A N N U A L R E P O R T 2 0 1 9
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
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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 more information about
our people and markets at www.firstnational.ca.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT A RECORD YEAR
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300,000+
$111.4 Billion
$1.3 Billion
Borrowers served by First National
Mortgages under administration (MUA) –
Revenue in 2019 grew 12% to a new
in 2019 across Canada.
the source of most of the Company’s
annual record, reflecting growth in
earnings – reached this all-time record at
mortgage origination and higher MUA.
year end 2019, a 5% increase over 2018.
$177.2 Million
40%
$144.4 Million
Record net income in 2019 ($2.90 per
The after-tax, Pre-Fair Market Value(1)
Value of common share dividends
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share) reflected good execution, wider
return on shareholders’ equity in 2019
declared in 2019, bringing the
mortgage spreads and more placement
demonstrated the efficiency of the First
cumulative total to $1.4 billion ($23.32
with institutional investors.
National business model.
per share) since the Company’s initial
public offering (IPO) in 2006.
514%
Total shareholder return between the IPO
date in 2006 and December 31, 2019.
(1) Non-IFRS measure. See MD&A for more details.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT OUR
LEADERSHIP
TEAM
STEPHEN SMITH
Co-founder, Chairman and
Chief Executive Officer
MORAY TAWSE
Co-founder and
Executive Vice President
JASON ELLIS
President and
Chief Operating Officer
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ROBERT INGLIS
Chief Financial Officer
SCOTT MCKENZIE
Senior Vice President,
Residential Mortgages
JEREMY WEDGBURY
Senior Vice President,
Commercial Mortgages
HILDA WONG
Senior Vice President and
General Counsel
MESSAGE TO
SHAREHOLDERS
Fellow Shareholders:
First National is a different kind of financial institution.
We are not a bank and do not accept deposits, and yet we are one of
Canada’s largest lenders, with prime mortgages accounting for about 94%
of our $111.4 billion portfolio of mortgages under administration.
We have a thousand employees, making us small in comparison to the Big Six
banks, and yet we originated and renewed $28.4 billion of mortgages in 2019.
We do not have storefronts, and yet the First National name is trusted by
hundreds of thousands of borrowers from coast to coast.
We are not a “fintech,” and yet our proprietary MERLIN underwriting system
is likely the leading technology in the mortgage broker distribution channel.
These differences make a difference to long-term shareholder value creation.
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Over the eight years since the Company converted to a corporation from an
income trust:
• Revenue grew at an average annual rate of 14%, and in 2019 surpassed
$1.3 billion;
• Net income grew at an average annual rate of 12% to settle at a record
$177.2 million, or $2.90 per common share, in 2019;
• Dividends grew every year, from $1.25 per common share to $1.90 per
common share, excluding special dividends paid in each of the past three
years; and
• After-tax Pre-Fair Market Value(1) return on shareholders’ equity averaged 43%.
We are proud of this track record and of the business model used to create
value. Established in 1988, it has proven to be both efficient and effective
through the natural ebb and flow of economic and housing market cycles.
A DIFFERENT BUSINESS MODEL
At its core, the business model focuses on funding the Company’s origination
activities through a variety of sources – including its own balance sheet – and
earning stable and recurring income from servicing these mortgages.
Since 2015, we have complemented this business model through the
development of a third-party underwriting and servicing business, where First
National adjudicates mortgages originated by other Canadian institutions and
underwrites them in accordance with customer guidelines.
This is a textbook definition of what we do, but leaves out two very important
drivers of performance: First National’s industry partners and our team.
(1) Non-IFRS measure. See MD&A for more details.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 6
“First National is committed
to the highest standards of integrity,
transparency, compliance
and discipline.”
A DIFFERENT APPROACH
Our partners include independent mortgage brokers who provide borrowers
with insightful advice in selecting a mortgage product. When brokers
recommend First National, it’s because we offer the best combination of
service, value and convenience. Our partners also include some of the
country’s largest insurance companies, banks and wealth management
firms. When these institutions want to invest in mortgages in a risk-
managed fashion, they come to First National because they value our
expertise in evaluating borrowers and structuring, pricing and servicing
loans from beginning to end.
I’m pleased to say that our partnerships have never been stronger as a result
of the efforts of the First National team. Up and down the line, employees
care deeply about the work they do and how they do it. To borrowers, brokers
and funding partners, the people of First National are imaginative problem
solvers who know how to get the right deal done in the right time frame.
If there is just one difference that has made First National a success story –
and makes us optimistic about the future – it is our workforce. This past
year, we continued to see evidence every day of employees building
meaningful relationships with our external stakeholders and business
partners, despite the high volume of transactions processed.
It is not easy to create a culture like First National’s. We believe a flat
organizational structure, careful recruitment, thorough onboarding, and
bias for promoting from within have contributed greatly to workplace
engagement and morale. Our Company is not too old to remember its
entrepreneurial roots. In the earliest days after First National was founded,
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there were no complex computer systems or policy manuals: there was
only hard work and creativity. Those two qualities and our integrity remain
central to First National’s long-term success.
2019 HIGHLIGHTS
The past year was a productive one. Both single-family residential and
commercial segments of First National posted record originations. Our
business model capitalized on a strong national economy and low interest
rates to deliver these results.
For single-family, growth reflected First National’s standing in the
mortgage broker channel. Growth was achieved in all regions, led by
Ontario and the Maritimes, with combined volumes 17% ahead of 2018.
The majority of the mortgages we underwrote in 2019 were prime, but we
also found good success with our Excalibur-branded mortgage program.
Excalibur features expanded underwriting criteria designed to serve
self-employed and other credit-worthy borrowers who fall just outside
traditional guidelines. Although Excalibur is only available to our Ontario
broker partners, volumes were healthy and the growth rate exceeded 40%.
For commercial, growth was driven by demand for CMHC-insured
mortgages, as well as conventional and bridge mortgages. The commercial
team was very active in serving owners of apartment, self-storage and
retirement-home properties. These property types are benefiting from
population growth, aging demographics, and the need for multi-unit
apartment rental stock in many urban markets. Always popular with
young Canadians, rentals are also attracting more retirees for lifestyle and
financial reasons. As a result of downsizing, demand for self-storage units
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT has increased. First National is well prepared
accept mortgage applications, recruited a skilled team in Toronto and
to meet these needs with financing at every
immersed ourselves in Manulife Bank’s credit policies, compliance standards
project stage – land acquisition, construction,
and controls. In turn, Manulife Bank funds all mortgages and retains full
term and property repositioning.
responsibility for underwriting guidelines, mortgage servicing and the client
Our third-party underwriting business also
relationship.
contributed to First National’s growth, as our
We were very pleased to be chosen for this mandate. It is an endorsement
long-standing customer continued to excel in
of First National and the mortgage broker channel. Reports show that
the broker channel.
mortgage brokers account for almost $100 billion of new mortgage
In December 2019, we expanded this arm of First
National by providing underwriting and fulfilment
originations each year. When leading institutions like this engage in the
channel, it provides brokers and borrowers with more choices.
processing services for mortgages originated by
With respect to our balance sheet, 2019 was a productive year. In November,
Manulife Bank of Canada through the residential
the Company issued $200 million of senior unsecured notes. The notes
mortgage broker channel in Ontario and
bear interest at 3.582%, payable in equal semi-annual amounts starting in
Atlantic Canada. This is an important agreement
May this year. Institutional participation in the offering was strong, and we
that leverages the capabilities and strengths
achieved a credit spread of 2.1% over the benchmark bond. This made the
of both parties. To deliver our services, First
offering our most successful debt deal to date.
National developed and deployed customized
software based on MERLIN technology to
SUCCESSION PLANNING
Following a successful transition into the role of Chief Operating Officer
in October 2018, Jason Ellis added the title of President of First National in
November 2019.
We were delighted to make this appointment. Jason is a 16-year First
National veteran who successfully led the Company’s Treasury and
Capital Markets activities in his previous role as Senior Vice President
and Managing Director, Capital Markets. He managed the majority of the
Company’s relationships with its funding partners before assuming his new
responsibilities.
Jason is an integral part of First National’s success, bringing new ideas
and energy to our deliberations, and will maintain our focus on operational
excellence. I have no doubt he will also continue to champion the
entrepreneurial culture upon which the Company was founded. As noted
above, we believe in promoting from within, as it strengthens our business
and ensures long-term continuity of our culture. This is the latest and
highest-profile example.
Also in the fourth quarter, Moray Tawse and I sold some of our shares. Even
with the sale, we control about 71% of the outstanding common shares of
First National, meaning we have full alignment with all public shareholders
as we perform our ongoing leadership duties. We are committed, engaged
and enthusiastic about First National and look forward to participating in
its future.
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MORTGAGES UNDER ADMINISTRATION
($ Billions)
MUA BY ASSET TYPE
5%
5-year compound annual growth
A
78%
Insured
B
16%
Uninsured single-family
residential
C
6%
Uninsured multi-residential
and commercial
C
B
A
2019 REVENUE SOURCES PRIOR
TO FAIR VALUE GAINS/LOSSES
2017
2018
2019
A
120
100
80
60
40
20
120
0
100
80
60
40
REVENUE
1200
($ Millions)
20
120
1000
0
2015
2016
2017
2018
2019
2015
2016
100
800
11%
80
600
5-year compound annual growth
60
400
40
200
1200
20
0
1000
0
800
600
400
300
200
250
1200
0
200
1000
150
800
100
600
2015
2015
2016
2016
2017
2017
2018
2018
2019
2019
2015
2016
2017
2018
2019
37%
Institutional placements
B
23%
Net interest –
securitized mortgages
C
26%
Mortgage servicing
D
14%
Investment income
65%
Institutional investors
B
31%
Securitization
C
4%
Internal
D
A
9
C
B
B
C
A
50
400
300
PRE-FAIR MARKET VALUE EBITDA(1)
0
($ Millions)
200
250
2015
2016
2017
2018
2019
2019 FUNDING
SOURCES
0
200
2017
2018
2019
A
2015
2016
150
7%
5-year compound annual growth
100
2015
2016
2017
2018
2019
50
300
0
250
200
150
100
50
0
2015
2016
2017
2018
2019
(1)Non-IFRS measure. See MD&A for more details.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT THE MARKETPLACE
LOOKING FORWARD
This past year was a quiet period for government
At the time of writing, two of First National’s leading indicators look
policy interventions in the housing market, as
promising. Single-family mortgage commitments have significantly
changes implemented from 2016 through 2018
outpaced the levels we saw at this time last year. In commercial, borrowers
were left to do their work to curb risk and, in
continue to have a good appetite for product and, consequently, our
some markets, end speculation. To my mind, it
commercial team anticipates a strong start to 2020.
seems the policymakers are content with the
impact of these measures. However, if there
are future changes, First National has shown
its adaptability – particularly with revised B-20
guidelines – and will remain quick to adapt.
That said, we will continue to face uncertain securitization margins.
Mortgage spreads tightened toward the end of 2019 and have not widened
so far in 2020. The effect of pre-2018 fair-value accounting conventions will
continue to have a negative impact on income in 2020, albeit at a slightly
lower level than in 2019.
As always, the economy and employment levels will dictate final outcomes
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2020 AGENDA
First National operates with a continuous improvement mindset: this
extends from our technology foundation to our customer service levels.
In 2020, we will refine our technology infrastructure to improve the
interactions we have with stakeholders. This will include enhancing MERLIN
through ongoing software updates.
Of course, a lender must have great technology and great execution, so we
will encourage our team to strive for ever faster and better service levels.
As part of standard operating practice, we will conduct biannual employee
surveys and pay close attention to the results to ensure First National
people remain highly engaged and well prepared to meet new challenges
and unlock new opportunities.
While seeking new customers, we will also strive to secure every mortgage
renewal. In 2020, as in years past, realizing the value inherent in our single-
family renewal book is a top priority.
THANKS
First National is a different kind of company. While we are proud to be
listed on the TSX and grateful for the confidence expressed by our public
shareholders, we run this business by thinking first about our customers.
With satisfied customers, all things are possible.
On behalf of the Board and our senior leaders, I express my deep
gratitude to our customers, including our business partners, as well as
to our shareholders. I also offer my sincere appreciation to First National
employees for their tremendous efforts. Their character and capabilities
make the difference.
Yours sincerely,
Stephen Smith
Chairman and Chief Executive Officer
MANAGEMENT’S DISCUSSION
AND ANALYSIS
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The following management’s discussion and analysis
(“MD&A”) of financial condition and results of operations is
prepared as of February 24, 2020. This discussion should be
read in conjunction with the audited consolidated financial
statements and accompanying notes of First National
Financial Corporation (the “Company” or “Corporation” or
“First National”) as at and for the year ended December
31, 2019. The audited consolidated financial statements
of the Company have been prepared in accordance with
International Financial Reporting Standards (“IFRS”).
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 2
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This MD&A contains forward-looking
First National Financial Corporation is the parent company of First National
GENERAL DESCRIPTION OF THE COMPANY
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information. Please see “Forward-Looking
Financial LP (“FNFLP”), a Canadian-based originator, underwriter and
Information” for a discussion of the risks,
servicer of predominantly prime residential (single-family and multi-unit)
uncertainties and assumptions relating to
and commercial mortgages. With over $111 billion in mortgages under
these statements. The selected financial
administration (“MUA”), First National is Canada’s largest non-bank
information and discussion below also refer
originator and underwriter of mortgages and is among the top three in
to certain measures to assist in assessing
market share in the mortgage broker distribution channel.
financial performance. These other measures,
such as “Pre-FMV EBITDA” and “After-tax
Pre-FMV Dividend Payout Ratio”, should not
be construed as alternatives to net income or
2019 RESULTS SUMMARY
loss or other comparable measures determined
in accordance with IFRS as an indicator of
Management is very pleased with the results of 2019. After a slow start
to the year, single-family origination increased 11% year over year, and
performance or as a measure of liquidity and
the commercial segment produced record origination volumes, which
cash flow. These measures do not have standard
increased 19% over 2018. On a consolidated basis, total new origination
meanings prescribed by IFRS and therefore
was higher by 13% compared to 2018. Higher volume had a favourable
may not be comparable to similar measures
impact as normalized earnings grew 12%.
presented by other issuers.
• MUA grew to $111.4 billion at December 31, 2019, from $106.2 billion at
Unless otherwise noted, tabular amounts are in
December 31, 2018, an increase of 5%; the growth from September 30,
thousands of Canadian dollars.
2019, when MUA was $110.6 billion, was 3% on an annualized basis.
Additional information relating to the
• Total new single-family mortgage origination was $13.5 billion in 2019
Company is available in First National
Financial Corporation’s profile on the System
compared to $12.2 billion in 2018, an increase of 11%. The Company
attributes this to a strong economy, lower mortgage rates and First
for Electronic Data Analysis and Retrieval
National’s market share in the mortgage broker channel. Commercial
(“SEDAR”) website at www.sedar.com.
segment origination of $7.4 billion was 19% more than the $6.2 billion
originated in 2018. Overall new origination increased by 13% in 2019
compared to 2018.
• The Company took advantage of opportunities
• Income before income taxes increased to $241.7 million in 2019 from
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in the year to renew $5.5 billion of single-family
$227.4 million in 2018. The increase was the result of strong mortgage
mortgages ($6.1 billion a year ago). For the
origination, wider mortgage spreads in 2019, and a shift in funding from
commercial segment, renewals increased to
securitization to institutional placement. The pace of growth was affected
$2.0 billion from $1.3 billion.
by changing capital market conditions. In aggregate, the impact from
• Revenue for 2019 increased by 12% to
$1.3 billion from $1.2 billion in 2018. The increase
financial instruments decreased pre-tax income by $12.5 million, comparing
2019 to 2018.
reflected the growth in mortgage origination
• The Company’s earnings before income taxes, depreciation and
in the year and a change in the funding mix,
amortization, and gains and losses on financial instruments (“Pre-FMV
which featured more placement with
EBITDA”) for 2019 increased by 12% to $251.3 million from $225.2 million
institutional investors as opposed to
in 2018. The increase is the result of increased origination, but also of the
securitization. The volume of origination for
Company’s decision to shift its funding from securitization to institutional
institutions increased by 24% compared to
placement. By placing mortgages with institutions, most of the economics
2018, which contributed to an increase of
of the transaction are recognized in the current period. Using
$63.6 million in placement fee revenue. In
securitization funding, the value inherent in the mortgages is realized
addition, the comparatively higher interest rate
over the term of the mortgages – typically five years. By increasing
environment, which began in mid-2017, had
funding through institutional placement by approximately $1.3 billion as
an impact. Because of higher interest rates in
opposed to securitization, First National has accelerated the recognition
recent years, mortgages added to the portfolio
of earnings into the current period. The Company has also benefited from
of securitized mortgages in those years have
comparatively wider mortgage spreads, which prevailed for most of 2019.
higher interest rates than the average rates
of the mortgages maturing in the securitized
portfolio. Interest revenue on securitized
mortgages increased by $87.5 million between
the years.
The Company’s Board of Directors increased the regular monthly dividend
from $1.90 to $1.95 per common share on an annualized basis effective
with the dividend paid on December 16, 2019, and declared a special
common share dividend in the amount of $0.50 per share, which was
also paid on December 16, 2019. The special dividend reflects the Board’s
determination that the Company has generated excess capital in the past
year and that the capital needed for near-term growth can be generated
from current operations.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT
SELECTED QUARTERLY INFORMATION
Quarterly Results of First National Financial Corporation
($000s, except per share amounts)
2019
Fourth quarter
Third quarter
Second quarter
First quarter
2018
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
$342,138
$362,833
$335,241
$286,311
$312,039
$321,835
$290,935
$256,701
$48,993
$60,578
$44,164
$23,478
$32,220
$51,958
$46,347
$35,902
$61,766
$80,772
$68,522
$40,225
$55,780
$62,989
$56,048
$50,368
$0.80
$37,685,593
$1.00
$37,249,143
$0.72
$37,229,876
$0.38
$36,193,793
$0.53
$0.85
$36,037,127
$35,597,827
$0.76
$35,794,066
$0.59
$33,846,283
(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.
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With First National’s large portfolio of mortgages
In the past eight quarters, the Company has experienced a relatively volatile
pledged under securitization, quarterly revenue
economic environment. In most of 2018, the economic outlook was positive
is driven primarily by the gross interest earned
and there was a surplus of liquidity for investment in financial assets. This
on the mortgages pledged under securitization.
bred a very competitive marketplace such that mortgage funding spreads
The gross interest on the mortgage portfolio
tightened to levels not seen since 2007. This reduced the profitability of
is dependent both on the size of the portfolio
the Company’s operations. However, toward the end of 2018, economic
of mortgages pledged under securitization, as
worries resurfaced, and interest rates fell. Mortgage lenders pulled back and
well as mortgage rates. Because mortgage rates
mortgage spreads widened by about 0.30%. This had a significant positive
and MUA have both increased, revenue has also
effect on the value of the Company’s operations. This trend is evident in
increased. Net income is partially dependent on
conditions in bond markets, which affect the
the Pre-FMV EBITDA figures above. In the first quarter of 2019, Pre-FMV
EBITDA was at its lowest in the two-year period, as tighter spread 2018
value of gains and losses on financial instruments
originated mortgages were securitized and placed. Combined with lower
arising from the Company’s interest rate hedging
origination volumes typically experienced in the first quarter of each year,
program. Accordingly, the movement of this
profitability was low. This trend reversed in the second quarter of 2019, as
measurement between quarters is related to
the Company was able to take advantage of wider mortgage spreads and
factors external to the Company’s core business.
increased profitability. In the third quarter of 2019, the Company shifted its
By removing this volatility and analyzing
mortgage funding strategy to use more institutional placements instead of
Pre-FMV EBITDA, management believes a more
securitization, which accelerated the recognition of the value inherent in the
appropriate measurement of the Company’s
mortgages originated, leading to the large increase in earnings in the quarter.
performance can be assessed.
OUTSTANDING SECURITIES OF THE CORPORATION
At December 31, 2019, and February 24, 2020, 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; 175,000 April 2020 senior unsecured notes; and 200,000 November
2024 senior unsecured notes outstanding.
SELECTED ANNUAL FINANCIAL INFORMATION AND RECONCILIATION TO PRE-FMV EBITDA(1)
($000s, except per share amounts)
For the year ended December 31,
INCOME STATEMENT HIGHLIGHTS
Revenue
2019
2018
2017
1,326,523
1,181,510
1,078,768
Interest expense – securitized mortgages
(739,071)
(646,069)
(511,939)
(83,260)
(227,739)
(193,032)
Brokerage fees
Salaries, interest and other operating expenses
Add (deduct): realized and unrealized losses (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
(102,596)
(238,926)
9,655
(4,300)
251,285
(4,217)
(75,354)
(3,162)
(4,000)
225,186
(4,931)
(5,355)
7,162
(64,500)
(60,990)
177,213
144,421
2.90
2.41
166,427
171,407
2.73
2.86
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(56,259)
—
234,278
(5,135)
56,259
(75,750)
209,652
184,400
3.42
3.08
Total long-term financial liabilities
$374,025
$174,829
$174,693
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.
$37,685,593
$36,037,127
$32,776,278
FIRST NATIONAL FINANCIAL CORPORATION 2019 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
2019, MUA totalled $111.4 billion, up from $106.2 billion at December 31, 2018,
lead the non-bank mortgage lending industry in
an increase of 5%. The growth of MUA in the fourth quarter of 2019 from
Canada, while appropriately managing risk. The
September 30, 2019, on an annualized basis was 3%.
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 2019, the Company’s single-
family origination increased across most of the country. The Company
believes this is the result of a strong economy coupled with lower mortgage
rates and First National’s market share in the mortgage broker distribution
channel. All of the Company’s sales offices experienced growth: Toronto
(17%), Vancouver (1%), Calgary (2%) and Montreal (6%). In aggregate, the
Company’s single-family origination grew by 11% in 2019. The commercial
segment had a record year in 2019, increasing volume by 19% to $7.4 billion
in 2019 compared to $6.2 billion in 2018. Together, overall new origination for
2019 increased 13% year over year.
KEY PERFORMANCE DRIVERS
Third-Party Mortgage Underwriting and Fulfilment Processing Services
In 2015, the Company launched its third-party underwriting and fulfilment
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. In late 2019, the Company entered into a
similar agreement with another Canadian bank.
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Relaunch of Excalibur Mortgage Products
Preferred Share Issuance
In April 2018, the Company relaunched its alternative single-family
Effective April 1, 2016, the Company reset the
(“Excalibur”) mortgage products. Alternative lending describes single-
dividend rate on the 2,887,147 Class A Series 1
family residential mortgages that are originated using broader underwriting
preference shares issued in 2011 that did not elect
criteria than those applied in originating prime mortgages. Alternative
to convert to Class A Series 2 preference shares.
borrowers are generally considered “A” quality borrowers in terms of their
The Series 1 shares provide an annual dividend
credit histories, but do not qualify for a prime mortgage because of non-
rate of 2.79%. Also, effective April 1, 2016, 1,112,853
conformities, such as the degree of income disclosure and verification
Class A Series 2 were issued on the conversion
required. The Excalibur program also includes a product for borrowers with
from Series 1 shares. These bear a floating rate
recently remediated credit. These mortgages generally have higher interest
dividend calculated quarterly based on the
rates than prime mortgages. Although the Company’s original alternative
90-day T-Bill rate. Both the Series 1 and Series 2
program was discontinued in 2008 as a result of the credit crisis, First
shares pay quarterly dividends, subject to Board
National’s relationships with mortgage brokers and underwriting systems
of Director approval, and are redeemable at the
allowed it to seamlessly relaunch the product in the spring of 2018. The
discretion of the Company such that after the
product has been originated primarily for placement with institutional
five-year term ending on March 31, 2021, the
investors, but beginning in April 2019, the Company finalized an agreement
Company can choose to extend the shares for
with a bank-sponsored securitization conduit to fund a portion of the
another five-year term at a fixed spread (2.07%)
Excalibur origination. The Excalibur relaunch was rolled out gradually,
over the relevant index (five-year Government of
beginning in Ontario. Currently the program is open to include all Ontario
Canada bond yield for any Series 1 shares or the
brokers, with a potential expansion to western Canada later in 2020.
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.
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RAISING CAPITAL FOR OPERATIONS
Bank Credit Facility
The Company has a revolving line of credit with a syndicate of banks of
$1.25 billion. This facility enables the Company to fund the large amounts of
mortgages accumulated for securitization. In the second quarter of 2019,
the Company extended the term of the facility by one year such that the
maturity is now March 2024. 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.
Note Issuance
On November 25, 2019, the Company issued 200,000 3.582% Series 2 senior
unsecured notes for a five-year term pursuant to a private placement under
an offering memorandum. The net proceeds of the offering, after broker
commissions, of $199.3 million were loaned to FNFLP. On settlement, the
proceeds were used to pay down a portion of the indebtedness under the
bank credit facility. The Company plans to draw on the bank credit facility
to repay the existing 4.01% $175 million Series 1 note when it matures in
April 2020. Effectively the new note issuance has increased the Company’s
leverage by $25 million, as $175 million has been earmarked for paying off
the older note on maturity.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT
EMPLOYING SECURITIZATION
TRANSACTIONS TO MINIMIZE
FUNDING COSTS
Approval as Both an Issuer of NHA-MBS and
Seller to the Canada Mortgage Bonds Program
debt decreased rapidly at the end of 2018 and the first quarter of 2019.
Despite the lower funding rates in the first quarter of 2019, mortgage rates
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 Canada Mortgage Bonds (“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.
Period
2006
2007
2008
2009–2016
2017–2018
2019
Average five-year mortgage
spread for the period
1.12%
1.50%
2.68%
1.77%
1.36%
1.42%
did not fall, as lenders delayed reducing profit margins in an unsettled
economy. With competitive pressures in the second and third quarter of
2019, spreads tightened but remained relatively wider than spreads in 2018.
In 2019, the Company originated and renewed for securitization purposes
approximately $7.2 billion of single-family mortgages and $1.7 billion of
multi-unit residential mortgages. In 2019, the Company securitized through
NHA-MBS approximately $6.6 billion of single-family mortgages and $0.9
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 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 CHT under one allocation. The available guarantees to be
allocated were increased to accommodate issuance to CHT and continue
to exceed the Company’s current needs. CMHC also modified the tiered
NHA-MBS guarantee fee pricing structure, increasing the issuance threshold
for increased fees to $9.0 billion. The tiered limit of $9.0 billion remains
unchanged for 2020. On December 31, 2019, CMHC announced that for
NHA-MBS pools issued after July 1, 2020, guarantee fees will be increased.
The Company estimates that the increase translates to an additional annual
The table shows an average spread of 1.12%
cost of funding of 0.05% per year for its NHA-MBS program.
in 2006. With the credit crisis, this spread
ballooned to as high as 3.46% in 2008. Between
2009 and 2013, liquidity issues at financial
institutions diminished and the competition for
mortgages increased such that spreads remained
consistently higher than pre-crisis levels. In 2014,
more competitive pressures took mortgage rates
lower and compressed mortgage spreads to
2007 levels; however, in 2015, mortgage spreads
quickly widened as a slowdown in economic
growth and the Bank of Canada rate cut reduced
bond yields dramatically. This trend continued
into 2016, as optimism about the economy was
mixed such that spreads remained at levels
in excess of 1.8%. In 2017 and 2018, economic
information was favourable, and competition was
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
their desire to participate. As a result, CHT has created guidelines through
CMHC that limit the amount that can be sold by each seller into the CMB
each quarter. The Company is subject to these limitations. In 2019, the
Company, through its subsidiary First National Asset Management Inc.
(“FNAM”), also took advantage of funding provided by the CMB, issuing
12 NHA-MBS pools totalling $131 million and securitizing those pools in the
strong such that spreads were the tightest seen
CMB program.
in the past decade, falling to 1.10% in the third
quarter of 2018. With renewed worries about
global economics, interest rates on government
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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
amortization, 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 by
• Dividend payout ratio.
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,
2019
December 31,
2018
December 31,
2019
December 31,
2018
342,138
66,593
61,766
312,039
44,050
55,780
1,326,523
241,713
251,285
1,181,510
227,417
225,186
37,685,593
36,038,527
37,685,593
36,038,527
Mortgages under administration
111,378,891
106,151,363
111,378,891
106,151,363
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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.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Determination of Common Share Dividend Payout Ratio
($000s)
FOR THE PERIOD
QUARTER ENDED
YEAR ENDED
December 31,
2019
December 31,
2018
December 31,
2019
December 31,
2018
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)
48,230
58,968
28,984
122%
60%
66%
31,465
88,202
28,235
280%
90%
72%
174,156
144,421
163,499
171,407
114,437
111,440
83%
66%
64%
105%
68%
70%
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, 2019, the
mortgages pledged for securitization. Accordingly, management does not
0
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common share payout ratio was 83% compared
consider this revenue to be available for dividend payment. If the gains
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to 105% in 2018. However, in November of both
and losses on financial instruments in the two years are excluded from the
2019 and 2018, the Company declared a special
above calculations, the dividend payout ratio for 2019 would have been 64%
dividend, which represented the distribution
compared to 70% in 2018.
The Company also paid $3.1 million of dividends on its preferred shares in
2019 compared to $2.9 million in 2018.
of excess retained earnings not required for
Company growth initiatives. Including such
dividends distorts the payout ratios. If the special
dividends are excluded from the calculation, the
payout ratios would have been 66% in 2019 and
68% in 2018. In both 2019 and 2018, the Company
recorded gains and losses on account of the
changes in fair value of financial instruments.
The gains and losses are recorded in the period
in which the prices on Government of Canada
bond yields change; however, the offsetting
economic impact is largely to be reflected in
narrower/wider spreads in the future from the
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 are
earn net interest margin on such transactions. Upon the recognition of a
allocated from one funding source to another
deferred placement fee, the Company establishes a “deferred placement fee
depending on market conditions and strategic
receivable” that is amortized as the fees are received by the Company. Of
considerations related to maintaining diversified
the Company’s $28.5 billion of new originations and renewals in 2019, $18.6
funding sources. The Company retains servicing
billion was placed with institutional investors.
rights on virtually all the mortgages it originates,
which provide the Company with servicing
fees to complement revenue earned through
originations. For the year ended December
31, 2019, new origination volume increased
from $18.5 billion to $21.0 billion, or about 13%,
compared to 2018.
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
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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
$28.5 billion of new originations and renewals
in 2019, $8.9 billion was originated for its own
securitization programs.
The Company services virtually all mortgages generated through its
mortgage origination activities on behalf of a wide range of institutional
investors. Mortgage servicing and administration is a key component of the
Company’s overall business strategy and a significant source of continuing
income and cash flow. In addition to pure servicing revenues, fees related
to mortgage administration are earned by the Company throughout the
mortgage term. Another aspect of servicing is the administration of funds
held in trust, including borrowers’ property tax escrows, reserve escrows
and mortgage payments. As acknowledged in the Company’s agreements,
any interest earned on these funds accrues to the Company as partial
compensation for administration services provided. The Company has
negotiated favourable interest rates on these funds with the chartered
banks that maintain the deposit accounts, which has resulted in significant
additional servicing revenue.
In addition to the interest income earned on securitized mortgages and
deferred placement fees receivable, the Company also earns interest income
on mortgage-related assets, including mortgages accumulated for sale or
securitization, mortgage and loan investments and purchased mortgage
servicing rights.
The Company provides underwriting and fulfilment processing services
to a mortgage originator using the mortgage broker distribution channel.
The Company earns a fee based on the dollar value of funded mortgages.
These fees are recognized at the time a mortgage funds and are included in
“mortgage servicing income” in the consolidated statement of income.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT RESULTS OF OPERATIONS
The following table shows the volume of mortgages originated by First National and mortgages under administration for the
periods indicated:
($ 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
QUARTER ENDED
YEAR ENDED
December 31,
2019
December 31,
2018
December 31,
2019
December 31,
2018
3,624
2,226
5,850
1,409
603
2,760
1,848
4,608
1,322
592
13,523
7,431
20,954
5,504
1,996
12,231
6,237
18,468
6,083
1,338
Total origination and renewals
$7,862
$6,522
$28,454
$25,889
MORTGAGE ORIGINATIONS
BY FUNDING SOURCE
Institutional investors – new residential
Institutional investors – renew residential
Institutional investors – multi/commercial
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NHA-MBS/CMB/ABCP securitization
Internal Company resources/CMBS
2,140
201
1,994
3,185
342
2,446
628
1,873
1,359
216
8,223
3,204
7,153
8,887
987
6,495
2,490
5,957
10,109
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Total
$7,862
$6,522
$28,454
$25,889
MORTGAGES UNDER ADMINISTRATION
Single-family residential
Multi-unit residential and commercial
Total
80,709
30,670
$111,379
79,166
26,985
$106,151
80,709
30,670
$111,379
79,166
26,985
$106,151
Total new mortgage origination volumes increased in 2019 compared to 2018 by 13%. Single-family volumes increased by 11% and
commercial segment volumes increased by 19% year over year. Management believes the increase in the single-family segment
is due to a strong economy coupled with low mortgage rates and the Company’s position in the mortgage broker distribution
channel. With lower risk-free interest rates, mortgage rates offered by the Company have decreased since December 31, 2018.
Accordingly, despite new stress tests implemented as part of revised B-20 guidelines effective in 2019, lower mortgage rates make
it comparatively easier for borrowers to qualify for similar mortgage amounts between the years. The Company believes that
its strong market share in the mortgage broker channel has also led to increased origination. All the Company’s regional offices
experienced growth, particularly in Ontario and the Maritimes, which increased by 17% over comparative volumes in 2018. When
combined with renewals, total production increased from $25.9 billion in 2018 to $28.5 billion in 2019, or by 10%. One part of the
strength in eastern Canada for new single-family origination is partially the result of the relaunch of its Excalibur program. Because
of the successful launch of the product in 2018, the Company was able to quickly establish new origination volume. In 2019, growth
for this program was similar to that of the overall single-family segment. The Company’s expertise in mortgage underwriting drove
commercial segment origination (including renewals) higher by 24% in 2019. Origination for direct securitization into NHA-MBS,
CMB and ABCP programs remained a large part of the Company’s strategy with volume of $8.9 billion in 2019.
Net Interest – Securitized Mortgages
Placement Fees
Comparing the year ended December 31, 2019, to
Placement fee revenue increased by 45% to $205.5 million from
the year ended December 31, 2018, “net interest –
$141.9 million in 2018. The increase was the result of a changing funding
securitized mortgages” decreased by about 4%
mix between the years. In 2019, the Company placed about $18.6 billion of
to $138.6 million from $144.1 million. The decrease
volume with institutional investors compared to $14.9 billion in 2018. The
was largely due to the accounting for financial
increase of 25% drove most of the increase in placement fees. In 2018, a
instruments. Prior to adopting hedge accounting
greater proportion of mortgage origination volume was securitized by the
in 2018, the Company recorded gains and losses
Company such that the value is now being recognized over time through
on financial instruments in its current earnings
net securitization margin. Placement fees on both newly originated and
and earned tighter or wider securitization
renewed single-family mortgages also benefited from the interest rate
spreads in future periods. In both 2017 and
environment. As described previously, the Company does not apply any
2016, the Company recorded very large gains as
hedge accounting for the interest rate risk program related to its single-
interest rates began to climb. The offset to these
family mortgage commitment pipeline. Accordingly, any gains or losses
gains is generally more expensive debt raised on
related to the financial instruments used for this program are recorded
the securitized mortgages. As the securitization
in the Company’s current period net income. To the extent that these
transactions related to these debts performs,
mortgage commitments became funded mortgages, the mortgages may
a lower net securitization margin is recorded.
be more or less valuable given changes in the interest rate environment
The Company estimates that the impact of this
during the commitment period. In the first six months of 2019, bond yields
accounting treatment has decreased net interest
dropped significantly, creating large losses on the financial instruments used
on securitized mortgages in 2019 by about
to economically hedge these commitments. The Company expensed these
$8.3 million year over year. Without this amount,
losses. However, when the mortgage commitments related to these financial
net interest on securitized mortgages increased
instruments transformed into funded mortgages, the mortgage rates on
by 2% between 2018 and 2019, as the Company
these mortgages were significantly higher than mortgage rates currently
increased the amount of mortgages pledged
being offered at the time. The Company was able to immediately crystallize
under securitization.
the value of such mortgages through placement transactions. Effectively,
the Company recouped a portion of the losses on financial instruments
recorded in the first two quarters of 2019 in third-quarter placement
3
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fees. The commercial segment was able to increase placement fees with
increased pricing given demand from its customers. Single-family renewals,
while lower than a year before, were comparatively more valuable to the
Company than those in 2018.
Gains on Deferred Placement Fees
Gains on deferred placement fees revenue decreased 1% to $11.6 million from
$11.7 million. The gains related to multi-unit residential mortgages originated
and sold to institutional investors. Volumes for these transactions decreased
by 6% from 2018, but spreads on these transactions widened year over year.
Mortgage Servicing Income
Mortgage servicing income increased 7% to $156.7 million from
$146.2 million. This increase was largely due to the benefits associated
with higher MUA and the funding shift from securitization to institutional
placements, which effectively moves revenues from net securitization
margin to servicing income.
Mortgage Investment Income
Mortgage investment income decreased 4% to $84.7 million from
$88.3 million. The decrease was due primarily to lower mortgage rates,
which prevailed in 2019 compared to 2018. Generally, five-year closed single-
family mortgage rates fell by about 1% from the peak in 2018 to 2019’s low.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Realized and Unrealized Gains (Losses) on
Financial Instruments
This financial statement line item typically
and the swaps used in its ABCP programs. This decision has reduced the
consists of three components: (1) gains and losses
volatility of gains and losses on financial instruments otherwise recorded in
related to the Company’s economic hedging
the Company’s regular earnings, as gains and losses on hedged items are
activities of single-family commitments, (2)
generally deferred and amortized into income over the term of the related
gains and losses related to holding a portfolio of
mortgages. The Company has not documented a hedging relationship for
mortgage and loan investments at fair value, and
its interest mitigation program used to economically hedge commitments
(3) gains and losses on interest rate swaps used
on single-family mortgages. The Company believes, given the optional
to mitigate interest rate risk associated with its
nature of these commitments, it is difficult to establish a valid hedging
CMB activity. With the adoption of IFRS 9 in 2018,
relationship. For financial reporting purposes, this means that there will still
a significant portion of the Company’s interest
be gains and losses on financial instruments, but these should be limited
rate management program qualifies as hedging
to those on the bonds sold short used to mitigate such risk. The Company
for accounting purposes. The Company has
has recorded mortgage and loan investments at fair value on its balance
elected to document hedging relationships for
sheet. Accordingly, there are fair value gains or losses associated with these
virtually all of the multi-residential commitments
mortgages. The following table summarizes these gains and losses by
and mortgages it originates for its own
category in the periods indicated:
securitization programs. It has also done the
same for the funded single-family mortgages
SUMMARY OF REALIZED AND UNREALIZED
GAINS (LOSSES) ON FINANCIAL INSTRUMENTS
($000s)
Gains (losses) on short bonds used for the
economic hedging program
Losses on mortgages held at fair value
Gains (losses) on interest rate swaps
Net gains (losses) on financial instruments
QUARTER ENDED
YEAR ENDED
December 31,
2019
December 31,
2018
December 31,
2019
December 31,
2018
5,931
(700)
244
5,475
(14,285)
(1,000)
3,569
(11,716)
(8,269)
(4,300)
2,914
(9,655)
5,822
(4,000)
1,340
3,162
In 2018, economic data was generally positive
December 31, 2019; however, about $28.2 million of these losses pertained to
and interest rates began the year climbing
mortgages to which the Company was able to apply hedge accounting. This
slowly higher. However, in the fourth quarter of
left losses on account of financial instruments in earnings of $8.3 million.
2018, poor economic data moved rates lower.
These losses largely reflect the decrease in the value of short bonds used to
Together with the adoption of hedge accounting
mitigate interest rate risk related to the Company’s single-family mortgage
by the Company in 2018, which removes some
commitments. The Company does not attempt to document a hedge
of the volatility from its earnings, First National
relationship on such commitments.
recorded gains on financial instruments of about
$5.8 million related to its short bond hedging
program in 2018. In 2019, economic concerns
had a significant impact on the bond market, as
bond prices rose in the first eight months of the
year until receding toward year end. Overall, the
Company experienced losses of $36.5 million on
its total short bond book during the year ended
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Brokerage Fees Expense
Interest Expense
Brokerage fees expense increased 36% to
Interest expense increased 11% to $77.7 million from $69.9 million. As
$102.6 million from $75.4 million. This increase is
discussed in the “Liquidity and Capital Resources” section of this analysis,
explained by higher origination volumes of prime
the Company warehouses a portion of the mortgages it originates prior to
single-family mortgages for institutional investors,
settlement with the investor or funding with a securitization vehicle. The
which increased by 32% year over year, excluding
Company used senior unsecured notes together with a $1.25 billion credit
Excalibur product. Broker fees on a per unit basis
facility with a syndicate of banks and 30-day repurchase facilities to fund the
were higher in 2019 compared to 2018 by about
mortgages during this period. The overall interest expense increased from
6%, as the Company increased broker loyalty
the prior year due to higher short-term interest rates in 2019 and increased
programs. Commercial segment broker fees were
mortgage origination, which required higher levels of warehouse debt.
15% higher in 2019 when compared to 2018.
Other Operating Expenses
Salaries and Benefits Expense
Other operating expenses decreased by 24% to $47.9 million from
Salaries and benefits expense increased 18% to
$63.0 million. The primary change in other operating expenses was lower
$117.6 million from $99.7 million. Salaries were
hedge expenses, which were $15.9 million less than in 2018. The expense
higher as overall headcount increased by 7% (987
decreased as bond yields moved downward in 2019. With 30-day interest
employees as at December 31, 2018, and 1,058
rates remaining relatively static, it became cheaper to borrow the short
at December 31, 2019). The increase was also
bonds that the Company uses to hedge interest rate exposure. As interest
the result of $9.2 million of higher compensation
rates fell to start 2019, the yield curve became inverted such that short-term
earned by commercial sales staff pursuant to
interest rates exceeded longer-term rates for much of the year. Accordingly,
increased origination in 2019. Management
there was only $2.8 million of costs related to hedging in 2019. Without
salaries were paid to the two senior executives
these costs, other operating expenses increased by $0.8 million, reflecting
(co-founders) who together control about 71%
costs to support the growth of the business and MUA.
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.
5
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Income before Income Taxes and Pre-FMV EBITDA
Income before income taxes increased by 6% to $241.7 million from
$227.4 million. This increase was the result of higher origination and a shift
in funding strategy to a higher proportion of institutional placement. These
results were affected by changing capital markets. In 2019, the Company
recorded $5.4 million of losses on financial instruments (excluding
$4.3 million of losses related to mortgage and loan investments).
Comparatively, in 2018, the Company recorded $7.2 million of gains on
financial instruments (excluding the impact of $4.0 million of losses related
to mortgage and loan investments). The change in these values, excluding
the losses on mortgage investments, accounted for a $12.5 million decrease
in comparative income before income taxes. Pre-FMV EBITDA, which
eliminates the impact of such gains and losses on financial instruments,
increased by 12% to $251.3 million from $225.2 million. As described
previously in this MD&A, not only did the Company increase new origination
volumes by 13%, but it also increased the amount of mortgages placed with
institutional investors. By placing mortgages with investors as opposed to
using securitization, the Company effectively accelerates the recognition of
the value inherent in the mortgages to the current accounting period. With
wider mortgage spreads prevalent for much of 2019, the per unit values of
the placements were more favourable than in 2018. Placement fee revenue
was also affected favourably by a falling interest rate environment. As
the Company committed to mortgages in the first six months of the year,
funding costs decreased, and the value of the mortgages placed increased
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT significantly. The Company had programs to mitigate the
effect of changing interest rates on programs. The losses
related to these instruments were recorded in the first two
quarters of 2019. All together, the value of higher placement
fee revenue, net of the cost of the related broker fees and
additional commercial compensation, increased earnings by
about $27 million year over year, accounting for most of the
increase in Pre-FMV EBITDA.
Income Tax Expense
The provision for taxes increased by 6% to $64.5 million
from $61.0 million. The provision increased proportionately
with net income before income taxes. The overall effective
tax rate was consistent between the two years.
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 $25.1 million of pre-tax net losses on such hedges
in 2019 that would have been recorded as losses on
financial instruments under the previous IFRS standard.
In the year, the Company amortized these losses and a
portion of opening accumulated OCI into regular earnings.
In 2019, $24.7 million of pre-tax OCI was amortized into the
Company’s net income. The remaining OCI amount will be
amortized into net income in future periods.
“2019 results exceeded
management’s
expectations, as
single-family
origination increased
by 11% from the
comparative amount in
2018 and commercial
segment origination
increased by 19%.”
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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 YEAR ENDED
RESIDENTIAL
COMMERCIAL
($000s, except percent amounts)
December 31,
2019
December 31,
2018
December 31,
2019
December 31,
2018
Originations and renewals
19,026,919
18,314,129
9,427,357
7,574,443
Percentage change
Revenue
Percentage change
Income before income taxes
Percentage change
AS AT
Identifiable assets
Mortgages under administration
4%
1,008,013
913,301
10%
171,423
4%
164,897
24%
318,510
19%
70,290
12%
268,209
62,517
December 31,
2019
December 31,
2018
December 31,
2019
December 31,
2018
28,535,288
80,709,370
27,719,231
79,165,363
9,120,529
30,669,521
8,289,520
26,985,711
RESIDENTIAL SEGMENT
COMMERCIAL SEGMENT
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Overall residential origination volumes including renewals increased by
2019 commercial revenues increased by about
4% between 2019 and 2018, while residential revenues increased by 10%.
19% compared to 2018. This increase was the
Revenues in both years were affected by gains and losses on fair value
result of higher origination and interest revenue
associated with changing interest rates. If revenues are normalized for
on the securitized mortgage portfolio that grew
these gains and losses, revenue would have increased by 12%. Revenue
by 15% year over year. Income before income
growth exceeded the growth in origination, as the Company placed a
taxes for this segment was not affected by fair
higher portion of its origination with institutional investors as opposed to
value considerations. This measure increased by
using securitization. Placement transactions accelerate the recognition
12% year over year. The increase is due to the
of the value inherent in a mortgage. Together with a wider spread
higher revenue offset by higher compensation
environment, which increased the value of placement fees on a per unit
payable to the Company’s commercial
basis, residential placement fee revenue increased by 46% year over year.
origination employees. Identifiable assets
Net income before tax was also affected by fair value related amounts.
increased from those at December 31, 2018, as
Without the impact of these revenues, net income before tax increased
the Company increased its investment
from $157.7 million in 2018 to $176.8 million in 2019, or by 12%. This was the
in mortgages pledged for securitization by
result of higher placement fees as described above. The cost of originating
$975 million and mortgage and loan investments
mortgages on a per unit basis was similar year over year such that the
by $150 million. This increase was offset by
additional placement revenue flowed through to increase net income.
a decrease in mortgages accumulated for
Identifiable assets increased from 2018 to 2019, as the Company increased
securitization of $315 million.
its investment in mortgages pledged under securitization by about
$450 million, restricted cash by about $100 million and hedging related
assets by about $215 million.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT LIQUIDITY AND CAPITAL RESOURCES
The Company’s fundamental liquidity strategy
December 31, 2018, and December 31, 2019, and now stands at $353.3 million
has been to invest in prime Canadian mortgages.
(December 31, 2018 – $191.1 million). This represents a debt-to-equity ratio of
Management’s belief has always been that these
approximately 0.63:1. This ratio increased from 0.36:1 at December 31, 2018.
mortgages are considered “AAA” by investors
In general, the increase is due to the Company’s investment in commercial
and should always be well bid and highly liquid.
bridge loans. Toward year end, a number of the Company’s large customers
This strategy proved effective during the turmoil
required financing to transition their real estate portfolios between
experienced in 2007 through 2009, when capital
traditional mortgage financing solutions. In the month of December
markets faltered and only the highest-quality
alone, the Company loaned about $150 million on such opportunities. The
assets were bid. As the Company’s results in
Company believes the ratio is appropriate given the nature of the assets
those years demonstrated, First National had
which the debt is funding.
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 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)
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mortgage and loan investments. The Company
has a credit facility with a syndicate of financial
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institutions for a total credit of $1.25 billion.
This facility was extended in May 2019 for a
five-year term maturing in May 2024. At
December 31, 2019, the Company entered
into repurchase transactions with financial
institutions to borrow $1.1 billion related to
$1.1 billion of mortgages held in “mortgages
accumulated for sale or securitization” on
the balance sheet.
At December 31, 2019, outstanding bank
indebtedness was $797.8 million (December 31,
2018 – $918.3 million). Together with the
unsecured notes of $375 million (December 31,
2018 – $175 million), this “combined debt” was
used to fund $817.5 million (December 31, 2018 –
$902.0 million) of mortgages accumulated
for sale or securitization. At December 30, 2019,
the Company’s other interest-yielding assets
included: (1) deferred placement fees receivable
of $42.0 million (December 31, 2018 –
$41.6 million) and (2) mortgage and loan
investments of $370.4 million (December
31, 2018 – $188.7 million). The difference
between “combined debt” and the mortgages
accumulated for sale or securitization funded
by it, which the Company considers a proxy
for “true leverage”, has increased between
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
government announced it was going to take steps to limit the securitization
of government-insured mortgages to CMHC-sponsored programs. As
ABCP is not sponsored by CMHC, such a limitation does impact the
Company. Almost two years after the announcement, legislation was
passed, and detailed transition information was published. 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 five 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 its ABCP and
NHA-MBS programs, primarily to provide credit enhancements as required
FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
by rating agencies. The most significant portion
Commencing January 1, 2018, the Company has recorded mortgages
of cash collateral is the investment made on
accumulated for sale and mortgage and loan investments as financial assets
behalf of the Company’s ABCP programs. As
measured at “fair value through profit or loss” such that changes in market
at December 31, 2019, the investment in cash
value are recorded in the consolidated statement of income. The mortgages
collateral was $83.6 million (December 31, 2018 –
accumulated for sale are held for very short periods, and any change in value
$75.9 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 March 31, 2010, are
designated as “eligible dividends”. Unless stated
due to changing interest rates is the obligation of the ultimate institutional
investor. Accordingly, the Company believes there will be 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 mortgage terms of 18 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.
otherwise, all dividends (and deemed dividends)
The Company believes its hedging policies are suitably designed such
paid by the Company hereafter are designated as
that the interest rate risk of holding mortgages prior to securitization is
“eligible dividends” for the purposes of such rules.
mitigated. Prior to 2018, the Company did not attempt to adopt hedge
accounting; however, with the introduction of IFRS 9 on January 1, 2018, the
Company began designating hedging relationships such that the results of
any effective hedging will not affect the Company’s statement of income.
See previous discussion in this MD&A under “Realized and Unrealized
9
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Gains (Losses) on Financial Instruments”. As at December 31, 2019, the
Company had about $1.5 billion of notional forward bond positions related
to its single-family programs. For multi-unit residential and commercial
mortgages, the Company assumes all mortgages committed will fund, and
hedges each mortgage individually. This includes mortgages committed for
the CMB program as well as mortgages to be sold to the Company’s other
securitization vehicles. As at December 31, 2019, the Company had entered
into $0.5 billion of notional value forward bond sales for this segment. The
Company is also a 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, 2019, the
aggregate notional value of these swaps, maturing between June 2021 and
September 2026, was $68.4 million. During 2019, the value of these swaps
increased by $2.9 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 channel was more expensive, as credit spreads elsewhere in the
marketplace for this type of mortgage had widened. The Company adjusted
for market-suggested increases in credit spreads in 2007 and 2008 by
adjusting the value of the mortgages downward. In 2009, the economic
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT CAPITAL EXPENDITURES
environment remained weak but did not worsen
A significant portion of First National’s business model consists of the
from the end of 2008. Overall credit spreads
origination and placement or securitization of financial assets. Generally,
stopped widening such that the Company
placement activities do not require much capital investment, as the
applied the same spreads to these mortgages,
Company acts primarily in the capacity of a broker. On the other hand, the
and the Company did not record any additional
undertaking of securitization transactions may require significant amounts
unrealized losses or gains related to credit
of the Company’s own capital. This capital is provided in the form of cash
spread movement. Despite entering into effective
collateral, credit enhancements, and the upfront funding of broker fees and
economic interest rate hedges, the Company’s
other origination costs. These are described more fully in the “Liquidity and
exposure to credit spreads remained. This risk is
Capital Resources” section above. The business requires capital expenditures
inherent in the Company’s business model and
on technology (both software and hardware), leasehold improvements, and
cannot be economically hedged.
office furniture. During the year ended December 31, 2019, the Company
purchased new computer equipment, software and made leasehold
improvements. In the long term, the Company expects capital expenditures
on fixed assets will be approximately $6.0 million annually.
SUMMARY OF CONTRACTUAL OBLIGATIONS
The Company’s long-term obligations include five- to 10-year leases of
premises for its offices across Canada, and its obligations for the ongoing
servicing of mortgages sold to securitization conduits and mortgages
related to purchased servicing rights. The Company sells its mortgages to
securitization conduits on a fully serviced basis and is responsible for the
collection of the principal and interest payments on behalf of the conduits,
including the management and collection of mortgages in arrears.
PAYMENTS DUE BY PERIOD
($000s)
Total 0–1 years
1–3 years 4–5 years
After
5 years
Lease obligations
29,086
7,484
21,602
—
—
The same exposure to risk is inherent in the
Company’s securitization through ABCP. The
Company is exposed to the risk that 30-day
ABCP rates are greater than 30-day BA rates.
Prior to the financial crisis, the Company
considered this a low risk given the quality of
the assets securitized, the amount of credit
enhancements provided by the Company, and
the strong covenant of the bank-sponsored
conduits with which the Company transacted.
In 2008, 30-day ABCP traded at approximately
1.10 percentage points over BAs, but by the end
of June 2011 and continuing through the current
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period, it was priced at a discount to BAs. At
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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,
2019, the Company had various exposures
to changing credit spreads. In particular, in
mortgages accumulated for sale or securitization,
there were almost $1.9 billion of mortgages that
are susceptible to some degree of changing
credit spreads.
CRITICAL ACCOUNTING POLICIES
AND ESTIMATES
The Company prepares its financial statements
mortgages. The method of determining the assumptions underlying the
in accordance with IFRS, which requires
estimates used for the quarter ended December 31, 2019, continue to be
management to make estimates, judgments
consistent with those used for the year ended December 31, 2018, and the
and assumptions that management believes
quarters ended September 30, June 30, and March 31, 2019.
are reasonable based upon the information
available. These estimates, judgments and
assumptions affect the reported amounts
of assets and liabilities and disclosure of
contingent assets and liabilities at the date
of the financial statements, and the 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, 2019. The policies that First
National believes are the most critical to aid in
fully understanding and evaluating its reported
financial results include the determination of the
gains on deferred placement fees and the impact
of fair value accounting on financial instruments.
The Company uses estimates in valuing its gain
or loss on the sale of its mortgages placed
with institutions earning a deferred placement
fee. Under IFRS, valuing a gain on deferred
placement fees requires the use of estimates
to determine the fair value of the retained
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.
On a quarterly basis, the Company reviews the
estimates used to ensure their appropriateness
and monitors the performance statistics of
the relevant mortgage portfolios to adjust
and improve these estimates. The estimates
used reflect the expected performance of
the mortgage portfolio over the lives of the
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 most significant
would be implicit in the valuation of mortgage and loan investments. These
are generally non-homogeneous mortgages and other loans where it is
difficult to find independent valuation comparatives. The Company uses
information in its underwriting files, regional real estate information and
other internal measures to determine the fair value of these assets.
1
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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
expected credit loss (“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.
Disclosure Controls and Internal Controls over Financial Reporting
The Company’s disclosure controls and procedures are designed to
provide reasonable assurance that information required to be disclosed by
the Company in reports filed under Canadian securities laws is recorded,
processed, summarized and reported within the time periods specified
under those laws, and include controls and procedures that are designed to
ensure that information is accumulated and communicated to management,
including the Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure.
As of December 31, 2019, 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 disclosure controls and procedures, as defined by National
Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim
Filings, were effective as of December 31, 2019.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT RISKS AND UNCERTAINTIES AFFECTING THE BUSINESS
Management is responsible for establishing
The business, financial condition and results of operations of the Company
and maintaining adequate internal control over
are subject to a number of risks and uncertainties and are affected by a
financial reporting. Internal control over financial
number of factors outside the control of management of the Company.
reporting is designed to provide reasonable
In addition to the risks addressed elsewhere in this discussion and the
assurance regarding the reliability of financial
financial statements, these risks include: ability to sustain performance
reporting and the preparation of financial
and growth, reliance on sources of funding, concentration of institutional
statements for external purposes in accordance
investors including third-party servicing customers, reliance on
with reporting standards; however, because
independent mortgage brokers, changes in interest rates, repurchase
of its inherent limitations, internal control over
obligations and breach of representations and warranties on mortgage
financial reporting may not prevent or detect
sales, risk of servicer termination including the impact of trigger events
misstatements on a timely basis.
on cash collateral and retained interests, reliance on multi-unit residential
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, 2019,
and that no material weaknesses have been
identified in the Company’s internal control over
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financial reporting as of December 31, 2019. No
changes were made in the Company’s internal
controls over financial reporting during the year
ended December 31, 2019, that have materially
affected, or are reasonably likely to materially
affect, the Company’s internal controls over
financial reporting.
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and commercial mortgages, general economic conditions, legislation and
government regulation (including regulations imposed by the Department
of Finance, CMHC and the policies set by and for mortgage default
insurance companies), potential for losses on uninsured mortgages,
competition, reliance on mortgage insurers, reliance on key personnel and
the ability to attract and retain employees and executives, conduct and
compensation of independent mortgage brokers, failure or unavailability of
computer and data processing systems and software, insufficient insurance
coverage, change in or loss of ratings, impact of natural disasters and other
events, unfavourable litigation, and environmental liability. In addition,
there are risks associated with the structure of the Company, including:
those related to the dependence on FNFLP, leverage and restrictive
covenants, dividends that are not guaranteed and could fluctuate with
the Company’s performance, restrictions on potential growth, the market
price of the Company’s shares, statutory remedies, control of the Company,
and contractual restrictions. The Company is subject to Canadian federal
and provincial income and commodity tax laws and pays such taxes as
it determines are compliant with such legislation. Among the risks of
all potential tax matters, there is a risk that tax legislation changes are
detrimental to the Company or that Canadian tax authorities interpret
tax legislation differently than the Company’s filing positions. Risk and
risk exposure are managed through a combination of insurance, a system
of internal controls and sound operating practices. The Company’s key
business model is to originate primarily prime mortgages and find funding
through various channels to earn ongoing servicing or spread income. For
the single-family residential segment, the Company relies on independent
mortgage brokers for origination and several large institutional investors
for sources of funding. These relationships are critical to the Company’s
success. In October 2019, the sale transaction involving an institution for
which the Company administers a large portfolio of third-party originated
mortgages was completed. The new owners of the institution may decide
not to renew the existing contract with First National or to exercise
termination clauses within the agreement. In the event of non-renewal
or termination, the Company’s MUA will decrease. For a more complete
discussion of the risks affecting the Company, reference should be made to
the Company’s Annual Information Form.
FORWARD-LOOKING INFORMATION
Forward-looking information is included in
forward-looking information contained in this discussion represents
this MD&A. In some cases, forward-looking
management’s expectations as of February 24, 2020, and is subject to
information can be identified by the use of
change after such date. However, management and the Company disclaim
terms such as “may”, “will“, “should”, “expect”,
any intention or obligation to update or revise any forward-looking
“plan”, “anticipate”, “believe”, “intend”, “estimate”,
information, whether as a result of new information, future events or
“predict”, “potential”, “continue” or other similar
otherwise, except as required under applicable securities regulations.
expressions concerning matters that are not
historical facts. Forward-looking information
may relate to management’s future outlook and
Outlook
anticipated events or results, and may include
statements or information regarding the future
2019 results exceeded management’s expectations, as single-family
origination increased by 11% from the comparative amount in 2018 and
financial position, business strategy and strategic
commercial segment origination increased by 19%. Management remains
goals, product development activities, projected
optimistic about 2020, as single-family mortgage commitments have
costs and capital expenditures, financial results,
risk management strategies, hedging activities,
continued to outpace commitments at the same time in 2019. The
commercial segment also anticipates a strong start to 2020, as borrower
geographic expansion, licensing plans, taxes and
appetite continues to be strong following the record fourth quarter of
other plans and objectives of or involving the
Company. Particularly, information regarding
growth objectives, any increase in mortgages
under administration, future use of securitization
vehicles, industry trends and future revenues is
2019. Despite these favourable indications, the Company will continue to
be faced with uncertain securitization margins, as mortgage spreads have
tightened toward the end of 2019 and have not widened in early 2020. The
effect of pre-2018 fair value accounting conventions will continue to have a
negative impact on income in 2020, albeit for a slightly lower amount than
forward-looking information. Forward-looking
in 2019.
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
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and cash flow from its $32 billion portfolio of mortgages pledged under
securitization and $77 billion servicing portfolio and focus on the value
inherent in its significant single-family renewal book.
information is based on certain factors and
assumptions regarding, among other things,
interest rate changes and responses to such
changes, the demand for institutionally placed
and securitized mortgages, the status of the
applicable regulatory regime, and the use of
mortgage brokers for single-family residential
mortgages. This forward-looking information
should not be read as providing guarantees
of future performance or results, and will
not necessarily be an accurate indication of
whether or not, or the times by which, those
results will be achieved. While management
considers these assumptions to be reasonable
based on information currently available to
it, they may prove to be incorrect. Forward-
looking information is subject to certain factors,
including risks and uncertainties, which could
cause actual results to differ materially from
what management currently expects. These
factors include reliance on sources of funding,
concentration of institutional investors, reliance
on independent mortgage brokers, and changes
in interest rates as outlined in the “Risk and
Uncertainties Affecting the Business” section.
In evaluating this information, the reader should
specifically consider various factors, including
the risks outlined in the “Risk and Uncertainties
Affecting the Business” section, which may
cause actual events or results to differ materially
from any forward-looking information. The
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT MANAGEMENT’S RESPONSIBILITY
FOR FINANCIAL REPORTING
The management of First National Financial
preparation of financial statements for external purposes. We evaluated,
Corporation (the “Company”) is responsible
or caused to be evaluated under our supervision, the effectiveness of the
for the integrity, consistency and reliability
of the consolidated financial statements and
Company’s internal control over financial reporting at the financial year end
and the Company has disclosed in its annual MD&A our conclusion about
Management’s Discussion and Analysis (“MD&A”).
the effectiveness of internal control over financial reporting at the financial
The consolidated financial statements have been
year-end based on that evaluation. We have also disclosed in the MD&A any
prepared by Management in accordance with
change in our internal control over financial reporting that occurred during
International Financial Reporting Standards.
the year that has materially affected, or is reasonably likely to materially
We certify that we have reviewed the financial
affect, our internal control over financial reporting.
statements and information contained in the
The Board of Directors oversees that management fulfils its responsibility
MD&A, and, based on our knowledge, they
for financial reporting and internal control. The financial statements have
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do not contain any untrue statement of a
been reviewed by the Audit Committee and approved by the Board of
material fact or omit to state a material fact
Directors. Ernst & Young LLP, the independent auditors appointed by
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required to be stated or that is necessary to
the shareholders, has performed an independent audit of the Company’s
make a statement not misleading in light of the
consolidated financial statements and provide their report which follows.
circumstances under which it was made, with
The auditors have full and free access to, and meet at least quarterly with,
respect to the period covered by the statements
the Audit Committee to discuss their audit and related matters.
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
STEPHEN SMITH
Chairman and Chief Executive Officer
ROBERT INGLIS
Chief Financial Officer
February 24, 2020
INDEPENDENT
AUDITOR’S REPORT
Report on the audit of the
consolidated financial statements
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:
• 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 and, in doing so,
consider whether the other information is materially inconsistent with the
consolidated financial statements or our knowledge obtained in the audit
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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 governance.
Corporation and its subsidiaries (collectively, the
“Company”), which comprise the consolidated
statements of financial position as at
December 31, 2019 and December 31, 2018,
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, 2019 and
December 31, 2018, 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.
Our responsibilities under those standards are
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.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Responsibilities of management and those
charged with governance for the consolidated
financial statements
Management is responsible for the preparation
As part of an audit in accordance with Canadian generally accepted auditing
and fair presentation of the consolidated financial
standards, we exercise professional judgment and maintain professional
statements in accordance with IFRSs, and for
skepticism throughout the audit. We also:
such internal control as management determines
is necessary to enable the preparation of
consolidated financial statements that are free
from material misstatement, whether due to
fraud or error.
• 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
In preparing the consolidated financial
higher than for one resulting from error, as fraud may involve collusion,
statements, management is responsible for
forgery, intentional omissions, misrepresentations, or the override of
assessing the Company’s ability to continue as a
internal control.
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.
Those charged with governance are responsible
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
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Auditor’s responsibilities for the audit of the
may cast significant doubt on the Company’s ability to continue as a
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consolidated financial statements
going concern. If we conclude that a material uncertainty exists, we are
Our objectives are to obtain reasonable
assurance about whether the consolidated
financial statements as a whole are free from
material misstatement, whether due to fraud
or error, and to issue an auditor’s report that
includes our opinion. Reasonable assurance is a
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 modify our opinion. Our conclusions are based on the audit
evidence obtained up to the date of our auditor’s report. However, future
events or conditions may cause the Company to cease to continue as a
going concern.
high level of assurance, but is not a guarantee
• Evaluate the overall presentation, structure, and content of the
that an audit conducted in accordance with
consolidated financial statements, including the disclosures, and whether
the consolidated financial statements represent the underlying
transactions and events in a manner that achieves fair presentation.
Canadian generally accepted auditing standards
will always detect a material misstatement when
it exists. Misstatements can arise from fraud or
error and are considered material if, individually
or in the aggregate, they could reasonably be
expected to influence the economic decisions of
users taken on the basis of these consolidated
financial statements.
• 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 significant audit findings, including
any significant deficiencies in internal control that
we identify during our audit.
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
reasonably be thought to bear on our independence, and
where applicable, related safeguards.
The engagement partner on the audit resulting in this
independent auditor’s report is Andre de Haan.
Toronto, Canada
February 24, 2020
“Our objectives are
to obtain reasonable
assurance about
whether the
consolidated financial
statements as a whole
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are free from material
misstatement.”
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As at December 31
(in thousands of Canadian dollars)
Notes
2019
2018
ASSETS
Restricted cash
Cash held as collateral for securitization
Accounts receivable and sundry
Mortgages accumulated for sale or securitization
Mortgages pledged under securitization
Deferred placement fees receivable
Mortgage and loan investments
Income taxes recoverable
Securities purchased under resale agreements
Other assets
Total assets
LIABILITIES AND EQUITY
Liabilities
Bank indebtedness
Obligations related to securities and mortgages sold under
repurchase agreements
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Accounts payable and accrued liabilities
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Securities sold short
Debt related to securitized mortgages
Senior unsecured notes
Income taxes payable
Deferred tax liabilities
Total liabilities
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
Director
ROBERT MITCHELL
Director
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18
15
7
9
15
16
14
10
12
18
18
17
17
681,596
83,587
131,042
577,096
75,913
150,668
1,918,581
2,204,886
31,995,424
30,567,036
42,046
370,414
—
2,414,835
48,068
41,584
188,666
3,982
2,188,149
39,147
$37,685,593
$36,037,127
797,758
918,347
1,072,062
149,906
2,397,325
1,262,395
106,095
2,183,411
32,245,793
30,781,007
374,025
4,764
82,300
174,829
—
78,800
$37,123,933
$35,504,884
122,671
97,394
345,029
(3,434)
561,660
122,671
97,394
315,294
(3,116)
532,243
$37,685,593
$36,037,127
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31
(in thousands of Canadian dollars, except earnings per share)
Notes
2019
2018
REVENUE
Interest revenue – securitized mortgages
Interest expense – securitized mortgages
Net interest – securitized mortgages
Placement fees
Gains on deferred placement fees
Mortgage investment income
Mortgage servicing income
Realized and unrealized gains (losses) on financial instruments
EXPENSES
Brokerage fees
Salaries and benefits
Interest
Other operating
INCOME BEFORE INCOME TAXES
Income tax expense
Net income for the year
EARNINGS PER SHARE
Basic
See accompanying notes
877,720
790,192
(739,071)
(646,069)
138,649
205,451
11,619
84,670
156,718
(9,655)
144,123
141,887
11,747
88,325
146,197
3,162
$ 587,452
$535,441
102,596
117,575
77,700
47,868
75,354
99,735
69,949
62,986
$345,739
$308,024
241,713
64,500
227,417
60,990
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$177,213
$166,427
2.90
2.73
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FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31
(in thousands of Canadian dollars)
NET INCOME FOR THE YEAR
OTHER COMPREHENSIVE INCOME (LOSS) ITEMS THAT
MAY BE SUBSEQUENTLY RECLASSIFIED TO INCOME
Net gains (losses) from change in fair value of cash flow hedges
Reclassification of net (gains) losses to income
Income tax recovery
Total other comprehensive income
Total comprehensive income
2019
177,213
(25,118)
24,700
(418)
100
(318)
$176,895
2018
166,427
3,210
(7,466)
(4,256)
1,140
(3,116)
$163,311
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
Years ended December 31
(in thousands of Canadian dollars)
Common
shares
Preferred
shares
Retained
earnings
Accumulated other
comprehensive loss Total equity
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BALANCE AS AT JANUARY 1, 2019
122,671
97,394
315,294
(3,116)
532,243
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Other comprehensive loss
Dividends paid or declared
—
—
—
—
—
—
177,213
—
(147,478)
—
177,213
(318)
(318)
—
(147,478)
BALANCE AS AT DECEMBER 31, 2019
$122,671
$97,394
$345,029
$(3,434)
$561,660
Common
shares
Preferred
shares
Retained
earnings
Accumulated other
comprehensive loss
Total equity
BALANCE AS AT JANUARY 1, 2018
122,671
97,394
323,202
Net income for the year
Other comprehensive loss
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
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 taxes
Non-cash portion of gains on deferred placement fees
Increase in restricted cash
Net investment in mortgages pledged under securitization
Net increase in debt related to securitized mortgages
Securities purchased under resale agreements, net
Securities sold short, net
Amortization of deferred placement fees receivable
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
Issuance of senior unsecured notes
Cash used in financing activities
Net decrease (increase) in bank indebtedness during the year
Bank indebtedness, beginning of year
Bank indebtedness, end of year
SUPPLEMENTAL CASH FLOW INFORMATION
Interest received
Interest paid
Income taxes paid
2019
2018
177,213
166,427
3,600
(11,176)
(104,500)
(1,403,327)
1,439,725
(226,686)
258,081
10,714
7,813
(43,200)
108,257
350,440
$458,697
(5,874)
(7,673)
(1,142,162)
956,114
$(199,595)
(147,220)
(190,333)
—
199,040
$(138,513)
120,589
(918,347)
$(797,758)
1,031,267
779,504
52,154
5,190
(11,298)
(15,626)
(2,982,003)
2,910,538
(2,787)
(27,851)
10,987
4,931
29,413
87,921
(425,261)
$(337,340)
(2,632)
(9,500)
(866,787)
1,053,834
$174,915
(174,031)
62,260
(323)
—
$(112,094)
(274,519)
(643,828)
$(918,347)
941,551
668,301
66,973
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FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(in thousands of Canadian dollars,
unless otherwise indicated)
December 31, 2019 and 2018
1. GENERAL ORGANIZATION AND
BUSINESS OF FIRST NATIONAL
FINANCIAL CORPORATION
First National Financial Corporation (the
statements are presented in Canadian dollars and all values are rounded to
“Corporation” or “Company”) is the parent
the nearest thousand except when otherwise indicated. The consolidated
company of First National Financial LP
financial statements were authorized for issue by the Board of Directors on
(“FNFLP”), a Canadian-based originator,
February 24, 2020.
underwriter and servicer of predominantly
prime residential (single family and multi-unit)
and commercial mortgages. With over
$111 billion in mortgages under administration
as at December 31, 2019, FNFLP is a significant
participant in the mortgage broker
distribution channel.
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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,
(B) BASIS OF CONSOLIDATION
The consolidated financial statements comprise the financial statements of
the Company and its subsidiaries, including FNFLP, First National Financial
GP Corporation (“GP”, the general partner of FNFLP), FNFC Trust, a special
purpose entity (“SPE”) that 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.
FNAM is a wholly owned subsidiary of the GP, and an indirect subsidiary of
Toronto, Ontario. The Corporation’s common and
the Company. FNAM is an NHA approved lender and NHA-MBS issuer in the
preferred shares are listed on the Toronto Stock
Exchange under the symbols FN, FN.PR.A and
capacity of an “aggregator”. Its business model is to purchase mortgages
from mortgage originators in order to create NHA-MBS pools, and
FN.PR.B, respectively.
subsequently sell these into the Canada Mortgage Bonds (“CMB”) programs.
2. SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PREPARATION
The Company did not consolidate, in its financial statements, three SPEs
over which the Company does not have control. The SPEs are sponsored
by third-party financial institutions that acquire assets from various sellers,
including mortgages from the Company. The Company earns interest
The consolidated financial statements have
income from the retained interest related to these mortgages. As at
been prepared in accordance with International
December 31, 2019, the Company recorded, on its consolidated statements
Financial Reporting Standards (“IFRS”). The
of financial position, its portion of the assets of the SPEs amounting
consolidated financial statements have been
to $1,275 million (2018 – $801 million). The Company also recorded, in
prepared on a historical cost basis, except for
its consolidated statements of income, interest revenue – securitized
derivative financial instruments and certain
mortgages of $31.4 million (2018 – $27.9 million) and interest expense –
financial assets and financial liabilities that
securitized mortgages of $27.4 million (2018 – $22.3 million) related to its
are recorded at fair value through profit or
interest in the SPEs.
loss (“FVTPL”) and measured at fair value.
The carrying values of recognized assets and
liabilities that are designated as hedged items
in fair value hedges, and that would otherwise
be carried at amortized cost, are adjusted to
record changes in fair value attributable to
the risks that are being mitigated in effective
hedge relationships. The consolidated financial
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 cash flows relating to transactions between these companies
are eliminated in full on consolidation.
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(C) USE OF ESTIMATES
The preparation of consolidated financial
for application of the new standard. As a result of adopting the new
statements in conformity with IFRS requires
standard, the Company recorded a right-of-use asset of $10,859 and a lease
management to make estimates and
liability of $10,859 on January 1, 2019.
assumptions that affect the reported amounts of
assets and liabilities, including contingencies, at
the date of the consolidated financial statements
Financial Instruments
and the reported amounts of revenue and
expenses during the reporting period. Actual
results may differ from those estimates. Major
areas requiring use of estimates by management
The Company accounts for its financial assets and liabilities in accordance
with IFRS – Financial Instruments (“IFRS 9”).
are those that require reporting of financial
Classification and Measurement of Financial Assets
assets and financial liabilities at fair value.
The Company classifies its financial assets as either amortized cost or at
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FVTPL, as summarized below:
(D) SIGNIFICANT ACCOUNTING POLICIES
Changes in Accounting Policies
IFRS 16 – Leases
On January 1, 2019, the Company adopted IFRS
16 – Leases (“IFRS 16”). The Company has elected
to apply IFRS 16 on a modified retrospective
approach, with no restatement of comparative
period results.
The Company has applied the cost method
Securities purchased under resale agreements
Amortized cost
Mortgages accumulated for securitization
Amortized cost
Mortgages accumulated for sale
FVTPL
Mortgages pledged under securitization
Amortized cost
Mortgage and loan investments
FVTPL
Deferred placement fees receivable
Amortized cost
to measure the right-of-use asset. The right-
Classification and Measurement of Financial Liabilities
of-use asset is subsequently amortized using
the straight-line method. If any impairment is
identified, the unamortized balance related to
the impaired asset is charged fully to income.
The lease liability is calculated using the present
value of future lease payment, discounted at
the Company’s incremental borrowing rate.
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
The lease liability is subsequently measured at
Debt related to securitized mortgages
amortized cost.
The Company’s major leases are for premises at
its Toronto head office and four regional offices.
The Company has elected not to recognize right-
of-use assets and a lease liability for its various
office equipment leases, which are insignificant
Servicing liabilities
Senior unsecured notes
FVTPL
FVTPL
Amortized cost
Amortized cost
Amortized cost
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Impairment
Hedge Accounting
The expected credit loss (“ECL”) impairment
On January 1, 2018, the Company commenced IFRS 9 hedge accounting for
model applies to all debt instruments within
certain mortgage commitments and funded mortgages.
financial assets classified as amortized cost or
FVOCI, as well as certain off-balance sheet loan
commitments. 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 31 days past due are
included in Stage 1, whereas mortgages with
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principal in arrears between 31 to 90 days are
included 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
The Company uses a combination of short Government of Canada bonds
and bond repo arrangements to manage exposure to interest rate risk
associated 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 hedge the cash flows
on the anticipated future 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 hedging
strategy when placing mortgages with 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 income. When the hedge relationship is
terminated, the cumulative amounts recognized in OCI are 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.
demand for repayment, there is an expectation
Fair Value Hedges
of a detrimental impact on the estimated cash
flows and, therefore, the Company considers
the mortgages as impaired and includes them in
Stage 3.
The Company’s ECL impairment model is
built on an unbiased and probability-weighted
method, determined by evaluating a range of
The Company enters into interest rate swaps to protect against changes in
the fair value of fixed-rate mortgages funded by 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
possible outcomes supported by past loss events
are funded until the date they are securitized or placed with an arm’s length
and expectation of future possible outcomes,
discounted to reflect the time value of money.
The key inputs in the measurement of ECL
investor. The Company 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
include probability of default, loss given default
or speculative purposes.
and forecast of future economic conditions,
which involve significant judgment.
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 is immediately recorded in regular income.
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Revenue Recognition
The Company earns revenue from placement,
Capitalized origination fees and debt discounts or premiums are amortized
securitization and servicing activities related to
on an effective yield basis over the term of the related mortgages or debt.
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 Company
with servicing fees.
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” arrange-
Interest Revenue and Expense from Mortgages
ment; and either (a) the Company has transferred substantially all the
Pledged under Securitization
The Company enters into securitization
transactions to fund a portion of the mortgages it
has 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 Company continues
to hold the mortgages on its consolidated
statements of financial position, unless:
(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
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.
Placement Fees and Deferred Placement Fees Receivable
The Company enters into placement agreements with institutional investors
to purchase the mortgages it originates. When mortgages are placed
with institutional investors, the Company transfers the contractual right to
receive mortgage cash flows to the investors. Because it has transferred
substantially all 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
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(ii) A significant portion, but not all, of the
are recognized as placement fees. When placement fees and associated
risks and rewards have been transferred.
servicing fees are earned over the term of the related mortgages, the
The asset is derecognized entirely if the
Company determines the present value of the future stream of placement
transferee has the ability to sell the financial
fees and records a gain on deferred placement fees and a deferred
asset; otherwise the asset continues to be
placement fees receivable. Since quoted prices are generally not available
recognized to the extent of the Company’s
for retained interests, the Company estimates values based on the net
continuing involvement.
present value of future expected cash flows, calculated using management’s
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 the 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.
best estimates of key assumptions related to expected prepayment rates
and discount rates commensurate with the risks involved.
Mortgage Servicing Income
The Company services substantially all of the mortgages that it originates,
whether the mortgage is placed with an institutional investor or transferred
to a securitization vehicle. In addition, mortgages are serviced on behalf
of third-party institutional investors and securitization structures. For
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 income
earned by the Company from holding cash in trust related to servicing
activities is classified as mortgage servicing income. The amortization of any
servicing liabilities is also recorded as mortgage servicing income.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT The Company provides underwriting and
Mortgages accumulated for sale are mortgages funded pending subsequent
fulfilment processing services for mortgages
settlement with institutional investors and are classified as FVTPL and
originated by two large Canadian banks through
recorded at fair value. These mortgages are held for terms usually not
the mortgage broker distribution channel. The
exceeding 90 days.
Mortgages Accumulated for Sale or Securitization
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.
Mortgages accumulated for securitization are mortgages funded pending
the arrangement of term debt through the Company’s various securitization
programs and are measured at amortized cost.
Securities Sold Short and Securities Purchased under Resale Agreements
Securities sold short consist typically of the short sale of Government of
Canada bonds. Bonds purchased under resale agreements consist of the
purchase of a bond with the commitment from the Company to resell the bond
to the 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
Brokerage Fees
mortgages that it intends to securitize in subsequent periods.
Brokerage fees are primarily fees paid to
Bonds sold short are classified as FVTPL and are recorded at fair value. The
external mortgage brokers. Brokerage fees
effective yield payable on bonds sold short is recorded as hedge expense
relating to mortgages placed with institutional
in other operating expenses. Bonds purchased under resale agreements are
investors are expensed as incurred, and those
carried at cost plus accrued interest, which approximates their market value.
relating to mortgages recorded at amortized
The difference between the cost of the purchase and the predetermined
cost are capitalized to the carrying cost of the
proceeds to be received on a resale agreement is recorded over the term
related mortgages and amortized over the term
of the hedged mortgages as an offset to hedge expense. Transactions are
of the mortgages.
recorded on a settlement date basis.
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Mortgages Pledged under Securitization
Mortgage and Loan Investments
Mortgages pledged under securitization are
Mortgage and loan investments are non-derivative financial assets with fixed
mortgages that the Company has originated and
or determinable payments, and are classified as FVTPL. The mortgages
funded with debt raised through the securitization
are measured at management’s best estimate of the net realizable value.
markets, and have been classified at amortized
Changes in fair value are recognized immediately in the consolidated
cost. The Company has a continuous involvement
statements of income.
in these mortgages, including the right to receive
future cash flows arising from these mortgages.
Origination costs, such as brokerage fees and bulk
insurance premiums that are directly attributable
to the acquisition of such assets, are deferred and
amortized over the term of the mortgages on an
effective yield basis.
Debt Related to Securitized 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.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost, less accumulated
using management’s best estimates of key
amortization, at the following annual rates and bases:
assumptions related to expected prepayment
rates and discount rates commensurate with
Computer equipment
30% declining balance
the risks involved. The Company earns the
Office equipment
Leasehold
improvements
20% declining balance
related servicing fees over the term of the
mortgages on an effective yield basis.
Straight-line over the term of the lease
Computer software
30% declining balance except for certain computer
licenses, which are straight-line over useful lives
Income Taxes
The Company accounts for income taxes in
accordance with the liability method of tax
Property, plant and equipment are subject to an impairment review if there
allocation. Under this method, the provision for
are events or changes in circumstances that indicate the carrying amount
income taxes is calculated based on income tax
may not be recoverable.
Goodwill
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
Goodwill represents the price paid for the Corporation’s business in excess
income taxes. Current and deferred taxes relating
of the fair value of the net tangible assets and identifiable intangible assets
to items in the Company’s equity are recorded
acquired in connection with the IPO. Goodwill is reviewed annually for
directly against equity.
impairment, or more frequently when an event or change in circumstances
indicates that the asset might be impaired.
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.
Bank Indebtedness
Bank indebtedness consists of bank loans net of cash balances or 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.
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.
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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
settled. Deferred tax assets and liabilities are
offset when they arise in the same tax reporting
group and relate to income taxes levied by the
same taxation authority, and when a legal right
to offset exists in the entity.
Servicing Liability
The Company places mortgages with third-party institutional clients,
Earnings per Common Share
and retains the rights and obligations to service these mortgages. When
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 that 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
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.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 3. MORTGAGES PLEDGED UNDER
SECURITIZATION
The Company securitizes residential and
As part of the ABCP transactions, the Company provides cash collateral for
commercial mortgages in order to raise debt
credit enhancement purposes, as required by the rating agencies. Credit
to fund these mortgages. Most of these
exposure to securitized mortgages is generally limited to this cash collateral.
securitizations consist of the transfer of fixed-
The principal and interest payments on the securitized mortgages are paid
and floating-rate mortgages into securitization
by the Company to the structured entities monthly over the term of the
programs, such as ABCP, NHA MBS, and the
mortgages. The full amount of the cash collateral is recorded as an asset
CMB program. In these securitizations, the
and the Company anticipates full recovery of these amounts. NHA MBS
Company transfers the assets to structured
securitizations may also require cash collateral in some circumstances. As at
entities for cash, and incurs interest-bearing
December 31, 2019, the cash held as collateral for securitization was $83,587
obligations typically matched to the term of the
(2018 – $75,913).
mortgages. These securitizations do not qualify
for derecognition, although the structured entities
and other securitization vehicles have no recourse
to the Company’s other assets for failure of the
mortgages to make payments when due.
The following table compares the carrying amount of mortgages pledged
for securitization and the associated debt:
Securitized mortgages
31,776,442
32,303,342
2019
Carrying amount of
securitized mortgages ($)
Carrying amount of
associated liabilities ($)
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Capitalized amounts related to hedge accounting
Capitalized origination costs
Debt discounts
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Add
Principal portion of payments recorded in restricted cash
43,280
175,702
—
$31,995,424
623,253
$32,618,677
2018
43,418
—
(100,967)
$32,245,793
—
$32,245,793
Securitized mortgages
30,385,005
30,876,519
Carrying amount of
securitized mortgages ($)
Carrying amount of
associated liabilities ($)
Capitalized amounts related to hedge accounting
Capitalized origination costs
Debt discounts
Add
Principal portion of payments held in restricted cash
12,578
169,453
—
$30,567,036
521,690
$31,088,726
18,356
—
(113,868)
$30,781,007
—
$30,781,007
The principal portion of payments held in restricted cash represents payments on account of mortgages pledged under
securitization that 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 and unamortized amounts related to hedge accounting.
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
2019
169,453
85,421
(79,172)
$175,702
2018
141,121
103,222
(74,890)
$169,453
During the year ended December 31, 2019, 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, 2019, of
$7,076,837 (2018 – $7,418,415).
The contractual maturity profile of the
mortgages pledged under securitization
programs is summarized as follows:
2020
2021
2022
2023
3,977,269
4,965,861
6,584,375
7,041,222
ARREARS DAYS
31 to 60
61 to 90
Greater than 90
2019
2018
32,244
5,279
25,683
$63,206
48,902
4,814
16,380
$70,096
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All the mortgages pledged under securitization in arrears are insured,
except for five mortgages that are uninsured and have a total principal
2024 and thereafter
9,207,715
balance of $874 as at December 31, 2019 (2018 – two mortgages, $605).
$31,776,442
The Company’s exposure to credit loss is limited to uninsured mortgages
with principal balances totalling $1,975,154 (2018 – $1,251,236), before
consideration of the value of underlying collateral. The majority of 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. The Company has provided $214 for ECL for the year ended
December 31, 2019 (2018 – nil).
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 4. DEFERRED PLACEMENT FEES
RECEIVABLE
The Company enters into transactions with
paying the Company a fee commensurate with the value of its investment
institutional investors to sell primarily fixed-rate
in the mortgage. The effect of variations, if any, between actual experience
mortgages in which placement fees are received
and assumptions will be recorded in future statements of income but is
over time as well as at the time of the mortgage
expected to be minimal.
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
the commercial segment was used, as borrowers
cannot refinance for financial advantage without
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
own securitization programs are classified
as amortized cost and are recorded at par
plus adjustment for unamortized origination
costs. Mortgages funded for placement with
institutional investors are designated as FVTPL
and are recorded at fair value. The fair values
of mortgages classified as FVTPL approximate
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:
During the year ended December 31, 2019, $2,419,508 (2018 – $2,655,764)
of mortgages were placed with institutional investors, which created gains
on deferred placement fees of $11,619 (2018 – $11,747). Cash receipts on
deferred placement fees receivable for the year ended December 31, 2019,
were $12,655 (2018 – $12,979).
The Company estimates that the expected undiscounted cash flows to be
received on the deferred placement fees receivable will be as follows:
2020
2021
2022
2023
2024 and thereafter
11,688
9,709
7,701
6,039
12,834
$47,971
Mortgages accumulated
for securitization
Mortgages accumulated
for sale
2019
2018
1,884,571
2,170,416
34,010
$1,918,581
34,470
$2,204,886
The Company’s exposure to credit loss is limited to $587,465 (2018 –
$321,341) of principal balances of uninsured mortgages within mortgages
accumulated for securitization, before consideration of the value of
underlying collateral. As at December 31, 2019, none of these mortgages is
in arrears past 31 days. These are primarily conventional prime single-family
mortgages similar to the mortgages described in note 3. Accordingly, the
expected credit loss related to these mortgages is insignificant.
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6. MORTGAGE AND LOAN INVESTMENTS
Mortgage and loan investments consist primarily of commercial first and
The following table discloses the composition
second mortgages held for various terms, the majority of which mature
of the Company’s portfolio of mortgage and
within one year.
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 $4,300 (2018 –
$4,000) for the year ended December 31, 2019.
loan investments by geographic region as at
December 31, 2019:
Province/Territory
Alberta
British Columbia
Manitoba
New Brunswick
Newfoundland and Labrador
Nova Scotia
Nunavut
Ontario
Quebec
Saskatchewan
Yukon
Prince Edward Island
Portfolio balance
Percentage of portfolio
8,163
20,734
11,904
844
717
33,094
105
252,859
41,198
502
249
44
2.20
5.60
3.21
0.23
0.19
8.93
0.03
68.26
11.12
0.14
0.07
0.01
1
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$370,414
100.00%
The following table discloses the mortgages that are past due as at
December 31:
ARREARS DAYS
31 to 60
61 to 90
Greater than 90
2019
5,016
4
34,235
$39,255
2018
4,871
39,232
$44,103
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT The portfolio contains $18,209 (December 31, 2018 – $13,133) of insured mortgages and $352,205 (December 31, 2018 – $175,533)
of uninsured mortgage and loan investments as at December 31, 2019. Of the uninsured mortgages, approximately $35,014
(December 31, 2018 – $39,941) have principal balances in arrears of more than 30 days. Three of these mortgages are non-
performing and the Company has stopped accruing interest. These mortgages had a total original principal balance of $38,825
and are recorded at a fair value of $13,133 as at December 31, 2019 (December 31, 2018 – three mortgages, original principal
balance of $44,001, and fair value of $22,609).
The maturity profile in the table below is based on the earlier of contractual renewal or maturity dates.
2020
2021
2022
2023
2019
2018
2024 and
thereafter Book value
Book value
Residential
Commercial
36,095
8,822
5,039
3,168
18,467
71,591
263,126
27,796
6,887
279
735
298,823
36,527
152,139
$299,221
$36,618
$11,926
$3,447
$19,202
$370,414
$188,666
Interest income earned for the year was $15,065 (2018 – $17,654) and is included in mortgage investment income on the
consolidated statements of income.
7. OTHER ASSETS
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The components of other assets are as follows
The right-of-use assets pertain to five premises leases for the Company’s
as at December 31:
office space across the country. The leases have remaining terms of three
Property, plant and
equipment, net
Right-of-use assets
2019
2018
grouped with accounts payable and accrued liabilities on the consolidated
to five years. The related lease liability of $7,466 as at December 31, 2019, is
statements of financial position.
11,029
7,263
9,371
—
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
Goodwill
29,776
29,776
that the Corporation’s recoverable amount exceeds the carrying value of its
$48,068
$39,147
net assets and accordingly, goodwill is not impaired.
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8. MORTGAGES UNDER ADMINISTRATION
As at December 31, 2019, the Company
companies, pension funds, mutual funds, trust companies, credit unions
managed mortgages under administration of
and securitization vehicles. As at December 31, 2019, the Company
$111,378,891 (2018 – $106,151,363), including
administered 310,415 mortgages (2018 – 306,221) for 108 institutional
mortgages held on the Company’s consolidated
investors (2018 – 111) with an average remaining term to maturity of 40
statements of financial position. Mortgages
months (2018 – 40 months).
under administration are serviced for
financial institutions such as banks, insurance
Mortgages under administration are serviced as follows:
Institutional investors
Mortgages accumulated for sale or securitization and
mortgage and loan investments
Mortgages pledged under securitization
CMBS conduits
2019
76,040,779
2,306,608
31,776,442
1,255,062
$111,378,891
2018
72,209,810
2,387,285
30,385,005
1,169,263
$106,151,363
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 these
in note 3 and uninsured mortgages held in
funds, they are not presented on the consolidated statements of financial
mortgages accumulated for securitization as
position. The aggregate of these accounts as at December 31, 2019, was
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described in note 5. As at December 31, 2019,
$690,394 (2018 – $630,166).
the Company has included in accounts receivable
and sundry $156 (2018 – $86) of uninsured
non-performing mortgages.
9. BANK INDEBTEDNESS
10. DEBT RELATED TO SECURITIZED MORTGAGES
Bank indebtedness includes a revolving credit
Debt related to securitized mortgages represents the funding for mortgages
facility of $1,250,000 (2018 – $1,250,000)
pledged under the NHA-MBS, CMB and ABCP programs. As at December 31,
maturing in March 2024. At December 31, 2019,
2019, debt related to securitized mortgages was $32,245,793 (2018 –
$797,758 (2018 – $918,347) was drawn, of which
$30,781,007), net of unamortized discounts of $100,967 (2018 – $113,868).
the following have been pledged as collateral:
A comparison of the carrying amounts of the pledged mortgages and the
(a) A general security agreement over all assets,
related debt is summarized in note 3.
other than real property, of the Company; and
Debt related to securitized mortgages is reduced on a monthly basis when
(b) A general assignment of all mortgages
owned by the Company.
The credit facility bears a variable rate of interest
based on prime and bankers’ acceptance rates.
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.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 11. SWAP CONTRACTS
Swaps are over-the-counter contracts in which
interest rate swaps where two counterparties exchange a series of
two counterparties exchange a series of cash
payments based on different interest rates applied to a notional amount in
flows based on agreed-upon rates to a notional
a single currency.
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
The following tables present, by remaining term to maturity, the notional
amounts and fair values of the swap contracts outstanding as at December 31,
2019 and 2018:
Less than 3 years
3 to 5 years
6 to 10 years
Total
notional amount
Fair value
2019
$2,560,603
$1,122,379
$32,442
$3,715,424
$18,402
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
Interest rate
swap contracts
Interest rate
swap contracts
Favourable fair values of the interest rate swap contracts are included in accounts receivable and sundry, and unfavourable fair
values are included in accounts payable and accrued liabilities on the consolidated statements of financial position.
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12. SENIOR UNSECURED NOTES
On April 9, 2015, the Company issued $175 million
On November 25, 2019, the Company issued $200 million Series 2 senior
Series 1 senior unsecured notes for a five-year
unsecured notes for a five-year term pursuant to a private placement under
term maturing on April 9, 2020. The notes bear
an offering memorandum. The notes bear interest at 3.582% payable in
interest at 4.01% payable in equal semi-annual
equal semi-annual payments commencing May 25, 2020. On settlement,
payments commencing October 9, 2015. The net
the net proceeds of the offering ($199.3 million, net of financing fees) were
proceeds of the issuance ($174.3 million, net of
loaned to FNFLP.
financing fees) have been invested in FNFLP.
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13. COMMITMENTS, GUARANTEES AND
CONTINGENCIES
days. These commitments have credit and interest rate risk profiles similar
As at December 31, 2019, the Company has the
to those mortgages that are currently under administration. Certain of
following operating lease commitments for its
these commitments have been sold to institutional investors, while others
office premises:
will expire before being drawn down. Accordingly, these amounts do not
2020
2021
2022
2023 and thereafter
7,484
7,255
8,004
6,343
$29,086
necessarily represent future cash requirements of the Company. A portion of
the Company’s commitments for premises listed above have been accounted
in right-of-use assets and recorded as other assets on the consolidated
statements of financial position.
In the normal course of business, the Company enters into a variety of
guarantees. Guarantees include contracts where the Company may be
required to make payments to a third party, based on changes in the value
of an asset or liability that the third party holds. In addition, contracts under
which the Company may be required to make payments if a third party fails
Outstanding commitments for future advances
to perform under the terms of the contract (such as mortgage servicing
on mortgages with terms of one to 10 years
amounted to $1,446,303 as at December 31,
2019 (2018 – $1,192,677). The commitments
generally remain open for a period of up to 90
contracts) are considered guarantees. The Company has determined that
the estimated potential loss from these guarantees is insignificant.
14. SECURITIES TRANSACTIONS UNDER
REPURCHASE AND RESALE AGREEMENTS
15. OBLIGATIONS RELATED TO SECURITIES AND MORTGAGES
SOLD UNDER REPURCHASE AGREEMENTS
The Company’s outstanding securities purchased
The Company uses repurchase agreements to fund specific mortgages
under resale agreements and securities sold
included in mortgages accumulated for sale or securitization. The current
under repurchase agreements have a remaining
contracts are with financial institutions, are based on bankers’ acceptance
5
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term to maturity of less than three months.
rates and mature on or before January 31, 2020.
16. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
The major components of accounts payable and accrued liabilities are as follows as at December 31:
Accrued liabilities
Accrued dividends payable
Accrued interest on securitization debt
Servicing liability
Lease liability
2019
52,748
10,508
58,225
20,959
7,466
2018
20,088
10,249
57,777
17,981
—
$149,906
$106,095
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 17. SHAREHOLDERS’ EQUITY
(a) Authorized
Unlimited number of common shares
Holders of the Class A Series 1 Preferred Shares receive a cumulative
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
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 Preferred Shares is 2.79% annually for a new five-
year term ending March 31, 2021.
(b) Capital Stock
Balance, December 31, 2019 and 2018
Holders of the Class A 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 declared
by the Board of Directors.
Common shares
59,967,429
$122,671
The par value per preferred share is $25.
#
$
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.
Preferred shares
4,000,000
$97,394
(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, 2019, and
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.
(d) Earnings per Share
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
2019
2018
177,213
166,427
(3,057)
(2,928)
174,156
163,499
59,967,429
59,967,429
$2.90
$2.73
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18. INCOME TAXES
The major components of deferred provision for
The major components of the current income tax expense for the years
income taxes for the years ended December 31
ended December 31 consists of the following:
consist of the following:
Related to origination
and reversal of timing
differences
Increase (decrease)
in future tax rates
2019
2018
2019
2018
3,769
4,857
(169)
333
$3,600
$5,190
Income taxes relating to the
current year
Income taxes related to the
prior year
60,900
56,100
—
(300)
$60,900
$55,800
The effective income tax rate reported in the consolidated statements of income varies from the Canadian tax rate of 26.61% for
the year ended December 31, 2019 (2018 – 26.64%) for the following reasons:
COMPANY’S STATUTORY TAX RATE
Income before income taxes
Income tax at statutory tax rate
Increase (decrease) resulting from
Permanent differences
Changes in future tax rates
Tax recovery from prior years
Other
INCOME TAX EXPENSE
2019
26.61%
241,713
64,320
345
(169)
—
4
2018
26.64%
227,417
60,584
316
333
(300)
57
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$64,500
$60,990
The movement in significant components of the Company’s deferred income tax liabilities and assets for the years ended
December 31, 2019 and 2018 are as follows:
As at
January 1, 2019
Recognized
in income and OCI
As at
December 31, 2019
DEFERRED INCOME TAX
Deferred placement fees receivable
Deferred costs – securitization
Unrealized gains on interest rate swaps
Other
Right-of-use asset
Lease liability
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
11,078
75,370
5,885
64
2,890
(2,890)
(424)
(4,261)
(4,790)
(4,122)
$78,800
111
(2,621)
7,469
441
(957)
903
(157)
303
(787)
(1,205)
$3,500
11,189
72,749
13,354
505
1,933
(1,987)
(581)
(3,958)
(5,577)
(5,327)
$82,300
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT The amount of deferred tax expense recorded in income and OCI consists of $3,600 recorded in net income and a recovery of
$100 recorded in OCI related to unrealized losses on cash flow hedges.
As at
January 1, 2018
Recognized
in income and OCI
As at
December 31, 2018
DEFERRED INCOME TAX
Deferred placement fees receivable
Deferred costs – securitization
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
58,916
17,866
77
(446)
(4,561)
(5,006)
(3,042)
$74,750
132
16,457
(11,981)
(13)
22
300
216
(1,080)
$4,050
11,078
75,370
5,885
64
(424)
(4,261)
(4,790)
(4,122)
$78,800
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.
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 income tax balances, and the change could be significant.
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19. FINANCIAL INSTRUMENTS AND
RISK MANAGEMENT
Risk Management
The various risks to which the Company is
or sale to an institutional investor. Primary among these strategies is the
exposed and the Company’s policies and
Company’s decision to sell mortgages at the time of commitment, passing
processes to measure and manage them
on interest rate risk that exists prior to funding to institutional investors.
individually are set out below:
The Company uses synthetic bond forwards (consisting of bonds sold
Interest Rate Risk
short and bonds purchased under resale agreements) to manage interest
rate exposure between the time a mortgage rate is committed to the
borrower and the time the mortgage is sold to a securitization vehicle and
Interest rate risk is the risk that the fair value or
the underlying cost of funding is set. As interest rates change, the values of
future cash flows of a financial instrument will
these interest-rate-dependent financial instruments vary inversely with the
fluctuate because of changes in market interest
values of the mortgage contracts. As interest rates increase, a gain will be
rates. The Company’s exposure to the risk of
recorded on the economic hedge, which will be offset by the reduced future
changes in market interest rates relates primarily
spread on mortgages pledged under securitization as the mortgage rate
to the Company’s mortgages accumulated for
committed to the borrower is fixed at the point of commitment.
securitization.
The Company uses various strategies to
reduce interest rate risk. The Company’s risk
management objective is to maintain interest
rate spreads from the point that a mortgage
commitment is issued to the transfer of the
mortgage to the related securitization vehicle
For single-family mortgages, only a portion of the commitments issued by
the Company eventually fund. The Company must assign a probability of
funding to each mortgage in the pipeline and estimate how that probability
changes as mortgages move through the various stages of the pipeline. The
amount that is actually economically hedged is the expected value of the
mortgages funding within the future commitment period.
Liquidity Risk and Capital Resources
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.
in 2019 and 2018.
100 BASIS POINT SHIFT
Decrease in
interest rate(1)
Increase in
interest rate
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
2019
2018
2019
2018
Company’s credit facilities are typically drawn
to fund: (i) mortgages accumulated for sale or
securitization, (ii) origination costs associated
Impact on net income
$5,909
$4,816 $(5,909)
$(4,816)
with mortgages pledged under securitization,
200 BASIS POINT SHIFT
Impact on net income
$12,069
$9,632 $(11,818)
$(9,632)
(1) Interest rate is not decreased below 0%.
Credit Risk
Credit risk is the risk of loss associated with a counterparty’s inability or
unwillingness to fulfil 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, 2019, 94% (2018 – 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
mortgage is held by the Company prior to securitization.
(iii) cash held as collateral for securitization,
(iv) costs associated with deferred placement
fees receivable, (v) accounts receivable and
sundry, and (vi) mortgage and loan investments.
The Company has a credit facility with a
syndicate of 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.
9
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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
Market Risk
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
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
priority ranking of the Company’s rights mitigate the potential size of any
interest rates and credit spreads.
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.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Customer Concentration Risk
Placement fees and mortgage servicing income
(c) Securities Owned and Sold Short
from one Canadian financial institution represent
approximately 8.7% (2018 – 9.0%) of the
Company’s total revenue.
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
Fair Value Measurement
The fair value of the servicing liability is determined by internal valuation
The Company uses the following hierarchy for
models using market data inputs, where possible. The fair value is
determining and disclosing the fair value of
determined by discounting the expected future cost related to the servicing
financial instruments recorded at fair value in the
of explicit mortgages at market interest rates. The expected future cash
consolidated statements of financial position:
flows are estimated based on certain assumptions that are not supported by
Level 1 – quoted market price observed in active
observable market data.
markets for identical instruments;
(e) Other Financial Assets and Financial Liabilities
Level 2 – quoted market price observed in active
The fair value of mortgages accumulated for sale, cash held as collateral
markets for similar instruments or other valuation
for securitization, restricted cash and bank indebtedness correspond to the
techniques for which all significant inputs are
respective outstanding amounts due to their short-term maturity profiles.
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
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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.
(f) Fair Value of Financial Instruments Not Carried at Fair Value
The fair value of these financial instruments is 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 that 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.
The valuation methods and key assumptions
Carrying Value and Fair Value of Selected Financial Instruments
used in determining fair values for the financial
assets and financial liabilities are as follows:
The fair value of the financial assets and financial liabilities of the
Company approximates its carrying value, except for mortgages pledged
(a) Mortgages and Loan Investments
under securitization, which has a carrying value of $31,995,424 (2018 –
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 estimate of the
net realizable value.
$30,567,036) and a fair value of $32,831,505 (2018 – $31,071,851); debt
related to securitized mortgages, which has a carrying value of $32,245,793
(2018 – $30,781,007) and a fair value of $31,831,691 (2018 – $30,592,827);
and senior unsecured notes, which have a carrying value of $374,025
(2018 – $174,829) and a fair value of $375,916 (2018 – $175,856). These
fair values are estimated using valuation techniques in which one or more
(b) Deferred Placement Fees Receivable
significant inputs are unobservable (Level 3).
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 that are not supported
by observable market data.
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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
Mortgage and loan investments
Interest rate swaps
Total financial assets
FINANCIAL LIABILITIES
Securities sold short
Interest rate swaps
Total financial liabilities
2019
Level 1
Level 2
Level 3
Total
—
—
—
—
—
—
34,010
—
34,010
—
370,414
370,414
29,970
—
29,970
$63,980
$370,414
$434,394
2,397,325
1,870
—
—
2,397,325
1,870
— $2,399,195
— $2,399,195
2018
Level 1
Level 2
Level 3
Total
—
—
—
—
—
—
—
34,470
—
34,470
1
6
—
188,666
188,666
51,410
—
51,410
$85,880
$188,666
$274,546
2,183,411
4,784
$2,188,195
—
—
—
2,183,411
4,784
$2,188,195
In estimating the fair value of financial assets and
December 31, 2019, that was estimated using a valuation technique based
financial liabilities using valuation techniques or
on assumptions that are not fully supported by observable market prices
pricing models, certain assumptions are used,
or rates was approximately a loss of $4,300 (2018 – $4,000). Although
including those that are not fully supported by
the Company’s management believes that the estimated fair values are
observable market prices or rates (Level 3). The
appropriate as at the date of the consolidated statements of financial
amount of the change in fair value recognized by
position, those fair values may differ if other reasonably possible alternative
the Company in net income for the year ended
assumptions are used.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT Transfers between levels in the fair value hierarchy
The following table presents changes in the fair values, including realized
are deemed to have occurred at the beginning
losses of $74,832 (2018 – gains of $32,942) of the Company’s financial
of the period in which the transfer occurred.
assets and financial liabilities for the years ended December 31, 2019 and
Transfers between levels can occur as a result of
2018, all of which have been classified as FVTPL:
additional or new information regarding valuation
inputs and changes in their observability. During
2019 and 2018, the Company did not have any
transfers between levels.
FVTPL mortgages
Securities sold short
Interest rate swaps
2019
(4,300)
(8,270)
2,915
$(9,655)
2018
(4,000)
5,822
1,340
$3,162
The Company does not have any assets or liabilities that are measured at fair value on a non-recurring basis.
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, 2019 and 2018. The Company classifies financial instruments to Level 3 when there is reliance on at least one
significant unobservable input in the valuation models.
Fair value as at
January 1, 2019
Investments
Unrealized loss
recorded in income
Payment and
amortization
Fair value as at
December 31, 2019
FINANCIAL ASSETS
Mortgage and
loan investments
FINANCIAL ASSETS
Mortgage and
loan investments
$188,666
$241,646
$(4,300)
$(55,598)
$370,414
Fair value as at
January 1, 2018
Investments
Unrealized loss
recorded in income
Payment and
amortization
Fair value as at
December 31, 2018
$379,713
$44,294
$(4,000)
$(231,341)
$188,666
20. CAPITAL MANAGEMENT
The Company’s objective is to maintain a
minimum capital requirement as stipulated by its bank credit facility. The
capital base so as to maintain investor, creditor
agreement limits the debt under bank indebtedness together with the
and market confidence and sustain future
unsecured notes to four times FNFLP’s equity. As at December 31, 2019,
development of the business. Management
the ratio was 1.91:1 (2018 – 1.90:1). The Company was in compliance with the
defines capital as the Company’s common share
bank covenant throughout the year.
capital and retained earnings. FNFLP has a
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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
2019
Residential
Commercial
Total
661,081
216,639
877,720
(558,742)
(180,329)
(739,071)
102,339
293,008
59,256
(5,332)
36,310
80,780
25,414
(4,323)
138,649
373,788
84,670
(9,655)
$449,271
$138,181
$587,452
7,023
59,452
211,373
$277,848
$171,423
790
18,248
48,853
$67,891
$70,290
7,813
77,700
260,226
$345,739
$241,713
28,535,288
9,120,529
37,655,817
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—
—
29,776
$28,535,288
$9,120,529
$37,685,593
$4,113
$1,761
$5,874
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
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 22. RELATED PARTY AND OTHER TRANSACTIONS
The Company has servicing contracts in connection
with commercial mezzanine mortgages originated by
the Company and subsequently sold to 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 $82,910 of new mortgages for
the related parties. The related parties also funded several
progress draws totalling $14,987 on existing mortgages
originated by the Company. All such mortgages, which are
administered by the Company, have a balance of $188,968
as at December 31, 2019 (December 31, 2018 – $121,556). As
at December 31, 2019, three of the mortgages are secured
by real estate in which the Company is also a subordinate
“It is not easy to
create a culture like
mortgage lender.
First National’s.
We believe a flat
organizational structure,
careful recruitment,
thorough onboarding,
and bias for promoting
from within have
contributed greatly to
workplace engagement
and morale.”
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 by the Company in 2019 was $3,016
(2018 – $2,339), net of third-party investor reimbursement.
The insurance company had also engaged the Company to
service a portfolio of mortgages at market servicing rates.
The portfolio had a balance of $1,625 as at December 31,
2018, but was fully paid down during the first quarter of 2019.
23. COMPARATIVE CONSOLIDATED FINANCIAL
STATEMENTS
Certain comparative figures have been reclassified to
conform to the current year’s presentation.
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CORPORATE
GOVERNANCE
First National’s Board of Directors and management
team fully acknowledge the importance of their duty to
serve the long-term interests of shareholders.
Sound corporate governance is fundamental to
maintaining the confidence of investors and increasing
shareholder value. As such, First National is committed
to the highest standards of integrity, transparency,
compliance and discipline.
These standards define the relationships among
all of our stakeholders – Board, management and
shareholders – and are the basis for building these
values and nurturing a culture of accountability and
responsibility across the organization.
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FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT 6
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POLICIES
COMMITTEES
The Board supervises and evaluates the
The Board of Directors has established an Audit Committee and a
management of the Company, oversees matters
Governance Committee to assist in the efficient functioning of the
related to our strategic direction and assesses
Company’s corporate governance strategy.
results relative to our goals and objectives.
As such, the Board has adopted several
policies that reflect recommended practices
in governance and disclosure. These include
a Disclosure Policy, a Code of Business Ethics
AUDIT COMMITTEE
The Audit Committee’s responsibilities include:
• Management of the relationship with the external auditor, including
the oversight and supervision of the audit of the Company’s
and Conduct Policy, a Whistleblower Policy and
financial statements;
an Insider Trading Policy. These policies follow
the corporate governance guidelines of the
Canadian Securities Administrators. As a public
• Oversight and supervision of the quality and integrity of the Company’s
financial statements, and
company, First National’s Board continues to
• Oversight and supervision of the adequacy of the Company’s internal
update, develop and implement appropriate
accounting controls and procedures, as well as its financial reporting
governance policies and practices as it sees fit.
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
GOVERNANCE COMMITTEE
The Governance Committee’s responsibilities include:
• 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;
• Reviewing conflicts of interest and transactions involving related parties
of the Company; and
• 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 National Instrument 58-101 – Disclosure of
Corporate Governance Practices.
Committee Members
Barbara Palk (Chair), Duncan Jackman and Robert Pearce
BOARD OF
DIRECTORS
STEPHEN SMITH
MORAY TAWSE
Stephen Smith, one of Canada’s leading financial
Moray 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 Guarantee
Mortgage Insurance Company, which he owns
in partnership with Ontario Teacher’s Pension
Plan. He is Chairman and co-owner of Duo Bank
of Canada, formerly Walmart Canada Bank. Mr.
Smith is the largest shareholder in Equitable
Bank, one of Canada’s leading alternative
lenders and the country’s ninth-largest publicly
traded bank. Mr. Smith is a member of the
Board of Directors of the C.D. Howe Institute,
E-L Financial Corporation Limited and the
Canada Infrastructure Bank. He is also Chairman
of Historica Canada, the producer of the
Heritage Minutes and publisher of The Canadian
Encyclopedia. In 2012, Mr. Smith received the
Queen Elizabeth II Diamond Jubilee Medal for
contributions to Canada.
In 2015, Queen’s University announced the
naming of the Stephen J.R. Smith School of
Business at Queen’s University, in honour of Mr.
Smith and his historic $50 million donation to
the school.
Mr. Smith holds a Bachelor of Science (Honours)
in Electrical Engineering from Queen’s University
and a Master of Science in Economics from the
London School of Economics.
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JOHN BROUGH
John Brough was President of both Torwest, Inc. and Wittington Properties
Limited, real estate development companies, from 1998 to December 31,
2007, upon his retirement. 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, a director and Chairman of the
Audit Committee and Lead Director of First National Financial Corporation,
and a director and Chairman of the Audit Committee of Canadian Real
Estate Investment Trust. He holds a Bachelor of Arts (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 at the University of Toronto, Rotman
School of Management. Mr. Brough is a member of the Institute of Corporate
Directors, Chartered Professional Accountants of Ontario and Chartered
Professional Accountants of Canada.
FIRST NATIONAL FINANCIAL CORPORATION 2019 ANNUAL REPORT DUNCAN JACKMAN
BARBARA PALK
Duncan Jackman has been Chairman, President
Barbara Palk retired as President of TD Asset Management Inc. in 2010,
and Chief Executive Officer of E-L Financial
following a 30-year career in institutional investment and investment
Corporation, an investment and insurance
management. She currently serves on the board of Crombie Real Estate
holding company, since 2003. In 2003, he was
Investment Trust, where she chairs the Human Resources Committee. Her
also elected Chairman of the Board of The
previous boards include Ontario Teachers’ Pension Plan, where she chaired
Empire Life Insurance Company. Mr. Jackman is
the Investment Committee; TD Asset Management USA Funds Inc.; the
also Chairman of Algoma Central Corporation,
Canadian Coalition for Good Governance, where she chaired the Governance
the largest Great Lakes bulk shipper, as well as
Committee; Greenwood College School; the Investment Counselling
Chairman and President of Economic Investment
Association of Canada; the Perimeter Institute; the Shaw Festival; UNICEF
Trust Limited and United Corporations Limited,
Canada; and Queen’s University, where she was the Chair of the Board
two Canadian listed closed-end funds. He also
of Trustees. Ms. Palk is a member of the Institute of Corporate Directors,
serves as a member of the Board of Directors of
a Fellow of the Canadian Securities Institute and a CFA charterholder.
several other public and private companies. Mr.
She holds a Bachelor of Arts (Honours) in Economics from Queen’s
Jackman is a member of the Business Council
University, and has been named one of Canada’s Top 100 Most Powerful
of Canada and formerly served on the Economic
Women (2004).
Advisory Council to the Minister of Finance,
Government of Canada. He is also Chair of the
Patron’s Council for Community Living Toronto,
which provides support to thousands
ROBERT PEARCE
of individuals with an intellectual disability.
Robert Pearce serves on the Board of Directors of Canada Guaranty
Mr. Jackman graduated from McGill University
Mortgage Insurance Company, First American Payment Systems, CPI Card
in Montreal.
ROBERT MITCHELL
Group and Duo Bank of Canada. Mr. Pearce spent 26 years with BMO
Bank of Montreal, from 1980 to 2006, most recently holding the position
of President and Chief Executive Officer, Personal and Commercial Client
Group. He also served on the Board of Directors of Mastercard International
from 1998 to 2006, and as Chairman of the Canadian Bankers’ Association
Robert Mitchell has been the President of Dixon
from 2004 to 2006. Mr. Pearce holds a Bachelor of Arts from the University
Mitchell Investment Counsel Inc., a Vancouver-
of Victoria and an MBA from the University of British Columbia. Mr. Pearce
based investment management company,
brings to the Board over 30 years of operational and leadership experience
since 2000. Prior to that, Mr. Mitchell was Vice
in the financial services industry.
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President, Investments at Seaboard Life Insurance
Company. Mr. Mitchell has an MBA from the
University of Western Ontario and a Bachelor
of Commerce (Finance) from the University of
Calgary, and is a CFA charterholder. Mr. Mitchell
sits on the board of Equestrian Canada.
STAKEHOLDER
INFORMATION
CORPORATE ADDRESS
INVESTOR RELATIONS CONTACTS
First National Financial Corporation
100 University Avenue
North Tower, Suite 700
Toronto, Ontario M5J 1V6
Phone: 416.593.1100
Fax: 416.593.1900
INVESTOR RELATIONS WEBSITE
www.firstnational.ca
ANNUAL MEETING
May 5, 2020, 9:00 a.m. EDT
TMX Broadcast Centre
The Gallery
The Exchange Tower
130 King Street West
Toronto, Ontario
REGISTRAR AND
TRANSFER AGENT
Computershare Investor Services Inc.,
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
Robert Inglis
Chief Financial Officer
rob.inglis@firstnational.ca
Ernie Stapleton
President, Fundamental
ernie@fundamental.ca
AUDITORS
Ernst & Young LLP, Toronto, Ontario
LEGAL COUNSEL
Stikeman Elliott LLP, Toronto, Ontario
SENIOR EXECUTIVES OF FIRST
NATIONAL FINANCIAL CORPORATION
Stephen Smith
Co-founder, Chairman and Chief Executive Officer
Moray Tawse
Co-founder and Executive Vice President
Jason Ellis
President and Chief Operating Officer
Robert Inglis
Chief Financial Officer
Scott McKenzie
Senior Vice President, Residential Mortgages
Jeremy Wedgbury
Senior Vice President, Commercial Mortgages
Hilda Wong
Senior Vice President and General Counsel
VANCOUVER
CALGARY
TORONTO
MONTREAL
HALIFAX
FIRSTNATIONAL.CA