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2023 ReportANNUAL REPORT First National Financial Corporation — 2 Corporate Profile First National Financial is Canada’s largest non-bank mortgage lender. Founded in 1988, our mortgage loan solutions are used by hundreds of thousands of borrowers across Canada to purchase single-family, multi-unit and commercial properties. Customers choose us and independent mortgage brokers recommend us because of our service, technology advantages and broad range of competitive products. 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. — 1 2020 Annual Report First National Financial Corporation A Record Year 342,252 1,211 Borrowers served by First National in 2020 across Canada, The number of full-time First National employees at year end, an increase of 10% from 2019. reflecting 18% year-over-year growth in our workforce to meet customer needs. $118.7 BILLION $1.38 BILLION Mortgages under administration (MUA) – the source of most of Revenue in 2020 grew 4% to a new annual record, despite the Company’s earnings – reached this milestone at year end the dampening effect of lower interest rates. 2020, a 7% increase over 2019. $190.2 MILLION 50% Record net income in 2020 ($3.12 per share) reflected higher The after-tax, Pre-Fair Market Value1 return on shareholders’ origination and wider mortgage spreads. equity in 2020 demonstrates the efficiency of the First National business model. $148.4 MILLION 573% Value of common share dividends declared in 2020, bringing Total shareholder return between our IPO in 2006 and the cumulative total to $1.5 billion ($25.80 per share) since the December 31, 2020. Company’s initial public offering in 2006. (1) Non-IFRS measure. See MD&A for more details. — 3 2020 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 ROBERT INGLIS Chief Financial Officer HILDA WONG Senior Vice President and General Counsel SCOTT MCKENZIE Senior Vice President, Residential Mortgages JEREMY WEDGBURY Senior Vice President, Commercial Mortgages — 4 First National Financial Corporation Message to Shareholders In the 33 years since First National began providing mortgages, Canada has faced several economic disruptions. Two of these – in 1990 and 2008 – were classified by the C.D. Howe Institute as the most severe since the mid-1950s. But 2020 was in a category all its own. The global COVID-19 health crisis created unique and severe challenges for our country, society and the economy that are far from over. It is in this context that I compose my annual message to you. As you will have noted from the opening pages of this report, First National took on these challenges and continued its record-setting pace of increased performance. Our key financial metrics – mortgages under administration (MUA), revenue and earnings – all reached record levels. Supported by strong earnings, the company increased its regular common share dividend payments by 7.7% and paid a special dividend of $0.50 per share. First National was also a job creator, adding 183 talented new employees to serve our customers and meet the demands of growth. Do not let this performance deceive you. This past year tested our people, our culture and our technology like they have never been tested before. Like other businesses, we had no advance warning of what was to come, although we did enter 2020 with a strong and proven foundation. In January, our budgets for the year were based on an optimistic, business-as-usual outlook supported by strong momentum in the form of new mortgage commitments. Our key concern was uncertain securitization margins as mortgage spreads had tightened entering 2020. Our outlook changed abruptly. On March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic and, within days, states of emergency were declared across Canada that shut down non-essential businesses and activities. This prompted the federal government to announce various measures to aid the millions of Canadians who lost income. It also led the Bank of Canada to drop its key overnight rate by 150 basis points in less than a month and introduce a large quantitative easing program to ensure the financial system remained liquid. Fortunately, First National was deemed essential under government pandemic protocols, which allowed us to remain open through each subsequent lockdown. However, the pandemic was game changing for our business because it forced our entire workforce to relocate. In March, we asked our employees across the country to work remotely from home so they could avoid exposure to the coronavirus. To support them, our IT team quickly secured and distributed computers to enable secure access to our systems. We also asked our employees to maintain the high levels of service our customers and partners in the mortgage broker community have come to expect and deserve. This was difficult in the weeks immediately following the first lockdown due to the extraordinary volume of requests for service and support. The Bank of Canada’s swift action also required equally swift action by our team to reset mortgage pricing and reassess market risk in our underwriting practices. Although First National only has direct credit exposure to $2.8 billion (2.4%) of MUA, these portfolios are risk managed. For the first time ever, we also granted mortgage payment deferrals to borrowers who demonstrated financial need due to the pandemic. By May, we had approved mortgage payment deferrals for 33,800 borrowers, or 13.9% of single-family MUA eligible for this program. Providing deferrals enabled these borrowers to regain the ability to meet their financial obligations, but also required First National to make timely payments of interest and amortizing principal on the NHA-MBS securities it had issued. By year end, virtually no borrowers were on deferral, an outcome that speaks to the economic recovery and the creditworthiness of the company’s borrowers. — 5 2020 Annual Report First National Financial Corporation “First National expects residential originations in 2021 to be comparable to the record set in 2020.” — 6 First National Financial Corporation Lessons Learned, Advantages Validated One cannot live through a crisis like this without seeing how a business and its markets stand up to extreme stress. From the experience of the past year, what we learned and validated about our business model can be summarized as follows. Nothing stops the First National team from helping customers and supporting business partners. Canadians need and value mortgage borrowers. Throughout the year, we saw numerous For the best advice and the most examples of extraordinary customer competitive mortgage offerings, the service. While at times we were independent broker channel has always challenged to meet the aggressive been unsurpassed, which is why its turnaround objectives we set for greatest proponent is First National. The ourselves, the people of First National pandemic also reinforced the channel’s set a new benchmark for excellence other advantage: convenience. Securing under the most trying of circumstances. a First National mortgage with the help of a broker is far easier and, in this environment, safer than a physical visit to a traditional lender. These competitive benefits are reflected in the channel’s market share gains over the years and particularly in 2020. Technology and innovation are more important to success than ever. First National made a name for itself by developing an innovative non-bank, non-branch business model and creating MERLIN™, the first underwriting system of its kind serving the mortgage broker channel. These innovations were introduced three decades ago but found even greater relevance in 2020 as they allowed us to rise above capital market volatility and the pandemic lockdown to deliver reliable funding and seamless service even while working from home. Innovation continued in 2020 in the way we used our IT backbone in areas such as recruitment, training, and employee and customer communication. — 7 2020 Annual Report Not all recessions are equal. Our funding is as reliable as that of any financial institution. Best Place to Work In typical recessions, job losses lead As a non-bank, we do not take A sustainable financial services to housing market correction. To consumer deposits. However, our company is one where people build date, this recession has rewritten the deep and diversified funding sources lifelong careers because the work economic history books, as the housing have allowed First National to lend in they do is meaningful, challenging market improved. We did not expect all economic conditions. Our ability and rewarding, and the workplace this last spring. Much to our surprise, to do so when other lenders pulled environment is professional, stable in the second quarter of 2020, new back served us well during the 2008 and supportive. Based on our long- single-family mortgage originations recession and again this past year. In tenured workforce, First National is a increased 15% or $600 million. In the our commercial business, this liquidity sustainable company. We are striving third and fourth quarters, the results advantage supported annual origination to keep it that way as we grow by were even better, with growth of 42% growth of 23% in 2020, bringing our maintaining a flat organizational or $1.7 billion and 65% or $2.3 billion, total commercial MUA to a record structure that is highly attuned to respectively. First National ended the $35.1 billion. These numbers tell only employee, customer and partner needs, year with single-family MUA of $83.6 part of the story. In the spring, investor offering effective human resources billion, a new record. Economists and demand for conventional commercial programs, and listening attentively to market commentators offered several product weakened because of employees both formally and informally explanations for the housing market’s perceived market risk. First National for improvement ideas. ability to withstand the gravitational seamlessly adjusted so that borrower pull of this recession. Among them: needs were met with insured financings. ultra-low interest rates, government Our ability to use conventional and income supports, and the idea that job insured products to address the needs losses were felt more acutely by those of commercial borrowers across more of in part-time positions who are not the credit spectrum makes us a valuable typically home buyers. All of these contributor in financing a wide variety of reasons seem plausible, and with property assets, including apartments – interest rates at current levels, it is our mainstay – as well as industrial, possible that Canada can look forward self-storage and office. In 2021, we to another year of strong housing expect further success in commercial market conditions. With all the usual markets because of our funding model caveats one needs to include with and expertise. We augment what we hear by inviting outside experts to independently survey our team. In 2020, First National once again – for the fourth consecutive year – achieved Great Places to Work® certification. This year, we qualified in two categories: 2020 Best Workplaces™ in Financial Services & Insurance and 2020 Best Workplaces™ in Ontario. such a forward-looking statement, First National expects residential originations in 2021 to be comparable to the record set in 2020. Our culture is not defined by our office address. With five locations across Canada, we have pride of place and believe corporate culture is more quickly formed and perpetuated in the office, which is why we look forward to returning when it is safe to do so. However, the ties that bind us run deeper than physical location. First National’s culture is entrepreneurial, principled and family oriented. We have continued to place an emphasis on preserving our culture while the pandemic keeps us apart. — 8 First National Financial Corporation 2021 Agenda In business, it is not a good idea to take anything for granted. In a pandemic, it is not possible. We simply do not know how or when this health crisis will finally play out. That said, we are very positive about First National’s prospects in 2021. I would encourage you to read the Outlook found in our MD&A to learn more. Our business agenda for the coming year is not radically different than it was last year. We will strive to be better in every way. This is a tall order, but continuous improvement is part of our mindset. One key difference is that we will pursue growth for at least part of the year while maintaining our work- from-home stance. It is too early to say when we can safely return to our offices, but we continue to monitor health guidelines so we are prepared when that day arrives. We are scheduled to move into new Toronto headquarters in late 2021, a change of scenery that we look forward to for several reasons, including the fact that the building is new, fit-for- purpose and able to accommodate our future workforce needs. — 9 2020 Annual Report Looking Forward Thank You First National will build on the lessons Many people deserve credit for this learned last year and over the past 33 past year’s record performance, starting years to stay grounded and focused with our employees. Up and down on what matters: relationships with the line, veterans and newcomers, the customers, partners, employees and First National team is comprised of shareholders. Relationships are the hard workers who are motivated to help key to success for our business. We our customers buy homes and finance must continue to find ways to offset commercial properties. Special thanks the distancing effect of COVID-19 to the leaders of our company – on all of these relationships. This including Jason Ellis, who added the will involve creative applications of title President of First National to his technology but also timely, thoughtful COO responsibilities just a few months communication and, in the case of before COVID-19 hit. My fellow directors customer relationships, value-added also deserve credit for their stewardship service and advice. In short, innovation during this most unusual period. built on the values we have created since our founding. I reserve and offer my utmost thanks to our customers, business partners and fellow shareholders for your loyalty, patronage and confidence. We will do our best to reward you in 2021. Yours sincerely, STEPHEN SMITH Chairman and Chief Executive Officer March 2, 2021 — 10 First National Financial Corporation MORTGAGES UNDER ADMINISTRATION ($ Billions) 2020 MUA BY ASSET TYPE 5% 4-year compound annual growth 120 100 80 60 40 20 120 0 100 80 2016 2017 2018 2019 2020 A 75% Insured B 19% Uninsured single-family residential C 6% Uninsured multi-residential and commercial C B A 2020 REVENUE SOURCES PRIOR TO FAIR VALUE GAINS/LOSSES 2018 2019 2020 A 60 1400 REVENUE 40 1200 ($ Millions) 20 1000 120 0 800 100 7% 600 80 4-year compound annual growth 2016 2017 400 60 1400 200 40 1200 0 20 1000 0 800 600 350 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 400 300 1400 200 250 1200 0 200 1000 150 800 100 600 350 50 PRE-FAIR MARKET VALUE INCOME(1) 400 300 0 ($ Millions) 200 250 2016 2018 2018 2017 2017 2019 2019 2020 2020 0 200 2016 7% 4-year compound annual growth 2017 150 2016 2017 2018 2019 2020 100 350 50 300 0 250 200 150 100 50 0 2016 2017 2018 2019 2020 (1)Non-IFRS measure. See MD&A for more details. 2018 2019 2020 A 49% Institutional placements B 18% Net interest – securitized mortgages C 24% Mortgage servicing D 9% Investment income 2020 FUNDING SOURCES 68% Institutional investors B 30% Securitization C 2% Internal D B C C B A A — 11 2020 Annual Report First National Financial Corporation Management’s Discussion and Analysis The following management’s discussion and analysis (“MD&A”) of financial condition and results of operations is prepared as of March 2, 2021. 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, 2020. The audited consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”). — 13 2020 Annual Report This MD&A contains forward-looking information. Please see “Forward- GENERAL DESCRIPTION OF THE COMPANY 2020 RESULTS SUMMARY Looking Information” for a discussion of First National Financial Corporation is Management is very pleased with the the risks, uncertainties and assumptions the parent company of First National performance of the Company during relating to these statements. The Financial LP (“FNFLP”), a Canadian- 2020, particularly given widespread selected financial information and based originator, underwriter and economic disruption that commenced discussion below also refer to certain servicer of predominantly prime with COVID-19-related employment measures to assist in assessing financial residential (single-family and multi- loss. First National’s employees worked performance. These other measures, unit) and commercial mortgages. With from home throughout most of 2020, such as “Pre-FMV Income” and over $118 billion in mortgages under beginning in mid-March, and remained “After-tax Pre-FMV Dividend Payout administration (“MUA”), First National is productive and efficient. Supported Ratio”, should not be construed as Canada’s largest non-bank originator and by a resilient housing market across alternatives to net income or loss or underwriter of mortgages and is among other comparable measures determined the top three in market share in the Canada, the Company increased single- family origination 42% year over year. in accordance with IFRS as an indicator mortgage broker distribution channel. The commercial segment had excellent of performance or as a measure of liquidity and cash flow. These measures do not have standard meanings prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers. Unless otherwise noted, tabular amounts are in thousands of Canadian dollars. Additional information relating to the Company is available in First National Financial Corporation’s profile on the System for Electronic Data Analysis and Retrieval (“SEDAR”) website at www.sedar.com. — 14 results given the economic environment and a challenging period for non- residential real estate. Commercial origination for the year increased by 23%. Total combined new origination was higher by 35% compared to 2019. Earnings were strong as the Company benefited from strong origination and wider mortgage spreads. • MUA grew to $118.7 billion at December 31, 2020 from $111.4 billion at December 31, 2019, an increase of 7%; the growth from September 30, 2020, when MUA was $117.1 billion, was 5% on an annualized basis. First National Financial Corporation • Total new single-family mortgage • Revenue for 2020 increased by 4% The Company’s Board of Directors origination was $19.2 billion in 2020 to $1.38 billion from $1.33 billion in increased the regular monthly dividend compared to $13.5 billion in 2019, 2019. The increase was affected by from $1.95 to $2.10 per common share an increase of 42%. The Company changes in the fair market of financial on an annualized basis effective with attributes this to an increasing instruments related to interest rate the dividend payable on December market share in the mortgage broker movements in both years. Excluding 15, 2020, and declared a special distribution channel. The Company such amounts, revenue grew 8% common share dividend in the amount believes that the value of its long- to $1.45 billion in 2020 from $1.34 of $0.50 per share, payable on time broker relationships and effective billion in 2019. This growth was December 15, 2020, to shareholders technology may have been a significant largely a function of higher mortgage of record on November 30, 2020. This advantage during the 2020 pandemic. origination, which fuelled an increase special dividend reflects the Board’s Commercial segment origination of in placement fee revenue of 62%. determination that the Company has $9.1 billion was 23% higher than the $7.4 billion originated in 2019. Overall new origination increased by 35% in 2020 compared to 2019. • Income before income taxes increased by 7% to $258.7 million in 2020 from $241.7 million in 2019. The increase was affected by changing capital market generated excess capital in the past year and that the capital needed for near-term growth can be generated from current operations. • The Company took advantage of conditions. Excluding the gains and opportunities in the year to renew over losses related to financial instruments, $6.7 billion of single-family mortgages the Company’s earnings before income ($5.5 billion a year ago). For the taxes and gains and losses on financial commercial segment, renewals were instruments (“Pre-FMV Income”) for similar at approximately $2.0 billion in 2020 increased by 31% to $323.0 each year. million from $247.1 million in 2019. The increase is largely the result of higher origination and wider mortgage spreads, which both had favourable impacts on placement fee revenue. — 15 2020 Annual Report SELECTED QUARTERLY INFORMATION Quarterly Results of First National Financial Corporation ($000s, except per share amounts) Revenue Net income (loss) for the period Pre-FMV income for the period(1) Net income (loss) per common share Total assets $387,303 $373,760 $344,581 $274,650 $342,138 $362,833 $335,241 $286,311 $69,123 $72,517 $50,844 ($2,255) $48,993 $60,578 $44,164 $23,478 $94,937 $99,644 $75,506 $52,921 $60,418 $79,816 $67,565 $39,269 $1.13 $1.20 $0.84 $39,488,527 $38,314,904 $39,040,298 ($0.05) $39,203,792 $0.80 $1.00 $0.72 $0.38 $37,685,593 $37,249,143 $37,229,876 $36,193,793 2020 Fourth quarter Third quarter Second quarter First quarter 2019 Fourth quarter Third quarter Second quarter First quarter (1) This non-IFRS measure adjusts income before income taxes by eliminating 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 figures presented for 2019 have been restated to conform to 2020’s presentation. With First National’s large portfolio of In the past eight quarters, the Company of wider mortgage spreads and increased mortgages pledged under securitization, has experienced a relatively volatile profitability. To start 2020, COVID-19- quarterly revenue is driven primarily economic environment. In 2018, the related financial turmoil meant that the by the gross interest earned on the economic outlook was positive and Company reported a small loss. In the mortgages pledged under securitization. there was a surplus of liquidity for final two quarters of 2020, the Company The gross interest on the mortgage investment in financial assets. This benefited from abnormally wide portfolio is dependent both on the size bred a very competitive marketplace mortgage spreads, which were the result of the portfolio of mortgages pledged such that mortgage funding spreads of the aftermath of the COVID-19-related under securitization, as well as mortgage tightened to levels not seen since 2007. financial crisis that began at the end of rates. Recently MUA increased, and This reduced the profitability of the the 2020 first quarter. These spreads revenue followed. Net income is partially Company’s operations. Toward the end were the basis for growth in Pre-FMV dependent on conditions in bond of 2018, economic worries resurfaced, Income in these quarters. markets, which affect the value of gains interest rates fell and mortgage spreads and losses on financial instruments widened by about 0.30%. This had a arising from the Company’s interest significant positive effect on the value rate hedging program. Accordingly, the of the Company’s operations. In the first movement of this measurement between quarter of 2019, Pre-FMV Income was at quarters is related to factors external its lowest in the two-year period prior to the Company’s core business. By to the COVID-19 pandemic, as tighter removing this volatility and analyzing spread 2018-originated mortgages were Pre-FMV Income, management believes securitized and placed. Combined with a more appropriate measurement of the lower origination volumes than typically Company’s performance can be assessed. experienced in the first quarter of each year, profitability was low. This trend reversed in the second quarter of 2019, as the Company was able to take advantage — 16 First National Financial Corporation OUTSTANDING SECURITIES OF THE CORPORATION At December 31, 2020, and March 2, 2021, the Corporation had 59,967,429 common shares; 2,887,147 Class A preference shares, Series 1; 1,112,853 Class A preference shares; 200,000 November 2024 senior unsecured notes; and 200,000 November 2025 senior unsecured notes outstanding. SELECTED ANNUAL FINANCIAL INFORMATION AND RECONCILIATION TO PRE-FMV INCOME(1) ($000s, except per share amounts) 2020 2019 2018 For the year ended December 31, INCOME STATEMENT HIGHLIGHTS Revenue Interest expense – securitized mortgages 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 Income(1) Add (deduct): realized and unrealized gains (losses) on financial instruments excluding those on mortgage investments Provision for income taxes Net income Common share dividends declared PER SHARE HIGHLIGHTS Net income per common share Dividends per common share At year end BALANCE SHEET HIGHLIGHTS Total assets 1,380,294 (708,162) (159,018) (254,385) 67,355 (3,076) 323,008 (64,279) (68,500) 190,229 148,419 3.12 2.47 1,326,523 (739,071) (102,596) (243,143) 9,655 (4,300) 247,068 (5,355) (64,500) 177,213 144,421 2.90 2.41 1,181,510 (646,069) (75,354) (232,670) (3,162) (4,000) 220,255 7,162 (60,990) 166,427 171,407 2.73 2.86 $39,488,527 $37,685,593 $36,037,127 Total long-term financial liabilities $398,554 $374,025 $174,829 Notes: (1) Pre-FMV Income is not a recognized earnings measure under IFRS and does not have a standardized meaning prescribed by IFRS. Therefore, Pre-FMV Income may not be comparable to similar measures presented by other issuers. Investors are cautioned that Pre-FMV Income 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. The figures for 2019 and 2018 have been restated to conform to 2020’s presentation. — 17 2020 Annual Report VISION AND STRATEGY GROWTH IN PORTFOLIO OF MORTGAGES UNDER ADMINISTRATION The Company provides mortgage Management considers the growth Company’s uninsured products. Together, financing solutions to the residential in MUA to be a key element of the overall new origination for 2020 and commercial mortgage markets Company’s performance. The portfolio increased 35% year over year. in Canada. By offering a full range grows in two ways: through mortgages of mortgage products, with a focus originated by the Company and through on customer service and superior third-party mortgage servicing contracts. technology, the Company believes that it Mortgage originations not only drive Third-Party Mortgage Underwriting and Fulfilment Processing Services is the leading non-bank mortgage lender revenues from placement and interest In 2015, the Company launched its in the industry. The Company intends from securitized mortgages, but perhaps third-party underwriting and fulfilment to continue leveraging these strengths more importantly, longer-term value from processing services business with a to lead the non-bank mortgage lending servicing rights, renewals and the growth large Canadian schedule I bank (“Bank”). industry in Canada, while appropriately of the customer base for marketing The business is designed to adjudicate managing risk. The Company’s strategy initiatives. As at December 31, 2020, MUA mortgages originated by the Bank is built on four cornerstones: providing totalled $118.7 billion, up from $111.4 billion through the single-family residential a full range of mortgage solutions for at December 31, 2019, an increase of 7%. mortgage broker channel. First National Canadian single-family and commercial The growth of MUA in the fourth quarter employs a customized software solution customers; growing assets under of 2020 from September 30, 2020, on an based on its industry-leading MERLIN™ administration; employing technology to annualized basis, was 5%. enhance service 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 GROWTH IN ORIGINATION OF MORTGAGES technology to accept mortgage applications from the Bank in the mortgage broker channel and underwrite these mortgages in accordance with the Bank’s underwriting guidelines. The Bank funds all the mortgages underwritten direct relationship with the mortgage Direct Origination by the Company under the agreement and retains full 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. KEY PERFORMANCE DRIVERS The Company’s success is driven by the following factors: 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 2020, the Company’s single-family origination increased across the country. The Company believes this is the result of its strong broker relationship and technology, which have both been significant benefits in the pandemic period. All of the Company’s sales • Growth in the portfolio of mortgages offices experienced double-digit growth. under administration; • Growth in the origination of mortgages; • Raising capital for operations; and In aggregate, the Company’s single- family origination grew by 42% in 2020 compared to 2019. The commercial segment also had higher origination. • Employing innovative securitization Total volumes increased by 23% to $9.1 transactions to minimize funding costs. billion in 2020 compared to $7.4 billion in 2019, even though investor appetite for non-residential mortgages was lower than in the prior year, resulting in contraction in origination of the 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. Excalibur Mortgage Products The Company originates alternative single-family (“Excalibur”) mortgage products. Alternative lending describes single-family residential mortgages that are originated using broader underwriting criteria than those applied in originating prime mortgages. These mortgages generally have higher interest rates than prime mortgages. First National’s relationships with mortgage brokers and its underwriting systems allow for cost effective origination of significant volumes. The product is originated primarily for placement with institutional investors, but beginning in April 2019, the Company finalized an agreement with a bank-sponsored securitization conduit to fund a portion — 18 First National Financial Corporation of the Excalibur origination. In early the bank credit facility. In April 2020, 2020, an agreement was entered into the Company drew on the bank credit with another bank-sponsored conduit facility to repay all of the 4.01% $175 to provide additional funding for this million Series 1 notes when they matured. product. The Excalibur relaunch was Effectively in 2020, the new note rolled out gradually, beginning in Ontario. issuance has increased the Company’s Currently the program is open to include medium-term debt by $200 million, all Ontario brokers. In the third quarter such that it now stands at approximately of 2020, the Company began testing the $400 million. product selectively in the BC region. 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 2019, the Company extended the term of the facility by one year such that the maturity is 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 senior unsecured notes, which are fully drawn during their term; (3) the three- 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 In November 2020, the Company issued 200,000 2.961% Series 3 senior unsecured notes for a five-year term pursuant to a private placement under an offering memorandum. These notes add to the Company’s 2019 issuance of 200,000 3.582% Series 2 senior unsecured notes. The net proceeds of both offerings, after broker commissions, were loaned to FNFLP. On settlement, the proceeds were used to pay down a portion of the indebtedness under Preferred Share Issuance Effective April 1, 2016, the Company reset the dividend rate on the 2,887,147 Class A Series 1 preference shares issued in 2011 that did not elect to convert to Class A Series 2 preference shares. The Series 1 shares provide an annual dividend rate of 2.79%. Also, effective April 1, 2016, 1,112,853 Class A Series 2 were issued on the conversion from Series 1 shares. These bear a floating rate dividend calculated quarterly based on the 90-day T-Bill rate. Both the Series 1 and Series 2 shares pay quarterly dividends, subject to Board of Directors approval, and are redeemable at the discretion of the Company such that after each five-year term ending on March 31, the Company can choose to extend the shares for another five-year term at a fixed spread (2.07%) over the relevant index (five- year Government of Canada bond yield for any Series 1 shares or the 90-day T-Bill rate for any Series 2 shares). In February 2021, the Company indicated to shareholders that it would not be redeeming the shares and would be resetting the dividend rates for another five-year term. 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 (and 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. — 19 2020 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 Canada Mortgage Bonds Program The Company has served as an issuer as central banks cut overnight rates The CMB program is an initiative where and administrator of NHA-MBS since significantly. Credit spreads widened and Canada Housing Trust (“CHT”) issues 1995. In December 2007, the Company the capital markets stopped functioning securities to investors in the form of was approved by Canada Mortgage and normally. In the second quarter, as semi-annual interest-yielding five- and Housing Corporation (“CMHC”) as an financial systems began to normalize 10-year bonds. As a seller into the CMB, issuer of NHA-MBS and as a seller into and markets began to recover, mortgage the Company is able to make direct the Canada Mortgage Bonds (“CMB”) coupons remained elevated as other sales into the program. The ability to sell program. Issuer status provides the credit spreads, including those on NHA- into the CMB has given the Company Company with direct and independent MBS, narrowed. The resulting spreads on access to lower costs of funds on access to reliable and low-cost funding. mortgages funded through NHA-MBS both single-family and multi-family 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 2020 Average five-year mortgage spread for the period 1.12% 1.50% 2.68% 1.77% 1.36% 1.42% 1.76% had positive impacts on 2020 results mortgage securitizations. Because of and have increased the profitability of the effectiveness of the CMB, many the Company’s securitization portfolio institutions have indicated their desire to in future periods. In 2020, the Company participate. As a result, CHT has created originated and renewed for securitization guidelines through CMHC that limit purposes approximately $8.3 billion of the amount that can be sold by each single-family mortgages and $2.8 billion seller into the CMB each quarter. The of multi-unit residential mortgages. In Company is subject to these limitations. 2020, the Company issued approximately Pursuant to the COVID-19 crisis, CHT $8.1 billion of NHA-MBS pools. announced that the 2020 CMB program The Company is subject to various $40 billion to $60 billion. For 2021, the regulations put in place by CMHC to Minister of Finance has reduced the control the amount of NHA-MBS that authorized amount of new guarantees a single issuer can create. These rules for CMB back to $40 billion. would be increased from a target of include the amount of CMHC guarantees that is a requirement to issue a pool. Currently there is a tiered NHA-MBS guarantee fee pricing structure, such that any guarantees issued to one issuer over $9.0 billion of issuance have The table shows a history of spread a higher price. The tiered limit of $9.0 information. Generally, when this billion remains unchanged for 2021. spread is wider, the Company can earn Late in 2020, CMHC announced that higher returns from its securitization guarantee fees will be increased for activities, although funding spreads are NHA-MBS pools issued after January also a variable in the profit equation. 1, 2021. The Company estimates the Between 2009 and 2019, liquidity issues increase will translate into a 0.05% at financial institutions created by increase in annual cost of funding the financial crisis diminished and the per year for its NHA-MBS program. competition for mortgages increased such that spreads tightened in the 10-year period as shown above, falling to a low of 1.10% in the third quarter of 2018. Toward the end of the first quarter of 2020, fears of a global pandemic related to COVID-19 led to a dramatic and sudden decrease in bond yields — 20 First National Financial Corporation KEY PERFORMANCE INDICATORS The principal indicators used to measure the fair value of financial instruments and adding back depreciation and amortization. the Company’s performance are: The addbacks of amortization ended in 2016 when IPO-related intangible assets were • Earnings before income taxes and losses and gains on financial instruments, with the exception of any losses related to mortgage investments (“Pre-FMV Income”(1)); and • Dividend payout ratio. fully amortized. Accordingly, effective January 1, 2020, the Company elected to simplify the non-IFRS measure it presents to adjust only for fair value-related gains and losses. This measure will be reported as “Pre-FMV Income”. Measures prior to 2020 were restated in accordance with this revised calculation. Pre-FMV Income is not recognized under IFRS. However, management believes that Pre-FMV Income is a useful measure that provides investors with an indication of income normalized for capital-market fluctuations. Pre-FMV Income should not be construed as an alternative to net income Beginning in 2012, the Company used determined in accordance with IFRS or to cash flows from operating, investing and Pre-FMV EBITDA as a key performance financing activities. The Company’s method of calculating Pre-FMV Income may differ measure. This non-IFRS measure was from other issuers and, accordingly, Pre-FMV Income may not be comparable to used to adjust the Company’s earnings measures used by other issuers. by excluding gains and losses related to ($000s) FOR THE PERIOD Revenue Income before income taxes Pre-FMV Income(1) AT PERIOD END Total assets QUARTER ENDED YEAR ENDED December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 387,303 94,273 94,937 342,138 66,593 60,418 1,380,294 1,326,523 258,729 323,008 241,713 247,068 39,488,527 37,685,593 39,488,527 37,685,593 Mortgages under administration 118,723,990 111,378,891 118,723,990 111,378,891 Note: (1) This non-IFRS measure adjusts income before income taxes by eliminating 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 2019 comparative figures were revised to conform to the 2020 presentation. Since going public in 2006, First has been able to pay distributions to its useful to shareholders, as it indicates National has been considered a high- shareholders that represent a relatively the percentage of earnings paid out as yielding, dividend-paying company. large ratio of its earnings. The Company dividends. Similar to the performance With a large MUA that generates calculates the dividend payout ratio measurement for earnings, the continuing income and cash flow and a as dividends declared on common Company also calculates the dividend business model that is designed to make shares over net income attributable to payout ratio on a basis using after-tax efficient use of capital, the Company common shareholders. This measure is Pre-FMV Income. — 21 2020 Annual Report Determination of Common Share Dividend Payout Ratio ($000s) FOR THE PERIOD 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) QUARTER ENDED YEAR ENDED December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 68,465 48,230 187,383 174,156 60,717 58,968 148,419 144,421 30,733 28,984 118,435 114,437 89% 45% 45% 122% 60% 66% 79% 63% 50% 83% 66% 64% 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 income 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, 2020, yields change; however, the offsetting calculations, the dividend payout ratio for the common share payout ratio was economic impact is generally reflected 2020 would have been 50% compared to 79% compared to 83% in 2019. However, in narrower or wider spreads in the 64% in 2019. in both 2020 and 2019, the Company future once the mortgages have been declared a special dividend and pledged for securitization. Accordingly, recorded gains and losses on account management does not consider these of the changes in fair value of financial losses to affect its dividend payment instruments. The gains and losses are policy. If the special dividends and gains recorded in the period in which the and losses on financial instruments in the prices on Government of Canada bond two years are excluded from the above The Company also paid $2.8 million of dividends on its preferred shares in 2020 compared to $3.1 million in 2019. — 22 First National Financial Corporation REVENUES AND FUNDING SOURCES Mortgage Origination Placement Fees and Gain on Deferred Placement Fees Mortgage Servicing and Administration The Company derives a significant The Company recognizes revenue at The Company services virtually all amount of its revenue from mortgage the time that a mortgage is placed with mortgages generated through its origination activities. Most mortgages an institutional investor. Cash amounts mortgage origination activities on originated are funded either by received in excess of the mortgage behalf of a wide range of institutional placement with institutional investors or principal at the time of placement are investors. Mortgage servicing and through securitization conduits, in each recognized in revenue as “placement administration is a key component of case with retained servicing. In general, fees”. The present value of additional the Company’s overall business strategy originations are allocated from one amounts expected to be received over and a significant source of continuing funding source to another depending the remaining life of the mortgage sold income and cash flow. In addition to on different criteria, including type of (excluding normal market-based servicing pure servicing revenues, fees related to mortgage and securitization limits, fees) is recorded as a “deferred placement mortgage administration are earned by with an overall consideration related to fee”. A deferred placement fee arises the Company throughout the mortgage maintaining diversified funding sources. The Company retains servicing rights on when mortgages with spreads in excess of a base spread are placed. Normally the term. Another aspect of servicing is the administration of funds held in virtually all the mortgages it originates, Company would earn an upfront cash trust, including borrowers’ property tax which provide the Company with placement fee, but investors prefer paying escrows, reserve escrows and mortgage servicing fees to complement revenue the Company over time, as they earn payments. As acknowledged in the earned through originations. For the net interest margin on such transactions. Company’s agreements, any interest year ended December 31, 2020, new Upon the recognition of a deferred earned on these funds accrues to the origination volume increased from $21.0 placement fee, the Company establishes Company as partial compensation for billion to $28.3 billion, or about 35%, a “deferred placement fee receivable” that administration services provided. The compared to 2019. is amortized as the fees are received by Company has negotiated favourable Securitization the Company. Of the Company’s $36.9 interest rates on these funds with the billion of new originations and renewals chartered banks that maintain the in 2020, $25.0 billion was placed with deposit accounts, which has resulted in The Company securitizes a portion of institutional investors. significant additional servicing revenue. its 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 $36.9 billion of new originations and renewals in 2020, $11.0 billion was originated for its own securitization programs. For all institutional placements, the In addition to the interest income earned Company earns placement fees. on securitized mortgages and deferred Revenues based on these originations placement fees receivable, the Company are equal to either (1) the present also earns interest income on mortgage- value of the excess spread, or (2) an related assets, including mortgages origination fee based on the outstanding accumulated for sale or securitization, principal amount of the mortgage. This mortgage and loan investments and revenue is received in cash at the time purchased mortgage servicing rights. of placement. In addition, under certain circumstances, additional revenue from institutional placements may be recognized as “gain on deferred placement fees” as described above. The Company provides underwriting and fulfilment processing services to two mortgage originators using the mortgage broker distribution channel. The Company earns a fee based on the dollar value of funded mortgages. These fees are recognized at the time a mortgage funds and are included in “Mortgage servicing income” in the consolidated statement of income. — 23 2020 Annual Report RESULTS OF OPERATIONS The following table shows the volume of mortgages originated by First National and mortgages under administration for the periods indicated: ($ 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, 2020 December 31, 2019 December 31, 2020 December 31, 2019 5,962 2,723 8,685 1,648 558 3,624 2,226 5,850 1,409 603 19,165 9,112 28,277 6,668 1,962 13,523 7,431 20,954 5,504 1,996 Total origination and renewals $10,891 $7,862 $36,907 $28,454 MORTGAGE ORIGINATIONS BY FUNDING SOURCE Institutional investors – new residential Institutional investors – renew residential Institutional investors – multi/commercial NHA-MBS/CMB/ABCP securitization Internal Company resources/CMBS 4,618 1,211 2,182 2,547 333 2,140 201 1,994 3,185 342 13,067 3,929 8,023 11,036 852 8,223 3,204 7,153 8,887 987 Total $10,891 $7,862 $36,907 $28,454 MORTGAGES UNDER ADMINISTRATION Single-family residential Multi-unit residential and commercial Total 83,601 35,123 $118,724 80,709 30,670 $111,379 83,601 35,123 $118,724 80,709 30,670 $111,379 Total new mortgage origination volumes efficiently during the pandemic. Lower $37 billion in 2020. Origination for direct increased in 2020 compared to 2019 by mortgage rates have also encouraged securitization into NHA-MBS, CMB and 35%. Single-family volumes increased home purchasing across the country. ABCP programs remained a large part by 42% and commercial segment In the commercial segment, the of the Company’s strategy, with volume volumes increased by 23% year over Company’s expertise in underwriting of $11.0 billion in 2020. year. Management believes the increase multi-unit mortgages was fundamental in the single-family segment is due to its to growth, and origination volumes strong broker and investor relationships and its MERLIN™ technology and grew by 23%. When combined with renewals, total production for both operating systems, which support business segments increased by 30% physical distancing and have allowed from $28.5 billion in 2019 to almost the Company to continue to underwrite — 24 First National Financial Corporation Net Interest – Securitized Mortgages Placement Fees Mortgage Servicing Income Comparing the year ended December Placement fee revenue increased by 62% Mortgage servicing income increased 31, 2020, to the year ended December to $333.7 million from $205.5 million in 12% to $175.0 million from $156.7 million. 31, 2019, “net interest – securitized the comparative year. The increase was This increase was largely attributable to mortgages” decreased by about 7% the result of 59% year-over-year growth the Company’s third-party underwriting to $129.4 million from $138.6 million. in residential mortgage volume with business unit. Much like the Company’s The decrease was largely due to the institutional investors. This growth was experience in single-family origination, consequences of the market disruption augmented by higher per unit placement mortgage brokers referring mortgages that accompanied the COVID-19 fees, which resulted from the aftermath to First National’s third-party customers pandemic. In March 2020, the Bank of the pandemic-related financial turmoil. have embraced the MERLIN™ technology. of Canada cut overnight interest rates As mortgage spreads widened beginning The Company believes the technology by 1.5%. The ensuing financial turmoil in the second quarter of 2020, the value has been advantageous during the affected securitization margins in of mortgages retained on the Company’s pandemic-related lockdown period and the first and second quarters. By balance sheet increased as other credit led to increased origination volumes. the third quarter, financial market spreads began to normalize. When the conditions had normalized. Even so, Company subsequently placed such net interest was negatively impacted origination, this value came through by the significant impact from the in the form of higher placement fees. cost of indemnities payable to MBS Similar economics were evident in the debtholders when mortgages prepaid commercial segment, where both volume prior to the scheduled maturity date. and wider mortgage spreads led to The indemnities are calculated to make increased placement fees. Mortgage Investment Income Mortgage investment income decreased 19% to $69.0 million from $84.7 million. The decrease was due primarily to the interest rate environment, as short-term rates fell significantly in March as the Bank of Canada cut its overnight rate by 1.5%. This started a steady reduction in the Company’s offered mortgage whole the debtholders who are assumed to reinvest the prepayment principal at risk-free reinvestment rates. With the recent decrease in interest rates, the cost of such indemnities has increased significantly. The Company calculates Gains on Deferred Placement Fees Gains on deferred placement fees rates. The result was lower amounts of revenue increased 179% to $32.4 interest earned while mortgages are million from $11.6 million. The gains accumulated for securitization and sale that because of the increase in indemnity related to multi-unit residential on the balance sheet. costs, net securitization spread is lower by about $18.4 million. The Company’s prime ABCP programs suffered in the first two quarters of 2020 as the cost of funds reacted negatively to the financial turmoil produced by the pandemic such that profitability was decreased. The Excalibur securitization program had favourable results as the Company increased this portfolio and credit loss ratios were lower than expected. mortgages originated and sold to institutional investors. Volumes for these transactions increased by 40% from 2019, and mortgage spreads on commercial segment mortgages widened significantly year over year. — 25 2020 Annual Report Realized and Unrealized Gains (Losses) on Financial Instruments This financial statement line item multi-residential commitments and mortgages it originates for its own securitization typically consists of three primary programs. It has also done the same for the funded single-family mortgages and the components: (1) gains and losses related swaps used in its ABCP programs. This decision has reduced the volatility of gains and to the Company’s economic hedging losses on financial instruments otherwise recorded in the Company’s regular earnings, activities of single-family commitments, as gains and losses on hedged items are generally deferred and amortized into (2) gains and losses related to holding income over the term of the related mortgages. The Company has not documented a a portfolio of mortgage and loan hedging relationship for its interest mitigation program used to economically hedge investments at fair value, and (3) gains commitments on single-family mortgages. The Company believes, given the optional and losses on interest rate swaps used nature of these commitments, it is difficult to establish a valid hedging relationship. to mitigate interest rate risk associated For financial reporting purposes, this means that there will still be gains and losses on with its CMB activity. With the adoption financial instruments, but these should be limited to those on the bonds sold short used of IFRS 9 in 2018, a significant portion of to mitigate such risk. The Company has recorded mortgage and loan investments at fair the Company’s interest rate management value on its balance sheet. Accordingly, there are fair value gains or losses associated program qualifies as hedging for with these mortgages. The following table summarizes these gains and losses by accounting purposes. The Company category in the periods indicated: has elected to document hedging relationships for virtually all of the SUMMARY OF REALIZED AND UNREALIZED GAINS (LOSSES) ON FINANCIAL INSTRUMENTS ($000s) Gains (losses) on short bonds used for the economic hedging program Gains (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, 2020 December 31, 2019 December 31, 2020 December 31, 2019 114 924 (778) 260 5,931 (700) 244 5,475 (75,689) (8,269) (3,076) 11,410 (67,355) (4,300) 2,914 (9,655) In the first quarter of 2020, financial a significant impact on the Company’s to decline, but at a slower pace. For the repercussions related to COVID-19 were short bond positions and the Company year, losses on account of short bonds very severe. With rapid unemployment recorded $66.4 million of losses in the totalled $75.7 million. In the fourth and liquidity fears, the Bank of Canada first quarter of 2020 on the bonds the quarter, interest rates were less volatile reduced its overnight lending rate by Company used to mitigate interest rate and the impact on financial instruments 1.50%, and bond yields quickly fell as risk on single-family commitments. As was much less significant. the fears of a global pandemic and the financial markets normalized after recession increased. The lower yields had the first quarter, bond yields continued — 26 First National Financial Corporation Brokerage Fees Expense Interest Expense Income before Income Taxes and Pre-FMV EBITDA Brokerage fees expense increased 55% Interest expense decreased 32% to $53.2 Income before income taxes increased by to $159.0 million from $102.6 million. million from $77.7 million. As discussed This increase is explained by higher in the “Liquidity and Capital Resources” origination volumes of single-family section of this analysis, the Company mortgages for institutional investors, warehouses a portion of the mortgages which increased by 59% year over it originates prior to settlement with the year. Unit broker fees were generally investor or funding with a securitization consistent between 2020 and 2019; vehicle. The Company used senior however, commercial segment fees and unsecured notes together with a $1.25 portfolio insurance costs did not grow at billion credit facility with a syndicate of 7% to $258.7 million from $241.7 million in 2019. This increase was partially the result of changing capital markets. As described previously in this MD&A, the Company’s results generally include gains or losses on account of financial instruments used to economically hedge residential mortgage commitments. In 2020, the Company recorded $64.3 the same rate as single-family origination. banks and 30-day repurchase facilities to million of losses on financial instruments These factors moderated the growth of fund the mortgages during this period. the overall brokerage fee expenses. The overall interest expense decreased (excluding $3.1 million of losses related to mortgage and loan investments). Salaries and Benefits Expense from the prior year due to the significant Comparatively, in 2019, the Company decrease in short-term lending rates recorded $5.4 million of gains on financial pursuant to the Bank of Canada’s 1.5% instruments (excluding the impact of Salaries and benefits expense increased rate cut in March 2020. 22% to $143.5 million from $117.6 million. Salaries were higher as overall headcount increased by 18% (1,028 employees Other Operating Expenses as at December 31, 2019, and 1,211 at Other operating expenses increased by December 31, 2020). The increase was 20% to $57.6 million from $47.9 million. also the result of $13.7 million of higher The primary change in other operating compensation earned by commercial expenses was higher hedging costs, sales staff and for increased bonus which increased $8.1 million between the provisions pursuant to increased years. The expense increased as 30-day origination levels and Company profits interest rates moved down significantly earned in 2020. Management salaries relative to five- and 10-year bond yields, were paid to the two senior executives making it more expensive to borrow the (co-founders) who together control short bonds that the Company uses to $4.3 million of losses related to mortgage and loan investments). The change in these values, excluding the losses on mortgage investments, accounted for a $58.9 million decrease in comparative income before income taxes. Pre-FMV Income, which eliminates the impact of such gains and losses on financial instruments, increased by 29% to $323.0 million from $251.3 million. This growth was largely the result of increased origination and higher per unit placement fee revenue, such that placement fee revenues net of brokerage fees increased about 71% of the Company’s common hedge interest rate exposure. Without by $71.8 million. shares. The current period expense is a these costs, other operating expenses result of the compensation arrangement increased by $1.6 million, reflecting costs executed on the closing of the initial to support the growth of the business public offering (“IPO”) in 2006. and MUA, particularly information technology costs. Discretionary costs, including promotion, travel and entertainment, were lower as a result of the pandemic. — 27 2020 Annual Report Income Tax Expense The provision for taxes increased by 6% to $68.5 million from $64.5 million. The provision increased proportionately with net income before income taxes. The overall effective tax rate was slightly lower in 2020, as one of the provinces where the Company operates reduced its corporate tax rate during the year. Other Comprehensive Income 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 or places the mortgage with an institutional investor. As the Company determined that these cash flow hedges were effective, the Company recorded $73.1 million of pre-tax net losses on such hedges in OCI in 2020. These losses would have been recorded as losses on financial instruments under the previous IFRS standard. In the year, the Company amortized a portion of these losses and a portion of opening accumulated OCI into regular earnings. In 2020, this amortization totalled $32.5 million. The remaining OCI amount will be amortized into net income in future periods. — 28 First National Financial Corporation OPERATING SEGMENT REVIEW The Company aggregates its business from two segments for financial reporting purposes: (i) Residential (which includes single-family residential mortgages), and (ii) Commercial (which includes multi-unit residential and commercial mortgages), as summarized below: OPERATING BUSINESS SEGMENTS FOR THE YEAR ENDED RESIDENTIAL COMMERCIAL ($000s, except percent amounts) December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Originations and renewals 25,833,197 19,026,919 11,075,085 9,427,357 Percentage change Revenue Percentage change Income before income taxes Percentage change AS AT Identifiable assets Mortgages under administration 36% 975,979 (3%) 141,085 (18%) 1,008,013 171,423 17% 404,315 27% 117,644 67% 318,510 70,290 December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 28,945,884 83,600,868 28,535,288 80,709,370 10,512,867 35,123,122 9,120,529 30,669,521 RESIDENTIAL SEGMENT COMMERCIAL SEGMENT LIQUIDITY AND CAPITAL RESOURCES Overall residential origination volumes 2020 commercial revenues increased The Company’s fundamental liquidity including renewals increased by 36% by about 27% compared to 2019. This strategy has been to invest in prime between 2020 and 2019, while residential increase was the result of higher spread Canadian mortgages. Management’s revenues decreased by 3%. Growth in origination, which drove a 77% increase belief has always been that these origination did not translate into growth in placement fees. Interest revenue on mortgages are considered “AAA” by in revenue, due to the reduction in the securitized mortgage portfolio grew investors and should always be well short-term interest rates that followed by 13% year over year. Income before bid and highly liquid. This strategy the Bank of Canada’s overnight rate cut income taxes for this segment was not proved effective during the turmoil of 1.5%. This negatively affected interest affected by fair-value considerations. experienced in 2007 through 2009, revenue – securitized mortgages, as This measure increased by 67% year over and once again in the COVID-19 crisis, well as mortgage investment income. year. The increase is due to the higher when capital markets were disrupted Net income before tax was affected by placement fee revenues offset partially and the demand for high-quality assets fair value-related revenues. Without the by higher compensation payable to increased. As the Company’s results impact of these revenues, net income the Company’s commercial origination in those years demonstrated, First before tax increased to $205.4 million employees. Identifiable assets increased National was able to attract investors in 2020 from $176.8 million in 2019, from those at December 31, 2019, as the to purchase its mortgage origination at or by 16%. This growth was largely Company increased its investment in profitable margins. Originating prime the result of income from placement mortgages pledged for securitization mortgages also allows the Company fees offset by lower securitization net by $1.4 billion. interest margin as described earlier in this MD&A. Identifiable assets increased from December 31, 2019, as the Company increased its investment in mortgages pledged for securitization by about $700 million. This growth was offset by lower hedging-related assets. 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, — 29 2020 Annual Report (2) the origination costs associated the nature of the assets which the debt Management believes that, at its peak, with securitization, and (3) mortgage is funding. and loan investments. The Company has a credit facility with a syndicate of financial institutions for 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, 2020, the Company had entered into repurchase transactions with financial institutions to borrow $1.4 billion related to $1.4 billion of mortgages held in “mortgages accumulated for sale or securitization” on the balance sheet. Since being approved as an issuer of NHA-MBS, the Company has funded the difference between the mortgages it uses to create NHA-MBS and the debt obligations it assumes upon issuance. In recent years, this requirement has generally been limited to mortgages in arrears where First National does not receive payments from the borrower but is obliged to pay the interest and amortizing principal on the NHA-MBS debt. However, due to the rapid rise in At December 31, 2020, outstanding national unemployment pursuant to bank indebtedness was $682.8 million the COVID-19 pandemic, this funding (December 31, 2019 – $797.8 million). requirement has increased as borrowers Together with the unsecured notes of requested mortgage payment deferrals. $399 million (December 31, 2019 – $375 In such situations, the Company million), this “combined debt” was used determined to grant mortgage payment to fund $805.7 million (December 31, deferrals. Qualifying borrowers received the Company granted deferrals to as many as 14% of its single-family borrowers. There have been no significant deferral requests granted to the multi-family segment of borrowers. The Company has significant credit lines and prime mortgage assets that continue to be liquid in turbulent economic times. Such facilities will provide the cash needed to fund this investment in ”timely payments”. For non-securitized MUA, the Company’s institutional investors will be required to fund any deferred payments which First National grants to borrowers in that investor’s portfolio. The Company’s current deferral program ended on September 30, 2020. At December 31, 2020, there were virtually no mortgages on deferral. 2019 – $817.5 million) of mortgages three months of payment deferral. The Company funds a portion of its accumulated for sale or securitization. In cases of extended hardship, the mortgage originations for institutional At December 31, 2020, the Company’s Company provided a second three- placement on the same day as the other interest-yielding assets included: month deferral after the initial deferral advance of the related mortgage. The (1) deferred placement fees receivable period ended. During this deferral remaining originations are funded by of $62.5 million (December 31, 2019 – period, a portion of such mortgages the Company on behalf of institutional $42.0 million) and (2) mortgage and ceased to amortize and interest investors or pending securitization by loan investments of $213.3 million otherwise payable was capitalized to the Company. On specified days, the (December 31, 2019 – $370.4 million). the principal of the mortgage. The three Company aggregates all mortgages The difference between “combined mortgage default insurers approved warehoused to date for an institutional debt” and the mortgages accumulated these steps, permitting the deferrals investor and transacts a settlement for sale or securitization funded by it, to occur without any impact on with that institutional investor. A similar which the Company considers a proxy subsequent claims under the mortgage process occurs prior to arranging for true leverage, decreased between insurance policies. In turn, First National for funding through securitization. December 31, 2019, and December 31, has been required to make “timely The Company uses a portion of 2020, and now stands at $275.8 million payments” on the NHA-MBS securities. the committed credit facility with (December 31, 2019 – $353.3 million). This means that despite not receiving the banking syndicate to fund the This represents a debt-to-equity ratio of payments from borrowers on the mortgages during this warehouse approximately 0.48:1. This ratio is lower mortgages that support the NHA-MBS, period. The credit facility is designed to than the ratio of 0.63:1 at December 31, the Company has been required to pay be able to fund the highest balance of 2019. In general, the decrease was the the interest and amortizing principal warehoused mortgages in a month and result of repayments of $157 million on the debt. In effect, the Company is normally only partially drawn. of mortgage and loan investments, de-leveraged its balance sheet by primarily related to the Company’s paying off the debt while the related commercial bridge loan portfolio. mortgages did not as amortize as These proceeds were used to pay down quickly. At December 31, 2020, the the Company’s debts. Despite some Company estimates that it had reduced significant losses on account of financial its NHA-MBS debt by approximately instruments incurred in the year, the $64 million because of the impact Company was able to increase earnings of deferred payments. This has been to offset such losses. The Company believes the ratio is appropriate given funded by the Company’s available cash resources. The Company also invests in short-term mortgages, usually for six- to 18-month terms, to bridge existing borrowers in the interim period before long-term financing. 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. — 30 First National Financial Corporation FINANCIAL INSTRUMENTS AND RISK MANAGEMENT The syndicate has also provided Commencing January 1, 2018, the family programs. For multi-unit credit to finance a portion of the Company has recorded mortgages residential and commercial mortgages, Company’s deferred placement fees accumulated for sale and mortgage the Company assumes all mortgages receivable and the origination costs and loan investments as financial assets committed will fund, and hedges each associated with securitization, as measured at “fair value through profit mortgage individually. This includes well as other miscellaneous longer-term or loss” such that changes in market mortgages committed for the CMB financing needs. value are recorded in the consolidated program as well as mortgages to be sold 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 by rating agencies. The most significant portion of cash collateral is the investment made on behalf of the Company’s ABCP programs. As at December 31, 2020, the investment in cash collateral was $88.2 million (December 31, 2019 – $83.6 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 June 30, 2010, are designated as “eligible dividends”. Unless stated otherwise, all dividends (and deemed dividends) paid by the Company hereafter are designated as “eligible dividends” for the purposes of such rules. statement of income. The mortgages to the Company’s other securitization accumulated for sale are held for very vehicles. As at December 31, 2020, short periods, and any change in value the Company had entered into $0.6 due to changing interest rates is the billion of notional value forward bond obligation of the ultimate institutional sales for this segment. The Company is investor. Accordingly, the Company also a party to four interest rate swaps believes there will be little, if any, effect that economically hedge the interest on its income related to the change rate exposure related to certain CMB in fair value of these mortgages. The transactions in which the Company majority of mortgages in mortgage has replacement obligations. As at and loan investments are uninsured December 31, 2020, the aggregate commercial segment bridge loans. notional value of these swaps, maturing These are primarily floating rate loans between June 2021 and September that have mortgage terms of 18 months 2026, was $99.0 million. During the or less. As the mortgages do not 2020 year, the value of these swaps conform to conventional mortgage increased by $11.4 million. 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. As described above, the Company employs various strategies to reduce interest rate risk. In the normal course of business, the Company also takes on 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 ultimate date of placement or securitization. If credit spreads widen during this holding period, this is unfavourable for the Company. It means that the Company cannot fund The Company believes its hedging the mortgages originated with a funding policies are suitably designed such source as effectively as originally that the interest rate risk of holding intended. Despite entering into effective mortgages prior to securitization interest rate hedges, the Company’s is mitigated. Prior to 2018, the exposure to credit spreads will remain. Company did not attempt to adopt This risk is inherent in the Company’s hedge accounting; however, with the business model and the Company introduction of IFRS 9 on January 1, believes it cannot be economically 2018, the Company began designating hedged. As at December 31, 2020, the hedging relationships such that the results of any effective hedging will Company had various exposures to changing credit spreads. In particular, not affect the Company’s statement of in mortgages accumulated for sale or income. See previous discussion in this securitization, there were approximately MD&A under “Realized and Unrealized $2.2 billion of mortgages that were Gains (Losses) on Financial Instruments”. susceptible to some degree of changing As at December 31, 2020, the Company credit spreads. had over $1.1 billion of notional forward bond positions related to its single- — 31 2020 Annual Report “ A significant portion of First National’s business model consists of the origination and placement or securitization of financial assets.” CAPITAL EXPENDITURES A significant portion of First National’s business model consists of the origination and placement or securitization of financial assets. Generally, placement activities do not require much capital investment, because of the Company’s business model. On the other hand, the undertaking of securitization transactions may require significant amounts of the Company’s own capital. This capital is provided in the form of cash collateral, credit enhancements, and the upfront funding of broker fees and other origination costs. These are described more fully in the “Liquidity and Capital Resources” section above. The business requires capital expenditures on technology (both software and hardware), leasehold improvements, and office furniture. During the year ended December 31, 2020, the Company purchased new computer equipment and software and made leasehold improvements. In the long term, the Company expects capital expenditures on fixed assets will be approximately $6.0 million annually, but will likely be higher in 2021 as the Toronto office moves its premises and invests in new leasehold improvements. 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) 0–1 1–3 4–5 Total years years years After 5 years Lease obligations 46,926 7,931 20,152 18,152 691 — 32 First National Financial Corporation CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company prepares its financial fixed-rate mortgages. Currently there are investments. These are generally statements in accordance with IFRS, no deferred placement fees related to non-homogeneous mortgages and which requires management to make single-family mortgages. estimates, judgements and assumptions that management believes are reasonable based upon the information available. These estimates, judgements 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, 2020. 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 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 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. used reflect the expected performance As a mortgage lender, the Company of the mortgage portfolio over the invests in uninsured mortgages. When lives of the mortgages. The method of it funds these mortgages through determining the assumptions underlying securitization debt, it continues to the estimates used for the year ended be liable for any credit losses. The December 31, 2020, continue to be key inputs in the measurement of consistent with those used for the year any expected credit loss (“ECL”) ended December 31, 2019, and the include probability of default, loss quarters ended September 30, June 30 given default and forecast of future and March 31, 2020. 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. A portion of the bonds sold short are designated as an effective hedge, and accordingly, 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 economic conditions, which involves significant judgement. 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 $0.7 million for 2020. 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, 2020, management evaluated, under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the — 33 2020 Annual Report RISKS AND UNCERTAINTIES AFFECTING THE BUSINESS Company’s disclosure controls and The business, financial condition and with such legislation. Among the risks procedures. Based on this evaluation, results of operations of the Company of all potential tax matters, there is a management concluded that the are subject to a number of risks and risk that tax legislation changes are Company’s disclosure controls and uncertainties and are affected by a detrimental to the Company or that procedures, as defined by National number of factors outside the control of Canadian tax authorities interpret tax Instrument 52-109, Certification of management of the Company. In addition legislation differently than the Company’s Disclosure in Issuers’ Annual and to the risks addressed elsewhere in this filing positions. Risk and risk exposure Interim Filings, were effective as of discussion and the financial statements, are managed through a combination of December 31, 2020. these risks include: ability to sustain insurance, a system of internal controls Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with reporting standards; however, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. Management evaluated, under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s internal control over financial reporting based on the criteria set forth in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and, based on that evaluation, concluded that the Company’s internal control over financial reporting was effective as of December 31, 2020, and that no material weaknesses have been identified in the Company’s internal control over financial reporting as of December 31, 2020. No changes were made in the Company’s internal controls over financial reporting during the year ended December 31, 2020, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. — 34 performance and growth, reliance on and sound operating practices. The sources of funding, concentration of Company’s key business model is to institutional investors including third- originate primarily prime mortgages and party servicing customers, reliance on find funding through various channels to independent mortgage brokers, changes earn ongoing servicing or spread income. in interest rates, repurchase obligations For the single-family residential segment, and breach of representations and the Company relies on independent warranties on mortgage sales, risk of mortgage brokers for origination and servicer termination including the impact several large institutional investors for of trigger events on cash collateral and sources of funding. These relationships retained interests, reliance on multi-unit are critical to the Company’s success. residential and commercial mortgages, In October 2019, the sale transaction general economic conditions, legislation involving an institution for which the and government regulation (including Company administers a large portfolio regulations imposed by the Department of third-party originated mortgages of Finance and CMHC and the policies set was completed. The new owners of the by and for mortgage default insurance institution may decide not to renew the companies), potential for losses on existing contract with First National or uninsured mortgages, competition, to exercise termination clauses within reliance on mortgage insurers, reliance the agreement. In the event of non- on key personnel and the ability to renewal or termination, the Company’s attract and retain employees and MUA will decrease. For a more complete executives, conduct and compensation discussion of the risks affecting the of independent mortgage brokers, Company, reference should be made to failure or unavailability of computer and the Company’s Annual Information Form. 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 It became clear to the Company in mid- March 2020 that COVID-19 was highly contagious and the Company executed its business continuity plan. In this case, the plan called for a “working from home” contingency. Within the first month, most of the Company’s staff across the country transitioned to working from home. The COVID-19 crisis has been the cause of significant unemployment across the country and widespread economic hardship. During the duration of this crisis, the probability of the risks listed above having a negative impact on the Company has increased. Related losses could be material. First National Financial Corporation FORWARD-LOOKING INFORMATION OUTLOOK Forward-looking information is included currently expects. These factors 2020 results exceeded management’s in this MD&A. In some cases, forward- include reliance on sources of funding, expectations. Single-family origination looking information can be identified by concentration of institutional investors, increased by 42% from the comparative the use of terms such as “may”, “will”, reliance on independent mortgage volume in 2019, and commercial ‘“should”, “expect”, “plan”, “anticipate”, brokers, and changes in interest rates as segment origination increased by “believe”, “intend”, “estimate”, “predict”, outlined in the “Risk and Uncertainties 23% despite the pandemic-related “potential”, “continue” or other similar Affecting the Business” section. In slowdown in demand for uninsured expressions concerning matters that evaluating this information, the reader commercial product. With COVID-19- are not historical facts. Forward-looking should specifically consider various related uncertainties still widespread, information may relate to management’s factors, including the risks outlined in it is difficult to look too far ahead. future outlook and anticipated events or the “Risk and Uncertainties Affecting the However, with the results of the last results, and may include statements or Business” section, that may cause actual three quarters of 2020 and a window on information regarding the future financial events or results to differ materially from the first quarter of 2021, management position, business strategy and strategic any forward-looking information. The is very positive about the 2021 fiscal goals, product development activities, forward-looking information contained in year. The expectation for the next projected costs and capital expenditures, this discussion represents management’s year includes: residential origination financial results, risk management expectations as of March 2, 2021, and comparable to 2020, commercial strategies, hedging activities, geographic is subject to change after such date. segment success in growing origination, expansion, licensing plans, taxes and However, management and the Company and continued employee productivity other plans and objectives of or involving disclaim any intention or obligation to from the Company’s work-from-home the Company. Particularly, information update or revise any forward-looking strategy. During 2020, the value regarding growth objectives, any increase information, whether as a result of new of First National’s business model in mortgages under administration, future use of securitization vehicles, information, future events or otherwise, was demonstrated. By designing except as required under applicable systems that do not rely on face- industry trends and future revenues is securities regulations. forward-looking information. Forward- looking information is based on certain factors and assumptions regarding, among other things, interest rate changes and responses to such changes, the demand for institutionally placed and securitized mortgages, the status of the applicable regulatory regime, and the use of mortgage brokers for single-family residential mortgages. This forward-looking 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 to-face interactions, the Company’s business practices resonated with mortgage brokers and borrowers alike during the pandemic period. The commercial segment benefited from reduced competition, and First National increased its market share while earning wider spreads. With the expected distribution of vaccines across the nation, the economic effects of COVID-19 will hopefully diminish. However, the return to normalcy is certainly some months away. Management believes it will continue to have an advantage over traditional bank origination channels, which have been faced with disruption during the pandemic. First National expects that goodwill with its broker partners and customers created during the past nine months will persist through 2021. On the funding side, there continues to be strong demand from institutional investors as a result of the substantial amount of liquidity in the financial system. Securitization markets have normalized after a period of disruption at the beginning of the crisis. While it is not early in the crisis, there is still significant uncertainty about its — 35 2020 Annual Report duration and the extent of repercussions. The outbreak of COVID-19 has resulted in governments worldwide enacting emergency measures to combat the spread of the virus. These measures, which include the implementation of travel bans, self-imposed quarantine periods and physical distancing, have caused material disruption to businesses globally, resulting in an economic recession. Global equity markets have experienced significant volatility. Governments and central banks have reacted with significant monetary and fiscal interventions designed to stabilize economic conditions. The duration and impact of the COVID-19 outbreak is unknown at this time, as is the long-term efficacy of the government and central bank interventions. It is not possible to reliably estimate the length and severity of these developments and the impact on the financial results and condition of the Company and its operating subsidiaries in future periods. When management reported for the second quarter, the nature of deferred mortgage payments and the need for cash resources to fund these assets was described. As of May 11, 2020, the Company had approved mortgage payment deferrals for approximately 13.9% of the Company’s single- family mortgages under administration eligible for such an approval. On September 30, 2020, the Company ended its deferral program, such that by the end of 2020, there were virtually no mortgages on deferral. The Company is confident that its strong relationships with mortgage brokers and diverse funding sources will continue to set First National apart from its competition. The Company will continue to generate income and cash flow from its $34 billion portfolio of mortgages pledged under securitization and $83 billion servicing portfolio and focus on the value inherent in its significant single-family renewal book. — 36 First National Financial Corporation — 37 2020 Annual Report Management’s Responsibility for Financial Reporting The management of First National We are responsible for establishing which follows. The auditors have full Financial Corporation (the “Company”) is and maintaining internal control over and free access to, and meet at least responsible for the integrity, consistency financial reporting for the Company. quarterly with, the Audit Committee to and reliability of the consolidated We have designed such internal control discuss their audit and related matters. STEPHEN SMITH Chairman and Chief Executive Officer ROBERT INGLIS Chief Financial Officer March 2, 2021 financial statements and Management’s over financial reporting, or caused it to Discussion and Analysis (“MD&A”). be designed under our supervision, to The consolidated financial statements provide reasonable assurance regarding have been prepared by Management in the reliability of financial reporting and accordance with International Financial the preparation of financial statements Reporting Standards. We certify that we have reviewed the financial statements and information contained in the MD&A, and, based on our knowledge, they do not contain any untrue statement of a material fact or omit to state a material fact required to be stated or that is necessary to make a statement not misleading in light of the circumstances under which it was made, with respect to the period covered by the statements and the annual report. Based on our knowledge, the financial statements together with MD&A and other financial information included in the annual report fairly present in all for external purposes. We evaluated, or caused to be evaluated under our supervision, the effectiveness of the 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 the effectiveness of internal control over financial reporting at the financial year- end based on that evaluation. We have also disclosed in the MD&A any change in our internal control over financial reporting that occurred during the year that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. material respects the financial condition, The Board of Directors oversees that results of operations and cash flows of management fulfils its responsibility for the Company as of the dates and for the financial reporting and internal control. periods presented. The preparation of The financial statements have been financial statements involves transactions reviewed by the Audit Committee and affecting the current period which approved by the Board of Directors. cannot be finalized with certainty Ernst & Young LLP, the independent until future periods. Estimates and auditors appointed by the shareholders, assumptions are based on historical has performed an independent audit of experience and current conditions, and the Company’s consolidated financial are believed to be reasonable. statements and provide their report — 38 First National Financial Corporation Independent Auditor’s Report To the Shareholders of First National Financial Corporation REPORT ON THE AUDIT OF THE CONSOLIDATED FINANCIAL STATEMENTS OPINION BASIS FOR OPINION KEY AUDIT MATTERS We have audited the consolidated We conducted our audit in accordance Key audit matters are those matters financial statements of First National with Canadian generally accepted that, in our professional judgement, Financial Corporation and its subsidiaries auditing standards. Our responsibilities were of most significance in the audit of [collectively, the “Company”], which under those standards are further the financial statements of the current comprise the consolidated statements described in the Auditor’s responsibilities period. These matters were addressed in of financial position as at December 31, for the audit of the consolidated financial the context of the audit of the financial 2020 and December 31, 2019, and the statements section of our report. We statements as a whole, and in forming consolidated statements of income, are independent of the Company in the auditor’s opinion thereon, and we do comprehensive income, changes in equity accordance with the ethical requirements not provide a separate opinion on these and cash flows for the years then ended, that are relevant to our audit of the matters. For each matter below, our and notes to the consolidated financial consolidated financial statements in description of how our audit addressed statements, including a summary of Canada, and we have fulfilled our ethical the matter is provided in that context. significant accounting policies. 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. 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, 2020 and December 31, 2019, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards [“IFRSs”]. We have fulfilled the responsibilities described in the Auditor’s responsibilities for the audit of the financial statements section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the accompanying financial statements. — 39 2020 Annual Report Measurement of Estimated Credit Losses Fair Value Measurement of Mortgage and Loan Investments As more fully described in Note 2 and We obtained an understanding of As more fully described in Note 6 to Note 3 to the financial statements, the management’s controls over exposure the financial statements, the Company Company is exposed to credit risk on its to credit risk, including mortgage held a portfolio of mortgage and loan mortgage assets. In 2020 the Company underwriting policies and processes investments classified as fair value has recorded an allowance for credit used to assess borrower capacity, through profit and loss with a balance losses of $862 thousand. The Company income verification, creditworthiness of $213 million. The mortgage and manages credit risk by employing and collateral. We tested the operating loan investments are measured at underwriting policies and procedures effectiveness of these controls by management’s best estimate of fair value, designed to minimize exposure to credit assessing for a sample of mortgages with changes in fair value recognized in losses, and by acquiring insurance originated and funded, compliance with income. A fair value loss of $3 million was against borrower default on substantially management’s underwriting policy and recorded in income during the current year. all its mortgages [93% were insured as processes and eligibility, when arranged, at December 31, 2020]. The remaining for insurance against borrower default residual credit risk is related to $2.5 based on criteria of the mortgage billion of uninsured mortgages, which are default insurer. Auditing the valuation of mortgage and loan investments required judgement. The fair value of these assets is based on non-observable inputs. As these For the purpose of auditing the mortgages do not conform to conventional allowance for credit losses, among mortgage lending, there are few active other procedures: • We tested the accuracy of the Company’s historic default and write-off data and evaluated management’s ECL impairment analysis, by obtaining the Company’s historical data, corroborated by data from independent sources, to develop a range for the estimated ECL on the uninsured portfolio of mortgages held at amortized cost • We compared our range to management’s estimate of allowance for credit losses • We also assessed the adequacy of the Company’s disclosures on the management of credit risk. quoted markets available to determine the fair value of these assets. Management estimates fair value using significant assumptions which include, among others, 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. These inputs give rise to estimation uncertainty and judgement in determining the fair value of these assets. Where the assets are in default, the valuation is highly dependent on the valuation of the underlying real property, which is subject to estimation uncertainty. To test the valuation of mortgage and loan investments, among other procedures, • We performed an independent assessment of the borrower’s credit quality for a sample of performing and non-performing mortgage and loan investments to evaluate the estimate of net realizable value. primarily conventional prime single-family. The Company’s expected credit loss [“ECL”] impairment analysis considers a range of possible outcomes supported by past loss events, current conditions and an expectation of future possible outcomes. The allowance for credit losses was identified as a key audit matter due to the high estimation uncertainty in determining the probability of default and loss given default assumptions. Management judgement was involved in selecting appropriate values for these critical assumptions, which in the event of a credit loss includes estimates of the amounts recoverable from underlying collateral. In forming their judgement, management had to both make an assessment of the effectiveness of their credit management strategies in minimizing future credit losses as well as make a forecast of possible future economic conditions and consider the impact of each on their critical assumptions. Variations in the key assumptions and judgements described can have a material effect on the measurement of ECL. — 40 First National Financial Corporation OTHER INFORMATION RESPONSIBILITIES OF MANAGEMENT AND THOSE CHARGED WITH GOVERNANCE FOR THE CONSOLIDATED FINANCIAL STATEMENTS • For a sample of mortgage and loan Management is responsible for Management is responsible for the investments, we involved our valuation the other information. The other preparation and fair presentation of specialists to assist in the assessment information comprises: of fair value by performing an independent valuation of the • Management’s Discussion and Analysis underlying collateral using independent • The information, other than the market data. consolidated financial statements the consolidated financial statements in accordance with IFRSs, and for such internal control as management determines is necessary to enable the preparation of consolidated financial • We also assessed the adequacy of the Company’s disclosures related to the fair value measurement of these mortgage and loan investments, and our auditor’s report thereon, in statements that are free from material the Annual Report misstatement, whether due to fraud Our opinion on the consolidated financial statements does not cover the or error. In preparing the consolidated financial including categorization in the fair other information and we do not and statements, management is responsible value hierarchy. will not express any form of assurance for assessing the Company’s ability to 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 continue as a 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. financial statements or our knowledge Those charged with governance obtained in the audit or otherwise appears are responsible for overseeing the to be materially misstated. Company’s financial reporting process. 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. — 41 2020 Annual Report AUDITOR’S RESPONSIBILITIES FOR THE AUDIT OF THE CONSOLIDATED FINANCIAL STATEMENTS Our objectives are to obtain reasonable • Evaluate the appropriateness of We communicate with those charged assurance about whether the consolidated financial statements as a whole are free from material accounting policies used and the with governance regarding, among other reasonableness of accounting matters, the planned scope and timing of estimates and related disclosures the audit and significant audit findings, misstatement, whether due to fraud made by management. or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with 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. • Conclude on the appropriateness of management’s use of the going including any significant deficiencies in internal control that we identify during our audit. concern basis of accounting and, We also provide those charged with based on the audit evidence obtained, governance with a statement that we whether a material uncertainty exists related to events or conditions that have complied with relevant ethical requirements regarding independence, may cast significant doubt on the and to communicate with them all Company’s ability to continue as a relationships and other matters that may going concern. If we conclude that reasonably be thought to bear on our a material uncertainty exists, we independence, and where applicable, are required to draw attention in our related safeguards. auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. As part of an audit in accordance with Our conclusions are based on the audit Canadian generally accepted auditing evidence obtained up to the date of standards, we exercise professional our auditor’s report. However, future judgement and maintain professional events or conditions may cause the skepticism throughout the audit. We also: Company to cease to continue as a • Identify and assess the risks of material going concern. misstatement of the consolidated • Evaluate the overall presentation, in extremely rare circumstances, we financial statements, whether due to structure, and content of the determine that a matter should not be fraud or error, design and perform audit consolidated financial statements, communicated in our report because the procedures responsive to those including the disclosures, and whether adverse consequences of doing so would risks, and obtain audit evidence that is sufficient and appropriate to provide the consolidated financial statements represent the underlying transactions reasonably be expected to outweigh the public interest benefits of such a basis for our opinion. The risk of and events in a manner that achieves communication. not detecting a material misstatement fair presentation. resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. The engagement partner on the audit • Obtain sufficient appropriate audit resulting in this independent auditor’s evidence regarding the financial report is Andre de Haan. information of the entities or business activities within the Company to express an opinion on the consolidated • Obtain an understanding of internal financial statements. We are control relevant to the audit in order to design audit procedures that are responsible for the direction, supervision and performance of the Toronto, Canada appropriate in the circumstances, Company’s audit. We remain solely March 2, 2021 but not for the purpose of expressing responsible for our audit opinion. an opinion on the effectiveness of the Company’s internal control. — 42 From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, First National Financial Corporation CONSOLIDATED STATEMENTS OF FINANCIAL POSITION As at December 31 (in thousands of Canadian dollars) Notes 2020 2019 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 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 Accounts payable and accrued liabilities Securities sold short Debt related to securitized mortgages Senior unsecured notes Income taxes payable Deferred income tax liabilities Total liabilities Common shares Preferred shares Retained earnings Accumulated other comprehensive loss Total equity Total liabilities and equity See accompanying notes On behalf of the Board: JOHN BROUGH Director ROBERT MITCHELL Director 3 3 5 3 4 6 15 7 9 15 16 14 10 12 18 18 17 17 669,219 88,206 119,531 2,250,519 34,137,421 62,535 213,301 1,884,811 62,984 681,596 83,587 131,042 1,918,581 31,995,424 42,046 370,414 2,414,835 48,068 $39,488,527 $37,685,593 682,832 797,758 1,418,445 185,772 1,888,049 1,072,062 149,906 2,397,325 34,265,504 32,245,793 398,554 11,470 67,100 374,025 4,764 82,300 $38,917,726 $37,123,933 122,671 97,394 383,993 (33,257) 570,801 122,671 97,394 345,029 (3,434) 561,660 $39,488,527 $37,685,593 — 43 2020 Annual Report CONSOLIDATED STATEMENTS OF INCOME Years ended December 31 (in thousands of Canadian dollars, except earnings per share) Notes 2020 2019 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 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 837,576 (708,162) 129,414 333,696 32,365 69,033 174,979 (67,355) $672,132 159,018 143,503 53,246 57,636 $413,403 258,729 68,500 $190,229 877,720 (739,071) 138,649 205,451 11,619 84,670 156,718 (9,655) $587,452 102,596 117,575 77,700 47,868 $345,739 241,713 64,500 $177,213 3.12 2.90 3 4 6 19 18 17 — 44 First National Financial Corporation 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 losses from change in fair value of cash flow hedges Reclassification of net losses to income Income tax recovery Total other comprehensive loss Total comprehensive income See accompanying notes CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Years ended December 31 Notes 18 2020 190,229 (73,147) 32,524 (40,623) 10,800 (29,823) 2019 177,213 (25,118) 24,700 (418) 100 (318) $160,406 $176,895 (in thousands of Canadian dollars) Common shares Preferred shares Retained earnings Accumulated other comprehensive loss Total equity BALANCE AS AT JANUARY 1, 2020 122,671 97,394 345,029 (3,434) 561,660 Net income for the year Other comprehensive loss Dividends paid or declared — — — — — — 190,229 — 190,229 — (29,823) (29,823) (151,265) — (151,265) BALANCE AS AT DECEMBER 31, 2020 $122,671 $97,394 $383,993 $(33,257) $570,801 Common shares Preferred shares Retained earnings Accumulated other comprehensive loss Total equity BALANCE AS AT JANUARY 1, 2019 122,671 97,394 315,294 (3,116) 532,243 Net income for the year 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 — 45 2020 Annual Report CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31 (in thousands of Canadian dollars) OPERATING ACTIVITIES Net income for the year Add (deduct) items Deferred income taxes Non-cash portion of gains on deferred placement fees Decrease (increase) in restricted cash Net investment in mortgages pledged under securitization Net increase in debt related to securitized mortgages 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 Issuance of senior unsecured notes Repayment of matured senior unsecured notes Cash provided by (used in) financing activities Net decrease in bank indebtedness during the year Bank indebtedness, beginning of year Bank indebtedness, end of year SUPPLEMENTAL CASH FLOW INFORMATION Interest received Interest paid Income taxes paid — 46 2020 2019 190,229 177,213 (4,400) (31,320) 12,377 (2,077,042) 1,954,756 530,024 (621,315) 10,831 7,660 63,082 34,882 (285,841) $(250,959) (3,585) (4,619) (817,101) 971,138 $145,833 (150,621) 346,383 199,290 (175,000) $220,052 114,926 (797,758) $(682,832) 999,551 735,830 66,194 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 First National Financial Corporation Notes to Consolidated Financial Statements [in thousands of Canadian dollars, unless otherwise indicated] December 31, 2020 and 2019 1. GENERAL ORGANIZATION AND BUSINESS OF FIRST NATIONAL FINANCIAL CORPORATION First National Financial Corporation [the “Corporation” or “Company”] is the parent company of First National Financial LP [“FNFLP”], a Canadian- based originator, underwriter and servicer of predominantly prime residential [single family and multi- unit] and commercial mortgages. With over $118 billion in mortgages under administration as at December 31, 2020, FNFLP is a significant participant in the mortgage broker distribution channel. 2. SIGNIFICANT ACCOUNTING POLICIES [A] BASIS OF PREPARATION The consolidated financial statements FNAM is a wholly owned subsidiary of have been prepared in accordance the GP, and an indirect subsidiary of the with International Financial Reporting Standards [“IFRS”]. The consolidated Company. FNAM is a NHA approved lender and NHA-MBS issuer in the financial statements have been prepared capacity of an “aggregator”. Its business on a historical cost basis, except for model is to purchase mortgages from derivative financial instruments and mortgage originators in order to create certain financial assets and financial NHA-MBS pools, and subsequently sell liabilities that are recorded at fair value these into the Canada Mortgage Bonds through profit or loss [“FVTPL”] and programs [“CMB”]. measured at fair value. The carrying values of recognized assets and liabilities The Corporation is incorporated under that are designated as hedged items the laws of the Province of Ontario, in fair value hedges, and that would Canada and has its registered office otherwise be carried at amortized cost, and principal place of business located are adjusted to record changes in fair at 100 University Avenue, Toronto, value attributable to the risks that are Ontario. The Corporation’s common and being mitigated in effective hedge preferred shares are listed on the Toronto relationships. The consolidated financial Stock Exchange under the symbols FN, statements are presented in Canadian FN.PR.A and FN.PR.B, respectively. dollars and all values are rounded to the nearest thousand except when otherwise indicated. The consolidated financial statements were authorized for issue by the Board of Directors on March 2, 2021. [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”] which is used to manage undivided co ownership interests in mortgage assets funded with Asset-Backed Commercial Paper [“ABCP”], First National Asset Management Inc. [“FNAM”], and First National Mortgage Corporation. The 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 which acquire assets from various sellers including mortgages from the Company. The Company earns interest income from the retained interest related to these mortgages. As at December 31, 2020, the Company recorded, on its consolidated statements of financial position, its portion of the assets of the SPEs amounting to $1,565 million [2019 – $1,275 million]. The Company also recorded, in its consolidated statements of income, interest revenue – securitized mortgages of $51.1 million [2019 – $31.4 million] and interest expense – securitized mortgages of $39.2 million [2019 – $27.4 million] related to its interest in the SPEs. The consolidated financial statements have been prepared using consistent accounting policies for like transactions and other events in similar circumstances. All intercompany assets and liabilities, equity, income, expenses and cash flows relating to transactions between these companies are eliminated in full on consolidation. — 47 2020 Annual Report [C] USE OF ESTIMATES [D] SIGNIFICANT ACCOUNTING POLICIES The preparation of consolidated FINANCIAL INSTRUMENTS The Company accounts for its financial assets and liabilities in accordance with IFRS 9, Financial Instruments [“IFRS 9”]. Classification and Measurement of Financial Assets The Company classifies its financial assets as either amortized cost or at FVTPL as summarized below: reporting of financial assets and financial Mortgages accumulated for sale Securities purchased under resale agreements Mortgages accumulated for securitization Mortgages pledged under securitization Mortgage and loan investments Deferred placement fees receivable financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including contingencies, at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. Major areas requiring use of estimates by management are those that require liabilities at fair value. The global pandemic related to an outbreak of COVID-19 has cast additional uncertainty on the assumptions used by management in making its judgements and estimates. Governments and central banks have reacted with significant monetary and fiscal interventions designed to stabilize economic conditions. The duration and impact of the COVID-19 outbreak is unknown at this time, as is the efficacy of the government and central bank interventions. It is not possible to reliably estimate the length Classification and Measurement of Financial Liabilities The Company classifies its financial liabilities as either amortized cost or at FVTPL as summarized below: Obligations related to securities and mortgages sold under repurchase agreements Securities sold short Amortized cost Amortized cost FVTPL Amortized cost FVTPL Amortized cost FVTPL FVTPL Amortized cost Amortized cost Amortized cost and severity of these developments Debt related to securitized mortgages and the impact on the consolidated financial results and condition of the Servicing liabilities Company and its operating subsidiaries Senior unsecured notes in future periods. Given that the full extent of the impact that COVID-19, including government and/or regulatory responses to the outbreak, will have on the Canadian economy and the Company’s business is highly uncertain and difficult to predict at this time, there is a higher level of uncertainty with respect to management’s judgements and estimates related to the fair value of mortgage and loan investments and the amount of expected credit losses for uninsured residential mortgages. — 48 First National Financial Corporation IMPAIRMENT The expected credit loss [“ECL”] expectation of future possible outcomes, same hedging strategy when placing impairment model applies to all debt discounted to reflect the time value mortgages with institutional investors who instruments within financial assets of money. The key inputs in the plan to use CMB funding. The effective classified as amortized cost or FVOCI, measurement of ECL include Probability portion of the change in the fair value as well as certain off-balance sheet loan of Default, Loss Given Default and of the designated hedging instrument commitments. The IFRS 9 ECL approach forecast of future economic conditions, qualifying as a cash flow hedge is has three stages: Stage 1 – the credit risk which involve significant judgement. recognized in other comprehensive has not increased significantly since initial recognition such that an allowance for credit loss is recognized and maintained Hedge Accounting 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 principal in arrears between 31 to 90 days are included in Stage 2. While mortgages in these two stages are not considered to be impaired, the Company recognizes a 12-month ECL for Stage 1 mortgages and The Company applies IFRS 9 hedge accounting for certain mortgage commitments and funded mortgages. 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. a lifetime ECL for Stage 2 mortgages. Cash Flow Hedges When a mortgage is in arrears for over 90 days or the Company has issued a legal demand for repayment, there is a specific expectation 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 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 The Company’s ECL impairment model cash flows on the anticipated future debt is built on an unbiased and probability- to be arranged through securitization of weighted method, determined by these mortgages obtained through CMB, evaluating a range of possible outcomes disclosed as debt related to securitized supported by past loss events and mortgages. The Company also uses the 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. Fair Value Hedges 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 are funded until the date they are securitized or placed with an arm’s length 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 or speculative purposes. — 49 2020 Annual Report REVENUE RECOGNITION In the case of the swaps and short The Company earns revenue from For securitized mortgages that do not bonds used to hedge funded placement, securitization and servicing meet the criteria for derecognition, no mortgages, changes in fair value of the activities related to its mortgage business. gain or loss is recognized at the time hedged item, to the extent that the The majority of originated mortgages of the transaction. Instead, net interest hedging relationship is effective, are are sold to institutional investors through income is recognized over the term offset by changes in the fair value of the the placement of mortgages or funded of the mortgages. Interest revenue – hedging instrument, both of which are through securitization conduits. The securitized mortgages represents the recognized in regular income. At hedge Company retains servicing rights on interest portion of mortgage payments unwind, the realized change in the value substantially all of the mortgages it received and accrued by borrowers and of the hedging instrument is adjusted originates, providing the Company with 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. Capitalized origination fees and debt discounts or premiums are amortized on an effective yield basis over the term of the related mortgages or debt. DERECOGNITION A financial asset is derecognized when: • The right to receive cash flows from the asset has expired; or • The Company has transferred its rights to receive cash flows from the assets or has assumed an obligation to pay the cash flows, received in full without material delay to a third party under a “pass-through” arrangement; and either [a] the Company has transferred substantially all the risks and rewards of the asset; or [b] the Company has neither transferred nor retained substantially all of the risks and rewards of the asset, but has transferred control of the asset. to the carrying value of the hedged servicing fees. 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 Interest Revenue and Expense from Mortgages Pledged under Securitization recorded in regular income. 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 [ii] a significant portion, but not all, of the risks and rewards have been transferred. The asset is derecognized entirely if the transferee has the ability to sell the financial asset; otherwise the asset continues to be recognized to the extent of the Company’s continuing involvement. Where [i] or [ii] above applies to a fully proportionate share of all or specifically identified cash flows, the relevant accounting treatment is applied to that proportion of the mortgage. — 50 First National Financial Corporation Placement Fees and Deferred Placement Fees Receivable Mortgage Servicing Income Mortgage Investment Income The Company enters into placement The Company services substantially The Company earns interest income agreements with institutional investors all of the mortgages that it originates, from its interest-bearing assets, including to purchase the mortgages it originates. whether the mortgage is placed with deferred placement fees receivable, When mortgages are placed with an institutional investor or transferred mortgage and loan investments and institutional investors, the Company to a securitization vehicle. In addition, mortgages accumulated for sale or transfers the contractual right to mortgages are serviced on behalf securitization. Mortgage investment receive mortgage cash flows to the of third-party institutional investors income is recognized on an accrual basis. investors. Because it has transferred and securitization structures. For all substantially all the risks and rewards of mortgages administered for investors or these mortgages, it derecognizes these assets. The Company retains a residual third parties, the Company recognizes servicing income when services are interest representing the rights and rendered. For mortgages placed under obligations associated with servicing the deferred placement arrangements, mortgages. Placement fees are earned the Company retains the rights and by the Company for its origination and obligations to service the mortgages. The underwriting activities on a completed deferred placement fees receivable is the transaction basis when the mortgage present value of the excess retained cash is funded. Amounts immediately flows over market servicing fee rates BROKERAGE FEES Brokerage fees are primarily fees paid to external mortgage brokers. Brokerage fees relating to mortgages placed with institutional investors are expensed as incurred, and those relating to mortgages recorded at amortized cost are capitalized to the carrying cost of the related mortgages and amortized over collected or collectible in excess of and is reported as deferred placement the term of the mortgages. the mortgage principal are recognized revenue at the time of placement. as placement fees. When placement Servicing income related to mortgages fees and associated servicing fees are placed with institutional investors is earned over the term of the related recognized in income over the life of mortgages, the Company determines the servicing obligation as payments the present value of the future stream are received from mortgagors. Interest of placement fees and records a gain on income earned by the Company from deferred placement fees and a deferred holding cash in trust related to servicing placement fees receivable. Since quoted activities is classified as mortgage prices are generally not available servicing income. The amortization of for retained interests, the Company any servicing liabilities is also recorded as estimates values based on the net mortgage servicing income. present value of future expected cash flows, calculated using management’s best estimates of key assumptions related to expected prepayment rates and discount rates commensurate with the risks involved. The Company provides underwriting and fulfilment processing services for mortgages originated by two large Canadian banks through the mortgage broker distribution channel. The Company recognizes servicing income when the services are rendered and the underwritten mortgages have been funded. — 51 2020 Annual Report MORTGAGES PLEDGED UNDER SECURITIZATION SECURITIES SOLD SHORT AND SECURITIES PURCHASED UNDER RESALE AGREEMENTS LEASES Mortgages pledged under securitization Securities sold short consist typically of The Company measures right-of-use are mortgages that the Company has the short sale of Government of Canada assets at cost. The right-of-use assets originated and funded with debt raised bonds. Bonds purchased under resale are subsequently amortized using the through the securitization markets, agreements consist of the purchase straight-line method. The right-of-use and have been classified at amortized of a bond with the commitment from assets are also subject to impairment. cost. The Company has a continuous the Company to resell the bond to Lease liabilities are calculated using involvement in these mortgages, the original seller at a specified price. the present value of future lease including the right to receive future cash The Company uses the combination payments, discounted at the Company’s flows arising from these mortgages. of bonds sold short and bonds incremental borrowing rate. After the Origination costs, such as brokerage fees and bulk insurance premiums purchased under resale agreements to economically hedge its mortgage commencement date, the amount of lease liabilities is increased to reflect the that are directly attributable to the commitments and the portion of funded accretion of interest and reduced for the acquisition of such assets, are deferred mortgages that it intends to securitize in lease payments made. and amortized over the term of the subsequent periods. The Company’s major leases are for Bonds sold short are classified as FVTPL premises at its Toronto head office and and are recorded at fair value. The four regional offices. The Company has effective yield payable on bonds sold elected not to recognize right-of-use short is recorded as hedge expense assets and a lease liability for its in other operating expenses. Bonds various office equipment leases, which purchased under resale agreements are are insignificant for application of carried at cost plus accrued interest, the standard. which approximates their market value. The difference between the cost of the purchase and the predetermined proceeds to be received on a resale agreement is recorded over the term of the hedged mortgages as an offset to hedge expense. Transactions are recorded on a settlement date basis. MORTGAGE AND LOAN INVESTMENTS Mortgage and loan investments are non-derivative financial assets with fixed or determinable payments, and are classified as FVTPL. The mortgages are measured at management’s best estimate of the net realizable value. Changes in fair value are recognized immediately in the consolidated statements of income. 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. MORTGAGES ACCUMULATED FOR SALE OR SECURITIZATION Mortgages accumulated for sale are mortgages funded pending subsequent settlement with institutional investors and are classified as FVTPL and recorded at fair value. These mortgages are held for terms usually not exceeding 90 days. 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. — 52 First National Financial Corporation PROPERTY, PLANT AND EQUIPMENT SERVICING LIABILITY Property, plant and equipment are recorded at cost, less accumulated amortization, at The Company places mortgages with the following annual rates and bases: third-party institutional clients, and retains the rights and obligations to 30% declining balance service these mortgages. When the Computer equipment Office equipment Leasehold improvements Computer software 20% declining balance Straight-line over the term of the lease 30% declining balance except for certain computer licenses, which are straight-line over useful lives Property, plant and equipment are subject to an impairment review if there are events or changes in circumstances that indicate the carrying amount may not be recoverable. GOODWILL Goodwill represents the price paid for the Company’s business in excess of the fair value of the net tangible assets and identifiable intangible assets acquired in connection with the IPO. Goodwill is reviewed annually for 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. service related fees are paid upfront by a third party, the Company records a servicing liability. The liability represents the portion of the upfront fee required to earn a market rate of servicing over the related mortgage term. This is similar to the method which the Company uses to calculate deferred placement fees. Since quoted prices are generally not available for retained interests, the Company estimates its value based on the net present value of future expected cash flows, calculated using management’s best estimates of key assumptions related to expected prepayment rates and discount rates commensurate with the risks involved. The Company earns the related servicing fees over the term of the mortgages on an effective yield basis. — 53 2020 Annual Report INCOME TAXES EARNINGS PER COMMON SHARE 3. MORTGAGES PLEDGED UNDER SECURITIZATION The Company accounts for income taxes The Company presents earnings per The Company securitizes residential in accordance with the liability method share [“EPS”] amounts for its common and commercial mortgages in order of tax allocation. Under this method, the shares. EPS is calculated by dividing the to raise debt to fund these mortgages. provision for income taxes is calculated net earnings attributable to common Most of these securitizations consist of based on income tax laws and income shareholders of the Company by the the transfer of fixed and floating rate tax rates substantively enacted as at the weighted average number of common mortgages into securitization programs, dates of the consolidated statements shares outstanding during the year. such as ABCP, NHA-MBS and CMB. In these securitizations, the Company transfers the assets to structured entities for cash, and incurs interest-bearing obligations typically matched to the term of the mortgages. These securitizations do not qualify for derecognition, although the structured entities and other securitization vehicles have no recourse to the Company’s other assets for failure of the mortgages to make payments when due. As part of the ABCP transactions, the Company provides cash collateral for credit enhancement purposes as required by the rating agencies. Credit exposure to securitized mortgages is generally limited to this cash collateral. The principal and interest payments on the securitized mortgages are paid by the Company to the structured entities monthly over the term of the mortgages. The full amount of the cash collateral is recorded as an asset and the Company anticipates full recovery of these amounts. NHA-MBS securitizations may also require cash collateral in some circumstances. As at December 31, 2020, the cash held as collateral for securitization was $88,206 [2019 – $83,587]. of financial position. The income tax provision consists of current income taxes and deferred income taxes. Current and deferred taxes relating to items in the Company’s equity are recorded directly against equity. Current income taxes are amounts expected to be payable or recoverable as the result of operations in the current year and any adjustment to tax payable or tax recoverable amounts recorded in previous years. Deferred income taxes arise on temporary differences between the carrying amounts of assets and liabilities on the consolidated statements of financial position and their tax bases. Deferred tax liabilities are generally recognized for all taxable temporary differences and deferred tax assets are recognized to the extent that future realization of the tax benefit is probable. Deferred taxes are calculated using the tax rates expected to apply in the periods in which the assets will be realized or the liabilities settled. Deferred tax assets and liabilities are offset when they arise in the same tax reporting group and relate to income taxes levied by the same taxation authority, and when a legal right to offset exists in the entity. — 54 First National Financial Corporation The following table compares the carrying amount of mortgages pledged for securitization and the associated debt: Securitized mortgages Capitalized amounts related to hedge accounting Capitalized origination costs Debt discounts Add Principal portion of payments recorded in restricted cash Securitized mortgages Capitalized amounts related to hedge accounting Capitalized origination costs Debt discounts Add Principal portion of payments held in restricted cash 2020 Carrying amount of securitized mortgages ($) Carrying amount of associated liabilities ($) 33,827,022 125,581 184,818 — 34,137,421 612,742 34,750,163 (34,231,557) (108,372) — 74,425 (34,265,504) — (34,265,504) 2019 Carrying amount of securitized mortgages ($) Carrying amount of associated liabilities ($) 31,776,442 43,280 175,702 — 31,995,424 623,253 32,618,677 (32,303,342) (43,418) — 100,967 (32,245,793) — (32,245,793) The principal portion of payments held in restricted cash represents payments on account of mortgages pledged under securitization which has been received at year-end but has not yet been applied to reduce the associated debt. This cash is applied to pay down the debt in the month subsequent to collection. In order to compare the components of mortgages pledged under securitization to securitization debt, this amount is added to the carrying value of mortgages pledged under securitization in the above table. — 55 2020 Annual Report Mortgages pledged under securitization have been classified as amortized cost and are carried at par plus adjustment for unamortized origination costs and 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 2020 175,702 95,849 (86,733) $184,818 2019 169,453 85,421 (79,172) $175,702 During the year ended December 31, The following table summarizes the mortgages pledged under securitization that are 31 2020, the Company invested in days or more past due as at December 31: 2020 2019 4,555 1,946 4,050 $10,551 3,098 416 4,464 $7,978 mortgages that were transferred into the securitization vehicles with principal balances as at December 31, 2020 of $7,638,054 [2019 – $7,076,837]. The contractual maturity profile of the ARREARS DAYS 31 to 60 mortgages pledged under securitization 61 to 90 programs is summarized as follows: Greater than 90 2021 2022 2023 2024 4,823,976 5,910,797 6,111,016 5,636,441 All the mortgages pledged under securitization in arrears are insured, except for nine mortgages which are uninsured and have a total principal balance of $2,572 as at December 31, 2020 [2019 – five mortgages, $874]. The Company’s exposure to credit 2025 and thereafter 11,344,792 loss is limited to uninsured mortgages with principal balances totalling $2,312,549 $33,827,022 [2019 – $1,975,154], 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. The Company has provided an allowance of $862 for the year ended December 31, 2020 [2019 – $214]. — 56 First National Financial Corporation 4. DEFERRED PLACEMENT FEES RECEIVABLE In order to assist its borrowers during the The Company enters into transactions During the year ended December 31, COVID-19 pandemic, in the first quarter with institutional investors to sell primarily 2020, $3,461,154 [2019 – $2,419,508] of of 2020, the Company started providing fixed-rate mortgages in which placement mortgages were placed with institutional up to three months of payment deferrals fees are received over time as well as investors, which created gains on to all single-family mortgagors applying at the time of the mortgage placement. deferred placement fees of $32,365 for payment relief because of temporary These mortgages are derecognized [2019 – $11,619]. Cash receipts on hardship resulting from the pandemic. when substantially all of the risks and deferred placement fees receivable for In the second and third quarters, the rewards of ownership are transferred and the year ended December 31, 2020 were Company granted extensions to the the Company has minimal exposure to $13,008 [2019 – $12,655]. original three months period to qualified the variability of future cash flows from borrowers based on additional due diligence. The payment deferral program these mortgages. The investors have no recourse to the Company’s other ended September 30, 2020. Interest assets for failure of mortgagors to make continues to accrue on these mortgages payments when due. The Company estimates that the expected undiscounted cash flows to be received on the deferred placement fees receivable will be as follows: 2021 2022 2023 2024 2025 and thereafter 15,013 12,842 10,997 9,229 22,423 $70,504 and the interest otherwise collectible is capitalized to the mortgage’s principal. As the deferral is provided temporarily in keeping with a larger industry wide relief program, the Company does not consider these mortgages to be in arrears for ECL disclosure purposes. As at December 31, 2020, the Company had permitted $58,996 of payment deferrals related to $4,053,078 of mortgages pledged under securitization. A small portion of this amount has amortized down during the year as the affected mortgages have matured, refinanced or resumed regular payments such that the deferred payment balance are being repaid over the amortization of the mortgage. As at February 26, 2021, the Company had permitted $55,495 of payment deferrals related to $3,926,611 of mortgages pledged under securitization. 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 paying the Company a fee commensurate with the value of its investment in the mortgage. The effect of variations, if any, between actual experience and assumptions will be recorded in future consolidated statements of income but is expected to be minimal. — 57 2020 Annual Report 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: Mortgages accumulated for securitization Mortgages accumulated for sale 2020 2019 2,200,484 50,035 $2,250,519 1,884,571 34,010 $1,918,581 The Company’s exposure to credit loss is limited to $216,667 [2019 – $212,736] of principal balances of uninsured mortgages within mortgages accumulated for securitization, before consideration of the value of underlying collateral. As at December 31, 2020, 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. — 58 First National Financial Corporation 6. MORTGAGE AND LOAN INVESTMENTS Mortgage and loan investments consist primarily of commercial first and second mortgages held for various terms, the majority of which mature within 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 $3,076 [2019 – $4,300] for the year ended December 31, 2020. The following table discloses the composition of the Company’s portfolio of mortgage and loan investments by geographic region as Portfolio balance Percentage of portfolio at December 31, 2020: Province/Territory Alberta British Columbia Manitoba New Brunswick Newfoundland and Labrador Nova Scotia Nunavut Ontario Quebec Saskatchewan Yukon Prince Edward Island 8,531 20,224 7,021 180 290 3,744 74 144,682 94 28,088 164 209 $213,301 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 2020 5,363 112 33,666 $39,141 The portfolio contains $5,544 [December 2019 – $35,014] have principal balances original principal balance of $38,423 31, 2019 – $18,209] of insured mortgages in arrears of more than 30 days. Three [December 31, 2019 – three mortgages, and $207,757 [December 31, 2019 – of these mortgages are non-performing original principal balance of $38,825, $352,205] of uninsured mortgage and and the Company has stopped accruing and fair value of $13,133]. loan investments as at December 31, interest. These mortgages are currently 2020. Of the uninsured mortgages, recorded at fair value of $9,655 as at approximately $34,738 [December 31, December 31, 2020 and had a total — 59 4.00 9.48 3.29 0.08 0.14 1.76 0.04 67.82 0.04 13.17 0.08 0.10 100.00% 2019 5,016 4 34,235 $39,255 2020 Annual Report The maturity profile of the principal amount of the loans in the table below is based on the earlier of contractual renewal or maturity dates: Residential Commercial 2021 57,456 160,529 2022 4,012 5,021 2023 578 666 2024 11,082 365 2025 and thereafter 2,152 209 2020 2019 Total 75,280 Total 71,591 166,790 298,823 $217,985 $9,033 $1,244 $11,447 $2,361 $242,070 $370,414 Interest income earned for the year was $14,337 [2019 – $15,065] and is included in mortgage investment income on the consolidated statements of income. The right-of-use assets pertain to five premises leases for the Company’s office 2019 space across the country. The leases have 11,029 7,263 29,776 remaining terms of one to seven years. The related lease liability of $22,922 as at December 31, 2020, is grouped with accounts payable and accrued liabilities on the consolidated statements of financial position. The recoverable amount of the Company’s goodwill is calculated by reference to the Company’s market capitalization, mortgages under administration, origination volume, and profitability. These factors indicate that the Company’s recoverable amount exceeds the carrying value of its net assets and accordingly, goodwill is not impaired. 7. OTHER ASSETS The components of other assets are as follows as at December 31: Property, plant and equipment, net Right-of-use assets Goodwill 2020 10,483 22,725 29,776 $62,984 $48,068 — 60 First National Financial Corporation 8. MORTGAGES UNDER ADMINISTRATION As at December 31, 2020, the Company managed mortgages under administration of $118,723,990 [2019 – $111,378,891], including mortgages held on the Company’s consolidated statements of financial position. Mortgages under administration are serviced for financial institutions such as banks, insurance companies, pension funds, mutual funds, trust companies, credit unions and securitization vehicles. As at December 31, 2020, the Company administered 342,871 mortgages [2019 – 310,415] for 105 institutional investors [2019 – 108] with an average remaining term to maturity of 42 months [2019 – 40 months]. 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 2020 2019 80,725,722 2,495,926 33,827,022 1,675,320 76,040,779 2,306,608 31,776,442 1,255,062 $118,723,990 $111,378,891 The Company’s exposure to credit loss is limited to mortgage and loan investments as described in Note 6, securitized mortgages as described in Note 3 and uninsured mortgages held in mortgages accumulated for securitization as described in Note 5. The Company maintains trust accounts on behalf of the investors it represents. The Company also holds municipal tax funds in escrow for mortgagors. Since the Company does not hold a beneficial interest in these funds they are not presented on the consolidated statements of financial position. The aggregate of these accounts as at December 31, 2020 was $852,361 [2019 – $690,394]. As at December 31, 2020, the Company has included in accounts receivable and sundry $374 [2019 – $156] of uninsured non-performing mortgages. 9. BANK INDEBTEDNESS 10. DEBT RELATED TO SECURITIZED MORTGAGES Bank indebtedness includes a revolving Debt related to securitized mortgages represents the funding for mortgages pledged credit facility of $1,250,000 [2019 – under the NHA-MBS, CMB and ABCP programs. As at December 31, 2020, debt related $1,250,000] maturing in March 2024. to securitized mortgages was $34,265,504 [2019 – $32,245,793], net of unamortized At December 31, 2020, $682,832 discounts of $74,425 [2019 – $100,967]. A comparison of the carrying amounts of the [2019 – $797,758] was drawn, of which pledged mortgages and the related debt is summarized in Note 3. the following have been pledged as collateral: Debt related to securitized mortgages is reduced on a monthly basis when the principal payments received from the mortgages are applied. Debt discounts and premiums [a] a general security agreement over all are amortized over the term of each debt on an effective yield basis. Debt related to assets, other than real property, of the securitization mortgages had a similar contractual maturity profile as the associated Company; and mortgages in mortgages pledged under securitization. [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. — 61 2020 Annual Report 11. SWAP CONTRACTS Swaps are over-the-counter contracts The swap agreements that the Company enters into are interest rate swaps where two in which two counterparties exchange counterparties exchange a series of payments based on different interest rates applied a series of cash flows based on agreed- to a notional amount in a single currency. upon rates to a notional amount. The Company uses interest rate swaps to manage interest rate exposure relating to variability of interest earned on mortgages pledged under securitization. The following tables present, by remaining term to maturity, the notional amounts and fair values of the swap contracts outstanding as at December 31, 2020 and 2019: Less than 3 years 3 to 5 years 6 to 10 years Total notional amount Fair value 2020 $2,634,822 $ 1,102,126 $44,983 $3,781,931 $(35,163) 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 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. 12. SENIOR UNSECURED NOTES On November 25, 2019, the Company On November 17, 2020, the Company issued $200 million Series 3 senior unsecured issued $200 million Series 2 senior notes for a five-year term pursuant to a private placement under an offering unsecured notes for a five-year term memorandum. The notes bear interest at 2.961% payable in equal semi-annual pursuant to a private placement under an payments commenting May 17, 2021. On settlement, the net proceeds of the offering offering memorandum. The notes bear [$199.3 million, net of financing fees], were invested in FNFLP. interest at 3.582% payable in equal semi- annual payments commencing May 25, 2020. On settlement, the net proceeds of the offering [$199.3 million, net of financing fees], were invested in FNFLP. On April 9, 2020, the Company repaid its maturing $175 million Series 1 senior unsecured notes. — 62 First National Financial Corporation 13. COMMITMENTS, GUARANTEES AND CONTINGENCIES As at December 31, 2020, the Company Outstanding commitments for future advances on mortgages with terms of one to has the following operating lease 10 years amounted to $2,456,591 as at December 31, 2020 [2019 – $1,446,303]. commitments for its office premises: The commitments generally remain open for a period of up to 90 days. These 2021 2022 2023 2024 and thereafter 7,931 10,303 9,848 18,844 $46,926 commitments have credit and interest rate risk profiles similar to those mortgages that are currently under administration. Certain of these commitments have been sold to institutional investors while others will expire before being drawn down. Accordingly, these amounts do not necessarily represent future cash requirements of the Company. 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 to perform under the terms of the contract [such as mortgage servicing contracts] are considered guarantees. The Company has determined that the estimated potential loss from these guarantees is insignificant. 14. SECURITIES TRANSACTIONS UNDER REPURCHASE AND RESALE AGREEMENTS 15. OBLIGATIONS RELATED TO SECURITIES AND MORTGAGES SOLD UNDER REPURCHASE AGREEMENTS The Company’s outstanding securities The Company uses repurchase agreements to fund specific mortgages included in purchased under resale agreements mortgages accumulated for sale or securitization. The current contracts are with and securities sold under repurchase financial institutions, are based on bankers’ acceptance rates and mature on or before agreements have a remaining term to January 31, 2021. maturity of less than three months. 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 2020 70,514 11,153 51,187 29,996 22,922 $185,772 2019 52,748 10,508 58,225 20,959 7,466 $149,906 — 63 2020 Annual Report 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. 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. The par value per preferred share is $25. [d] Earnings per Share Net income attributable to shareholders Less: dividends declared on preferred shares Net income attributable to common shareholders Number of common shares outstanding Basic earnings per common share 2020 2019 190,229 177,213 (2,846) (3,057) 187,383 174,156 59,967,429 59,967,429 $3.12 $2.90 17. SHAREHOLDERS’ EQUITY [a] Authorized Unlimited number of common shares Unlimited number of cumulative 5-year rate reset preferred shares, Class A Series 1 Unlimited number of cumulative 5-year rate reset preferred shares, Class A Series [b] Capital Stock Balance, December 31, 2020 and 2019 # $ Common shares Preferred shares 59,967,429 4,000,000 $122,671 $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 at December 31, 2020, and December 31, 2019, 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. Holders of the Class A Series 1 Preferred Shares receive a cumulative quarterly fixed dividend at a rate equal to the five year Government of Canada yield plus 2.07%. The dividend rate may be reset every five years, as and when approved by the Board of Directors. The current dividend rate on the Class A Series 1 Preferred Shares is 2.79% annually for a new five-year term ending March 31, 2021. — 64 First National Financial Corporation 18. INCOME TAXES The major components of deferred provision for (recovery of) The major components of the current income tax expense for income taxes for the years ended December 31 consist of the the years ended December 31 consists of the following: following: Related to origination and reversal of timing differences Decrease in future tax rates 2020 2019 2020 2019 (3,971) (429) $(4,400) 3,769 (169) $3,600 Income taxes relating to the current year Income taxes related to the prior year 72,800 60,900 100 $72,900 — $60,900 The effective income tax rate reported in the consolidated statements of income varies from the Canadian tax rate of 26.47% for the year ended December 31, 2020 [2019 – 26.61%] 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 Prior year adjustment Other INCOME TAX EXPENSE 2020 26.47% 258,729 68,486 200 (429) 100 143 2019 26.61% 241,713 64,320 345 (169) — 4 $68,500 $64,500 The movement in significant components of the Company’s deferred income tax liabilities and assets for the years ended December 31, 2020 and 2019 are as follows: As at January 1, 2020 Recognized in income and OCI As at December 31, 2020 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 11,189 72,749 13,354 505 1,933 (1,987) (581) (3,958) (5,577) (5,327) 5,364 (4,859) (16,217) 306 4,082 (4,080) 3,210 296 (2,363) (939) Total $82,300 $(15,200) 16,553 67,890 (2,863) 811 6,015 (6,067) 2,629 (3,662) (7,940) (6,266) 67,100 — 65 2020 Annual Report The amount of deferred tax recovery recorded in income and OCI consists of a recovery of $4,400 recorded in net income and a recovery of $10,800 recorded in OCI related to unrealized losses on cash flow hedges. 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 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. 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. 19. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT Risk Management The various risks to which the Company that a mortgage commitment is issued to the transfer of the mortgage to the related is exposed and the Company’s policies securitization vehicle or sale to an institutional investor. Primary among these strategies and processes to measure and manage is the Company’s decision to sell mortgages at the time of commitment, passing on them individually are set out below: interest rate risk that exists prior to funding to institutional investors. The Company Interest Rate Risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company’s exposure to the risk of changes in market interest rates relates primarily to the Company’s mortgages accumulated for securitization. The Company uses various strategies to reduce interest rate risk. The Company’s risk management objective is to maintain uses synthetic bond forwards [consisting of bonds sold short and bonds purchased under resale agreements] to manage interest rate exposure between the time a mortgage rate is committed to the borrower and the time the mortgage is sold to a securitization vehicle and the underlying cost of funding is set. As interest rates change, the values of these interest rate dependent financial instruments vary inversely with the values of the mortgage contracts. As interest rates increase, a gain will be recorded on the economic hedge which will be offset by the reduced future spread on mortgages pledged under securitization as the mortgage rate committed to the borrower is fixed at the point of commitment. 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 interest rate spreads from the point commitment period. — 66 First National Financial Corporation The table below provides the financial impact that an immediate and sustained 100 Liquidity risk is the risk that the Company basis point and 200 basis point increase and decrease in short-term interest rates will be unable to meet its financial would have had on the net income of the Company in 2020 and 2019. obligations as they come due. Liquidity Risk and Capital Resources 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 2020 2019 2020 2019 flow from operations to fund longer-term assets. The Company’s credit facilities are typically drawn to fund: [i] mortgages Impact on net income $4,255 $5,909 $(4,255) $(5,909) accumulated for sale or securitization, 200 BASIS POINT SHIFT Impact on net income $15,995 $12,069 $(8,511) $(11,818) (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 fulfill its payment obligations. The Company’s credit risk is mainly lending related in [ii] origination costs associated with mortgages pledged under 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 the form of mortgage default. The Company uses stringent underwriting criteria and in financing. 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, 2020, 93% [2019 – 94%] 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. The maximum credit exposures of the financial assets are their carrying values as reflected on the consolidated statements of financial position. The Company does not have significant concentration of credit risk within any particular geographic region or group of customers. The Company is at risk that the underlying mortgages default and the servicing cash flows cease. The large portfolio of individual mortgages that underlies these assets is diverse in terms of geographical location, borrower exposure and the underlying type of real estate. This diversity and the priority ranking of the Company’s rights mitigate the potential size of any single credit loss. Securities purchased under resale agreements are transacted with large regulated Canadian institutions such that the risk of credit loss is very remote. Securities transacted are all Government of Canada bonds and, as such, have virtually no risk of credit loss. 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. Market Risk Market risk is the risk of loss that may arise from changes in market factors such as interest rates and credit spreads. The level of market risk to which the Company is exposed varies depending on market conditions, expectations of future interest rates and credit spreads. — 67 2020 Annual Report Customer Concentration Risk Placement fees and mortgage servicing [b] Deferred Placement Fees Receivable market industry pricing practices, including the rate of unscheduled prepayment. Discount rates used are determined by comparison to similar term loans made to borrowers with similar credit. This methodology will reflect changes in interest rates which have occurred since the mortgages were originated. These fair values are estimated using valuation techniques in which one or more significant inputs are unobservable [Level 3], and are calculated for disclosure purposes only. Carrying Value and Fair Value of Selected Financial Instruments The fair value of the financial assets and financial liabilities of the Company approximates its carrying value, except for mortgages pledged under securitization, which has a carrying value of $34,137,421 [2019 – $31,995,424] and a fair value of $36,212,226 [2019 – $32,831,505]; debt related to securitized mortgages, which has a carrying value of $34,265,504 [2019 – $32,245,793] and a fair value of $34,909,488 [2019 – $31,831,691]; and senior unsecured notes, which have a carrying value of $398,554 [2019 – $374,025] and a fair value of $412,786 [2019 – $375,916]. These fair values are estimated using valuation techniques in which one or more significant inputs are unobservable [Level 3]. income from one Canadian financial institution represent approximately 13.1% [2019 – 8.7%] of the Company’s total revenue. Fair Value Measurement The Company uses the following hierarchy for determining and disclosing the fair value of financial instruments recorded at fair value in the consolidated statements of financial position: The fair value of deferred placement fees receivable is determined by internal valuation models using market data inputs, where possible. The fair value is determined by discounting the expected future cash flows related to the placed mortgages at market interest rates. The expected future cash flows are estimated based on certain assumptions which are not supported by observable market data. Level 1 – quoted market price observed in [c] Securities Owned and Sold Short active markets for identical instruments; The fair values of securities owned Level 2 – quoted market price observed in active markets for similar instruments or other valuation techniques for which all significant inputs are based on observable market data; and and sold short used by the Company to hedge its interest rate exposure are determined by quoted prices on a secondary market. Level 3 – valuation techniques in which [d] Servicing Liability one or more significant inputs are unobservable. Valuation Methods and Assumptions The Company uses valuation techniques to estimate fair values, including reference to third party valuation service providers using proprietary pricing models and internal valuation models such as discounted cash flow analysis. The valuation methods and The fair value of the servicing liability is determined by internal valuation models using market data inputs, where possible. The fair value is determined by discounting the expected future cost related to the servicing of explicit mortgages at market interest rates. The expected future cash flows are estimated based on certain assumptions which are not supported by observable market data. key assumptions used in determining [e] Other Financial Assets and Financial fair values for the financial assets and Liabilities financial liabilities are as follows: [a] Mortgages and Loan Investments Mortgages and loan investments are measured at FVTPL. The fair value of these mortgages is based on non- observable inputs, and is measured at The fair value of mortgages accumulated for sale, cash held as collateral for securitization, restricted cash and bank indebtedness correspond to the respective outstanding amounts due to their short-term maturity profiles. management’s best estimate of the net [f] Fair Value of Financial Instruments realizable value. Not Carried at Fair Value The fair value of these financial instruments are determined by discounting projected cash flows using — 68 First National Financial Corporation 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 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 Level 1 Level 2 Level 3 Total 2020 — — — — — — 50,035 — 21,109 $71,144 — 213,301 — 50,035 213,301 21,109 $213,301 $284,445 1,888,049 $1,888,049 — — 1,888,049 $1,888,049 Level 1 Level 2 Level 3 Total 2019 — — — — — — — 34,010 — 29,970 $63,980 2,397,325 1,870 $2,399,195 — 370,414 — 34,010 370,414 29,970 $370,414 $434,394 — — — 2,397,325 1,870 $2,399,195 In estimating the fair value of financial fair value recognized by the Company loss of $4,300]. Although the Company’s assets and financial liabilities using in net income for the year ended management believes that the estimated valuation techniques or pricing models, December 31, 2020 that was estimated fair values are appropriate as at the certain assumptions are used, including using a valuation technique based on date of the consolidated statements those that are not fully supported assumptions that are not fully supported of financial position, those fair values by observable market prices or rates by observable market prices or rates was may differ if other reasonably possible [Level 3]. The amount of the change in approximately a loss of $3,076 [2019 – alternative assumptions are used. — 69 2020 Annual Report Transfers between levels in the fair value inputs and changes in their observability. Company’s financial assets and financial hierarchy are deemed to have occurred During 2020 and 2019, the Company did liabilities for the years ended December at the beginning of the period in which not have any transfers between levels. 31, 2020 and 2019, all of which have been the transfer occurred. Transfers between levels can occur as a result of additional or new information regarding valuation The following table presents changes in the fair values, including realized losses of $112,015 [2019 – losses of $74,832] of the classified as FVTPL: FVTPL mortgages Securities sold short Interest rate swaps 2020 (3,076) (75,689) 11,410 $(67,355) 2019 (4,300) (8,270) 2,915 $(9,655) 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, 2020 and 2019. 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, 2020 Investments Unrealized losses recorded in income Payment and amortization Fair value as at December 31, 2020 FINANCIAL ASSETS Mortgage and loan investments FINANCIAL ASSETS Mortgage and loan investments $370,414 $130,165 $(3,076) $(284,202) $213,301 Fair value as at January 1, 2019 Investments Unrealized losses recorded in income Payment and amortization Fair value as at December 31, 2019 $188,666 $241,646 $(4,300) $(55,598) $370,414 20. CAPITAL MANAGEMENT The Company’s objective is to maintain capital and retained earnings. FNFLP equity. As at December 31, 2020, the a capital base so as to maintain investor, has a minimum capital requirement as ratio was 1.77:1 [2019 – 1.91:1]. The creditor and market confidence and stipulated by its bank credit facility. Company was in compliance with the sustain future development of the The agreement limits the debt under bank covenant throughout the year. business. Management defines capital bank indebtedness together with the as the Company’s common share unsecured notes to four times FNFLP’s — 70 First National Financial Corporation 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 [note 6] Realized and unrealized losses on financial statements EXPENSES Amortization Interest Other operating INCOME BEFORE INCOME TAXES Identifiable assets Goodwill Total assets 2020 Residential Commercial Total 592,641 (507,187) 85,454 400,506 47,111 (64,279) $468,792 7,118 40,736 279,853 $327,707 $141,085 244,935 (200,975) 43,960 140,534 21,922 (3,076) $203,340 542 12,510 72,644 $85,696 $117,644 837,576 (708,162) 129,414 541,040 69,033 (67,355) $672,132 7,660 53,246 352,497 $413,403 $258,729 28,945,884 10,512,867 39,458,751 — — 29,776 $28,945,884 $10,512,867 $39,488,527 CAPITAL EXPENDITURES $2,510 $1,075 $3,585 2019 Residential Commercial Total REVENUE Interest revenue – securitized mortgages Interest expense – securitized mortgages Net interest – securitized mortgages Placement and servicing Mortgage investment income Realized and unrealized losses on financial statements EXPENSES Amortization Interest Other operating INCOME BEFORE INCOME TAXES Identifiable assets Goodwill Total assets CAPITAL EXPENDITURES 661,081 (558,742) 102,339 293,008 59,256 (5,332) $449,271 7,023 59,452 211,373 $277,848 $171,423 28,535,288 — 216,639 (180,329) 36,310 80,780 25,414 (4,323) $138,181 790 18,248 48,853 $67,891 $70,290 9,120,529 — 877,720 (739,071) 138,649 373,788 84,670 (9,655) $587,452 7,813 77,700 260,226 $345,739 $241,713 37,655,817 29,776 $28,535,288 $9,120,529 $37,685,593 $4,113 $1,761 $5,874 — 71 2020 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 $48,671 of new mortgages for the related parties. The related parties also funded several progress draws totalling $21,677 on existing mortgages originated by the Company. All such mortgages, which are administered by the Company, have a balance of $179,320 as at December 31, 2020 [December 31, 2019 – $188,968]. As at December 31, 2020, three of the mortgages are secured by real estate in which the Company is also a subordinate mortgage lender. 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 2020 was $3,212 [2019 – $3,016], net of third- party investor reimbursement. — 72 First National Financial Corporation — 73 2020 Annual Report First National Financial Corporation 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. — 75 2020 Annual Report Policies Committees The Board supervises and evaluates The Board of Directors has established the management of the Company, an Audit Committee and a Governance oversees matters related to our strategic Committee to assist in the efficient direction and assesses results relative functioning of the Company’s corporate to our goals and objectives. As such, governance strategy. the Board has adopted several policies that reflect recommended practices in governance and disclosure. These include a Disclosure Policy, a Code of Business Ethics and Conduct Policy, a Whistleblower Policy and an Insider Trading Policy. As a public company, First National’s Board continues to update, develop and implement AUDIT COMMITTEE GOVERNANCE COMMITTEE The Audit Committee’s responsibilities The Governance Committee’s include: responsibilities include: • Management of the relationship with • Periodically assessing and making the external auditor, including the recommendations on the Company’s oversight and supervision of the audit approach to governance issues; appropriate governance policies and of the Company’s financial statements; • Assisting in the development of • Oversight and supervision of the quality and integrity of the Company’s governance policies, practices and procedures for approval by the Board financial statements, and of Directors; • Oversight and supervision of the • Reviewing conflicts of interest and adequacy of the Company’s internal transactions involving related parties accounting controls and procedures, of the Company; and as well as its financial reporting practices. • Periodically reviewing the composition The Audit Committee consists of three and effectiveness of the Board independent directors, all of whom are of Directors. considered financially literate for the purposes of National Instrument 52-110 – Audit Committees. Committee Members 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. John Brough (Chair), Robert Mitchell and Robert Pearce Committee Members Barbara Palk (Chair), Duncan Jackman and Robert Pearce practices as it sees fit. — 76 First National Financial Corporation Board of Directors STEPHEN SMITH MORAY TAWSE JOHN BROUGH Stephen Smith, one of Canada’s leading Moray Tawse is Executive Vice President John Brough was President of both financial services entrepreneurs, is the and Secretary of the Corporation, Torwest, Inc. and Wittington Properties Chairman, Chief Executive Officer and Executive Vice President of First National Limited, real estate development Co-founder of First National Financial and Co-founder of First National. companies, from 1998 to December 31, Corporation. He has been an innovator Mr. Tawse directs the operations of all 2007. Prior thereto, from 1996 to 1998, in the development and utilization of First National’s commercial mortgage Mr. Brough was Executive Vice President of various securitization techniques origination activities. With over 30 years and Chief Financial Officer of iSTAR to finance mortgage assets, as well as a leader in the development and of experience in the real estate finance industry, Mr. Tawse is one of Canada’s Internet, Inc. From 1994 to 2020, he was a Director and Chair of the Audit application of information technology leading experts on commercial real and Risk Committee of Kinross Gold in the mortgage industry. estate and is often called upon to Corporation. From 1974 to 1996, he held Mr. Smith is Chairman of Canada deliver keynote addresses at national a number of positions with Markborough Guaranty Mortgage Insurance Company, real estate symposiums. Properties, Inc., his final position being which he owns in partnership with Ontario Teachers’ Pension Plan. He is Chairman and co-owner of Duo Bank of Canada, formerly Walmart Canada Bank, whose subsidiary Fairstone Financial Inc. is Canada’s largest non-bank consumer finance lender. Mr. Smith is the largest shareholder in Equitable Bank, Canada’s Challenger Bank™ . He is also Chairman of Peloton Capital Management, a North American focused private equity firm. 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, which produces the Heritage Minutes and publishes The Canadian Encyclopedia. In 2019, Mr. Smith was inducted into the Canadian Business Hall of Fame. 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 M.Sc. in Economics from the London School of Economics. Senior Vice President and Chief Financial Officer, which 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 Committee of Wheaton Precious Metals Corp. Mr. Brough was formerly a director and Chairman of the Audit Committee of Canadian Real Estate Investment Trust from 2008 to 2018. He holds a Bachelor of Arts degree (Economics) from the University of Toronto and is a Chartered Professional Accountant and a Chartered Accountant. He is also a graduate of the Institute of Corporate Directors – Director Education Program 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. — 77 2020 Annual Report DUNCAN JACKMAN BARBARA PALK ROBERT PEARCE Duncan Jackman has been Chairman, Barbara Palk retired as President of Robert Pearce serves on the Board of President and Chief Executive Officer of TD Asset Management Inc. in 2010, Directors of Canada Guaranty Mortgage E-L Financial Corporation, an investment following a 30-year career in institutional Insurance Company, First American and insurance holding company, since investment and investment management. Payment Systems, CPI Card Group and 2003. In 2003, he was also elected She currently serves on the board of Duo Bank of Canada. Mr. Pearce spent Chairman of the Board of The Empire Crombie Real Estate Investment Trust, 26 years with BMO Bank of Montreal, Life Insurance Company. Mr. Jackman where she chairs the Human Resources from 1980 to 2006, most recently is also Chairman of Algoma Central Corporation, the largest Great Lakes Committee. Her previous boards include Ontario Teachers’ Pension Plan, where holding the position of President and Chief Executive Officer, Personal and bulk shipper, as well as Chairman and she chaired the Investment Committee; Commercial Client Group. He also served President of Economic Investment Trust TD Asset Management USA Funds on the Board of Directors of Mastercard Limited and United Corporations Limited, Inc.; the Canadian Coalition for Good International from 1998 to 2006, and two Canadian listed closed-end funds. Governance, where she chaired the as Chairman of the Canadian Bankers’ He also serves as a member of the Board Governance Committee; Greenwood Association from 2004 to 2006. of Directors of several other public and College School; the Investment Mr. Pearce holds a Bachelor of Arts from private companies. Mr. Jackman is a Counselling Association of Canada; the the University of Victoria and an MBA member of the Business Council Perimeter Institute; the Shaw Festival; from the University of British Columbia. of Canada and formerly served on UNICEF Canada; and Queen’s University, Mr. Pearce brings to the Board over the Economic Advisory Council to the where she was the Chair of the Board 30 years of operational and leadership Minister of Finance, Government of of Trustees. Ms. Palk is a member of the experience in the financial services Canada. He is also Chair of the Patron’s Institute of Corporate Directors, industry. Council for Community Living Toronto, a Fellow of the Canadian Securities which provides support to thousands Institute and a CFA charterholder. of individuals with an intellectual She holds a Bachelor of Arts (Honours) in disability. Mr. Jackman graduated from Economics from Queen’s University, and McGill University in Montreal. has been named one of Canada’s Top 100 Most Powerful Women (2004). ROBERT MITCHELL Robert Mitchell was appointed Executive Chair and Chair of the Investment Committee of Dixon Mitchell Investment Canada Inc., a Vancouver-based investment management company, on January 1, 2021. From 2000 to 2020, he was President of Dixon Mitchell Investment Counsel Inc. Prior to that, he was Vice 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. — 78 First National Financial Corporation Stakeholder Information CORPORATE ADDRESS LEGAL COUNSEL First National Financial Corporation Stikeman Elliott LLP, Toronto, Ontario 100 University Avenue North Tower, Suite 700 Toronto, Ontario M5J 1V6 Phone: 416.593.1100 Fax: 416.593.1900 INVESTOR RELATIONS WEBSITE www.firstnational.ca ANNUAL MEETING May 6, 2021, 9:30 a.m. EDT Virtually as provided by Computershare Investor Services Inc. 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 https://web.lumiagm.com/291683989 Senior Vice President, Residential Mortgages Jeremy Wedgbury Senior Vice President, Commercial Mortgages Hilda Wong Senior Vice President and General Counsel 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 INVESTOR RELATIONS CONTACTS Robert Inglis Chief Financial Officer rob.inglis@firstnational.ca Ernie Stapleton President, Fundamental ernie@fundamental.ca AUDITORS Ernst & Young LLP, Toronto, Ontario VANCOUVER CALGARY TORONTO MONTREAL HALIFAX FIRSTNATIONAL.CA
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