
solutions to the residential and commercial
Company’s performance. The portfolio grows in two ways: through
mortgage markets in Canada. By offering a full
mortgages originated by the Company and through third-party mortgage
range of mortgage products, with a focus on
servicing contracts. Mortgage originations not only drive revenues from
customer service and superior technology, the
placement and interest from securitized mortgages, but perhaps more
Company believes that it is the leading non-bank
importantly, longer-term value from servicing rights, renewals and the
mortgage lender in the industry. The Company
growth of the customer base for marketing initiatives. As at December 31,
intends to continue leveraging these strengths to
2018, MUA totalled $106.2 billion, up from $101.6 billion at December 31, 2017,
lead the “non-bank” mortgage lending industry in
an increase of 5%. The growth of MUA in the fourth quarter of 2018 on an
Canada, while appropriately managing risk. The
annualized increase is also 5%.
Company’s strategy is built on four cornerstones:
providing a full range of mortgage solutions
for Canadian single-family and commercial
customers; growing assets under administration;
GROWTH IN ORIGINATION OF MORTGAGES
employing technology to enhance service
Direct origination by the Company
to mortgage brokers and borrowers, lower
costs and rationalize business processes; and
maintaining a conservative risk profile. An
important element of the Company’s strategy
is its direct relationship with the mortgage
borrower. The Company is considered by most
of its borrowers as the mortgage lender. This
is a critical distinction. It allows the Company
to communicate with each borrower directly
throughout the term of the related mortgage.
Through this relationship, the Company
can negotiate new transactions and pursue
marketing initiatives. Management believes this
strategy will provide long-term profitability and
sustainable brand recognition for the Company.
The origination of mortgages not only drives the growth of MUA as
described above, but leverages the Company’s origination platform, which
has a large fixed-cost component. As more mortgages are originated, the
marginal costs of underwriting decrease. Increased origination satisfies
demand from its institutional customers and produces volume for the
Company’s own securitization programs. In 2018, the Company’s single-
family origination grew at a steady rate. Whether it is the effect of OSFI
guideline B-20 or gaining market share in the mortgage broker channel, the
Company experienced higher origination in eastern Canada while its Calgary
and Vancouver offices suffered from regional real estate related issues:
Toronto (+19%), Vancouver (-3%), Calgary (-11%) and Montreal (+28%). In
aggregate, the Company’s single-family origination increased in 2018 by
10%. The commercial segment demonstrated steady growth as volume
increased 8% over 2017. Together, overall new origination for 2018 increased
9% year over year.
KEY PERFORMANCE DRIVERS
Third Party Mortgage Underwriting and Fulfillment Processing Services
In 2015, the Company launched its third party underwriting and fulfillment
The Company’s success is driven by the
processing services business with a large Canadian schedule I bank
following factors:
• Growth in the portfolio of mortgages
under administration;
• Growth in the origination of mortgages;
(“Bank”). The business is designed to adjudicate mortgages originated by
the Bank through the single-family residential mortgage broker channel.
First National employs a customized software solution based on its industry
leading MERLIN technology to accept mortgage applications from the
Bank in the mortgage broker channel and underwrite these mortgages in
• Raising capital for operations; and
accordance with the Bank’s underwriting guidelines. The Bank funds all the
• Employing innovative securitization
transactions to minimize funding costs.
mortgages underwritten under the agreement and retains full responsibility
for mortgage servicing and the client relationship. Management considers
the agreement a way to leverage the capabilities and strengths of First
National in the mortgage broker channel and add some diversity to the
Company’s service offerings.
16
MANAGEMENT’S DISCUSSION AND ANALYSIS
Relaunch of Excalibur Mortgage Products
Preferred Share Issuance
In 2018, the Company relaunched its alternative single family (“Excalibur”)
Commencing on April 1, 2016, the Company reset
mortgage products. Alternative lending describes single family residential
the dividend rate on the 2,887,147 Class A Series
mortgages that are originated using broader underwriting criteria than
1 preference shares issued in 2011 which did not
those applied in originating prime mortgages. Alternative borrowers are
elect to convert to Class A Series 2 preference
generally considered “A” quality borrowers in terms of their credit histories,
shares. The Series 1 shares provide an annual
but do not qualify for a prime mortgage because of non-conformities, such
dividend rate of 2.79%. Also effective April 1,
as the degree of income disclosure and verification required. The Excalibur
2016, 1,112,853 Class A Series 2 were issued on
program also includes a product for borrowers with recently remediated
the conversion from Series 1 shares. These bear
credit. These mortgages generally have higher interest rates than prime
a floating rate dividend calculated quarterly
mortgages. Although the Company’s original alternative program was
based on the 90-day T-Bill rate. Both the Series
discontinued in 2008 as a result of the credit crisis, First National’s
1 and Series 2 shares pay quarterly dividends,
relationships with mortgage brokers and underwriting systems allowed
subject to Board of Director approval and are
it to seamlessly relaunch the product in the spring of 2018. To start, the
redeemable at the discretion of the Company
product has been originated for placement with institutional investors and
such that after the five-year term ending on
the Company earned a one-time placement fee and servicing income over
March 31, 2021, the Company can choose to
the term of the mortgages. The Excalibur relaunch was rolled out gradually,
extend the shares for another five-year term at
starting in Ontario. Currently the program is open to include all Ontario
a fixed spread (2.07%) over the relevant index
brokers with a potential expansion to Western Canada in 2019.
(five-year Government of Canada bond yield
RAISING CAPITAL FOR OPERATIONS
Bank Credit Facility
In the second quarter of 2018, the Company increased its revolving line of
credit with a syndicate of banks from $1.06 billion to $1.25 billion. This facility
enables the Company to fund the large amounts of mortgages accumulated
for securitization. At the same time, the Company extended the term of the
facility by about one year such that the maturity is now March 2023. The
facility bears interest at floating rates. The Company has elected to undertake
this debt for a number of reasons: (1) the facility provides the amount of
debt required to fund mortgages originated for securitization purposes; (2)
the debt is revolving and can be used and repaid as the Company requires,
providing more flexibility than the senior unsecured notes, which are fully
drawn during their term; (3) the five-year remaining term gives the Company a
committed facility for the medium term; and (4) the cost of borrowing reflects
the Company’s BBB issuer rating.
for any Series 1 shares or the 90-day T-Bill rate
for any Series 2 shares). While the investors in
these shares have an option on each five-year
anniversary to convert their Series 1 preference
shares into Series 2 preference shares (or vice
versa), there is no provision of redemption rights
to these shareholders. As such, the Company
considers these shares to represent a permanent
source of capital and classifies the shares
as equity on its balance sheet. Management
believes this capital has provided the Company
with the opportunity to pursue its strategy of
increased securitization, which requires upfront
investment.
17
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT EMPLOYING SECURITIZATION
TRANSACTIONS TO MINIMIZE
FUNDING COSTS
Approval as both an Issuer of NHA-MBS and
competition made for tighter spreads. With the recent strength in the
Seller to the Canada Mortgage Bonds Program
economy and tougher mortgage rules, competition further increased and
The Company has served as an issuer and
administrator of NHA-MBS since 1995. 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
provides the Company with direct and
independent access to reliable and low-cost
funding.
Mortgage spreads can be illustrated by
comparing posted five-year fixed single-family
mortgage rates to a similar-term Government of
Canada bond as listed in the table below.
Average Five Year Mortgage
Spread for the Period
spreads have tightened significantly. While funding spreads have also
improved, generally the advantage of securitization compared to placement
with investors is not as pronounced as it was in the previous 10-year period.
In 2018, the Company originated and renewed for securitization purposes
approximately $9.0 billion of single-family mortgages and $1.1 billion of multi-
unit residential mortgages. In 2018, the Company securitized through NHA-
MBS approximately $8.2 billion of single-family mortgages and $0.7 billion of
multi-unit residential mortgages.
In August 2013, CMHC announced that it would be limiting the amount
of guarantees it would provide on NHA-MBS pools created for sale to the
“market.” CMHC indicated that the amount of guarantees it was providing
for such market pools (generally any pool not sold to the Canada Housing
Trust “CHT” for the CMB) was growing significantly. To better control
the absolute amount of risk that it takes on in this respect, CMHC has
implemented policies to allocate the amount of guarantees to issuers. The
maximum amount allocated under the process has exceeded First National’s
Period
2006
2007
2008
2009 - 2013
2014
2015
2016
2017
2018
1.12%
requirements in every quarter since inception. The process was amended
in July 2016 to combine both NHA-MBS pools for sale to the market and to
1.50%
CHT under one allocation. The available guarantees to be allocated were
2.68%
1.79%
1.57%
1.87%
1.76%
1.36%
1.36%
increased to accommodate issuance to CHT and continue to exceed the
Company’s current needs.
Canada Mortgage Bonds Program
The CMB program is an initiative sponsored by CMHC whereby the CHT
issues securities to investors in the form of semi-annual interest-yielding
five- and 10-year bonds. Pursuant to the Company’s approval as a seller into
the CMB, the Company is able to make direct sales into the program. The
ability to sell into the CMB has given the Company access to lower costs
of funds on both single-family and multi-family mortgage securitizations.
Because of the effectiveness of the CMB, many institutions have indicated
The table shows an average spread of 1.12%
their desire to participate. As a result, CHT has created guidelines through
in 2006. With the credit crisis, this spread
CMHC that limit the amount that can be sold by each seller into the CMB
ballooned to as high as 3.46% in 2008.
Between 2009 and 2013, liquidity issues
each quarter. The Company is subject to these limitations. Beginning in July
2016, CHT effectively increased the price of the timely payment guarantees
at financial institutions diminished and the
which CMB participants are required to purchase with the issuance of each
competition for mortgages increased such that
CMB transaction. Although nominally CMB fees decreased, these rules
spreads remained consistently higher than pre-
require guarantee fees to be levied on the creation of NHA MBS pools
crisis levels. In 2014, more competitive pressures
being sold to the CMB. Prior to this rule change, the NHA MBS pools to be
took mortgage rates lower and compressed
sold into the CMB were exempt from such fees. In aggregate, guarantee
mortgage spreads to 2007 levels; however,
fees increased between 25% and 50% for CMB participants. This increase
in 2015, mortgage spreads quickly widened
as a slowdown in economic growth and the
translates to approximately five basis points of cost over the term of the
securitization. Since 2016, CMHC has also modified the tiered NHA MBS
Bank of Canada rate cut reduced bond yields
guarantee fee pricing structure, increasing the issuance threshold for
dramatically. This trend continued into 2016, as
increased fees from $7.5 billion to $9.0 billion. The tiered limit of $9.0 billion
optimism about the economy was mixed such
remains unchanged for 2019. In 2018, the Company, through its subsidiary
that spreads remained at levels in excess of 1.8%
First National Asset Management Inc. (“FNAM”), also took advantage of
until the third quarter when increased
funding provided by the CMB, issuing three NHA MBS pools totaling $85
million and securitizing those pools in two 5-year CMB transactions.
18
MANAGEMENT’S DISCUSSION AND ANALYSIS
ADOPTION OF NEW IFRS ACCOUNTING
STANDARDS
IFRS 9 – Financial Instruments
On January 1, 2018 the Company adopted the
the presentation of the impact of own credit risk on financial liabilities,
International Accounting Standard Board’s
which will be recognized in other comprehensive income [“OCI”], rather
[“IASB”] new standard - IFRS 9 – Financial
than in profit and loss as under IAS 39. The new general hedge accounting
Instruments, which replaced IAS 39. IFRS 9
principles under IFRS 9 are aimed to align hedge accounting more closely
includes a model for classification and
with risk management. This new standard does not fundamentally change
measurement, a single, forward-looking
the types of hedging relationships or the requirement to measure and
“expected loss” impairment model and a
recognize ineffectiveness; however, it has provided more hedging strategies
substantially reformed approach to hedge
that are used for risk management to qualify for hedge accounting and
accounting. Under this standard, financial assets
these introduce more judgment to assess the effectiveness of a hedging
are classified and measured based on the
relationship. All of the changes as a result of adopting IFRS 9 have been
business model in which they are held and the
characteristics of their contractual cash flows.
accounted for on a prospective basis by the Company so that there are no
adjustments to the opening equity of the Company.
The accounting model for financial liabilities
is largely unchanged from IAS 39, except for
Classifications and Measurement
IFRS 9 requires that all financial assets are to be measured at either at FVTPL, fair value through OCI [“FVOCI”], or amortized cost.
Based on its business models, the Company has determined which measurement convention is most appropriate for its mortgage
assets as summarized below with a comparison to the classification and measurement under IAS 39:
IAS 39
IFRS 9
Mortgages accumulated for securitization
Loans and Receivable
Amortized Cost
Mortgages accumulated for sale
FVTPL
FVTPL
Mortgages pledged under securitization
FVTPL or Loan and Receivables
Amortized Cost
Mortgage and loan investments
Loans and Receivable
FVTPL
As at December 31, 2017, the mortgages pledged under securitization which were classified as FVTPL had a mark to market
discount to par of $1,683.
Impairment
IFRS 9 introduces an expected credit loss
full lifetime expected credit loss, with interest revenue calculated on the
[“ECL”] model applicable to all debt instruments
carrying amount (net of the allowance for credit loss), rather than the gross
within financial assets classified as amortized
carrying value of the financial assets.
cost or FVOCI and certain off-balance sheet loan
commitments. The model has three stages: Stage
1 – the credit risk has not increased significantly
since initial recognition such that an allowance
for credit loss is recognized and maintained
equal to 12 months of expected credit loss; Stage
2 – the credit risk has increased significantly
since initial recognition, and the allowance for
credit loss is increased to cover full lifetime
expected credit loss; and Stage 3 – a financial
asset is considered credit-impaired and the
allowance for credit loss continues to be the
The key inputs in the measurement of ECL include Probability of Default,
Loss Given Default and forecast of future economic conditions which
involves significant judgment. Upon application of the impairment portion
of IFRS 9, there has been no impact on the Company’s earnings due to
the high proportion of government insured mortgages in its securitized
portfolio and the low historical loss rates on the uninsured mortgages on
which the Company lends.
19
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
“Since going public
Hedge Accounting
The Company has adopted hedge accounting for a portion of its
mortgage commitments and virtually all of its fixed rate funded mortgages
accumulated for securitization.
For multi-unit residential commercial segment mortgages, the Company
has applied “cash flow” hedge accounting by hedging the anticipated future
debt to be arranged through securitization on these mortgages. Effective
January 1, 2018 the Company commenced designating the short sales of
Government of Canada bonds at the time of mortgage commitment as
hedging instruments. When effective hedging is achieved, any gains or
losses will be recorded in OCI and amortized into interest expense over the
term of the hedged debt. Under ordinary market conditions, this accounting
should remove some of the volatility related to marking to market hedging
instruments from the Company’s regular income.
For residential mortgages accumulated for securitization, the Company has
applied “fair value” hedge accounting to minimize the exposure to changing
interest rates by selling short Government of Canada bonds at the time
these mortgages are funded. The Company will re-balance and evaluate
the hedge effectiveness on an ongoing basis. For an effective hedge, the
gains or losses on the hedging instrument should be offset by the losses or
gains of value on the hedged mortgages. At the termination of the hedging
relationship of an effective hedge, the changes in the value of the hedging
instrument will be adjusted to the carrying value of the hedged mortgages,
and amortized into interest revenue over the term of the hedged mortgages.
Any changes in the market value of an ineffective hedge will be immediately
recorded in the Company’s regular income.
IFRS 15 – Revenue from Contracts with Customers
On January 1, 2018 the Company adopted IASB issued IFRS 15 – Revenue
from Contracts with Customers. The standard contains a single model that
applies to contracts with customers and two approaches to recognizing
revenue: at a point in time or over time. The model features a contract-
based, five-step revenue recognition process to determine the nature,
amount, timing and uncertainty of revenue and cash flows from the
contracts with customers.
The Company applied the standard on January 1, 2018, using the modified
retrospective approach. The main revenue stream that has been affected by
IFRS 15 is mortgage servicing revenue, including the ongoing measurement
of servicing liabilities. Because of the immaterial impact of applying
this standard, there was no significant effect on the Company’s 2018
consolidated financial statements and there has not been any required
restatement of comprehensive income for prior years.
in 2006, First
National has been
considered a high
yielding dividend
paying company.”
20
20
MANAGEMENT’S DISCUSSION AND ANALYSIS
KEY PERFORMANCE INDICATORS
The principal indicators used to measure the
Pre-FMV EBITDA is not a recognized measure under IFRS. However,
Company’s performance are:
management believes that Pre-FMV EBITDA is a useful measure that
• Earnings before income taxes, depreciation,
and losses and gains on financial instruments
with the exception of any losses related to
mortgage investments (“Pre-FMV EBITDA”(1));
and
provides investors with an indication of income normalized for capital
market fluctuations. Pre-FMV EBITDA should not be construed as an
alternative to net income determined in accordance with IFRS or to cash
flows from operating, investing and financing activities. The Company’s
method of calculating Pre-FMV EBITDA may differ from other issuers and,
accordingly, Pre-FMV EBITDA may not be comparable to measures used
• Dividend payout ratio.
by other issuers.
($000s)
FOR THE PERIOD
Revenue
Income before income taxes
Pre-FMV EBITDA(1)
AT PERIOD END
Total assets
QUARTER ENDED
YEAR ENDED
December 31,
2018
December 31,
2017
December 31,
2018
December 31,
2017
312,039
44,050
55,780
270,015
1,181,510
1,078,768
63,158
61,093
227,417
225,186
285,402
234,278
36,037,127
32,776,278
36,038,527
32,776,278
Mortgages under administration
106,151,363
101,589,153
106,151,363
101,589,153
Note:
(1) This non-IFRS measure adjusts income before income taxes by adding back expenses for depreciation of capital assets, but it also eliminates the impact of changes
in fair value by adding back losses on the valuation of financial instruments (except those on mortgage investments) used in and deducting gains on the valuation of
financial instruments.
Since going public in 2006, First National has been considered a high-yielding dividend paying company. With a large MUA that
generates continuing income and cash flow and a business model that is designed to make efficient use of capital, the Company
has been able to pay distributions to its shareholders that represent a relatively large ratio of its earnings. The Company calculates
the dividend payout ratio as dividends declared on common shares over net income attributable to common shareholders. This
measure is useful to shareholders as it indicates the percentage of earnings paid out as dividends. Similar to the performance
measurement for earnings, the Company also calculates the dividend payout ratio on a basis using after-tax Pre-FMV EBITDA.
21
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT Determination of Common Share Dividend Payout Ratio
($000s)
FOR THE PERIOD
QUARTER ENDED
YEAR ENDED
December
31, 2018
December
31, 2017
December
31, 2018
December
31, 2017
Net income attributable to common shareholders
Total dividends paid or declared on common shares
Dividends paid or declared on common shares,
excluding special dividend
Total Common Share Dividend Payout Ratio
Regular Common Share Dividend Payout Ratio (1)
After-tax Pre-FMV Dividend Payout Ratio (2)
31,465
88,202
28,235
280%
90%
72%
44,972
102,694
27,735
228%
62%
65%
163,499
205,331
171,407
184,400
111,440
109,441
105%
68%
70%
90%
53%
67%
Note:
(1) This ratio is calculated by excluding the payment of the special dividends declared at the end of each year.
(2) This non-IFRS measure adjusts the net income used in the calculation of the “Regular common share dividend payout ratio” to after tax Pre-FMV earnings so as to
eliminate the impact of changes in fair value by adding back losses on the valuation of financial instruments (except those on mortgage investments) and deducting gains
on the valuation of financial instruments. The Company uses its aggregate effective tax rate to tax affect the impact of the valuation of financial instruments on this ratio.
For the year ended December 31, 2018, the
largely to be reflected in narrower spreads in the future from the mortgages
common share payout ratio was 105% compared
pledged for securitization. Accordingly, management does not consider
to 90% in 2017. However, in November of both
this revenue to be available for dividend payment. If the gains on financial
2018 and 2017, the Company declared a special
instruments in the two years are excluded, the dividend payout ratio for
dividend which represented the distribution of
2018 would have been 70% compared to 67% in 2017.
The Company also paid $2.9 million of dividends on its preferred shares in
2018 compared to $2.7 million in 2017.
excess retained earnings generated over the
course of several prior years. Including such
dividends distorts the payout ratios. If the special
dividends are excluded from the calculation, the
payout ratios would have been 68% in 2018 and
53% in 2017. In both 2018 and 2017, the Company
recorded gains on account of the changes in
fair value of financial instruments. The gains
are recorded in the period in which the prices
on Government of Canada bond yields change;
however, the offsetting economic impact is
22
MANAGEMENT’S DISCUSSION AND ANALYSIS
REVENUES AND FUNDING SOURCES
Mortgage Origination
Placement Fees and Gain on Deferred Placement Fees
The Company derives a significant amount of
The Company recognizes revenue at the time that a mortgage is placed
its revenue from mortgage origination activities.
with an institutional investor. Cash amounts received in excess of the
Most mortgages originated are funded either
mortgage principal at the time of placement are recognized in revenue as
by placement with institutional investors or
“placement fees”. The present value of additional amounts expected to be
through securitization conduits, in each case
received over the remaining life of the mortgage sold (excluding normal
with retained servicing. Depending upon market
market-based servicing fees) is recorded as a “deferred placement fee”. A
conditions, either an institutional placement
deferred placement fee arises when mortgages with spreads in excess of a
or a securitization conduit may be the most
base spread are placed. Normally the Company would earn an upfront cash
cost-effective means for the Company to fund
placement fee, but investors prefer paying the Company over time as they
individual mortgages. In general, originations
earn net interest margin on such transactions. Upon the recognition of a
are allocated from one funding source to
deferred placement fee, the Company establishes a “deferred placement fee
another depending on market conditions and
receivable” that is amortized as the fees are received by the Company. Of
strategic considerations related to maintaining
diversified funding sources. The Company retains
the Company’s $25.9 billion of new originations and renewals in 2018, $14.9
billion was placed with institutional investors.
servicing rights on virtually all of the mortgages
it originates, which provide the Company with
servicing fees to complement revenue earned
through originations. For the year ended
December 31, 2018, new origination volume
increased from $16.9 billion to $18.5 billion, or
about 9%, compared to 2017.
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 mortgage. 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.
Securitization
The Company securitizes a portion of its
Mortgage Servicing and Administration
origination through various vehicles, including
NHA-MBS, CMB and Asset-backed Commercial
Paper (“ABCP”). Although legally these
transactions represent sales of mortgages, for
accounting purposes they do not meet the
requirements for sale recognition and instead
are accounted for as secured financings. These
mortgages remain as mortgage assets of the
Company for the full term and are funded with
securitization-related debt. Of the Company’s
$25.9 billion of new originations and renewals
in 2018, $10.1 billion was originated for its own
securitization programs.
The Company services virtually all mortgages generated through its
mortgage origination activities on behalf of a wide range of institutional
investors. Mortgage servicing and administration is a key component of the
Company’s overall business strategy and a significant source of continuing
income and cash flow. In addition to pure servicing revenues, fees related
to mortgage administration are earned by the Company throughout the
mortgage term. Another aspect of servicing is the administration of funds
held in trust, including borrowers’ property tax escrows, reserve escrows
and mortgage payments. As acknowledged in the Company’s agreements,
any interest earned on these funds accrues to the Company as partial
compensation for administration services provided. The Company has
negotiated favourable interest rates on these funds with the chartered
banks that maintain the deposit accounts, which has resulted in significant
additional servicing revenue.
In addition to the interest income earned on securitized mortgages and
deferred placement fees receivable, the Company also earns interest income
on mortgage-related assets, including mortgages accumulated for sale or
securitization, mortgage and loan investments and purchased mortgage
servicing rights.
The Company provides underwriting and fulfilment processing services to
a mortgage originator using the mortgage broker distribution channel.
The Company earns a fee based on the dollar value of funded mortgages.
These fees are recognized at the time a mortgage funds and are included
in “Mortgage servicing income” in the consolidated statement of income.
23
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT RESULTS OF OPERATIONS
The following table shows the volume of mortgages originated by First National and mortgages under administration for the
periods indicated:
($ millions)
MORTGAGE ORIGINATIONS
BY SEGMENT
New single-family residential
New multi-unit and commercial
Sub-total
Single-family residential renewals
Multi-unit and commercial renewals
Total origination and renewals
MORTGAGE ORIGINATIONS
BY FUNDING SOURCE
Institutional investors – new residential
Institutional investors – renew residential
Institutional investors – multi/commercial
NHA-MBS/CMB/ABCP securitization
Internal Company resources /CMBS
Total
MORTGAGES UNDER ADMINISTRATION
Single-family residential
Multi-unit residential and commercial
Total
QUARTER ENDED
YEAR ENDED
December 31,
2018
December 31,
2017
December 31,
2018
December 31,
2017
2,760
1,848
4,608
1,322
592
$6,522
2,446
628
1,873
1,359
216
$6,522
79,166
26,985
$106,151
2,787
1,645
4,432
1,124
257
$5,813
1,254
564
1,271
2,449
275
$5,813
12,231
6,237
18,468
6,083
1,338
11,133
5,770
16,903
5,219
1,127
$25,889
$23,249
6,495
2,490
5,957
10,109
838
6,240
2,688
5,342
8,199
780
$25,889
$23,249
77,423
24,166
$101,589
79,166
26,985
$106,151
77,423
24,166
$101,589
Total new mortgage origination volumes increased in 2018 compared to 2017 by 9%. Single-family volumes increased by 10%
and commercial segment volumes increased by 8% year over year. The increase in the single-family segment is due to growth in
eastern Canada which offset lower volumes experienced by the Company’s Calgary and Vancouver offices, which together had
volumes 6% lower than in 2017. When combined with renewals, total production increased from $23.2 billion in 2017 to $25.9 billion
in 2018, or by 11%. The Company believes higher new single-family origination is partially the result of the relaunch of its Excalibur
program which has added origination volume where there was none in 2017. Overall volumes were also affected favourably by a
28% increase in the Quebec market. In 2017 there was significant mortgage rate pressure in this region from local competitors. In
2018 this subsided so as to make the Company’s products more competitive. The Company’s expertise in mortgage underwriting
drove commercial segment origination (including renewals) higher by 10% in 2018. Origination for direct securitization into NHA-
MBS, CMB and ABCP programs remained a large part of the Company’s strategy with volume of $10.1 billion in 2018. Although
the Company used such securitization funding to a greater degree in 2018 compared to 2017, the Company continued to grow
origination for its arms-length investors so as to support its long-term strategy of maintaining diverse funding sources.
24
MANAGEMENT’S DISCUSSION AND ANALYSIS
Net Interest - Securitized Mortgages
Placement Fees
Comparing the year ended December 31, 2018 to
Placement fee revenue decreased by 2% to $141.9 million from $144.6 million
the year ended December 30, 2017, “net interest
in 2018. The decrease would be larger if the 2017 revenue was normalized
– securitized mortgages” decreased by 2% to
for the impact of changing interest rates which arguably understated
$144.1 million from $146.8 million. The decrease
placement fee revenue that year. As described in the 2017 MD&A, the
was due to a tighter weighted-average spread
Company recorded about $14.4 million of gains on financial instruments in
on the portfolio, offset by a larger portfolio
the second quarter of 2017 which detracted from placement fee revenue in
of securitized mortgages year over year. The
the third quarter of 2017 (when the related mortgages were placed). If the
portfolio of securitized mortgages increased by
amount is added back to 2017 revenues, placement fees were lower by 12%
11% from $27.6 billion at December 31, 2017 to
compared to 2018. This decrease resulted from a change in product mix
$30.6 billion by the end of December 2018. The
with the re-introduction of the Excalibur program. Because the Excalibur
increase in the securitized portfolio was offset
mortgages are shorter term (typically 1 year), the fee for placement is
by tighter securitization spreads as mortgage
lower on a per unit basis. With the Company’s success at originating this
spreads to risk-free Government of Canada
product, average placement fees were adversely affected. The broker fees
have decreased by about 0.50% since 2015. The
associated with Excalibur mortgages are also smaller such that despite the
impact of accounting for financial instruments
lower revenue, the origination is favorable to net income. First National was
has also affected this revenue. The consequence
also successful in increasing single-family renewals by about 17% year over
of large gains on financial instruments recognized
year; however, the Company elected to securitize a larger portion of these
in 2017 and 2016, is generally more expensive
in 2018 compared to 2017 such that lower placement fees were earned on
debt raised on the securitized mortgages. As
these mortgages. The decline was also the result of tightening mortgage
the securitization transactions related to these
spreads which reduced the per unit placement fee with a portion of the
debts performs, a lower net securitization
Company’s institutional investors. These placements were transacted based
margin is recorded. The Company estimates
on capital market conditions which were less favorable in 2018 compared
that the impact of this accounting treatment has
to 2017. Commercial placement fees increase 3% year over year in line with
decreased net interest – securitized mortgages
higher volume.
by $11.3 million year over year.
Gains on Deferred Placement Fees
Gains on deferred placement fees revenue increased 17% to $11.7 million
from $10.0 million. The gains related to multi-unit residential mortgages
originated and sold to institutional NHA-MBS issuers. Although, volumes
for these transactions increased by 33% from 2017, spreads on these
transactions tightened such that the Company realized lower per unit gains.
Mortgage Servicing Income
Mortgage servicing income increased 4% to $146.2 million from $140.8
million. This increase was largely due to the third-party underwriting
business which experienced an increase in the volume of mortgages
processed, and the benefits associated with higher MUA.
Mortgage Investment Income
Mortgage investment income increased 23% to $84.3 million from $68.3
million. The increase was due primarily to an increase in market interest
rates providing more investment income. The Company recorded mark-to-
market losses of $4.0 million (2017 – credit losses of $4.0 million) regarding
four non-performing properties in the commercial bridge portfolio in 2018.
These were recorded as losses on financial instruments in 2018. In addition,
the interest rates associated with the Company’s mortgages warehoused
prior to securitization were higher this year such that more interest income
was earned during the warehousing period.
25
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT Realized and Unrealized Gains (Losses) on
Financial Instruments
In previous periods, this financial statement line
Company has elected to document hedging relationships for virtually all of
item typically consisted of two components:
the multi-residential commitments and mortgages it originates for its own
(1) gains and losses related to the Company’s
securitization programs. It has also done the same for the funded single-
economic hedging activities using short
family mortgages and the swaps used in its ABCP programs. This decision
bonds, and (2) gains and losses related to
will likely reduce the volatility of gains and losses on financial instruments
holding term assets derived using discounted
seen in the last several fiscal years as gains and losses on these hedged
cash flow methodology. Under previous IFRS
items are generally deferred and amortized into income over the term
accounting standards, the Company’s use of
of the related mortgage. The Company has not documented a hedging
short Government of Canada bonds together
relationship for the short bonds used to economically hedge commitments
with repurchase agreements to create synthetic
on single-family mortgages. The Company believes given the optional
forward interest rate contracts to hedge
nature of these commitments it is difficult to establish a valid hedging
interest rate risk, did not qualify as hedges for
relationship. For financial reporting purposes, this means that there will
accounting purposes. The result was large gains
still be gains and losses on financial instruments in the years after 2017, but
and losses related to changes in the fair value
these should be limited to those on the short bonds used to mitigate the
of these instruments. The gains or losses were
interest rate risk associated with single-family commitments. The Company
recorded in earnings in the period in which
has recorded most of the mortgages held as assets on its balance sheet at
the bond prices changed. With the adoption
amortized cost. Accordingly, there should be much lower fair value gains or
of IFRS 9, these instruments can now qualify
losses associated with “mortgages held at fair value” compared to the past
as hedges for accounting purposes with the
several years. The following table summarizes these gains and losses by
proper documentation and oversight. The
category in the periods indicated:
SUMMARY OF REALIZED AND UNREALIZED
GAINS (LOSSES) ON FINANCIAL INSTRUMENTS
($000s)
Gains on short bonds used for the economic
hedging program
Losses on mortgages held at fair value
Gains (losses) on interest rate swaps
Other gains (losses)
NET GAINS ON FINANCIAL INSTRUMENTS
QUARTER ENDED
YEAR ENDED
December 31,
2018
December 31,
2017
December 31,
2018
December 31,
2017
(14,285)
(1,000)
3,569
—
(11,716)
1,383
(7,171)
9,276
137
3,625
5,822
(4,000)
1,340
—
3,162
35,467
(25,311)
47,133
(1,030)
56,259
In 2017, economic data turned positive
removed from the Company’s statement of income.
and interest rates jumped higher with the
expectations of a Bank of Canada increase
in overnight rates. This meant that 5-year
bond prices decreased so that generally the
Company recorded large gains on its hedging
program. This trend continued through the
first three quarters of 2018 and bond yields
increased steadily. However in November 2018,
economic sentiment changed and bond yields
decreased abruptly and returned to the same
levels recorded at the beginning of the year. The
impact of the movement in 2018 had a lower
impact to the Company’s gains and losses on
financial instruments due to the adoption of
hedge accounting such that a portion of both
gains and losses recorded during the year were
26
MANAGEMENT’S DISCUSSION AND ANALYSIS
In 2018, the Company recorded gains on these instruments of $5.8 million
(2017 – $35.5 million). On its commercial segment hedges, the value of
the Company’s hedges increased by $3.2 million; however because of the
designation of a hedge relationship, the amount was recorded in Other
Comprehensive Income. This amount will be amortized into the Company’s
regular income over the terms of the related securitization and placement
transactions. Because of the nature of the timing of such gains and losses
within the year, $7.5 million of gains were amortized into the Company’s
income. For the residential segment, the Company has designated hedge
relationships to protect the fair value of funded mortgages prior to
securitization or placement. The $5.8 million gain above reflects the increase
in value of short bonds used to hedge the Company’s commitments for
which the Company does not attempt to document a hedge relationship.
The change in value related to funded mortgages that were hedged
effectively in the year was deferred on the Company’s balance sheet.
Brokerage Fees Expense
Interest Expense
Brokerage fees expense decreased 9% to $75.4
Interest expense increased 51% to $69.9 million from $46.4 million. As
million from $83.3 million. This decrease is
discussed in the “Liquidity and Capital Resources” section of this analysis,
explained by lower origination volumes of prime
the Company warehouses a portion of the mortgages it originates prior
single-family mortgages for institutional investors
to settlement with the investor or funding with a securitization vehicle.
and lower per unit broker fees in the residential
The Company used the senior unsecured notes together with a $1.25
segment. Despite the increase in overall
billion credit facility with a syndicate of banks and 30-day repurchase
single-family origination of 10%, origination for
facilities to fund the mortgages during this period. The overall interest
institutional investors increased by just 6%. This
expense increased from the prior year due to higher short-term interest
increase was largely the result of the relaunch
rates pursuant to Bank of Canada announcements that increased short-
of the Excalibur program. These mortgages are
term borrowing rates by 0.75% beginning in the third quarter of 2017.
generally for 1 year terms and accordingly have a
The Company also held higher balances of mortgages accumulated for
significantly lower broker fee per unit cost than a
securitization and mortgage and loan investments in 2018, which required
typical prime mortgage origination. Accordingly
greater use of the Company’s credit facilities.
comparable broker costs where lower year over
year based on origination volumes. For prime
mortgage origination, per unit broker fees
were also lower than in 2017. Generally in 2017,
broker compensation for insured mortgages
was abnormally high as the market competed
for such mortgages after new insurance rules,
announced in 2016, reduced the amount of
insured mortgages available in the market. In
2018 fees returned to “normal” levels such that
2018 per-unit broker fees were generally 5%
lower than in 2017. Portfolio insurance costs are
also included in this expense line and were also
lower than in 2017 as the Company was able to
use previously purchased insurance policies to
cover a portion of 2018’s insurance requirements.
Salaries and Benefits Expense
Salaries and benefits expense increased by 2%
to $99.7 million from $97.8 million. Salaries were
higher by 2% and overall headcount increased
by 5% (936 employees as at December 31, 2017
and 987 at December 31, 2018). Although overall
headcount rose, much of the increase occurred
in the fourth quarter and expenses for salaries
grew by standard cost of living increases. These
increases were offset by $1.4 million of lower
compensation earned by commercial sales staff
as spreads were tighter in the year. Management
salaries were paid to the two senior executives
(Co-founders) who together control about 74%
of the Company’s common shares. The current
period expense is a result of the compensation
arrangement executed on the closing of the
initial public offering (“IPO”) in 2006.
Other Operating Expenses
Other operating expenses increased by 17% to $63.0 million from $53.9
million. Other operating expenses increased by $6.9 million related to
higher hedge expenses which increased in step with higher bond yields
and a larger hedge book. Because of more mortgages originated for
securitization, the Company carried notional hedges of approximately $2.0
billion during 2018. In addition, the rising interest rate environment which
was prevalent during most of the year, created a steeper yield curve which
made it more expensive to carry the short bonds the Company employs
to mitigate interest rate risk associated with the Company’s commitment
and funded warehouse pipeline. The remaining increase in other operating
expenses of $2.2 million reflects costs to support a growing business
including information technology and the relaunch of the Excalibur program.
Income before Income Taxes and Pre-FMV EBITDA
Income before income taxes decreased by 20% to $227.4 million from
$285.4 million. This decrease was affected by changing capital markets. In
2018, the Company recorded $7.2 million of gains on financial instruments
(excluding $4.0 million of losses related to mortgage and loan investments).
In 2017, the Company recorded $56.3 million of gains on financial
instruments. The change in these values accounted for a $49.1 million
decrease in comparative income before income taxes. Pre-FMV EBITDA,
which eliminates the impact of gains and losses on financial instruments,
decreased by 4% to $225.2 million from $234.3 million. This decrease was
partially the result of fair value accounting on placement fee revenues in
the third quarter of 2017. As described in the 2017 MD&A, the Company
recorded about $14.4 million of gains on financial instruments in the second
quarter of 2017 which detracted from placement fee revenue in the third
quarter of 2017 when the related mortgages were placed. If the amount is
added back to 2017 Pre-FMV EBITDA, the decrease between 2018 and 2017
was 9%. The decrease in this normalized earning measure is the result of
tighter securitization spreads. As described previously in this MD&A, the
spread between the interest rates on prime mortgages and the cost of debt
used to fund these assets, has become significantly narrower in the last two
27
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT “With the adoption
of hedge accounting
in 2018, management
expects less volatile
earnings going
forward.”
years. This was particularly true for the third and fourth quarters of 2018
when Canadian banks maintained their offered mortgage rates despite a
rising interest rate environment. Tight mortgage spreads not only affected
the Company’s net margin from securitized mortgages, but placement
fees as well as there was less spread to share with some of the Company’s
institutional investors who securitize the mortgages that they purchase
from First National. Lower net income from securitization and placement of
prime mortgages was offset partially by increased earnings from mortgage
servicing and the Excalibur program which was relaunched in early 2018.
Although origination increased by approximately 10% from 2017, most of
the additional volume was securitized by the Company. By securitizing
mortgages instead of placing them with institutional investors, the Company
delays the earning’s process: placement fee revenues are reduced and the
costs of hedging and interest during the warehousing period are increased.
Provision for Income Taxes
The provision for taxes decreased by 20% to $61.0 million from $75.8 million.
The provision decreased proportionately with net income before income
taxes. The overall effective tax rate was marginally higher in 2018 as a
provincial tax rate increased by 1% at the start of 2018.
Other Comprehensive Income
Beginning January 1, 2018, the Company adopted IFRS 9. As a part of this
transition the Company began accounting for some of its interest rate risk
mitigation strategies as hedges for reporting purposes. For the commercial
segment, the Company hedges the interest rate risk associated with insured
multi-residential mortgages. This hedging begins on commitment and ends
when the Company either securitizes the mortgages (primarily through
CMB funding) or places the mortgage with an institutional investor. As
the Company determined that these hedges were effective, the Company
recorded $3.2 million of net gains on such hedges in 2018 that would have
been recorded in gains on financial instruments under the previous IFRS
standard. The amount consisted of $19.7 million of gains and $16.5 million of
losses. Because the losses pertained primarily to the fourth quarter of 2018
when bond prices rose significantly, the related mortgages have not yet
been securitized or placed. Accordingly the losses were largely unamortized
while the gains have been amortized. The net amortization of the values in
OCI totaled $7.5 million for 2018 and has been reflected in the Company’s
Net Income. The remaining OCI amount represents losses of $4.3 million
which will be amortized in future periods.
28
28
MANAGEMENT’S DISCUSSION AND ANALYSIS
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:
FOR THE QUARTER ENDED
RESIDENTIAL
COMMERCIAL
($000s except percent amounts)
December 31,
2018
December 31,
2017
December 31,
2018
December 31,
2017
Originations and renewals
18,314,129
16,352,753
Percentage change
Revenue
Percentage change
Income before income taxes
Percentage change
AS AT
Identifiable assets
Mortgages under administration
12%
913,301
10%
164,897
(23%)
827,160
215,370
7,574,443
10%
268,209
7%
62,517
(11%)
6,897,582
251,608
70,032
December 31,
2018
December 31,
2017
December 31,
2018
December 31,
2017
27,719,231
79,165,363
25,653,160
77,422,655
8,289,520
26,985,711
7,093,342
24,166,498
RESIDENTIAL SEGMENT
COMMERCIAL SEGMENT
Overall residential origination including renewals
2018 commercial revenues increased by about 7% compared to 2017.
increased by 12% between the 2018 and 2017
Without the impact of gains and losses on account of fair value, revenue
while residential revenues increased by 10%.
increased by 11% year over year. This was in line with the increased
Revenues in both quarters were affected by
origination and higher interest revenue on securitized mortgages of 16%
gains of fair value associated with rising interest
year over year as the average mortgage rate in the securitized portfolio
rates. If revenues are normalized for these gains,
increased with the higher interest rate environment. Income before income
revenue increased by 14%. Revenue growth
taxes was also affected by fair value considerations. By excluding fair value
exceeded the growth in origination as the
gains and losses, this measure would have increased by 6% year over year
Company’s revenue from securitized mortgages
as the large increases in origination evidenced in 2018 and 2017 created
in this segment increased by 21% as mortgage
higher net securitization and servicing income, which more than offset
interest rates increased in the market. Net
lower placement fees. Identifiable assets increased from those at December
income before tax was also affected by fair value
31, 2017, as the Company increased its investment mortgages pledged for
related amounts. Without the impact of these
securitization by $0.9 billion and mortgages accumulated for securitization
revenues, net income before tax decreased
by $0.3 billion. The reduction of $0.2 billion of its investment in mortgage
from $184.4 million in 2017 to $157.7 million in
investments was offset by an increase in hedging assets.
2018 or by 14%. This was the result of tighter
securitization margins and the Company’s
decision to securitize a larger portion of its
residential origination in the year. The costs
of underwriting, hedging and warehousing
these mortgages are significant and there is
only a marginal contribution to earnings on
new transactions in the year of securitization.
Identifiable assets increased from December 31,
2017, as the Company increased its investment
in mortgages pledged under securitization by
about $2.1 billion.
29
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT LIQUIDITY AND CAPITAL RESOURCES
The Company’s fundamental liquidity strategy
Company considers a proxy for “true leverage”, has decreased between
has been to invest in prime Canadian mortgages.
December 31, 2017 and December 31, 2018, and now stands at $191.1 million
Management’s belief has always been that
(December 31, 2017 – $262.4 million). This represents a debt-to-equity ratio
these mortgages are considered “AAA” by
of approximately 0.36:1. This ratio decreased from 0.48:1 at December 31,
investors and should always be well bid and
2017. In general, in 2018, the Company used the cash from repayment of
highly liquid. This strategy proved effective
$191 million of mortgage and loan investments to (1) invest in $79 million
during the turmoil experienced in 2007
of broker fees related to securitized mortgages and, (2) to pay the special
through 2009, when capital markets faltered
dividend of $60 million in December 2018. The Company believes the ratio is
and only the highest-quality assets were
appropriate given the nature of the assets which the debt is funding.
bid. As the Company’s results in those years
demonstrated, First National had little trouble
finding investors to purchase its mortgage
origination at profitable margins. Originating
prime mortgages also allows the Company to
securitize in the capital markets; however, this
activity requires significant cash resources to
purchase and hold mortgages prior to arranging
for term debt through the securitization
markets. For this purpose, the Company uses
the combination of the $175 million unsecured
notes and the Company’s revolving bank credit
facility. This aggregate indebtedness is typically
used to fund: (1) mortgages accumulated for
sale or securitization, (2) the origination costs
associated with securitization, and (3) mortgage
and loan investments. The Company has a
credit facility with a syndicate of ten financial
institutions for a total credit of $1.25 billion. This
facility was extended in May 2018 for a five-year
term maturing in March 2023. At December 31,
2018, the Company entered into repurchase
The Company funds a portion of its mortgage originations for institutional
placement on the same day as the advance of the related mortgage. The
remaining originations are funded by the Company on behalf of institutional
investors or pending securitization by the Company. On specified days, the
Company aggregates all mortgages warehoused to date for an institutional
investor and transacts a settlement with that institutional investor. A similar
process occurs prior to arranging for funding through securitization. The
Company uses a portion of the committed credit facility with the banking
syndicate to fund the mortgages during this warehouse period. The credit
facility is designed to be able to fund the highest balance of warehoused
mortgages in a month and is normally only partially drawn.
The Company also invests in short-term mortgages, usually for six- to
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 indebtedness. 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.
The Company has used ABCP as an efficient source of funding primarily
for short-term insured mortgages. In the May 2013 federal budget, the
transactions with financial institutions to borrow
government announced it was going to take steps to limit the securitization
$1.3 billion related to $1.3 billion of mortgages
held in “mortgages accumulated for sale or
securitization” on the balance sheet.
At December 31, 2018, outstanding bank
indebtedness was $918.3 million (December
31, 2017 - $643.8 million). Together with the
unsecured notes of $175 million (December 31,
2017 – $175 million), this “combined debt” was
used to fund $902.0 million (December 31, 2017
- $556.1 million) of mortgages accumulated for
sale or securitization. At December 31, 2018,
the Company’s other interest-yielding assets
included: (1) deferred placement fees receivable
of $41.6 million (December 31, 2017 – $41.3
million) and (2) mortgage and loan investments
of $188.7 million (December 31, 2017 - $379.7
million). The difference between “combined
debt” and the mortgages accumulated for
sale or securitization funded by it, which the
of government insured mortgages to CMHC-sponsored programs. As ABCP
is not sponsored by CMHC, such a limitation would impact the Company.
Almost two years after the announcement, legislation was passed and
detailed transition information was published. With the change in the
federal government, the legislation was reconfirmed in February 2016 with
some delayed application dates. Generally, the regulations make mortgage
default insurance invalid for any single-family mortgages with maturity
dates beyond December 31, 2021 in a non-CMHC sponsored securitization
vehicle. Accordingly, existing single-family mortgages in ABCP conduits
can be funded by ABCP until their maturity, not to exceed 5 years and new
insured single-family mortgages can be sold in as long as the maturity
date of the mortgage is prior to January 1, 2022. As this date approaches,
the Company must find other funding sources for the insured mortgages
it has historically funded with ABCP. The Company is considering various
alternatives including whole loan sales and selling short-term NHA-MBS
pools to ABCP conduits. The Company may also adjust its renewal offering
to provide incentives to borrowers to select five-year terms as opposed to
shorter terms. These alternatives may not be as economical to the Company
as ABCP. A portion of the Company’s capital has been employed to support
30
MANAGEMENT’S DISCUSSION AND ANALYSIS
FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
its ABCP and NHA-MBS programs, primarily to
Commencing January 1, 2018, the Company has recorded mortgages
provide credit enhancements as required by
accumulated for sale and mortgage and loan investments, as financial assets
rating agencies. The most significant portion
measured at “fair value through profit or loss” such that changes in market
of cash collateral is the investment made on
value are recorded in the consolidated statement of income. The mortgages
behalf of the Company’s ABCP programs. As
accumulated for sale are held for very short periods and any change
at December 31, 2018, the investment in cash
in value due to changing interest rates is the obligation of the ultimate
collateral was $75.9 million (December 31, 2017 -
institutional investor. Accordingly, the Company believes there will be
$66.4 million).
The Company’s Board of Directors has elected
to pay dividends, when declared, on a monthly
basis on the outstanding common shares and on
a quarterly basis on the outstanding preference
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 the Company
to Canadian residents on both common and
preference shares after December 31, 2010, are
little, if any, effect on its income related to the change in fair value of these
mortgages. The majority of mortgages in mortgage and loan investments
are uninsured commercial segment bridge loans. These are primarily
floating rate loans that have mortgages terms of eighteen months or less.
As the mortgages do not conform to conventional mortgage lending, there
are few active quoted markets available to determine the fair value of these
assets. The Company estimates fair value based upon: benchmark interest
rates, credit spreads for similar products, creditworthiness and status of the
borrower, valuation of the underlying real property, payment history, and
other conditions specific to the rationale for the loan. Any favourable or
unfavourable amounts will be recorded in the statement of income
each quarter.
designated as “eligible dividends”. Unless stated
The Company believes its hedging policies are suitably designed such
otherwise, all dividends (and deemed dividends)
that the interest rate risk of holding mortgages prior to securitization is
paid by the Company hereafter are designated
mitigated. Prior to 2018, the Company did not attempt to adopt hedge
as “eligible dividends” for the purposes of such
accounting; however, with the introduction of IFRS 9 on January 1, 2018, the
rules. For the preference shares, the Company
Company began designating hedging relationships such that the results of
has elected to pay any tax under Part VI.1 of the
any effective hedging will not affect the Company’s statement of income.
Income Tax Act, such that corporate holders of
See previous discussion in this MD&A under “Realized and Unrealized
the shares will not be required to pay tax under
Gains (Losses) on Financial Instruments”. As at December 31, 2018, the
Part VI.1 of the Income Tax Act on dividends
Company had about $1.3 billion of notional forward bond positions related
received on such shares.
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 committed for
the CMB program as well as mortgages to be sold to the Company’s other
securitization vehicles. As at December 31, 2018, the Company had entered
into $0.5 billion of notional value forward bond sales for this segment.
The Company is party to four interest rate swaps that economically hedge
the interest rate exposure related to certain CMB transactions in which
the Company has replacement obligations. As at December 31, 2018, the
aggregate notional value of these swaps, maturing between June 2021 and
September 2026, was $37.4 million. During 2018, the value of these swaps
increased by $1.3 million.
As described above, the Company employs various strategies to reduce
interest rate risk. In the normal course of business, the Company 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 mortgages originated for the
CMBS market in the spring of 2007. These mortgages were originated at
credit spreads designed to be profitable to the Company when sold to a
bank-sponsored CMBS conduit. Unfortunately for the Company, when these
mortgages funded, the CMBS market had shut down. The alternative to this
31
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT CAPITAL EXPENDITURES
channel was more expensive, as credit spreads
A significant portion of First National’s business model consists of the
elsewhere in the marketplace for this type of
origination and placement or securitization of financial assets. Generally,
mortgage had widened. The Company adjusted
placement activities do not require much capital investment as the
for market-suggested increases in credit spreads
Company acts primarily in the capacity of a broker. On the other hand, the
in 2007 and 2008 by adjusting the value of the
undertaking of securitization transactions may require significant amounts
mortgages downward. In 2009, the economic
of the Company’s own capital. This capital is provided in the form of cash
environment remained weak but did not worsen
collateral, credit enhancements, and the upfront funding of broker fees and
from the end of 2008. Overall credit spreads
other origination costs. These are described more fully in the “Liquidity and
stopped widening such that the Company
Capital Resources” section above. For fixed assets, the business requires
applied the same spreads to these mortgages
capital expenditures on technology (both software and hardware), leasehold
and the Company did not record any additional
improvements, and office furniture. During the year ended December 31,
unrealized losses or gains related to credit
2018, the Company purchased new computer equipment and software. In
spread movement. Despite entering into effective
the long term, the Company expects capital expenditures on fixed assets
economic interest rate hedges, the Company’s
will be approximately $5.0 million annually.
exposure to credit spreads remained. This risk is
inherent in the Company’s business model and
cannot be economically hedged.
SUMMARY OF CONTRACTUAL OBLIGATIONS
The same exposure to risk is inherent in the
The Company’s long-term obligations include five- to 10-year leases of
Company’s securitization through ABCP. The
premises for its six offices across Canada, and its obligations for the ongoing
Company is exposed to the risk that 30-day
servicing of mortgages sold to securitization conduits and mortgages
ABCP rates are greater than 30-day BA rates.
related to purchased servicing rights. The Company sells its mortgages to
Prior to the financial crisis, the Company
securitization conduits on a fully-serviced basis and is responsible for the
considered this a low risk given the quality of
collection of the principal and interest payments on behalf of the conduits,
the assets securitized, the amount of credit
including the management and collection of mortgages in arrears.
PAYMENTS DUE BY PERIOD
($000s)
Total 0-1 Years 1-3 Years 4-5 Years
After
5 Years
Lease obligations
36,089
7,467
22,240
6,382
—
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 June 2011 and continuing through the current
period, it was priced at a discount to BAs. At
the same time, the Company has leveraged
on changing credit spreads. The success of
this approach 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, 2018, the Company had various exposures
to changing credit spreads. In particular, in
mortgages accumulated for sale or securitization,
there were almost $2.2 billion of mortgages that
are susceptible to some degree of changing
credit spreads.
32
MANAGEMENT’S DISCUSSION AND ANALYSIS
CRITICAL ACCOUNTING POLICIES AND
ESTIMATES
The Company prepares its financial statements
On a quarterly basis, the Company reviews the estimates used to ensure
in accordance with IFRS, which requires
their appropriateness and monitors the performance statistics of the
management to make estimates, judgments
relevant mortgage portfolios to adjust and improve these estimates.
and assumptions that management believes are
The estimates used reflect the expected performance of the mortgage
reasonable based upon the information available.
portfolio over the lives of the mortgages. The method of determining
These estimates, judgments and assumptions
the assumptions underlying the estimates used for the quarter ended
affect the reported amounts of assets and
December 31, 2018 continue to be consistent with those used for the year
liabilities and disclosure of contingent assets and
ended December 31, 2017 and the quarters ended September 30, June 30
liabilities at the date of the financial statements,
and March 31, 2018.
and the reported amounts of revenue and
expenses during the reporting period.
Management bases its estimates on historical
experience and other assumptions that 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 annual consolidated
financial statements as at December 31, 2018.
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.
Effective January 1, 2018, the Company elected to treat certain of its
financial assets and liabilities, including mortgages accumulated for
sale, 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. If the bonds sold short are designated as an effective hedge,
a portion of the change in the short bonds fair value may be recorded
in Other Comprehensive Income or deferred against hedge assets. This
accounting should reduce the volatility in current earnings as changes in
the value on short bonds should be better matched to the change in value
of the hedged items (mortgages). 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 the assets listed above are subject to Company estimates.
The Company uses estimates in valuing its gain
The most significant would be implicit in the valuation of mortgage and
or loss on the sale of its mortgages placed
loan investments. These are generally non-homogeneous mortgages and
with institutions earning a deferred placement
other loans where it is difficult to find independent valuation comparatives.
fee. Under IFRS, valuing a gain on deferred
The Company uses information in its underwriting files, regional real estate
placement fees requires the use of estimates
information and other internal measures to determine the fair value of
to determine the fair value of the retained
these assets.
interest (derived from the present value of
expected future cash flows) in the mortgages.
These retained interests are reflected on the
Company’s balance sheet as deferred placement
fees receivable. The key assumptions 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
assumes there is virtually no prepayment on
multi-unit residential fixed-rate mortgages.
Currently there are no deferred placement fees
related to single-family mortgages.
As a mortgage lender, the Company invests in uninsured mortgages.
When it funds these mortgages through securitization debt, it continues
to be liable for any credit losses. The key inputs in the measurement of
any ECL include Probability of Default, Loss Given Default and forecast
of future economic conditions which involves significant judgment. Upon
application of IFRS 9 with respect to impairment, there has been no impact
on the Company’s earnings. Because of the high proportion of government
insured mortgages in its securitized portfolio and the low historical loss
rates on the uninsured mortgages on which the Company lends, ECL has
been determined to be insignificant.
33
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT FUTURE ACCOUNTING CHANGES
The following accounting pronouncements issued by the IASB, although not yet effective, may have a future impact
on the Company:
IFRS 16 – Leases
Disclosure Controls and Internal Controls over Financial Reporting
In January 2016, the IASB issued IFRS 16 – Leases,
The Company’s disclosure controls and procedures are designed to
replacing IAS 17 – Leases. IFRS 16 requires lessees
provide reasonable assurance that information required to be disclosed by
to recognize assets and liabilities for most leases
the Company in reports filed under Canadian securities laws is recorded,
instead of previous categories of finance leases,
processed, summarized and reported within the time periods specified
which are reported on the balance sheet, or
under those laws, and include controls and procedures that are designed to
operating leases, which are disclosed only in the
ensure that information is accumulated and communicated to management,
notes to the financial statements, under IAS 17.
including the Chief Executive Officer and Chief Financial Officer, to allow
IFRS 16 also set out enhanced guidance for the
timely decisions regarding required disclosure.
recognition, measurement, presentation and
disclosure of the leasing activities. IFRS 16 is
effective for annual periods beginning on or after
January 1, 2019.
As of December 31, 2018, management evaluated, under the supervision
of and with the participation of the Chief Executive Officer and Chief
Financial Officer, the effectiveness of the Company’s disclosure controls
and procedures. Based on this evaluation, management concluded that
The Company’s major leases are office space
the Company’s disclosure controls and procedures, as defined by National
leases for its Toronto head office and four regional
Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim
offices. The Company’s various office equipment
Filings, were effective as of December 31, 2018.
leases are insignificant for application of the new
standard. Based on the preliminary assessment,
the Company will record approximately $30
million as right-of-use asset as well as lease
liability on its consolidated statements of financial
position as of January 1, 2019.
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 statements
for external purposes in accordance with reporting standards; however,
because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements on a timely basis.
Management evaluated, under the supervision of and with the participation
of the Chief Executive Officer and Chief Financial Officer, the effectiveness
of the Company’s internal control over financial reporting based on the
criteria set forth in Internal Control – Integrated Framework (2013)issued by
the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”) and, based on that evaluation, concluded that the Company’s
internal control over financial reporting was effective as of December
31, 2018 and that no material weaknesses have been identified in the
Company’s internal control over financial reporting as of December 31, 2018.
No changes were made in the Company’s internal controls over financial
reporting during the year ended December 31, 2018 that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
controls over financial reporting.
34
MANAGEMENT’S DISCUSSION AND ANALYSIS
RISKS AND UNCERTAINTIES
AFFECTING THE BUSINESS
The business, financial condition and results
business model is to originate primarily prime mortgages and find funding
of operations of the Company are subject to
through various channels to earn ongoing servicing or spread income. For
a number of risks and uncertainties and are
the single-family residential segment, the Company relies on independent
affected by a number of factors outside the
mortgage brokers for origination and several large institutional investors
control of management of the Company. In
for sources of funding. These relationships are critical to the Company’s
addition to the risks addressed elsewhere in this
success. For a more complete discussion of the risks affecting the Company,
discussion and the financial statements, these
reference should be made to the Company’s Annual Information Form.
risks include: ability to sustain performance
and growth, reliance on sources of funding,
concentration of institutional investors, reliance
on independent mortgage brokers, changes
FORWARD-LOOKING INFORMATION
in interest rates, repurchase obligations and
Forward-looking information is included in this MD&A. In some cases,
breach of representations and warranties on
forward-looking information can be identified by the use of terms such as
mortgage sales, risk of servicer termination
‘‘may’’, ‘‘will”, ‘‘should’’, ‘‘expect’’, ‘‘plan’’, ‘‘anticipate’’, ‘‘believe’’, ‘‘intend’’,
events and trigger events on cash collateral
‘‘estimate’’, ‘‘predict’’, ‘‘potential’’, ‘‘continue’’ or other similar expressions
and retained interests, reliance on multi-unit
concerning matters that are not historical facts. Forward-looking
residential and commercial mortgages, general
information may relate to management’s future outlook and anticipated
economic conditions, legislation and government
events or results, and may include statements or information regarding
regulation (including regulations imposed
the future financial position, business strategy and strategic goals, product
by the Department of Finance, CMHC and
development activities, projected costs and capital expenditures, financial
the policies set by and for mortgage default
results, risk management strategies, hedging activities, geographic
insurance companies), potential for losses on
expansion, licensing plans, taxes and other plans and objectives of
uninsured mortgages, competition, reliance on
or involving the Company. Particularly, information regarding growth
mortgage insurers, reliance on key personnel
objectives, any increase in mortgages under administration, future use of
and the ability to attract and retain employees
securitization vehicles, industry trends and future revenues is forward-
and executives, conduct and compensation
looking information. Forward-looking information is based on certain factors
of independent mortgage brokers, failure or
and assumptions regarding, among other things, interest rate changes
unavailability of computer and data processing
and responses to such changes, the demand for institutionally placed and
systems and software, insufficient insurance
securitized mortgages, the status of the applicable regulatory regime, and
coverage, change in or loss of ratings, impact of
the use of mortgage brokers for single-family residential mortgages. This
natural disasters and other events, unfavorable
forward-looking information should not be read as providing guarantees
litigation, and environmental liability. In addition,
of future performance or results, and will not necessarily be an accurate
there are risks associated with the structure of
indication of whether or not, or the times by which, those results will
the Company including: those related to the
be achieved. While management considers these assumptions to be
dependence on FNFLP, leverage and restrictive
reasonable based on information currently available to it, they may prove
covenants, dividends which are not guaranteed
to be incorrect. Forward-looking information is subject to certain factors,
and could fluctuate with the Company’s
including risks and uncertainties, which could cause actual results to differ
performance, restrictions on potential growth,
materially from what management currently expects. These factors include
the market price of the Company’s shares,
reliance on sources of funding, concentration of institutional investors,
statutory remedies, control of the Company, and
reliance on independent mortgage brokers, and changes in interest rates
contractual restrictions. The Company is subject
as outlined in the ‘‘Risk and Uncertainties Affecting the Business’’ section.
to Canadian federal and provincial income and
In evaluating this information, the reader should specifically consider
commodity tax laws and pays such taxes as it
various factors, including the risks outlined in the ‘‘Risk and Uncertainties
determines are compliant with such legislation.
Affecting the Business’’ section, which may cause actual events or results
Among the risks of all potential tax matters,
there is a risk that tax legislation changes are
to differ materially from any forward-looking information. The forward-
looking information contained in this discussion represents management’s
detrimental to the Company or that Canadian
expectations as of February 25, 2019, and is subject to change after such
tax authorities interpret tax legislation differently
date. However, management and the Company disclaim any intention or
than the Company’s filing positions. Risk and risk
obligation to update or revise any forward-looking information, whether as
exposure are managed through a combination
a result of new information, future events or otherwise, except as required
of insurance, a system of internal controls and
under applicable securities regulations.
sound operating practices. The Company’s key
35
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT OUTLOOK
Management is pleased with the results of 2018. Despite the addition
of a new debt service qualifying test to B-20 underwriting guidelines in
January 2018, the Company’s new single-family origination increased by
10%. New commercial mortgage origination increased by 8%. Including
renewals, total origination was up 11% for the year ended December 31, 2018.
While earnings, adjusted for fair value considerations related to hedging
activities, were lower by 9%, a large part of this was the outcome of shifting
mortgages to securitization programs from placement transactions. By
securitizing mortgages instead of placing them directly with institutional
investors, the Company delays the earning’s process: current period
placement fee revenues are reduced and the costs associated with
securitization are increased. In addition, the Company recognized
significant gains related to hedging activities in 2017. The narrower margin
on the related securitization is recognized over the remaining term of the
mortgages and was partially reflected in 2018 earnings
Going into 2019, the Company is cautiously optimistic. Economic concerns
arose in November 2018 and continued through to year end. Equity
markets sold off and credit spreads widened. While perhaps too early to
determine if these events are a harbinger for a recession, in the short term
the consequences may be lessened at First National. Because the Company
uses government sponsored funding programs such as NHA MBS and CMB,
it expects these sources of funding to remain liquid and to outperform other
debt instruments during a spread widening cycle. In addition, while the
yields on underlying government bond benchmarks have fallen, mortgage
lenders have been disciplined in the face of an uncertain economy and
mortgage coupons have not fallen to the same extent. The consequence
is a wider spread between the interest rates on prime mortgages and the
costs of CMHC sponsored funding sources, despite increased credit spreads.
Generally if persistent, these circumstances will provide the Company with
greater securitization margins in 2019. It is unclear, however, how long this
environment will last and whether competitive pressures will reduce these
margins back to the levels experienced in 2018. The Company is confident
that its strong relationships with mortgage brokers and diverse funding
sources will continue to set First National apart from its competition. The
Company will continue to generate income and cash flow from its $30
billion portfolio of mortgages pledged under securitization and $73 billion
servicing portfolio and focus on the value inherent in its significant single-
family renewal book.
“The Company
will continue to
generate income
and cash flow
from its $30
billion portfolio
of mortgages
pledged under
securitization
and $73 billion
servicing
portfolio...”
36
36
MANAGEMENT’S DISCUSSION AND ANALYSIS
MANAGEMENT’S
RESPONSIBILITY FOR
FINANCIAL REPORTING
The management of First National Financial
effectiveness of the Company’s internal control over financial reporting at the
Corporation (the “Company”) is responsible
financial year end and the Company has disclosed in its annual MD&A our
for the integrity, consistency and reliability
conclusion about the effectiveness of internal control over financial reporting
of the consolidated financial statements and
at the financial year-end based on that evaluation. We have also disclosed
Management’s Discussion and Analysis (“MD&A”).
The consolidated financial statements have been
in the MD&A any change in our internal control over financial reporting that
occurred during the year that has materially affected, or is reasonably likely
prepared by Management in accordance with
to materially affect, our internal control over financial reporting.
International Financial Reporting Standards.
The Board of Directors oversees that management fulfills its responsibility
We certify that we have reviewed the financial
for financial reporting and internal control. The financial statements have
statements and information contained in the
been reviewed by the Audit Committee and approved by the Board of
MD&A, and, based on our knowledge, they
Directors. Ernst & Young LLP, the independent auditors appointed by
do not contain any untrue statement of a
the shareholders, has performed an independent audit of the Company’s
material fact or omit to state a material fact
consolidated financial statements and provide their report which follows.
required to be stated or that is necessary to
The auditors have full and free access to, and meet at least quarterly with,
make a statement not misleading in light of the
the Audit Committee to discuss their audit and related matters.
Stephen Smith
Chairman and Chief Executive Officer
Robert Inglis
Chief Financial Officer
February 25, 2019
circumstances under which it was made, with
respect to the period covered by the statements
and the annual report. Based on our knowledge,
the financial statements together with MD&A
and other financial information included in
the annual report fairly present in all material
respects the financial condition, results of
operations and cash flows of the Company as
of the dates and for the periods presented. The
preparation of financial statements involves
transactions affecting the current period which
cannot be finalized with certainty until future
periods. Estimates and assumptions are based on
historical experience and current conditions, and
are believed to be reasonable.
We are responsible for establishing and
maintaining internal control over financial
reporting for the Company. We have designed
such internal control over financial reporting,
or caused it to be designed under our
supervision, to provide reasonable assurance
regarding the reliability of financial reporting
and the preparation of financial statements for
external purposes. We evaluated, or caused
to be evaluated under our supervision, the
37
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
INDEPENDENT
AUDITOR’S REPORT
To the Shareholders of
First National Financial Corporation
OPINION
OTHER INFORMATION
We have audited the consolidated financial
Management is responsible for the other information. The other information
statements of First National Financial
comprises:
Corporation and its subsidiaries (collectively
the Company), which comprise the
consolidated statement of financial position as
at December 31, 2018 and December 31, 2017,
and the consolidated statements of income,
comprehensive income, changes in equity and
cash flows for the years then ended, and notes to
the consolidated financial statements, including a
summary of significant accounting policies.
In our opinion, the accompanying consolidated
financial statements present fairly, in all material
respects the consolidated financial position
of the Company as at December 31, 2018 and
December 31, 2017, and its consolidated financial
performance and its consolidated cash flows
for the years then ended in accordance with
International Financial Reporting Standards
(IFRSs).
BASIS FOR OPINION
We conducted our audit in accordance with
Canadian generally accepted auditing standards.
• Management’s Discussion and Analysis
• The information, other than the consolidated financial statements and
our auditor’s report thereon, in the Annual Report
Our opinion on the consolidated financial statements does not cover the
other information and we do not and will not express any form of assurance
conclusion thereon. In connection with our audit of the consolidated
financial statements, our responsibility is to read the other information
identified above and, in doing so, consider whether the other information
is materially inconsistent with the consolidated financial statements or our
knowledge obtained in the audit, or otherwise appears to be materially
misstated.
We obtained Management’s Discussion and Analysis prior to the date of this
auditor’s report. If, based on the work we have performed, we conclude that
there is a material misstatement of this other information, we are required
to report that fact in this auditor’s report. We have nothing to report in this
regard.
The Annual Report is expected to be made available to us after the date
of the auditor’s report. If, based on the work we will perform on this other
information, we conclude that there is a material misstatement of this other
information, we are required to report that fact to those charged with
Our responsibilities under those standards are
governance.
further described in the Auditor’s Responsibilities
for the Audit of the Consolidated Financial
Statements section of our report. We are
independent of the Company in accordance
with the ethical requirements that are relevant
to our audit of the consolidated financial
statements in Canada, and we have fulfilled our
ethical responsibilities in accordance with these
requirements. We believe that the audit evidence
we have obtained is sufficient and appropriate to
provide a basis for our opinion.
38
INDEPENDENT AUDITOR’S REPORT
RESPONSIBILITIES OF MANAGEMENT
AND THOSE CHARGED WITH
GOVERNANCE FOR THE CONSOLIDATED
FINANCIAL STATEMENTS
AUDITOR’S RESPONSIBILITIES FOR THE AUDIT OF THE
CONSOLIDATED FINANCIAL STATEMENTS
Our objectives are to obtain reasonable assurance about whether the
consolidated financial statements as a whole are free from material
Management is responsible for the preparation
misstatement, whether due to fraud or error, and to issue an auditor’s
and fair presentation of the consolidated financial
report that includes our opinion. Reasonable assurance is a high level of
statements in accordance with IFRSs, and for
assurance, but is not a guarantee that an audit conducted in accordance with
such internal control as management determines
Canadian generally accepted auditing standards will always detect a material
is necessary to enable the preparation of
misstatement when it exists. Misstatements can arise from fraud or error
consolidated financial statements that are free
and are considered material if, individually or in the aggregate, they could
from material misstatement, whether due to
reasonably be expected to influence the economic decisions of users taken
fraud or error.
on the basis of these consolidated financial statements.
In preparing the consolidated financial
As part of an audit in accordance with Canadian generally accepted auditing
statements, management is responsible for
standards, we exercise professional judgment and maintain professional
assessing the Company’s ability to continue as a
skepticism throughout the audit. We also:
going concern, disclosing, as applicable, matters
related to going concern and using the going
concern basis of accounting unless management
either intends to liquidate the Company or to
cease operations, or has no realistic alternative
but to do so.
• Identify and assess the risks of material misstatement of the consolidated
financial statements, whether due to fraud or error, design and perform
audit procedures responsive to those risks, and obtain audit evidence that
is sufficient and appropriate to provide a basis for our opinion. The risk of
not detecting a material misstatement resulting from fraud is higher
than for one resulting from error, as fraud may involve collusion, forgery,
Those charged with governance are responsible
intentional omissions, misrepresentations, or the override of internal control.
for overseeing the Company’s financial reporting
process.
• Obtain an understanding of internal control relevant to the audit in order
to design audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control.
• Evaluate the appropriateness of accounting policies used and the
reasonableness of accounting estimates and related disclosures made by
management.
• Conclude on the appropriateness of management’s use of the going
concern basis of accounting and, based on the audit evidence obtained,
whether a material uncertainty exists related to events or conditions that
may cast significant doubt on the Company’s ability to continue as a going
concern. If we conclude that a material uncertainty exists, we are required
to draw attention in our auditor’s report to the related disclosures in the
consolidated financial statements or, if such disclosures are inadequate, to
39
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT modify our opinion. Our conclusions are based
significant audit findings, including any significant deficiencies in internal
on the audit evidence obtained up to the date of
control that we identify during our audit.
our auditor’s report. However, future events or
conditions may cause the Company to cease to
continue as a going concern.
We also provide those charged with governance with a statement that we
have complied with relevant ethical requirements regarding independence,
and to communicate with them all relationships and other matters that may
• Evaluate the overall presentation, structure, and
reasonably be thought to bear on our independence, and where applicable,
content of the consolidated financial
related safeguards.
statements, including the disclosures, and
whether the consolidated financial statements
represent the underlying transactions and
events in a manner that achieves fair
presentation.
• Obtain sufficient appropriate audit evidence
regarding the financial information of the
entities or business activities within the
Company to express an opinion on the
consolidated financial statements. We are
responsible for the direction, supervision and
performance of the group audit. We remain
solely responsible for our audit opinion.
We communicate with those charged with
governance regarding, among other matters,
the planned scope and timing of the audit and
The engagement partner on the audit resulting in this independent auditor’s
report is Andre de Haan.
Toronto, Canada
February 25, 2019
40
INDEPENDENT AUDITOR’S REPORT
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As at December 31
(in thousands of Canadian dollars)
Notes
2018
2017
ASSETS
Restricted cash
Cash held as collateral for securitization
Accounts receivable and sundry
Securities purchased under resale agreements
Mortgages accumulated for sale or securitization
Mortgages pledged under securitization
Deferred placement fees receivable
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 short
Debt related to securitized and participation mortgages
Senior unsecured notes
Income taxes payable
Deferred tax liabilities
Total liabilities
EQUITY ATTRIBUTABLE TO SHAREHOLDERS
Common shares
Preferred shares
Retained earnings
Accumulated other comprehensive income
Total equity
Total liabilities and equity
See accompanying notes
On behalf of the Board:
John Brough
Robert Mitchell
Director
Director
3
3
14
5
3
4
6
19
7
9
15
16
14
10
12
18
18
17
17
577,096
75,913
150,668
2,188,149
2,204,886
561,470
66,413
144,159
2,185,362
1,789,765
30,567,036
27,566,677
41,584
188,666
3,982
39,147
41,273
379,713
—
41,446
$36,037,127
$32,776,278
918,347
643,828
1,262,395
124,451
2,183,411
1,200,135
118,081
2,180,253
30,762,651
27,834,080
174,829
—
78,800
174,693
7,191
74,750
$35,504,884
$32,233,011
122,671
97,394
315,294
(3,116)
122,671
97,394
323,202
—
$532,243
$543,267
$36,037,127
$32,776,278
41
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31
(in thousands of Canadian dollars, except earnings per share)
Notes
2018
2017
3
4
6
19
18
790,192
(646,069)
144,123
141,887
11,747
88,325
146,197
3,162
658,783
(511,939)
146,844
144,589
10,020
68,276
140,841
56,259
$535,441
$566,829
75,354
99,735
69,949
62,986
$308,024
227,417
60,990
83,260
97,824
46,428
53,915
$281,427
285,402
75,750
$166,427
$209,652
166,427
—
208,078
1,574
$166,427
$209,652
17
2.73
3.42
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 on financial instruments
EXPENSES
Brokerage fees
Salaries and benefits
Interest
Other operating
INCOME BEFORE INCOME TAXES
Income tax expense
NET INCOME FOR THE YEAR
NET INCOME ATTRIBUTABLE TO
Shareholders
Non-controlling interests
EARNINGS PER SHARE
Basic
See accompanying notes
42
INDEPENDENT AUDITOR’S REPORT
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31
(in thousands of Canadian dollars)
NET INCOME FOR THE PERIOD
OTHER COMPREHENSIVE INCOME ITEMS THAT MAY
BE SUBSEQUENTLY RECLASSIFIED TO INCOME
Net gains from change in fair value of cash flow hedges
Reclassification of net gains to income
Income tax recovery
Total other comprehensive income
Total comprehensive income
2018
166,427
3,210
(7,466)
(4,256)
1,140
(3,116)
2017
209,652
—
—
—
—
—
$163,311
$ 209,652
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Years ended December 31
(in thousands of Canadian dollars)
Common
shares
Preferred
shares
Retained
earnings
Accumulated other
comprehensive
Income
Total equity
BALANCE AS AT JANUARY 1, 2018
122,671
97,394
323,202
Net income
Other comprehensive income, net of tax
Dividends paid or declared
—
—
—
—
—
—
166,427
—
(174,335)
—
—
543,267
166,427
(3,116)
(3,116)
—
(174,335)
BALANCE AS AT DECEMBER 31, 2018
$122,671
$97,394
$315,294
$(3,116)
$532,243
Common
shares
Preferred
shares
Retained
earnings
Non-controlling
interest
Total equity
BALANCE AS AT JANUARY 1, 2017
122,671
97,394
302,271
27,961
550,297
Comprehensive income
Dividends paid or declared
Redemptions by non-controlling interests
—
—
—
—
—
—
208,078
(187,147)
1,574
209,652
(1,535)
(188,682)
—
(28,000)
(28,000)
BALANCE AS AT DECEMBER 31, 2017
$122,671
$97,394
$323,202
—
$543,267
43
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31
(in thousands of Canadian dollars)
OPERATING ACTIVITIES
Net income for the year
Add (deduct) items
Deferred income tax expense
Non-cash portion of gains on deferred placement fees
Decrease (increase) in restricted cash
Net investment in mortgages pledged under securitization
Net increase in debt related to securitized mortgages
Provision for loan loss
Amortization of deferred placement fees receivable
Amortization of purchased mortgage servicing rights
Amortization of property, plant and equipment
Unrealized losses (gains) on financial instruments
Net change in non-cash working capital balances related to operations
Cash provided by (used in) operating activities
INVESTING ACTIVITIES
Additions to property, plant and equipment
Investment of cash held as collateral for securitization
Investment in mortgage and loan investments
Repayment of mortgage and loan investments
Cash provided by (used in) investing activities
FINANCING ACTIVITIES
Dividends paid
Obligations related to securities and mortgages sold under repurchase agreements
Decrease in debt related to participation mortgages
Securities purchased under resale agreements, net
Securities sold short, net
Redemption by non-controlling interests
Cash used in financing activities
Net 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
44
INDEPENDENT AUDITOR’S REPORT
2018
2017
166,427
209,652
5,190
(11,298)
(15,626)
(3,000,359)
2,928,894
—
10,987
—
4,931
25,157
114,303
(425,261)
$(310,958)
(2,632)
(9,500)
(400,701)
587,748
$(174,915)
(174,031)
62,260
(323)
(2,787)
(23,595)
—
$(138,476)
(274,519)
(643,828)
$(918,347)
941,551
668,301
66,973
11,650
(9,452)
123,877
(1,485,325)
1,325,674
2,740
11,082
664
5,135
(23,254)
172,443
21,865
$194,303
(4,249)
(43,536)
(475,129)
347,906
$(175,008)
(188,066)
190,563
(5,775)
874,233
(28,000)
$(34,606)
(15,306)
(628,522)
$(643,828)
794,240
531,799
80,163
NOTES TO
CONSOLIDATED
FINANCIAL
STATEMENTS
[in thousands of Canadian dollars, unless
otherwise indicated]
December 31, 2018 and 2017
NOTE 1. GENERAL ORGANIZATION
AND BUSINESS OF FIRST NATIONAL
FINANCIAL CORPORATION
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
[A] BASIS OF PREPARATION
First National Financial Corporation [the
The consolidated financial statements have been prepared in accordance
“Corporation” or “Company”] is the parent
with International Financial Reporting Standards [“IFRS”]. The consolidated
company of First National Financial LP
financial statements have been prepared on a historical cost basis, except
[“FNFLP”], a Canadian-based originator,
for derivative financial instruments and financial assets and financial
underwriter and servicer of predominantly prime
liabilities that are recorded at fair value through profit or loss [“FVTPL”]
residential [single family and multi unit] and
and measured at fair value. The carrying values of recognized assets and
commercial mortgages. With over $106 billion in
liabilities that are designated as hedged items in fair value hedges, and
mortgages under administration as at December
that would otherwise be carried at amortized cost, are adjusted to record
31, 2018, FNFLP is a significant participant in the
changes in fair value attributable to the risks that are being in effective
mortgage broker distribution channel.
hedge relationships. The consolidated financial statements are presented in
The Corporation is incorporated under the
laws of the Province of Ontario, Canada and
has its registered office and principal place
of business located at 100 University Avenue,
Toronto, Ontario. The Corporation’s common and
Canadian dollars and all values are rounded to the nearest thousand except
when otherwise indicated. The consolidated financial statements were
authorized for issue by the Board of Directors on February 25, 2019.
[B] BASIS OF CONSOLIDATION
preferred shares are listed on the Toronto Stock
The consolidated financial statements comprise the financial statements of
Exchange under the symbols FN, FN.PR.A and
the Company and its subsidiaries, including FNFLP, First National Financial
FN.PR.B, respectively.
GP Corporation [“GP”, the general partner of FNFLP], FNFC Trust, a special
purpose entity [“SPE”] which is used to manage undivided co ownership
interests in mortgage assets funded with Asset-Backed Commercial Paper
[“ABCP”], First National Asset Management Inc. [“FNAM”], and First
National Mortgage Corporation. The 2017 comparative financial information
includes the financial statements of First National Mortgage Investment
Fund [the “Fund”] and FN Mortgage Investment Trust [the “Trust”] until
their termination on December 19, 2017.
FNAM is wholly-owned subsidiary of the GP, and an indirect subsidiary of
the Company. FNAM is a NHA approved lender and NHA-MBS issuer in the
capacity of an “aggregator”. Its business model is to purchase mortgages
from arms-length mortgage originators in order to create NHA-MBS pools,
and subsequently sell these into the Canada Mortgage Bonds programs
[“CMB”]. In 2018, FNAM issued three NHA-MBS pools totalling $85 million.
45
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT [C] USE OF ESTIMATES
The Fund and the Trust were created in 2012 as
The preparation of consolidated financial statements in conformity with
special purpose vehicles to obtain exposure to a
IFRS requires management to make estimates and assumptions that affect
diversified portfolio of high yielding mortgages.
the reported amounts of assets and liabilities, including contingencies,
Pursuant to the trustee’s determination, both
at the date of the consolidated financial statements and the reported
the Fund and the Trust were terminated on
amounts of revenue and expenses during the reporting period. Actual
December 19, 2017. While the Fund and Trust
results may differ from those estimates. Major areas requiring use of
operated, because of its status as the sole seller
estimates by management are those that require reporting of financial
of assets to the Fund and its rights as promoter,
assets and financial liabilities at fair value.
the Company determined that it had de facto
control of both the Fund and the Trust, and
[D] SIGNIFICANT ACCOUNTING POLICIES
therefore, consolidated the operations and net
assets of the Fund and the Trust until termination.
Financial Instruments
Non controlling interests in the Fund and the
Trust were shown as a separate component
of equity on the consolidated statements of
financial position to distinguish them from the
equity of the Company’s shareholders. The net
income attributable to non-controlling interests
is also separately disclosed on the consolidated
statements of comprehensive income. On
termination, the Company effectively purchased
the interest in the Fund and Trust from the non-
controlling interests.
On January 1, 2018, the Company adopted IFRS 9 – Financial Instruments
[“IFRS 9”]. As permitted by the transition provisions of IFRS 9, the
Company elected not to restate comparative period results. All
comparative period information is presented in accordance with the
accounting policies as described in the annual consolidated financial
statements for the year ended December 31, 2017.
Classification and measurement of financial assets
IFRS 9 requires that all financial assets are measured at either fair value
through profit or loss [“FVTPL”], fair value through OCI [“FVOCI”], or
amortized cost, based on the contractual cash flow characteristics of the
financial assets and the business model under which the financial assets
The Company did not consolidate, in its financial
are managed.
The Company originates and underwrites single-family residential
mortgages and multi-unit residential commercial mortgages. Subsequent
to origination, the mortgages are either placed with third party investors
[mortgages accumulated for sale] or securitized through various
securitization vehicles [mortgages accumulated for securitization]. When
mortgages are securitized, typically they do not meet de-recognition
criteria, and continue to be held on the Company’s balance sheet as
mortgages pledged under securitization.
The Company also invests in commercial bridge mortgages and other
miscellaneous loans using its own internal funding sources. These
assets are classified as FVTPL and are presented as mortgage and loan
investments on its consolidated statement of financial position.
Based on its business models as described above, the Company has
determined the classification of its financial assets as below:
statements, three SPEs over which the Company
does not have control. The SPEs are sponsored
by third-party financial institutions which acquire
assets from various sellers including mortgages
from the Company. The Company earns interest
income from the retained interest related to
these mortgages. As at December 31, 2018,
the Company recorded, on its consolidated
statements of financial position, its portion
of the assets of the SPEs amounting to $801
million [2017 – $800 million]. The Company
also recorded, in its consolidated statements
of comprehensive income, interest revenue –
securitized mortgages of $27.9 million [2017 –
$8.2 million] and interest expense – securitized
mortgages of $22.3 million [2017 – $7.7 million]
related to its interest in the SPEs.
The consolidated financial statements have been
prepared using consistent accounting policies
for like transactions and other events in similar
circumstances. All intercompany assets and
liabilities, equity, income, expenses and cashflows
relating to transactions between these companies
are eliminated in full on consolidation.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
IFRS 9
IAS 39
Securities purchased
under resale agreement
Mortgages accumulated
for securitization
Mortgages accumulated
for sale
Amortized Cost
Amortized Cost
Amortized Cost
Loans and
Receivables
FVTPL
FVTPL
Mortgages pledged under
securitization
Amortized Cost
Mortgage and loan
investments
Deferred placement
fees receivable
FVTPL
Amortized Cost
FVTPL
FVTPL or Loan
and Receivables
Loans and
Receivable
As at December 31, 2017, the difference resulting from the change in
accounting classification of the assets was insignificant; accordingly, no
adjustment to opening retained earnings was recorded.
Classifications and measurement of financial liabilities
The Company classifies its financial liabilities as either amortized cost or at
FVTPL as summarized below:
Obligations related to
securities and mortgages
sold under repurchase
agreements
Securities sold short
Debt related to
securitized mortgages
IFRS 9
IAS 39
FVTPL
FVTPL
FVTPL
FVTPL
in Stage 2. Mortgages in these two stages
are not considered to be impaired, and the
Company recognizes a 12-month ECL for Stage
1 mortgages and a lifetime ECL for Stage 2
mortgages. When a mortgage is in arrears for
over 90 days or the Company has issued a legal
demand for repayment, there is an expectation
of a detrimental impact on the estimated cash
flows and, therefore, the Company considers the
mortgages as impaired and includes in Stage 3.
The Company’s ECL impairment model is
built on an unbiased and probability-weighted
method, determined by evaluating a range of
possible outcomes supported by past loss events
and expectation of future possible outcomes,
discounted to reflect the time value of money.
The key inputs in the measurement of ECL
include Probability of Default, Loss Given Default
and forecast of future economic conditions
which involves significant judgment.
Hedge accounting
On January 1, 2018, the Company adopted hedge
accounting within IFRS 9 for certain mortgage
commitments and funded mortgages. Hedge
accounting has been applied prospectively from
that date. The Company did not apply hedge
accounting prior to January 1, 2018.
Amortized Cost
Amortized Cost
The Company uses a combination of short
Servicing liabilities
Amortized Cost
Amortized Cost
Government of Canada bonds and bond
Senior unsecured notes
Amortized Cost
Amortized Cost
Impairment
IFRS 9 introduces an expected credit loss [“ECL”] impairment model
applicable to all debt instruments within financial assets classified as
amortized cost or FVOCI, as well as certain off-balance sheet loan
commitments. Prior to January 1, 2018, credit losses were recognized under
an incurred loss model. The IFRS 9 ECL approach has three stages: Stage
1 – the credit risk has not increased significantly since initial recognition
such that an allowance for credit loss is recognized and maintained equal
to 12 months of expected credit loss; Stage 2 – the credit risk has increased
significantly since initial recognition, and the allowance for credit loss is
increased to cover full lifetime expected credit loss; and Stage 3 – a financial
asset is considered credit-impaired and the allowance for credit loss
continues to be the full lifetime expected credit loss, with interest revenue
calculated on the carrying amount [net of the allowance for credit loss],
rather than the gross carrying value of the financial assets.
The Company assesses the credit risk of the mortgages based on the
expected repayments of principal and interest. All mortgages with arrears
that are less than 30 days past due are included in Stage 1 whereas
mortgages with principal in arrears between 31 to 90 days are included
repo arrangements to manage exposure to
interest rate risk associate with mortgage
commitments and funded mortgages held prior
to securitization. In addition, the Company
uses interest rate swaps to manage exposure
to interest rate risk for mortgages in SPEs. The
Company documents a hedging relationship
between the hedging instrument and the
hedged item at inception when the relationship
is established. The Company also assesses
the effectiveness of the hedges at both the
hedge inception and on an ongoing basis. Any
ineffectiveness of any hedging relationship is
recognized immediately in the consolidated
statements of income.
Cash flow hedges
The Company applies cash flow hedge
accounting for the anticipated funding of its
multi-unit residential commercial segment
mortgages. At the time of mortgage
commitment, the Company shorts Government
of Canada bonds as the hedging instrument to
47
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT REVENUE RECOGNITION
hedge the cash flows on the anticipated future
The Company earns revenue from placement, securitization and servicing
debt to be arranged through securitization
of these mortgages obtained through CMB,
disclosed as debt related to securitized
mortgages. The Company also uses the same
activities related to its mortgage business. The majority of originated
mortgages are sold to institutional investors through the placement of
mortgages or funded through securitization conduits. The Company retains
servicing rights on substantially all of the mortgages it originates, providing the
hedging strategy when placing mortgages with
Company with servicing fees.
institutional investors who plan to use CMB
funding. The effective portion of the change in the
fair value of the designated hedging instrument
qualifying as a cash flow hedge is recognized
in other comprehensive income [“OCI”] in the
consolidated statements of comprehensive
Interest revenue and expense from mortgages pledged under securitization
The Company enters into securitization transactions to fund a portion the
mortgages it originated. 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 securitized mortgages and the
income. When the hedge relationship is terminated,
Company continues to hold the mortgages on its consolidated statements of
the cumulative amounts recognized in OCI are
financial position, unless:
amortized into interest expense – securitized
mortgages over the term of the securitized
debt, or amortized against placement fees from
institutional investors. Any change in fair value of
the hedge determined as ineffective is recognized
immediately in regular income.
Fair value hedges
The Company enters into interest rate swaps
to protect against changes in the fair value of
fixed rate mortgages funded by Asset-backed
Commercial Paper [“ABCP”] debt. The Company
also shorts Government of Canada bonds to
manage interest rate exposure for a portion
of single-family mortgage commitments and
funded residential mortgages accumulated for
securitization. The Company applies hedge
accounting for the swaps. For the short bond
hedges, the Company documents a hedging
relationship during the period when the mortgages
[i] substantially all of 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 mortgages that do not meet the criteria for derecognition, no
gain or loss is recognized at the time of the transaction. Instead, net interest
income is recognized over the term of the mortgages. Interest revenue –
securitized mortgages represents interest portion of mortgage payments
received and accrued by borrowers and is net of the amortization of capitalized
origination costs. Interest expense – securitized mortgages represents the
costs to finance these mortgages, net of the amortization of debt discounts
and premiums.
are funded until the date they are securitized or
Capitalized origination fees and debt discounts or premiums are amortized
placed with an arm’s length investor. The Company
on an effective yield basis over the term of the related mortgages or debt.
Derecognition
A financial asset is derecognized when:
• The right to receive cash flows from the asset has expired; or
• The Company has transferred its rights to receive cash flows from the
assets or has assumed an obligation to pay the cash flows, received 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 Company has neither
transferred nor retained substantially all of the risks and rewards of the
asset, but has transferred control of the asset.
does not apply hedge accounting to the short
bonds used to mitigate interest risk on single-
family mortgage commitments. The Company’s
policy is not to utilize derivative financial
instruments for trading or speculative purposes.
In the case of the swaps and short bonds used to
hedge funded mortgages, changes in fair value of
the hedged item, to the extent that the hedging
relationship is effective, are offset by changes in
the fair value of the hedging instrument, both of
which are recognized in regular income. At hedge
unwind, the realized change in the value of the
hedging instrument is adjusted to the carrying
value of the hedged mortgages, and amortized
into interest revenue over the term of the hedged
mortgages. Any changes in the fair value of an
ineffective hedge will be immediately recorded in
regular income.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PLACEMENT FEES AND DEFERRED
PLACEMENT FEES RECEIVABLE
The Company enters into placement agreements
income earned by the Company from holding cash in trust related to servicing
with institutional investors to purchase the
activities is classified as mortgage servicing income. The amortization of any
mortgages it originates. When mortgages are
servicing liabilities is also recorded as mortgage servicing income.
placed with institutional investors, the Company
transfers the contractual right to receive
mortgage cash flows to the investors. Because
it has transferred substantially all the risks and
rewards of these mortgages, it derecognizes
these assets. The Company retains a residual
interest representing the rights and obligations
associated with servicing 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
collectible in excess of the mortgage principal
The Company provides underwriting and fulfillment processing services for
mortgages originated by a large Canadian bank through its mortgage broker
distribution channel. The Company recognizes servicing income when the
services are rendered and the underwritten mortgages have
been funded.
MORTGAGE INVESTMENT INCOME
The Company earns interest income from its interest-bearing assets including
deferred placement fees receivable, mortgage and loan investments and
mortgages accumulated for sale or securitization. Mortgage investment
income is recognized on an accrual basis.
are recognized as placement fees. When
BROKERAGE FEES
placement fees and associated servicing fees are
earned over the term of the related mortgages,
the Company determines the present 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 values based on the
Brokerage fees are primarily fees paid to external mortgage brokers.
Brokerage fees relating to mortgages placed with institutional investors are
expensed as incurred, and those relating to mortgages recorded at amortized
cost are capitalized to the carrying cost of the related mortgages and
amortized over the term of the mortgages.
MORTGAGES PLEDGED UNDER SECURITIZATION
net present value of future expected cash flows,
Mortgages pledged under securitization are mortgages that the Company has
calculated using management’s best estimates of
originated and funded with debt raised through the securitization markets,
key assumptions related to expected prepayment
and have been classified at amortized cost. The Company has a continuous
rates and discount rates commensurate with the
involvement in these mortgages, including the right to receive future cash
risks involved.
flows arising from these mortgages. Origination costs, such as brokerage fees
and bulk insurance premiums that are directly attributable to the acquisition
MORTGAGE SERVICING INCOME
of such assets, are deferred and amortized over the term of the mortgages on
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 all mortgages
administered for investors or third parties, the
Company recognizes servicing income when
services are rendered. For mortgages placed
under deferred placement arrangements, the
Company 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 market 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
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
and issuance costs on raising these debts that is directly attributable to
obtaining such liabilities is deferred and amortized over the term of the debt
obligations.
Debt related to participation mortgages represents obligations related to the
financing of a portion of commercial mortgages included in mortgage and
loan investments. These mortgages are subject to participation agreements
with other financial institutions such that the Company’s investment is
subordinate to the other institutions’ investment. The Company has retained
various rights and a proportionately larger share of the interest earned on
these mortgages, such that the full mortgage has been recorded on the
Company’s consolidated statements of financial position with an offsetting
debt. This debt is recorded at face value and measured at its amortized cost.
49
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT MORTGAGES ACCUMULATED FOR SALE
OR SECURITIZATION
PROPERTY, PLANT AND EQUIPMENT
Mortgages accumulated for sale are mortgages
Property, plant and equipment are recorded at cost, less accumulated
funded for the purpose of placing with investors
amortization, at the following annual rates and bases:
and are classified as FVTPL and are recorded at
fair value. These mortgages are held for terms
usually not exceeding 90 days.
Computer equipment
30% declining balance
Office equipment
20% declining balance
Mortgages accumulated for securitization
are mortgages funded pending arrangement
of term debt through the Company’s various
securitization programs and are measured at
amortized cost.
Leasehold improvements straight-line over the term of the lease
Computer software
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 circumstances that indicate the carrying amount
SECURITIES SOLD SHORT AND
SECURITIES PURCHASED UNDER
RESALE AGREEMENTS
may not be recoverable.
GOODWILL
Securities sold short consist typically of the short
Goodwill represents the price paid for the Corporation’s business in excess
sale of government of Canada bonds. Bonds
of the fair value of the net tangible assets and identifiable intangible assets
purchased under resale agreements consist of
acquired in connection with the IPO. Goodwill is reviewed annually for
the purchase of a bond with the commitment
impairment or more frequently when an event or change in circumstances
from the Company to resell the bond to the
indicates that the asset might be impaired.
original seller at a specified price. The Company
uses the combination of bonds sold short and
bonds purchased under resale agreements to
economically hedge its mortgage commitments
and the portion of funded mortgages that it
intends to securitize in subsequent periods.
RESTRICTED CASH
Restricted cash represents principal and interest collected on mortgages
pledged under securitization that is held in trust until the repayment of debt
related to these mortgages is made in a subsequent period.
Bonds sold short are classified as FVTPL and are
recorded at fair value. The effective yield payable
BANK INDEBTEDNESS
on bonds sold short is recorded as hedge
Bank indebtedness consists of bank indebtedness net of cash balances or
expense in other operating expenses. Bonds
deposit with banks.
CASH HELD AS COLLATERAL FOR SECURITIZATION
Cash held as collateral for securitization represents cash-based credit
enhancements held by various securitization vehicles, including FNFC
Trust and a Canadian Trust Company acting as the title custodian for the
Company’s NHA MBS program.
purchased under resale agreements are carried
at cost plus accrued interest, which approximates
their market value. The difference between the
cost of the purchase and the predetermined
proceeds to be received on a resale agreement is
recorded over the term of the hedged mortgages
as an offset to hedge expense. Transactions are
recorded on a settlement date basis.
MORTGAGE AND LOAN INVESTMENTS
Mortgage and loan investments are non-derivative
financial assets with fixed or determinable
payments, and are classified as FVTPL. The
mortgages are measured at management’s best
estimate of the net realizable value. Changes
in fair value are recognized immediately in the
consolidated statement of income.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SERVICING LIABILITY
The Company places mortgages with third-party
settled. Deferred tax assets and liabilities are offset when they arise in the
institutional clients, and retains the rights and
same tax reporting group and relate to income taxes levied by the same
obligations to service these mortgages. When
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 attributable to
common shareholders of the Company by the weighted average number of
common shares outstanding during the year.
NOTE 3. MORTGAGES PLEDGED UNDER SECURITIZATION
The Company securitizes residential and commercial mortgages in order to
raise debt to fund these mortgages. Most of these securitizations consist
of the transfer of fixed and floating rate mortgages into securitization
programs, such as ABCP, NHA MBS, and the Canada Mortgage Bonds
[“CMB”] program. In these securitizations, the Company transfers the assets
to structured entities for cash, and incurs interest-bearing obligations
typically matched to the term of the mortgages. These securitizations do
not qualify for derecognition, although the structured entities and other
securitization vehicles have no recourse to the Company’s other assets for
failure of the mortgages to make payments when due.
As part of the ABCP transactions, the Company provides cash collateral
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 securitized mortgages are paid
by the Company to the structured entities 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
securitizations may also require cash collateral in some circumstances. As at
December 31, 2018, the cash held as collateral for securitization was $75,913
[2017 – $66,413].
the service related fees are paid upfront by a
third party, the Company records a servicing
liability. The liability represents the portion
of the upfront fee required to earn a market
rate of servicing over the related mortgage
term. This is similar to the method which the
Company uses to calculate deferred placement
fees. Since quoted prices are generally not
available for retained interests, the Company
estimates its 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. The Company earns the related
servicing fees over the term of the mortgages on
an effective yield basis.
INCOME TAXES
The Company accounts for income taxes in
accordance with the liability 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 dates of the consolidated statements
of financial position. The income tax provision
consists of current income taxes and deferred
income taxes. Current and deferred taxes relating
to items in the Company’s equity are recorded
directly against equity.
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 or tax recoverable
amounts recorded in previous years.
Deferred income taxes arise on temporary
differences between the carrying amounts
of assets and liabilities on the consolidated
statements 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 taxes are calculated using
the tax rates expected to apply in the periods in
which the assets will be realized or the liabilities
51
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT The following table compares the carrying amount of mortgages pledged under securitization and the associated debt:
Securitized mortgages
Capitalized hedge loss
Capitalized origination costs
Debt discounts
Add
Principal portion of payments held in restricted cash
Securitized mortgages
Mark-to-market adjustment
Capitalized origination costs
Debt discounts
Add
Principal portion of payments held in restricted cash
Participation debt
2018
Carrying amount of
securitized mortgages ($)
Carrying amount of
associated liabilities ($)
30,385,005
30,876,519
12,578
169,453
—
$30,567,036
521,690
$31,088,726
2017
—
—
(113,868)
$30,762,651
—
$30,762,651
Carrying amount of
securitized mortgages ($)
Carrying amount of
associated liabilities ($)
27,427,239
27,914,097
(1,683)
141,121
—
$27,566,677
514,793
—
—
—
(80,340)
$27,833,757
—
323
$28,081,470
$27,834,080
The principal portion of payments held in restricted cash represents payments on account of mortgages pledged under
securitization which has been received at year end but has not yet been applied to reduce the associated debt. This cash is
applied to pay down the debt in the month subsequent to collection. In order to compare the components of mortgages pledged
under securitization to securitization debt, this amount is added to the carrying value of mortgages pledged under securitization
in the above table.
Mortgages pledged under securitization have been classified as amortized cost and are carried at par plus adjustment for
unamortized origination costs.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The changes in capitalized origination costs for the years ended December 31 are summarized as follows:
OPENING BALANCE, JANUARY 1
Add: new origination costs capitalized in the year
Less: amortization in the year
ENDING BALANCE, DECEMBER 31
2018
141,121
103,222
(74,890)
$169,453
2017
138,940
70,716
(68,535)
$141,121
During the year ended December 31, 2018, the
The following table summarizes the mortgages pledged under securitization
Company invested in mortgages that were
that are 31 days or more past due as at December 31:
transferred into the securitization vehicles with
principal balances as of December 31, 2018 of
$7,418,415 [2017 – $5,928,283].
The contractual maturity profile of the
mortgages pledged under securitization
programs is summarized as follows:
ARREARS DAYS
31 to 60
61 to 90
Greater than 90
4,233,634
3,794,321
2019
2020
2021
2022
2023 and thereafter
2018
2017
48,902
4,814
16,380
70,096
35,652
5,841
28,707
70,200
5,356,973
All the mortgages listed above are insured, except for two mortgages
6,624,587
10,375,490
$30,385,005
which are uninsured and have a total principal balance of $605 as at
December 31, 2018 [2017 – $289]. The Company’s exposure to credit loss is
limited to uninsured mortgages with principal balances totalling $1,251,236
[2017 – $1,106,796], before consideration of the value of underlying
collateral. Virtually all such mortgages are conventional prime single-family
mortgages, with an 80% or less loan to value ratio at origination, and
verified borrower income. Accordingly, the expected credit loss related to
these mortgages is insignificant, and the Company has not provided any
allowance for ECL for the year ended December 31, 2018.
53
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT NOTE 4. DEFERRED PLACEMENT
FEES RECEIVABLE
The Company enters into transactions with
the value of its investment in the mortgage. The effect of variations, if any,
institutional investors to sell primarily fixed-rate
between actual experience and assumptions will be recorded in future
mortgages in which placement fees are received
statements of income but is expected to be minimal.
During the year ended December 31, 2018, $2,655,764 [2017 – $2,005,667]
of mortgages were placed with institutional investors, which created gains
on deferred placement fees of $11,747 [2017 – $10,020]. Cash receipts on
deferred placement fees receivable for the year ended December 31, 2018
were $12,979 [2017 – $12,772].
The Company estimates that the expected undiscounted cash flows to be
received on the deferred placement fees receivable will be as follows:
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 minimal exposure to the variability of future
cash flows from these mortgages. The investors
have no recourse to the Company’s other assets
for failure of mortgagors to make payments
when due.
Deferred placement fees receivable is classified
as amortized cost, and has been calculated
initially based on the present value of the
anticipated future stream of placement fees.
An assumption of no credit losses was used,
commensurate with the credit quality of the
investors. An assumption of no prepayment for
2019
2020
2021
2022
the commercial segment was used, as borrowers
2023 and thereafter
cannot refinance for financial advantage without
paying the Company a fee commensurate with
11,893
9,638
7,700
5,752
12,519
$47,502
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, together with
mortgages funded in advance of settlement
with institutional investors.
Mortgages originated for the Company’s
Mortgages accumulated
for securitization
Mortgages accumulated
for sale
2018
2017
2,170,416
1,770,275
34,470
$2,204,886
19,490
$1,789,765
own securitization programs are classified
The Company’s exposure to credit loss is limited to $321,341 [2017 –
as amortized cost and are recorded at par
$569,571] of principal balances of uninsured mortgages within mortgages
plus adjustment for unamortized origination
accumulated for securitization, before consideration of the value of
costs. Mortgages funded for placement with
underlying collateral. As at December 31, 2018, none of these mortgages
institutional investors are designated as FVTPL
are in arrears past 31 days. These are conventional prime single-family
and are recorded at fair value. The fair values
mortgages similar to the mortgages described in note 3. Accordingly the
of mortgages classified as FVTPL approximate
expected credit loss related to these mortgages is insignificant.
their carrying values as the time period between
origination and sale is short. The following table
summarizes the components of mortgages
according to their classification:
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
“Mortgage and
loan investments
consist primarily
of commercial
first and second
mortgages
held for various
terms...”
NOTE 6. MORTGAGE AND
LOAN INVESTMENTS
Mortgage and loan investments consist primarily of commercial first and
second mortgages held for various terms, the majority of which mature
within twelve months.
Mortgage and loan investments are measured at FVTPL, and are recorded
on a fair value basis. Any changes in fair value are immediately recognized
in income. The Company recorded a fair value loss of $4,000 for the
year ended December 31, 2018. The mortgages were classified as loans
and receivables prior to the adoption of IFRS 9, and a $4,000 credit
loss related to these mortgages was recorded as an offset to mortgage
investment income on the consolidated statement of income for the year
ended December 31, 2017.
The following table discloses the composition of the Company’s
portfolio of mortgage and loan investments by geographic region as at
December 31, 2018:
Province/Territory
Alberta
British Columbia
Manitoba
New Brunswick
Newfoundland and Labrador
Nova Scotia
Nunavut
Ontario
Quebec
Saskatchewan
Yukon
Portfolio
balance
Percentage of
portfolio
5,678
17,855
21,162
2,678
56
4,046
134
108,654
27,993
122
288
3.01
9.46
11.22
1.42
0.03
2.15
0.07
57.58
14.84
0.07
0.15
The following table discloses the mortgages that are past due as at
$188,666
100.00%
December 31:
ARREARS DAYS
31 to 60
Greater than 90
2018
2017
4,871
39,232
$44,103
13,433
43,974
$57,407
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
55
55
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
The portfolio contains $13,133 [December 31,
more than 30 days. Three of these mortgages are non-performing and
2017 — $15,145] of insured mortgages and
the Company has stopped accruing interest. These mortgages had a total
$175,533 [December 31, 2017 — $364,568] of
original principal balance of $44,001 and are recorded at a fair value of
uninsured mortgage and loan investments as at
$25,262 as at December 31, 2018 [December 31, 2017 — four mortgages,
December 31, 2018. Of the uninsured mortgages,
original principal balance of $48,600, and fair value of $32,001].
approximately $39,941 [December 31, 2017 —
$49,693] have principal balances in arrears of
The maturity profile in the table below is based on the earlier of contractual renewal or maturity dates.
Residential
Commercial
2019
11,647
2020
924
113,366
33,173
2021
8,254
1,800
2022
5,261
2,057
2018
2017
2023 and
thereafter Book value
Book value
10,441
36,527
34,820
1,743
152,139
344,893
$125,013
$34,097
$10,054
$7,318
$12,184
$188,666
$379,713
Interest income earned for the year was $17,654 [2017 – $18,610] and is included in mortgage investment income on the
consolidated statements of income.
NOTE 7. OTHER ASSETS
The components of other assets are as follows
as at December 31:
Property, plant and
equipment, net
2018
2017
9,371
11,670
Goodwill
29,776
29,776
The recoverable amount of the Company’s goodwill is calculated by
reference to the Company’s market capitalization, mortgages under
administration, origination volume, and profitability. These factors indicate
that the Corporation’s recoverable amount exceeds the carrying value of its
$39,147
$41,446
net assets and accordingly, goodwill is not impaired.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. MORTGAGES UNDER
ADMINISTRATION
As at December 31, 2018, the Company
managed mortgages under administration of
$106,151,363 [2017 – $101,589,153], including
mortgages held on the Company’s consolidated
statements of financial position. Mortgages
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, 2018, the Company administered 306,221 mortgages
[2017 – 301,492] for 111 institutional investors [2017 – 103] with an average
remaining term to maturity of 40 months [2017 – 41 months].
Mortgages under administration are serviced as follows:
Institutional investors
Mortgages accumulated for sale or securitization and mortgage and loan
investments
Deferred placement investors
Mortgages pledged under securitization
CMBS conduits
2018
59,768,374
2,387,285
12,441,436
30,385,005
1,169,263
2017
59,601,263
2,190,393
11,125,228
27,427,239
1,245,030
$106,151,363
$101,589,153
The Company’s exposure to credit loss is limited
The Company maintains trust accounts on behalf of the investors it
to mortgage and loan investments as described
represents. The Company also holds municipal tax funds in escrow for
in note 6, securitized mortgages as described
mortgagors. Since the Company does not hold a beneficial interest in
in note 3 and uninsured mortgages held in
these funds, they are not presented on the consolidated statements of
mortgages accumulated for securitization
financial position. The aggregate of these accounts as at December 31,
as described in note 5. As at December 31,
2018 was $630,166 [2017 – $670,259].
2018, the Company has included in accounts
receivable and sundry $86 [2017 – $86] of
uninsured non performing mortgages.
57
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT NOTE 9. BANK INDEBTEDNESS
NOTE 10. DEBT RELATED TO SECURITIZED AND
PARTICIPATION MORTGAGES
Bank indebtedness includes a revolving credit
Debt related to securitized mortgages represents the funding for
facility of $1,250,000 [2017 – $1,060,000]
mortgages pledged under the NHA-MBS, CMB and ABCP programs.
maturing in March 2023. At December 31, 2018,
As at December 31, 2018, debt related to securitized mortgages was
$918,347 [2017 – $643,828] was drawn, of which
$30,762,651 [2017 – $27,833,757], net of unamortized discounts of $113,868
the following have been pledged as collateral:
[2017 – $80,340]. A comparison of the carrying amounts of the pledged
[a] a general security agreement over all assets,
mortgages and the related debt is summarized in note 3.
other than real property, of the Company; and
As at December 31, 2018, the Company did not record any debt related to
[b] a general assignment of all mortgages owned
participation mortgages [December 31, 2017 – $323].
by the Company.
Debt related to securitized and participation mortgages is reduced on a
The credit facility bears a variable rate of interest
based on prime and bankers’ acceptance rates.
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. Debt related to securitization
mortgages had a similar contractual maturity profile as the associated
mortgages in mortgages pledged under securitization.
NOTE 11. SWAP CONTRACTS
Swaps are over-the-counter contracts in which two counterparties exchange a series of cash flows based on agreed upon rates
to a notional amount. The Company uses interest rate swaps to manage interest rate exposure relating to variability of interest
earned on mortgages pledged under securitization. The swap agreements that the Company enters into are interest rate swaps
where two counterparties exchange a series of payments based on different interest rates applied to a notional amount in a
single currency.
The following tables present, by remaining term to maturity, the notional amounts and fair values of the swap contracts
outstanding as at December 31, 2018 and 2017:
Interest rate
swap contracts
Interest rate
swap contracts
Less than 3 years
3 to 5 years
6 to 10 years
Total
notional amount
Fair value
2018
$2,011,026
$1,634,911
$20,671
$3,666,608
$40,549
Less than 3 years
3 to 5 years
6 to 10 years
Total
notional amount
Fair value
2017
$1,138,520
$3,139,547
$10,370
$4,288,437
$57,565
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 statements of financial position.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. SENIOR UNSECURED NOTES
On April 9, 2015, the Company issued $175 million of new senior unsecured notes for a five-year term maturing on April
9, 2020. The notes bear interest at 4.01% payable in equal semi-annual payments commencing October 9, 2015. The net
proceeds of the issuance [$174.3 million, net of financing fees] have been invested in FNFLP.
NOTE 13. COMMITMENTS, GUARANTEES
AND CONTINGENCIES
NOTE 14. SECURITIES TRANSACTIONS UNDER REPURCHASE
AND RESALE AGREEMENTS
As at December 31, 2018, the Company has the
The Company’s outstanding securities purchased under resale agreements
following operating lease commitments for its
and securities sold under repurchase agreements have a remaining term to
office premises:
maturity of less than three months.
2019
2020
2021
2022 and thereafter
7,467
7,418
7,238
13,966
$36,089
NOTE 15. OBLIGATIONS RELATED TO SECURITIES AND
MORTGAGES SOLD UNDER REPURCHASE AGREEMENTS
The Company uses repurchase agreements to fund specific mortgages
included in mortgages accumulated for sale or securitization. The current
contracts are with financial institutions, are based on bankers’ acceptance
rates and mature on or before January 31, 2019.
Outstanding commitments for future advances
on mortgages with terms of one to 10 years
amounted to $1,192,677 as at December 31, 2018
NOTE 16. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
The major components of accounts payable and accrued liabilities are as
follows as at December 31:
[2017 – $1,634,058]. 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
that 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
include contracts where the Company may be
required to make payments to a third party,
based on changes in the value of an asset or
liability that the third party holds. In addition,
contracts under which the Company may be
required to make payments if a third party fails
to perform under the terms of the contract
[such as mortgage servicing contracts] are
considered guarantees. The Company has
determined that the estimated potential loss
from these guarantees is insignificant.
enters into a variety of guarantees. Guarantees
Swap liabilities
Accrued liabilities
Accrued dividends payable
Accrued interest on
securitization debt
Servicing liability
2018
15,303
10,249
57,777
17,981
23,141
$124,451
2017
39,195
9,946
43,940
18,876
6,124
$118,081
Accrued interest on securitization debt is the interest due on securitization
related debt due subsequent to year end.
59
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT NOTE 17. SHAREHOLDERS’ EQUITY
[a] Authorized
Unlimited number of common shares
Unlimited number of cumulative 5-year rate
reset preferred shares, Class A Series 1
Unlimited number of cumulative 5-year rate
reset preferred shares, Class A Series 2
[b] Capital stock
Holders of the Class A Series 1 Preferred Shares receive a cumulative
quarterly fixed dividend at a rate equal to the five year Government of
Canada yield plus 2.07%. The dividend rate may be reset every five years,
as and when approved by the Board of Directors. The current dividend
rate on the Class A Series 1 shares is 2.79% annually for a new five year
term ending March 31, 2021.
Holders of the Series 2 Preferred Shares will be entitled 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
Balance, December 31, 2018 and 2017
declared by the Board of Directors.
Common
shares
Preferred
shares
#
$
Both classes of Preferred Shares do not have voting rights, are redeemable
only at the option of the Company, and are therefore classified as equity.
59,967,429
$122,671
The par value per preferred share is $25.
4,000,000
$97,394
[d] Earnings per share
[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.
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 certain conditions, on
March 31, 2021 and on March 31 every five years
thereafter. As of December 31, 2018, there were
2,887,147 Series 1 preferred shares and 1,112,853
Series 2 preferred shares outstanding with a
total carrying value of $97,394.
Net income attributable to
shareholders
Less: dividends declared on
preferred shares
Net earnings attributable to
common shareholders
Number of common
shares outstanding
Basic earnings per
common share
2018
2017
166,427
208,078
(2,928)
(2,747)
163,499
205,331
59,967,429
59,967,429
$2.73
$3.42
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18. INCOME TAXES
The major components of deferred tax expense
The major components of current income tax expense for the years ended
for the years ended December 31 consist of the
following:
December 31 consists of the following:
Related to origina-
tion and reversal of
timing differences
Increase in future
tax rates
2018
2017
4,857
11,650
333
—
$5,190
$11,650
Income taxes relating to the
current year
Income taxes related to the
prior year
2018
2017
56,100
64,100
(300)
—
$55,800
$64,100
The effective income tax rate reported in the consolidated statements of comprehensive income varies from the Canadian tax
rate of 26.64% for the year ended December 31, 2018 [2017- 26.52%] for the following reasons:
COMPANY’S STATUTORY TAX RATE
Income before income taxes
Income tax at statutory tax rate
Increase (decrease) resulting from
Income not subject to tax
Permanent differences
Changes in future tax rates
Tax recovery from prior years
Other
INCOME TAX EXPENSE
2018
26.64%
227,417
60,584
—
316
333
(300)
57
2017
26.52%
285,402
75,689
(111)
291
(39)
—
(80)
$60,990
$75,750
The movement in significant components of the Company’s deferred tax liabilities and assets for the years ended December 31,
2018 and 2017 are as follows:
As at
January 1, 2018
Recognized
in income and OCI
As at
December 31, 2018
DEFERRED INCOME TAX (ASSETS) LIABILITIES
Deferred placement fees receivable
Capitalized broker fees
Unamortized discount on debt related to
securitized mortgages
Unrealized gains on interest rate swaps
Other
Carrying values of mortgages pledged under
securitization in excess of tax values
Cumulative eligible capital property
Servicing liability
Fair value adjustments not deducted for tax purposes
Total
10,946
37,610
21,306
17,866
77
(446)
(4,561)
(5,006)
(3,042)
$74,750
132
7,411
9,043
(11,981)
(13)
22
300
216
(1,080)
$4,050
11,078
45,021
30,349
5,885
64
(424)
(4,261)
(4,790)
(4,122)
$78,800
61
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
The amount recognized in income and OCI consists of income tax expense of $5,190 recorded in income and a recovery of $1,140
record in OCI related to unrealized losses on cash flow hedges.
As at
January 1, 2017
Recognized
in income
As at
December 31, 2017
DEFERRED INCOME TAX (ASSETS) LIABILITIES
Deferred placement fees receivable
Capitalized broker fees
Carrying values of mortgages pledged under
securitization in excess of tax values
Unamortized discount on debt related to securitized
mortgages
Unrealized gains on interest rate swaps
Other
Cumulative eligible capital property
Servicing liability
Loan loss reserves not deducted for tax purposes
Total
11,660
38,015
5,671
15,331
4,787
589
(4,908)
(4,749)
(3,296)
$63,100
(714)
(405)
(6,117)
5,975
13,079
(512)
347
(257)
254
$11,650
10,946
37,610
(446)
21,306
17,866
77
(4,561)
(5,006)
(3,042)
$74,750
The calculation of taxable income of the Company is based on estimates and the interpretation of 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 Company’s policies and processes to measure and manage them
individually are set out below:
Interest rate risk
Interest rate risk is the risk that the fair value
uses synthetic bond forwards [consisting of bonds sold short and bonds
or future cash flows of a financial instrument
purchased under resale agreements] to manage interest rate exposure
will fluctuate because of changes in market
between the time a mortgage rate is committed to the borrower and the
interest rates. The Company’s exposure to
time the mortgage is sold to a securitization vehicle and the underlying
the risk of changes in market interest rates
cost of funding is set. As interest rates change, the values of these interest
relates primarily to the Company’s mortgages
rate dependent financial instruments vary inversely with the values of the
accumulated for securitization.
mortgage contracts. As interest rates increase, a gain will be recorded on
The Company uses various strategies to
reduce interest rate risk. The Company’s risk
management objective is to maintain interest
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.
rate spreads from the point that a mortgage
For single-family mortgages, only a portion of the commitments issued by
commitment is issued to the transfer of the
the Company eventually fund. The Company must assign a probability of
mortgage to the related securitization vehicle or
funding to each mortgage in the pipeline and estimate how that probability
sale to an institutional investor. Primary among
these strategies is the Company’s decision to
changes as mortgages move through the various stages of the pipeline. The
amount that is actually economically hedged is the expected value of the
sell mortgages at the time of commitment,
mortgages funding within the future commitment period.
passing on interest rate risk that exists prior to
funding to institutional investors. The Company
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below provides the financial impact that an immediate and
Liquidity risk is the risk that the Company will be
sustained 100 basis point and 200 basis point increase and decrease in
unable to meet its financial obligations as they
short-term interest rates would have had on the net income of the Company
come due.
Liquidity risk and capital resources
in 2018 and 2017.
100 BASIS POINT SHIFT
Impact on net income and
equity attributable
to shareholders
200 BASIS POINT SHIFT
Impact on net income and
equity attributable
to shareholders
(1) Interest rate is not decreased below 0%.
Credit risk
Decrease in
interest rate(1)
Increase in
interest rate
2018
2017
2018
2017
$4,816
$1,946 $(4,816)
$(958)
$9,632
$10,875 $(9,632)
$(1,917)
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 mortgage default. The Company uses
stringent underwriting criteria and experienced adjudicators to mitigate
this risk. The Company’s approach to managing credit risk is based on the
consistent application of a detailed set of credit policies and prudent arrears
management. As at December 31, 2018, 96% [2017 – 96%] of the pledged
mortgages were insured mortgages. See details in note 3. The Company’s
exposure is further mitigated by the relatively short period over which a
The Company’s liquidity strategy has been to use
bank credit to fund working capital requirements
and to use cash flow from operations to fund
longer-term assets. The Company’s credit facilities
are typically drawn to fund: [i] mortgages
accumulated for sale or securitization, [ii]
origination costs associated with mortgages
pledged under securitization, [iii] cash held as
collateral for securitization, [iv] costs associated
with deferred placement fees receivable and [v]
mortgage and loan investments. The Company
has a credit facility with a syndicate of eleven
financial institutions, which provides for a total of
$1,250,000 in financing.
The Company finances the majority of its
mortgages with debt derived from the
securitization markets, primarily NHA MBS,
ABCP and CMB. Debt related to NHA-MBS and
ABCP securitizations reset monthly such that the
receipts of principal 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.
mortgage is held by the Company prior to securitization.
Market risk
The maximum credit exposures of the financial assets are their carrying
values as reflected on the consolidated statements of financial position. 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 mortgages that
underlies these assets is diverse in terms of geographical location, borrower
exposure and the underlying type of real estate. This diversity 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 institutions such that the risk of credit loss is very
remote. Securities transacted are all Government of Canada bonds and, as
such, have virtually no risk of credit loss.
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 and mortgage servicing income
from one Canadian financial institution represent
approximately 9.0% [2017 – 9.9%] of the
Company’s total revenue.
63
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT
Fair value measurement
The Company uses the following hierarchy for determining and disclosing
[f] Fair value of financial instruments not
the fair value of financial instruments recorded at fair value in the
carried at fair value
consolidated statements of financial position:
The fair value of these financial instruments are
Level 1 – quoted market price observed in active markets for identical
determined by discounting projected cash flows
using market industry pricing practices, including
the rate of unscheduled prepayment. Discount
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. These fair values are
estimated using valuation techniques in which
one or more significant inputs are unobservable
[Level 3], and are calculated for disclosure
purposes only.
instruments;
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.
Valuation methods and assumptions
The Company uses valuation techniques to estimate fair values, including
reference to third party valuation service providers using proprietary pricing
models and internal valuation models such as discounted cash flow analysis.
The valuation methods and key assumptions used in determining fair values
for the financial assets and financial liabilities are as follows:
[a] Mortgages and loan investments
Mortgages and loan investments are measured at FVTPL. The fair value of
these mortgages is based on non-observable inputs, and is measured at
management’s best estimated of the net realizable value.
[b] Deferred placement fees receivable
The fair value of deferred placement fees receivable is determined by
internal valuation models 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 certain assumptions which are not supported
by observable market data.
[c] Securities owned and sold short
The fair values of securities owned and sold short used by the Company
to hedge its interest rate exposure are determined by quoted prices on a
secondary market.
[d] Servicing liability
The fair value of the servicing liability is determined by internal valuation
models using market data inputs, where possible. The fair value is
determined by discounting the expected future cost related to the servicing
of explicit mortgages at market interest rates. The expected future cash
flows are estimated based on certain assumptions which are not supported
by observable market data.
[e] Other financial assets and financial liabilities
The fair value of mortgages accumulated for sale or securitization, cash
held as collateral for securitization, restricted cash and bank indebtedness
correspond to the respective outstanding amounts due to their short-term
maturity profiles.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Carrying value and fair value of selected financial instruments
The fair value of the financial assets and financial liabilities of the Company approximates its carrying value, except for mortgages
pledged under securitization, which has a carrying value of $30,567,036 [2017 – $27,566,677] and a fair value of $31,071,851[2017
– $27,557,542], debt related to securitized and participation mortgages, which has a carrying value of $30,762,651 [2017 –
$27,834,080], and a fair value of $30,574,471 [2017 – $27,748,498], and senior unsecured notes, which have a carrying value of
$174,829 [December 31, 2017 – $174,693], and a fair value of $175,856 [December 31, 2017 – $176,372].
The following tables represent the Company’s financial instruments measured at fair value on a recurring basis as at December 31:
FINANCIAL ASSETS
Mortgages accumulated for sale
Mortgage and loan investments
Interest rate swaps
Total financial assets
FINANCIAL LIABILITIES
Securities sold short
Interest rate swaps
Total financial liabilities
FINANCIAL ASSETS
Mortgages accumulated for sale
FVTPL mortgages
Deferred placement fees receivable
Interest rate swaps
Total financial assets
FINANCIAL LIABILITIES
Securities sold short
Interest rate swaps
Total financial liabilities
2018
Level 1
Level 2
Level 3
Total
—
—
—
—
—
—
—
34,470
—
34,470
—
188,666
188,666
51,410
—
51,410
$85,880
$188,666
$274,546
2,183,411
4,784
$2,188,195
2017
—
—
—
2,183,411
4,784
$2,188,195
Level 1
Level 2
Level 3
Total
—
—
—
—
—
—
—
—
19,490
—
19,490
—
—
2,986,097
2,986,097
41,273
41,273
63,689
—
63,689
$83,179
$3,027,370
$3,110,549
2,180,253
6,124
$2,186,377
—
—
—
2,180,253
6,124
$2,186,377
65
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT In estimating the fair value of financial
appropriate as at the date of the consolidated statements of financial
assets and financial liabilities using valuation
position, those fair values may differ if other reasonably possible alternative
techniques or pricing models, certain
assumptions are used.
assumptions are used, including those that are
not fully supported by observable market prices
or rates [Level 3]. The amount of the change
in fair value recognized by the Company in net
income for the year ended December 31, 2018
that was estimated using a valuation technique
based on assumptions that are not fully
supported by observable market prices or rates
was approximately a loss of $4,000 [2017 –
$26,342]. Although the Company’s management
believes that the estimated fair values are
Transfers between levels in the fair value hierarchy are deemed to have
occurred at the beginning of the period in which the transfer occurred.
Transfers between levels can occur as a result of additional or new information
regarding valuation inputs and changes in their observability. During 2018 and
2017, the Company did not have any transfers between levels.
The following table presents changes in the fair values, including realized gains
of $32,942 [2017 – $33,006] of the Company’s financial assets and financial
liabilities for the years ended December 31, 2018 and 2017, all of which have
been classified as FVTPL:
FVTPL mortgages
Deferred placement fees receivable
Securities sold short
Interest rate swaps
2018
(4,000)
—
6,189
1,340
2017
(25,312)
(1,030)
35,468
47,133
$3,529
$56,259
The above table includes an unrealized fair value loss of $4,000 on the mortgage and loan investments. These mortgages were
classified as loan and receivables under IAS 39 prior to January 1, 2018, but have now been classified as FVTPL under IFRS 9.
Accordingly, there is no gain or loss reported in 2017 with respect to mortgage and loan investments. The mortgages pledged
under securitization that were classified as FVTPL in 2017 have now been classified as amortized cost with the transition to IFRS 9.
Accordingly, there is no gain or loss reported in 2018 with respect to mortgages pledged under securitization.
The Company does not have any assets or liabilities that are measured at fair value on a non recurring basis.
66
NOTES TO CONSOLIDATED 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, 2018 and 2017. The Company classifies financial instruments to Level 3 when there is reliance on at least one significant
unobservable input in the valuation models.
Fair value as
at December
31, 2017
under IAS 39
Fair value as at
January 1, 2018
under IFRS 9
Unrealized loss
recorded in
income
Payment and
amortization
Fair value as at
December 31,
2018
Investments
FINANCIAL ASSETS
FVTPL mortgages
2,986,097
Deferred placement
fees receivable
Mortgage and
loan investments
FINANCIAL ASSETS
FVTPL mortgages
Deferred placement
fees receivable
Mortgage and
loan investments
41,273
—
—
—
—
—
—
—
—
—
—
—
379,713
44,294
(4,000)
(231,341)
188,666
$3,027,370
$379,713
$44,294
$(4,000)
$(231,341)
$188,666
Fair value as at
January 1, 2017
Investments
Unrealized loss
recorded in
income
Payment and
amortization
Fair value as at
December 31,
2017
2,663,756
1,612,325
(25,312)
(1,264,672)
2,986,097
43,933
9,452
(1,030)
(11,082)
41,273
41,858
10,049
—
(51,907)
—
$2,749,547
$1,631,826
$(26,342)
$(1,327,661)
$3,027,370
NOTE 20. CAPITAL MANAGEMENT
The Company’s objective is to maintain a capital base so as to maintain
investor, creditor and market confidence and sustain future development of
the business. Management defines capital as the Company’s common share
capital and retained earnings. FNFLP has a minimum capital requirement
as stipulated by its bank credit facility. The agreement limits the debt under
bank indebtedness together with the unsecured notes to four times FNFLP’s
equity. As at December 31, 2018, the ratio was 1.90:1 [2017 – 1.39:1]. The
Company was in compliance with the bank covenant throughout the year.
67
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT NOTE 21. EARNINGS BY BUSINESS SEGMENT
The Company operates principally in two business segments, Residential and Commercial. These segments are organized by
mortgage type and contain revenue and expenses related to origination, underwriting, securitization and servicing activities.
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
Realized and unrealized gains on financial instruments
EXPENSES
Amortization
Interest
Other operating
INCOME BEFORE INCOME TAXES
Identifiable assets
Goodwill
Total assets
CAPITAL EXPENDITURES
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
Placement and servicing
Mortgage investment income
Realized and unrealized gains (losses) on financial instruments
EXPENSES
Amortization
Interest
Other operating
INCOME BEFORE INCOME TAXES
Identifiable assets
Goodwill
Total assets
CAPITAL EXPENDITURES
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2018
Residential
Commercial
Total
607,672
182,520
790,192
(495,386)
(150,683)
(646,069)
112,286
236,636
61,821
7,171
417,914
3,943
54,659
194,414
253,016
164,898
31,837
63,195
26,504
(4,009)
117,527
988
15,290
38,730
55,008
62,519
144,123
299,831
88,325
3,162
535,441
4,931
69,949
233,144
308,024
227,417
27,719,231
8,288,120
36,007,351
—
—
29,776
27,719,231
8,288,120
36,037,127
1,842
790
2,632
2017
Residential
Commercial
Total
500,789
157,994
(382,604)
(129,335)
118,185
237,041
47,452
41,878
28,659
58,409
20,824
14,381
658,783
(511,939)
146,844
295,450
68,276
56,259
444,556
122,273
566,829
4,074
37,635
187,477
229,186
215,370
1,061
8,793
42,387
52,241
70,032
5,135
46,428
229,864
281,427
285,402
25,653,160
7,093,342
32,746,502
—
—
29,776
25,653,160
7,093,342
32,776,278
2,974
1,275
4,249
NOTE 22. RELATED PARTY AND OTHER
TRANSACTIONS
The Company has servicing contracts in
December 31, 2018 [December 31, 2017 – $61,034]. As at December 31, 2018,
connection with several originated commercial
three of the mortgages are secured by real estate in which the Company is
mezzanine mortgages subsequently sold to
also a subordinate mortgage lender.
various entities controlled by a senior executive
and shareholder of the Company. The Company
services these mortgages during their terms at
market commercial servicing rates. During the
year, the Company originated $128,465 of new
mortgages for the related parties. The related
parties also funded several mortgage related
progress draws totalling $9,149 on existing
mortgages originated by the Company. All
such mortgages, which are administered by
the Company, have a balance of $121,556 as at
A senior executive and shareholder of the Company has a significant
investment in a mortgage default insurance company. In the ordinary
course of business, the insurance company provides insurance policies
to the Company’s borrowers at market rates. In addition, the insurance
company has also provided the Company with portfolio insurance at market
premiums. The total bulk insurance premium paid in 2018 was $2,339 [2017
– $494], net of third-party investor reimbursement. The insurance company
has also engaged the Company to service a portfolio of mortgages at
market commercial servicing rates. As at December 31, 2018, the portfolio
had a balance of $1,625 [2017 – $3,822].
NOTE 23. FUTURE ACCOUNTING
CHANGES
The following accounting pronouncement issued
by the IASB, although not yet effective, may have
a future impact on the Company:
IFRS 16 – Leases
The Company’s major leases are office space leases for its Toronto head
office and four regional offices. The Company’s various office equipment
leases are insignificant for application of the new standard. Based on the
preliminary assessment, the Company will apply IFRS 16 on a modified
retrospective approach, and record approximately $30 million as right-of-
In January 2016, the IASB issued IFRS 16 –
use asset as well as lease liability on its consolidated statements of financial
Leases, replacing IAS 17 – Leases. IFRS 16 requires
position as of January 1, 2019.
lessees to recognize assets and liabilities for
most leases instead of previous categories of
finance leases, which are reported on the balance
sheet, or operating leases, which are disclosed
only in the notes to the financial statements,
under IAS 17. IFRS 16 also set out enhanced
guidance for the recognition, measurement,
presentation and disclosure of the leasing
activities. IFRS 16 is effective for annual periods
beginning on or after January 1, 2019.
69
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT CORPORATE
GOVERNANCE
First National’s Board of Directors and
COMMITTEES
management team fully acknowledge the
The Board of Directors has established an Audit Committee and a Governance
importance of their duty to serve the long-
Committee to assist in the efficient functioning of the Company’s corporate
term interests of shareholders.
governance strategy.
Sound corporate governance is fundamental
to maintaining the confidence of investors
and increasing shareholder value. As such,
AUDIT COMMITTEE
The Audit Committee’s responsibilities include:
First National is committed to the highest
• Management of the relationship with the external auditor including the
standards of integrity, transparency,
compliance and discipline.
oversight and supervision of the audit of the Company’s financial statements;
• Oversight and supervision of the quality and integrity of the Company’s
financial statements, and;
These standards define the relationships
• Oversight and supervision of the adequacy of the Company’s internal
among all of our stakeholders – Board,
management and shareholders – and are the
basis for building these values and nurturing
a culture of accountability and responsibility
across the organization.
accounting controls and procedures, as well as its financial reporting practices.
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), Robert Mitchell and Robert Pearce
POLICIES
GOVERNANCE COMMITTEE
The Board supervises and evaluates the
The Governance Committee’s responsibilities include:
management of the Company, 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 recommended practices
• Periodically assessing and making recommendations on the Company’s
approach to governance issues;
• Assisting in the development of governance policies, practices and
procedures for approval by the Board of Directors;
in governance and disclosure. These include a
• Reviewing conflicts of interest and transactions involving related parties
Disclosure Policy, a Code of Business Conduct,
of the Company; and
a Whistleblower Policy and an Insider Trading
Policy. These policies follow 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.
• Periodically reviewing the composition and effectiveness of the Board
of Directors.
The Governance Committee consists of three directors, all of whom are
independent for the purposes of the Canadian Securities Administrators’
Multilateral Instrument 58-101 – Disclosure of Corporate Governance Practices.
Committee Members
Barbara Palk (Chair), Duncan Jackman and Robert Pearce
70
CORPORATE GOVERNANCE
BOARD OF
DIRECTORS
STEPHEN SMITH
MORAY TAWSE
Stephen Smith, one of Canada’s leading financial
Mr. Tawse is Executive Vice President and Secretary of the Corporation,
services entrepreneurs, is the Chairman, Chief
Executive Vice President of First National and Co-founder of First National.
Executive Officer and Co-Founder of First
Mr. Tawse directs the operations of all of First National’s commercial
National Financial Corporation. He has been an
mortgage origination activities. With over 30 years of experience in the
innovator in the development and utilization
real estate finance industry, Mr. Tawse is one of Canada’s leading experts on
of various securitization techniques to finance
commercial real estate and is often called upon to deliver keynote addresses
mortgage assets as well as a leader in the
at national real estate symposiums.
development and application of information
technology in the mortgage industry.
Mr. Smith is Chairman of Canada Guaranty
JOHN BROUGH
Mortgage Insurance Company, which he owns in
partnership with Ontario Teachers’ Pension Plan.
He is the largest shareholder in Equitable Bank,
one of Canada’s leading alternative lenders and
the country’s ninth largest bank. Mr. Smith is a
member of the Board of Governors of the Royal
Ontario Museum, the Board of Directors of the
C. D. Howe Institute, E L Financial Corporation
and the Canada Infrastructure Bank. He is also
Chairman of Historica Canada, producer of the
Heritage Minutes and publisher of The Canadian
Encyclopaedia. In 2012, Mr Smith received the
Queen Elizabeth II Diamond Jubilee Medal for
contributions to Canada.
John Brough was President of both Torwest, Inc. and Wittington Properties
Limited, real estate development companies, from 1998 to December 31, 2007.
Prior thereto, from 1996 to 1998, Mr. Brough was Executive Vice President
and Chief Financial Officer of iSTAR Internet, Inc. Prior thereto, from 1974 to
1996, he held a number of positions with Markborough Properties, Inc., his
final position being Senior Vice President and Chief Financial Officer which
position he held from 1986 to 1996. Mr. Brough is an executive with over 40
years of experience in the real estate industry. He is currently a director and
Chairman of the Audit and Risk Committee of Kinross Gold Corporation.
Mr. Brough was formerly a director and Chairman of the Audit Committee
of Canadian Real Estate Investment Trust from 2008 to 2018. He holds a
Bachelor of Arts degree (Economics) from the University of Toronto and is a
Chartered Professional Accountant and a Chartered Accountant. He is also a
graduate of the Institute of Corporate Directors – Director Education Program
In 2015, Queen’s University announced the
naming of The Stephen J.R. Smith School of
at the University of Toronto, Rotman School of Management. Mr. Brough is a
member of the Institute of Corporate Directors and Chartered Professional
Business at Queen’s University in honour of Mr.
Accountants of Ontario and Chartered Professional Accountants of Canada.
Smith and his historic $50-million donation to
the school.
Mr. Smith holds a B.Sc (Hons.) in Electrical
Engineering from Queen’s University and a
M.Sc. in Economics from the London School of
Economics.
71
FIRST NATIONAL FINANCIAL CORPORATION 2018 ANNUAL REPORT DUNCAN JACKMAN
BARBARA PALK
Mr. Jackman is the Chairman, President and Chief
Ms. Palk retired as President of TD Asset Management Inc. in 2010 following
Executive Officer of E-L Financial Corporation
a 30-year career in institutional investment and investment management.
Limited, an investment and insurance holding
She currently serves as a Director of TD Asset Management USA Funds Inc.
company and has held similar positions with
in New York, the Ontario Teachers’ Pension Plan and Crombie Real Estate
E-L Financial since 2003. Mr. Jackman is also the
Investment Trust. Her previous board experience includes the Canadian
Chairman and President of Economic Investment
Coalition for Good Governance, whose Governance Committee she chaired,
Trust Limited and United Corporations Limited,
Greenwood College School, the Investment Counselling Association of
both closed-end investment corporations,
Canada, the Perimeter Institute, the Shaw Festival, UNICEF Canada and
and has acted in a similar capacity with these
Queen’s University, where she was the Chair of the board of Trustees. Ms. Palk
corporations since 2001. Mr. Jackman sits on a
is a member of the Institute of Corporate Directors, a Fellow of the Canadian
number of public and private company boards.
Securities Institute and a CFA charterholder. She holds a Bachelor of Arts
Prior to 2001, Mr. Jackman held a variety of
(Honours, Economics) degree from Queen’s University, and in 2004 was
positions including portfolio manager at Cassels
named one of Canada’s Top 100 Most Powerful Women.
Blaikie and investment analyst at RBC Dominion
Securities Inc. Mr. Jackman holds a Bachelor of
Arts from McGill University.
ROBERT PEARCE
ROBERT MITCHELL
Robert Pearce serves on the board of directors of Canada Guaranty Mortgage
Insurance Company, First American Payment Systems and CPI Card Group.
Mr. Pearce spent 26 years with BMO Bank of Montreal from 1980 to 2006,
Mr. Mitchell President has been President of
most recently holding the position of President and Chief Executive Officer,
Dixon Mitchell Investment Counsel Inc., a
Personal and Commercial Client Group. He also served on the board of
Vancouver-based investment management
directors of MasterCard International from 1998 to 2006 and as Chairman of
company since 2000. Prior to that, Mr. Mitchell
the Canadian Bankers’ Association from 2004 to 2006. Mr. Pearce holds a
was Vice President, Investments at Seaboard Life
BA from the University of Victoria and an MBA from the University of British
Insurance Company. Mr. Mitchell has an MBA from
Columbia. Mr. Pearce brings to the board over 30 years of operational and
the University of Western Ontario, a Bachelor
leadership experience in the financial services industry.
of Commerce (Finance) from the University of
Calgary and is a CFA charterholder. Mr. Mitchell
sits on the board of Equestrian Canada.
72
BOARD OF DIRECTORS
STAKEHOLDER
INFORMATION
CORPORATE ADDRESS
LEGAL COUNSEL
First National Financial Corporation
Stikeman Elliott LLP, Toronto, Ontario
100 University Avenue
North Tower, Suite 700
Toronto, Ontario M5J 1V6
Phone: 416.593.1100
Fax: 416.593.1900
ANNUAL MEETING
May 8, 2019, 9:00 a.m. EDT
TMX Broadcast Centre
The Gallery
The Exchange Tower
130 King Street West
Toronto, Ontario
AUDITORS
Ernst & Young LLP, Toronto, Ontario
INVESTOR RELATIONS CONTACTS
Robert Inglis
Chief Financial Officer
rob.inglis@firstnational.ca
Ernie Stapleton
President, Fundamental
ernie@fundamental.ca
SENIOR EXECUTIVES OF FIRST
NATIONAL FINANCIAL LP
Stephen Smith
Co-founder, Chairman and Chief Executive Officer
Moray Tawse
INVESTOR RELATIONS WEBSITE
www.firstnational.ca
REGISTRAR AND
TRANSFER AGENT
Co-founder and Executive Vice President
Computershare Investor Services Inc.,
Jason Ellis
Chief Operating Officer
Robert Inglis
Chief Financial Officer
Scott McKenzie
Senior Vice President, Residential Mortgages
Jeremy Wedgbury
Senior Vice President, Commercial Mortgages
Lisa White
Senior Vice President, Mortgage Operations
Hilda Wong
Senior Vice President and General Counsel
Toronto, Ontario
1.800.564.6253
EXCHANGE LISTING
AND SYMBOLS
Common shares: (TSX) FN
Class A Series 1 Preference Shares: (TSX) FN.PR.A
Class A Series 2 Preference Shares: (TSX) FN.PR.B
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