Home Capital Group Annual Report 2013

Plain-text annual report

Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 CANADA’S ONE-STOP MORTGAGE LENDER A CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2013 The Right Strategy Record Results H O M E C A P I T A L G R O U P I N C . A N N U A L R E P O R T 2 0 1 3 Business Profile Home Capital Group Inc., together with its operating subsidiary Home Trust Company, has developed a track record of success as Canada’s leading alternative lender. Building on the demonstrated strength of its core residential mortgage lending business, the Company also offers complementary lending services, as well as highly competitive deposit investment products. MISSION STATEMENT Home Capital’s mission is to deliver superior shareholder value by focusing on well-deﬁ ned niches in the Canadian lending and deposit- taking market place that generate above average returns, have acceptable residual risk proﬁ les and are not adequately served by traditional ﬁ nancial institutions, while protecting the depositors and operating within regulatory guidelines and the Company’s risk appetite. Home Trust Branches MORTGAGE LENDING Home Trust is one of Canada’s leading mortgage lenders, focusing on homeowners who typically do not meet all the lending criteria of traditional ﬁ nancial institutions. By offering a range of mortgage products, Home Trust is uniquely positioned to provide ﬁ nancial solutions to meet the needs of thousands of Canadians. With a proprietary lending approach, comprehensive borrower proﬁ ling and ﬂ exible alternative options, Home Trust is a one-stop shop for borrowers and mortgage brokers. Home Trust is also a provider of commercial ﬁ rst mortgages to high-quality borrowers in selected markets across Canada. CONSUMER LENDING Home Trust’s Equityline Visa program brings the advantages to cardholders of accessing the equity they have built in their homes together with the features and convenience of a Gold Visa card. The Company also offers deposit-secured credit cards for individuals who wish to build or re-establish a positive credit history. Home Trust’s Retail Credit Services provides installment ﬁ nancing for customers making purchases from established businesses. PSiGate, a wholly owned subsidiary, offers electronic card-based payment services to merchants who conduct business primarily on the Internet. DEPOSIT INVESTMENTS Home Trust provides a broad range of deposit investment services through its extensive deposit broker network. In addition, Home Trust recently launched its direct-to-consumer brand, Oaken Financial, which offers a competitive suite of deposit products, including a daily interest savings account, to provide customers with a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust offers a number of solutions to meet the long -term and short -term needs of investors looking to diversify their portfolios. CONTENTS 1 Report to Shareholders 6 Proven Results 7 Performance vs. Target 8 Corporate Governance at Home Capital 11 Corporate Social Responsibility 12 Management’s Discussion and Analysis 73 Consolidated Financial Statements 80 Notes to the Consolidated Financial Statements HOMECap 2736 ENG_2013AR_cover_v2.indd 1 14-03-21 12:37 PMFri, Mar 21, 2014 Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 CANADA’S ONE-STOP MORTGAGE LENDER A CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2013 The Right Strategy Record Results H O M E C A P I T A L G R O U P I N C . A N N U A L R E P O R T 2 0 1 3 Business Profile Home Capital Group Inc., together with its operating subsidiary Home Trust Company, has developed a track record of success as Canada’s leading alternative lender. Building on the demonstrated strength of its core residential mortgage lending business, the Company also offers complementary lending services, as well as highly competitive deposit investment products. MISSION STATEMENT Home Capital’s mission is to deliver superior shareholder value by focusing on well-deﬁ ned niches in the Canadian lending and deposit- taking market place that generate above average returns, have acceptable residual risk proﬁ les and are not adequately served by traditional ﬁ nancial institutions, while protecting the depositors and operating within regulatory guidelines and the Company’s risk appetite. Home Trust Branches MORTGAGE LENDING Home Trust is one of Canada’s leading mortgage lenders, focusing on homeowners who typically do not meet all the lending criteria of traditional ﬁ nancial institutions. By offering a range of mortgage products, Home Trust is uniquely positioned to provide ﬁ nancial solutions to meet the needs of thousands of Canadians. With a proprietary lending approach, comprehensive borrower proﬁ ling and ﬂ exible alternative options, Home Trust is a one-stop shop for borrowers and mortgage brokers. Home Trust is also a provider of commercial ﬁ rst mortgages to high-quality borrowers in selected markets across Canada. CONSUMER LENDING Home Trust’s Equityline Visa program brings the advantages to cardholders of accessing the equity they have built in their homes together with the features and convenience of a Gold Visa card. The Company also offers deposit-secured credit cards for individuals who wish to build or re-establish a positive credit history. Home Trust’s Retail Credit Services provides installment ﬁ nancing for customers making purchases from established businesses. PSiGate, a wholly owned subsidiary, offers electronic card-based payment services to merchants who conduct business primarily on the Internet. DEPOSIT INVESTMENTS Home Trust provides a broad range of deposit investment services through its extensive deposit broker network. In addition, Home Trust recently launched its direct-to-consumer brand, Oaken Financial, which offers a competitive suite of deposit products, including a daily interest savings account, to provide customers with a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust offers a number of solutions to meet the long -term and short -term needs of investors looking to diversify their portfolios. CONTENTS 1 Report to Shareholders 6 Proven Results 7 Performance vs. Target 8 Corporate Governance at Home Capital 11 Corporate Social Responsibility 12 Management’s Discussion and Analysis 73 Consolidated Financial Statements 80 Notes to the Consolidated Financial Statements HOMECap 2736 ENG_2013AR_cover_v2.indd 1 14-03-21 12:37 PMFri, Mar 21, 2014 Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s, except per share amounts) Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue Net income Book value of common shares Earnings per share – basic Earnings per share – fully diluted 2013 2012 2011 2010 IFRS 2010 GAAP 2009 2008 2007 2006 2005 2004 $ $ $ $ $ $ $ $ $ $ $ $ 20,075,850 21,997,781 18,019,901 19,941,832 5,210,021 12,765,954 1,177,697 949,547 256,542 33.90 7.40 7.32 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 18,041,584 16,089,648 14,091,755 14,028,255 9,616,251 7,145,826 4,505,026 4,436,420 3,284,829 4,085,013 2,813,459 3,613,643 2,568,513 3,069,253 2,257,740 2,758,480 6,706,160 10,136,599 968,213 887,685 221,983 27.96 6.40 6.38 8,243,350 7,922,124 774,785 790,274 190,080 22.38 5.48 5.46 8,116,636 6,595,979 628,585 687,249 154,752 18.14 4.46 4.45 – – – – – – – 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 2,269,157 742,280 533,937 180,944 21.42 5.21 5.20 590,288 489,179 144,493 17.00 4.19 4.15 432,753 454,695 108,687 12.57 3.15 3.13 348,040 368,881 90,241 10.08 2.62 2.59 276,866 282,549 67,815 8.10 1.99 1.95 218,885 234,704 60,861 6.44 1.80 1.72 162,207 181,839 44,551 4.80 1.33 1.27 In 2011, Home Capital Group Inc. implemented International Financial Reporting Standards (IFRS) with a transition date of January 1, 2010. Figures for 2010 have been restated on an IFRS basis. Figures for 2009 and prior years are on a former Canadian Generally Accepted Accounting Principles (GAAP) basis. 23.9% Return on equity was 23.9%, exceeding 20% for the 16th consecutive year $256.5million Net income for 2013 was $256.5 million, an increase of 15.6% over 2012 $19.94billion Total loans under administration grew by 10.5% over 2012 to reach $19.94 billion at the end of 2013 Net Income ($ millions) Earnings per Share (basic in dollars) Return on Equity (percentage) 257 222 181 190 155 144 7.40 6.40 5.48 5.21 4.46 4.19 28.2 27.2 27.3 27.1 25.5 23.9 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 15.6% 250 200 150 Home Capital reported a 15.6% increase in net income over the $222.0 million attained in 2012, reaching $256.5 million for the year ended 2013. 100 50 Former Canadian GAAP Basis IFRS Basis 0 09 10 10 11 12 13 15.6% 7 6 5 Basic earnings per share rose to $7. 40 for the year ended December 31, 4 2013, a 1 5. 6% increase over the 3 $6. 40 reported for 2012. 2 1 IFRS Basis 0 23.9% Home Capital surpassed 20% return on equity for the 16th consecutive year, reaching 23.9% at December 31, 2013. 30 25 20 15 10 5 0 09 10 10 11 12 13 09 10 10 11 12 12 "09" "10" "10" "11" "12" "13" 144 181 155 190 222 257 "09" "10" "10" "11" "12" "13" 4.19 5.21 4.46 5.48 6.4 7.4 "09" "10" "10" "11" "12" "12" 28.2 27.2 27.3 27.1 25.5 23.9 HOMECap 2736 ENG_2013AR_cover_v2.indd 2 Ten-year Cumulative Total Return on $100 Investment Comparison between S&P/TSX Composite Index (S&P/TSX) and Home Capital Group Inc. (HCG) December 31, 2003–December 31, 2013 Compounded Annual Growth Over 10 Years 19% $7.32 Diluted earnings per share were $7.32 for the year, an increase of 14.7% over 2012 HCG 19% S&P/TSX 8% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $31.25 $34.75 $34.05 $41.90 $19.80 $41.85 $51.79 $49.10 $59.07 $80.93 1,000 800 600 400 200 0 HCG Stock Price Performance Closing Price as of December 31 Share prices have been restated to reflect two-for-one stock split on January 29, 2004. 1000 800 600 400 200 0 “2003” “2004” “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” “2003” . . . . . . . 100 . . . . . . . . . 100 “2004” . . . . . . . 114.48 . . . . . . . 188.91 “2005” . . . . . . . 142.1 . . . . . . . . 211.06 “2006” . . . . . . . 166.63 . . . . . . . 208.59 “2007” . . . . . . . 183.01 . . . . . . . 259.49 “2008” . . . . . . . 122.61 . . . . . . . 124.71 “2009” . . . . . . . 165.59 . . . . . . . 268.84 “2010” . . . . . . . 194.75 . . . . . . . 337.72 “2011” . . . . . . . 177.78 . . . . . . . 324.87 “2012” . . . . . . . 190.56 . . . . . . . 398.06 “2013” . . . . . . . 215.32 . . . . . . . 554.78 Corporate Directory HOME TRUST COMPANY Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Senior Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B Senior Vice President, Corporate Counsel and Corporate Secretary David J. Novak Senior Vice President, Chief Risk Ofﬁ cer Marie Holland, CPA, CA Senior Vice President, Internal Audit John Hong Senior Vice President, Chief Compliance Ofﬁ cer and Chief Anti-Money Laundering Ofﬁ cer Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Greg Parker Senior Vice President, Treasurer Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2013, there were 34,744,090 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada Directors: Kevin P. D. Smith Chairman of the Board Hon. William G. Davis P.C., C.C., Q.C. Vice Chair of the Board James C. Baillie William Falk Diana L. Graham John M. E. Marsh Robert A. Mitchell, CPA, CA Martin Reid Gerald M. Soloway Bonita Then Leslie Thompson Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Blowes, FCPA, FCA Chief Financial Ofﬁ cer and Executive Vice President m o c . r i m b . w w w o s s e d a r I s l l i M n a y r B r i m b y b d e n g i s e D Auditors: Ernst & Young LLP Chartered Accountants Toronto, Ontario Principal Bankers: Bank of Montreal Bank of Nova Scotia Transfer Agent: Computershare Investor Services Inc. 100 University Avenue Toronto, Ontario M5J 2Y1 Tel: 1-800-564-6253 Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG FSC LOGO TO GO HERE. Halifax: 5251 Duke Street Suite 1205, Duke Tower Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Rue University Suite 2420 Montreal, Quebec H3A 2A5 Tel: 514-843-0129 1-866-542-0129 Fax: 514-843-7620 1-866-620-7620 Winnipeg: 201 Portage Avenue 18th Floor Winnipeg, Manitoba R3B 3K6 Tel: 204-942-1619 Fax: 204-942-1638 Fariba Rawhani Senior Vice President, Chief Information Ofﬁ cer Branches: Toronto: 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 Calgary: 10655 Southport Road SW Suite 920 Calgary, Alberta T2W 4Y1 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 2500 2000 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1500 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 1000 500 0 2000 For Shareholder Information, Please Contact: 1999 Chris Ahlvik Senior Vice President, Corporate Counsel Home Capital Group Inc. 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 2001 2002 2003 2004 2005 2006 2007 2008 2009 an eleventh hour change before we printed the report with 2008 on the cover resulted in the styled graph losing one year and being stretched to accommodate, the rough graph below was not edited at the time due to short scheduling, this year’s graph will be created the same way (again… short scheduling) 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca 14-03-21 12:37 PMFri, Mar 21, 2014 Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s, except per share amounts) Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue Net income Book value of common shares Earnings per share – basic Earnings per share – fully diluted 2013 2012 2011 2010 IFRS 2010 GAAP 2009 2008 2007 2006 2005 2004 $ $ $ $ $ $ $ $ $ $ $ $ 20,075,850 21,997,781 18,019,901 19,941,832 5,210,021 12,765,954 1,177,697 949,547 256,542 33.90 7.40 7.32 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 18,041,584 16,089,648 14,091,755 14,028,255 9,616,251 7,145,826 4,505,026 4,436,420 3,284,829 4,085,013 2,813,459 3,613,643 2,568,513 3,069,253 2,257,740 2,758,480 6,706,160 10,136,599 968,213 887,685 221,983 27.96 6.40 6.38 8,243,350 7,922,124 774,785 790,274 190,080 22.38 5.48 5.46 8,116,636 6,595,979 628,585 687,249 154,752 18.14 4.46 4.45 – – – – – – – 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 2,269,157 742,280 533,937 180,944 21.42 5.21 5.20 590,288 489,179 144,493 17.00 4.19 4.15 432,753 454,695 108,687 12.57 3.15 3.13 348,040 368,881 90,241 10.08 2.62 2.59 276,866 282,549 67,815 8.10 1.99 1.95 218,885 234,704 60,861 6.44 1.80 1.72 162,207 181,839 44,551 4.80 1.33 1.27 In 2011, Home Capital Group Inc. implemented International Financial Reporting Standards (IFRS) with a transition date of January 1, 2010. Figures for 2010 have been restated on an IFRS basis. Figures for 2009 and prior years are on a former Canadian Generally Accepted Accounting Principles (GAAP) basis. 23.9% Return on equity was 23.9%, exceeding 20% for the 16th consecutive year $256.5million Net income for 2013 was $256.5 million, an increase of 15.6% over 2012 $19.94billion Total loans under administration grew by 10.5% over 2012 to reach $19.94 billion at the end of 2013 Net Income ($ millions) Earnings per Share (basic in dollars) Return on Equity (percentage) 257 222 181 190 155 144 7.40 6.40 5.48 5.21 4.46 4.19 28.2 27.2 27.3 27.1 25.5 23.9 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 15.6% 250 200 150 Home Capital reported a 15.6% increase in net income over the $222.0 million attained in 2012, reaching $256.5 million for the year ended 2013. 100 50 Former Canadian GAAP Basis IFRS Basis 0 09 10 10 11 12 13 15.6% 7 6 5 Basic earnings per share rose to $7. 40 for the year ended December 31, 4 2013, a 1 5. 6% increase over the 3 $6. 40 reported for 2012. 2 1 IFRS Basis 0 23.9% Home Capital surpassed 20% return on equity for the 16th consecutive year, reaching 23.9% at December 31, 2013. 30 25 20 15 10 5 0 09 10 10 11 12 13 09 10 10 11 12 12 "09" "10" "10" "11" "12" "13" 144 181 155 190 222 257 "09" "10" "10" "11" "12" "13" 4.19 5.21 4.46 5.48 6.4 7.4 "09" "10" "10" "11" "12" "12" 28.2 27.2 27.3 27.1 25.5 23.9 HOMECap 2736 ENG_2013AR_cover_v2.indd 2 Ten-year Cumulative Total Return on $100 Investment Comparison between S&P/TSX Composite Index (S&P/TSX) and Home Capital Group Inc. (HCG) December 31, 2003–December 31, 2013 Compounded Annual Growth Over 10 Years 19% $7.32 Diluted earnings per share were $7.32 for the year, an increase of 14.7% over 2012 HCG 19% S&P/TSX 8% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $31.25 $34.75 $34.05 $41.90 $19.80 $41.85 $51.79 $49.10 $59.07 $80.93 1,000 800 600 400 200 0 HCG Stock Price Performance Closing Price as of December 31 Share prices have been restated to reflect two-for-one stock split on January 29, 2004. 1000 800 600 400 200 0 “2003” “2004” “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” “2003” . . . . . . . 100 . . . . . . . . . 100 “2004” . . . . . . . 114.48 . . . . . . . 188.91 “2005” . . . . . . . 142.1 . . . . . . . . 211.06 “2006” . . . . . . . 166.63 . . . . . . . 208.59 “2007” . . . . . . . 183.01 . . . . . . . 259.49 “2008” . . . . . . . 122.61 . . . . . . . 124.71 “2009” . . . . . . . 165.59 . . . . . . . 268.84 “2010” . . . . . . . 194.75 . . . . . . . 337.72 “2011” . . . . . . . 177.78 . . . . . . . 324.87 “2012” . . . . . . . 190.56 . . . . . . . 398.06 “2013” . . . . . . . 215.32 . . . . . . . 554.78 Corporate Directory HOME TRUST COMPANY Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Senior Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B Senior Vice President, Corporate Counsel and Corporate Secretary David J. Novak Senior Vice President, Chief Risk Ofﬁ cer Marie Holland, CPA, CA Senior Vice President, Internal Audit John Hong Senior Vice President, Chief Compliance Ofﬁ cer and Chief Anti-Money Laundering Ofﬁ cer Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Greg Parker Senior Vice President, Treasurer Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2013, there were 34,744,090 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada Directors: Kevin P. D. Smith Chairman of the Board Hon. William G. Davis P.C., C.C., Q.C. Vice Chair of the Board James C. Baillie William Falk Diana L. Graham John M. E. Marsh Robert A. Mitchell, CPA, CA Martin Reid Gerald M. Soloway Bonita Then Leslie Thompson Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Blowes, FCPA, FCA Chief Financial Ofﬁ cer and Executive Vice President m o c . r i m b . w w w o s s e d a r I s l l i M n a y r B r i m b y b d e n g i s e D Auditors: Ernst & Young LLP Chartered Accountants Toronto, Ontario Principal Bankers: Bank of Montreal Bank of Nova Scotia Transfer Agent: Computershare Investor Services Inc. 100 University Avenue Toronto, Ontario M5J 2Y1 Tel: 1-800-564-6253 Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG FSC LOGO TO GO HERE. Halifax: 5251 Duke Street Suite 1205, Duke Tower Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Rue University Suite 2420 Montreal, Quebec H3A 2A5 Tel: 514-843-0129 1-866-542-0129 Fax: 514-843-7620 1-866-620-7620 Winnipeg: 201 Portage Avenue 18th Floor Winnipeg, Manitoba R3B 3K6 Tel: 204-942-1619 Fax: 204-942-1638 Fariba Rawhani Senior Vice President, Chief Information Ofﬁ cer Branches: Toronto: 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 Calgary: 10655 Southport Road SW Suite 920 Calgary, Alberta T2W 4Y1 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 2500 2000 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1500 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 1000 500 0 2000 For Shareholder Information, Please Contact: 1999 Chris Ahlvik Senior Vice President, Corporate Counsel Home Capital Group Inc. 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 2001 2002 2003 2004 2005 2006 2007 2008 2009 an eleventh hour change before we printed the report with 2008 on the cover resulted in the styled graph losing one year and being stretched to accommodate, the rough graph below was not edited at the time due to short scheduling, this year’s graph will be created the same way (again… short scheduling) 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca 14-03-21 12:37 PMFri, Mar 21, 2014 Report to Shareholders In 2013 we celebrated another year of record performance and another year in which we met or exceeded all of our annual financial and operating objectives. Looking ahead, with a strong and stable Canadian economy and real estate market, and continuing solid demand for our products, we are confident 2014 will be yet another record year as we enhance our position as Canada’s leading alternative financial institution. Another Year of Record Performances Our results in 2013 are yet another example of how our value-enhancing strategies are effective through all phases of the economic cycle. Since the Company’s founding over a quarter of a century ago, our focus has been on generating steady and sustainable growth in earnings while at the same time maintaining a stable risk profile with a strong financial position and industry-leading capital ratios. 3 Well-Defined Strategic Priorities Report to Shareholders (continued) As a result of this proven business model, once again in 2013 we generated a year with record earnings, strong growth across all of our business lines, and an exceptional return on equity. We met or exceeded all of our annual financial goals and objectives for the year: > Net income rose 15.6% for the year; > Diluted earnings per share were up 14.7%; > Total loans under administration increased 10.5%; and > Our 23.9% return on shareholders’ equity once again beat our 20% goal, the 16th consecutive year that our annual return on equity has exceeded 20%. Overall, total loans under administration rose to over $19.94 billion, up 10.5% from $18.04 billion in 2012. Strong demand for all our mortgage lending products resulted in total mortgage originations increasing by 15.2% for the year from $6.01 billion to $6.92 billion. Supported by a stable Canadian economy and real estate market, originations in our traditional mortgage products, which continue to be of exceptional credit quality, rose a significant 6.3% to $4.77 billion in 2013 as we continue to experience growing demand for this segment of our business. In 2012, we refocused our attention on these higher-margin, more profitable non-securitized loans, and our efforts produced solid results in 2013. We continue to experience strong demand for these traditional product offerings, and as we have increased this segment of our business we have also improved the credit profile with average credit scores up from last year and lower loan-to- value ratios. We look for this segment of our business to continue to grow and generate increased profitability in the years ahead. 1 strategic priority Building and maintaining Canada’s leading Alternative Financial Institution Serving an established and growing market niche 2 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 2 strategic priority maintaining a Strong, Conservative Financial Position Generating strong shareholder returns through good times and bad Our Accelerator, or insured residential mortgage originations, also increased in 2013, up a very strong 25.7% to $1.01 billion from 2012. this segment of our business remains one of our key products and helps to fulfill our mandate to provide a true full-service, one-stop shop for the Canadian mortgage business. We look for the securitized segment of our mortgage originations to continue growing. Rounding out our product offerings, our consumer retail credit portfolio, which includes durable household goods such as water heaters and large-ticket home improvement items, also rose by 25% in 2013 to $340.0 million, the result of our success at building and expanding relationships with our business partners. Looking ahead, our intention is to continue increasing this aspect of our business as it offers attractive returns with an excellent risk profile. In 2013, as in prior years, we enhanced the quality and strength of our capital base while reducing our risk profile. While a key goal at Home Capital is to expand our businesses, it is critical that we also ensure we are well positioned to prosper through both good times and bad. to this end, capital ratios under the new Basel III guidelines remained robust at year-end, with solid Common equity tier 1 and total capital ratios of 16.8% and 19.7%, respectively, well above our minimum annual targets. the credit quality of our loan portfolio also remained strong with non-performing loans representing only 0.35% of the total portfolio as at December 31, 2013, well within our expected and acceptable range. provisions for credit losses at 0.09% of gross loans represent a nominal percentage of our net interest margin, leaving a significant spread for overhead and profit. With our consistent growth and positive outlook on the future, we were pleased to announce, after the end of the second quarter, an 8% increase in our common share dividends to $1.12 on an annual basis. On February 12, 2014, a further $0.04 increase in our quarterly common share dividends was announced, raising our annualized dividend to $1.28 per share, a further reflection of our commitment to enhancing shareholder value. these increases represent total dividend growth of 23% year over year. In addition, on February 12, 2014 we declared a stock dividend of one common share for every issued and outstanding share, resulting in an effective two-for-one stock split of our common shares. With this initiative, we expect to provide greater liquidity for our shareholders, increase and broaden the Company’s shareholder base, and improve accessibility to Home Capital common shares. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 3 3 strategic priority Building on our operational excellence Investing to ensure our growth is managed and prudent We implemented a similar stock dividend in January 2004, when our common shares were trading at a price of $33.90, resulting in an after-split price of $16.95. Over the ten years since that stock dividend was declared, the total value of our shares has increased by more than four and a half times. Over this same ten-year period, our common share dividends have been increased nineteen times, resulting in an 967% overall increase in cash dividends paid to shareholders. Our average annual return on equity over the same period was in excess of 25%. these significant increases in shareholder returns and shareholder value have been achieved in spite of the financial crisis that occurred in 2007 and 2008, again a clear indication of how our strategies and our adherence to our operating priorities are creating real and tangible benefits for shareholders through all phases of the economic cycle. Strategies that Succeed Our first strategic priority is to build and maintain our presence as Canada’s leading alternative financial institution. By serving those segments of the financial services market that we believe are underserved, we have built an established and growing market niche, and we continue to offer a full line of products that meet the needs of borrowers and brokers while targeting our high-value alternative mortgage segment. to further enhance our presence and diversify our product offerings, in December 2013 we launched a new direct-to- consumer brand, Oaken Financial, offering consumer deposit products that include GICs and the new Oaken Savings Account. With Oaken, we offer our customers a secure and competitive way to independently manage their savings with some of the highest deposit rates available in Canada. Our second strategic priority is to maintain a strong and conservative financial position, as reported by our balance sheet, so that we can continue to generate enviable returns for our shareholders through good times and bad. Our conservative capital ratios, strong liquidity position and prudent risk profile all position Home Capital to prosper going forward. 4 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Our third strategic priority is to enhance operational excellence by continuing to invest in industry-leading corporate governance, risk management and customer service processes and systems. At Home Capital, we recognize that quality and value require that effective and efficient processes and controls be in place ahead of growth in our businesses. the Company has continued to invest in oversight functions staffed by experienced professionals which has resulted in an enhanced risk culture. Implementation of advanced technology solutions to monitor and detect activities associated with financial crime, a risk-sensitive capital allocation approach, and forward-looking analysis of our strategic opportunities create value for shareholders and increase protection of depositors. We will continue to invest in these important oversight and control functions, and will carefully manage the continued growth we see in the years ahead. A Positive outlook Looking ahead, we are confident that our growth will continue. the Canadian economy and real estate market remain strong, supported by continuing low interest rates, stable and improving employment, and increasing immigration. With our proprietary and proven approach to underwriting, we are in a stronger position than ever before to serve our niche market — homeowners who we know are good, reliable and stable customers. With this positive outlook, we have established the following objectives for 2014: > 13% to 18% growth in total net earnings; > 13% to 18% growth in diluted earnings per share; > 15% to 20% growth in total loans under administration; and > 20% return on shareholders’ equity. the Board of Directors would like to acknowledge Leslie thompson, who will not be standing for re-election at this year’s Annual Meeting of Shareholders. We thank her for her contribution and wish her all the best for the future. the Board and management welcome Ms. Jacqueline Beaurivage who will stand as a nominee for election to the Board at the upcoming Annual Meeting of Shareholders. Ms. Beaurivage brings over 30 years of experience as a senior executive in various leadership roles at large Canadian chartered banks, and most recently with Ontario teachers’ pension plan, and is well versed in strategic planning, corporate governance, risk management and banking. We are confident that her significant expertise and depth of knowledge will be assets to the Board and the Company. In closing, we thank everyone at Home Capital for their contribution to our record performance in 2013. By adhering to our core competencies, and focusing on our well-defined strategic priorities, we are growing our business and delivering superior returns to our shareholders. With your help, we expect this progress to continue for years to come. Dr. Kevin P.D. Smith Chairman of the Board Gerald m. Soloway Chief Executive Officer Home CAPItAl GRouP InC. AnnuAL RepORt 2013 5 Proven Results GRoWtH Home Capital sustained its strength in key financial measurements. the Company’s core business activities generated strong results, contributing to asset growth of 6.8% and an increase in total revenue of 7.0%. RetuRnS the Company recorded pre-tax return on assets of 1.7% and after-tax return on assets of 1.3%, while shareholders’ equity increased to $1.18 billion, a 21.6% rise from the previous year. RISK Home Capital continued to surpass all applicable regulatory and related standards. the level of impaired loans is comparable to that of large, traditional financial institutions. Home Capital’s robust risk management framework is a key component of the Company’s philosophy. 20,076 18,800 17,696 21,998 19,682 17,696 15,519 15,879 15,519 950 888 790 687 11,509 534 489 7,361 7,712 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 "09" "10" "10" "11" "12" "13" 7361 7712 15519 17696 18800 20076 11509 15879 15519 17696 19682 21998 "09" "10" "10" "11" "12" "13" 3.2 3.0 2.4 2.2 1.6 1.5 1.7 1.6 1.2 1.1 1.3 1.2 1,178 968 742 775 590 629 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 13 09 10 10 11 13 "09" "10" "10" "11" "12" "13" 3 3.2 1.6 1.5 1.6 1.7 "09" "10" "10" "11" "12" "13" 12 2.2 2.4 1.2 1.1 1.2 1.3 "09" "10" "10" "11" "12" "13" * * 18.08 17.29 17.01 16.80 16.43 20.46 20.68 19.69 19.37 18.00 0.85 0.58 0.33 0.35 0.24 0.25 21000 16800 12600 8400 4200 0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 20 15 10 5 0 22000 16500 11000 5500 0 "09" "10" "10" "11" "12" "13" 2.5 2.0 1.5 1.0 0.5 0.0 22.0 16.5 11.0 5.5 0.0 489 534 687 790 888 950 12 590 742 629 775 968 1178 1000 800 600 400 200 0 1200 1000 800 600 400 200 0 0.9 0.6 0.3 0.0 09 10 11 12 13 09 10 11 12 13 09 10 10 11 12 13 09 10 11 12 13 13 09 10 11 12 13 13 09 10 10 11 12 13 Former Canadian GAAp Basis IFRS Basis IFRS Basis * these figures are calculated under Basel III for 2013 and Basel II for 2012 and earlier. 6 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 "09" "10" "10" "11" "12" "13" 16.43 18.08 18.08 17.29 17.01 16.8 "09" "10" "10" "11" "12" "13" 18 19.57 19.37 20.46 20.68 19.69 "09" "10" "10" "11" "12" "13" 0.85 0.58 0.24 0.25 0.33 0.35 Performance vs. target RetuRn on eQuItY (Roe) Home Capital again exceeded 20% in return on equity, reaching 23.9% for the year ended December 31, 2013, representing the 16th consecutive year in which the Company surpassed 20% ROe. tARGet: 20% return on equity eARnInGS the Company reported net earnings of $256.5 million for the year ended December 31, 2013, representing a 15.6% increase over the $222.0 million achieved in 2012. tARGet: 13% to 18% increase in total earnings Return on equity at Increase in earnings of 23.9% for the year ended December 31, 2013 15.6% over 2012 eARnInGS PeR SHARe Diluted earnings per share rose to $7.32 at December 31, 2013, a 14.7% increase over $6.38 recorded for 2012. tARGet: 13% to 18% increase in diluted earnings per share totAl loAnS unDeR ADmInIStRAtIon total loans under administration grew to $19.94 billion by December 31, 2013, an increase of 10.5% over the $18.04 billion recorded on December 31, 2012. tARGet: 10% to 15% increase in total loans under administration Diluted earnings per share grew total loans increased 14.7% over 2012 10.5% over year-end 2012 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 7 Corporate Governance at Home Capital Home Capital recognizes the importance of strong and effective corporate governance. As a reporting issuer and publicly accountable entity, Home Capital has governance standards that are consistent with the corporate governance guidelines set out by the toronto Stock exchange and are compliant with applicable rules adopted by the Canadian Securities Administrators. the Board of Directors of Home Capital is responsible for the stewardship of Home Capital and for supervising the management of the business affairs of the Company. this includes creating a culture of integrity throughout the Company. All employees, officers and directors are subject to Home Capital’s Code of Business Conduct and ethics, which requires the highest standards of ethical behaviour in all dealings on behalf of the Company. the Board ensures that appropriate structures and procedures are in place so that it can independently and effectively oversee the Company’s strategy, risk profile and operations. A straightforward, proven business model and comparatively simple products afford a thorough understanding of risk and opportunity. new product initiatives are subjected to a formal, rigorous evaluation process to ensure they are both well understood and consistent with the Company’s risk appetite. Home Capital uses a Board-driven, strategic planning process that links strategic analysis and insight with financial forecasting, stress testing and capital adequacy. the Company aligns employee incentives with long-term value creation through a regulatory-compliant compensation process that includes the engagement of expert third-party compensation advice. In addition to regularly scheduled meetings, the Board and its committees hold ad hoc meetings as the need arises and directors attend education sessions for emerging trends, industry developments and best practices. the Company continually looks for ways to improve its corporate governance policies and procedures, and the Governance, nominating and Conduct Review Committee is responsible for reviewing Home Capital’s corporate governance practices at least annually. Home Capital and its wholly owned subsidiary, Home trust, also adopted the Office of the Superintendent of Financial Institutions’ Corporate Governance Guideline. the Board reviews and approves Home Capital’s strategic and financial plans and risk appetite at least annually. the Board receives strategic updates throughout the year from each of the principal business groups and receives regular risk updates from the enterprise Risk Management and Compliance departments. Effective Oversight Risk Appetite Strategic Planning S t r P l a a t e n g i c n i n g Effective Governance Structure Robust Policy Frameworks Timely and Transparent Reporting G a o n v d e r O n v a e r n c e s i g h t C F o Enterprise Risk Management Compliance Credit Audit Finance u n c n t r ti o o l n s B O u Lines of Business Operations Human Resources Information Technology 8 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 s i n p e r a e ti o s s n s Highlights of Home Capital’s corporate governance framework include: > The Board and its committees function under charters that specify their roles, accountabilities and responsibilities. > Nine of ten directors are independent, the Chairs and all members of each of the Board committees are independent, and the roles of CEO and Chairman of the Board are separate. > The Board is responsible for adopting and approving the Company’s risk appetite and strategic and financial plans annually. > The Board reviews and approves all critical risk policies, delegations of authority, and Company-wide limits. > The Board holds in-camera meetings of the independent directors at every Board meeting, and meets independently with the Chief Financial Officer, Chief Risk Officer, Chief Credit Officer, Senior Vice President of Internal Audit, Chief Compliance Officer and Chief Anti-Money Laundering Officer, and external auditors no less than quarterly. > Home Capital provides an orientation program for new directors and conducts ongoing education sessions. > The Company maintains a minimum share ownership requirement for directors, the Chief Executive Officer and other named executive officers to ensure alignment with the interests of all shareholders. > The Board has adopted a Shareholder Rights Plan to preserve the fair treatment of all shareholders in the event of a take-over bid. > The Chair of the Governance, Nominating and Conduct Review Committee conducts an annual Board evaluation to assess the effectiveness of the Board and its committees, as well as the effectiveness of each director through self-evaluation and one-on-one meetings with the Chairman of the Board. the Board of Directors is assisted in its oversight of the business by four committees of the Board and by independent oversight functions within the business that report directly to the Board and its committees. Audit Committee the Audit Committee assists the Board in its oversight role with respect to: > the quality and integrity of financial reporting to shareholders; > the external auditor’s performance, qualifications and independence; > complaints with respect to accounting, internal accounting control or auditing matters; and > the effectiveness of the Company’s internal controls, including the effectiveness and independence of the Company’s finance, internal audit and compliance functions. the Chief Financial Officer, Chief Compliance Officer and Chief Anti-Money Laundering Officer, and the Senior Vice president of Internal Audit each report to the Audit Committee independently and meet in camera at least quarterly. the Committee meets with the external auditors at least quarterly. Risk and Capital Committee the Risk and Capital Committee assists the Board in its oversight role with respect to: > reviewing and recommending Board approval of the Company’s overall risk appetite framework, including risk limits; > identifying, assessing and managing the Company’s risk profile; > reviewing and approving the Company’s risk and capital policies; > reviewing the effectiveness of the Company’s risk and capital practices; and > reviewing the Company’s adherence to internal risk and capital policies and procedures through timely management reporting. the Chief Risk Officer and the Chief Credit Officer each report to the Risk and Capital Committee independently and meet in camera at least quarterly. Governance, nominating and Conduct Review Committee the Governance, nominating and Conduct Review Committee assists the Board in its oversight role with respect to: > identifying individuals qualified and suitable to become members of the Board of Directors and recommending nominees to the Board for each annual meeting of shareholders; > the development of the Company’s corporate governance policies, practices and processes; > the effectiveness of the Board, its committees and the Chairs of those committees; > evaluating the contributions of individual directors; Home CAPItAl GRouP InC. AnnuAL RepORt 2013 9 Corporate Governance at Home Capital (continued) > reviewing conflicts of interest, confidential information, transactions involving related parties of the Company, and disclosure of information; and > Director orientation, education and development policy and programs. Human Resources and Compensation Committee the Human Resources and Compensation Committee assists the Board in its oversight role with respect to: > the Company’s human resources strategy, policies and programs; > all matters relating to proper utilization of human resources within the Company, with special focus on management succession, development and compensation; > management of compensation-related risk; and > the compliance of Directors, officers and employees with the Company’s Code of Conduct and Business Ethics Policy. the Vice president, Human Resources meets in camera with the Human Resources and Compensation Committee at least quarterly. Board of directors Shareholders Appoint Shareholders’ Auditors Elect Report Human Resources and Compensation Committee Governance, Nominating and Conduct Review Committee Appoint Board of Directors Appoint Audit Committee Risk and Capital Committee Appoint Report Report Credit Enterprise Risk Management CEO Finance Corporate Compliance Internal Audit Home Capital views robust corporate governance principles and practices not only as a critical matter of regulatory compliance, but also as a competitive advantage in its core market. For more information about corporate governance at Home Capital, please refer to Home Capital’s Management Information Circular. the Circular contains detailed information about directors and management, as well as the Company’s Statement of Corporate Governance practices. www.homecapital.com the Company’s website contains information about corporate governance at Home Capital, including the Statement of Corporate Governance practices, Charters of the Board of Directors and Board Committees, position Descriptions, Director Compensation and Independence Standards, Code of Business Conduct and ethics policy, Disclosure policy, Whistleblower policy and Shareholder Rights plan. 10 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Board of directors Corporate Social Responsibility 1 2 3 A Commitment to Our Communities Home Capital recognizes the importance of contributing to our communities through corporate commitment and employee fundraising efforts. We invest in communities through a variety of charitable donations and sponsorships, and are proud to partner with organizations whose focus aligns with our principles – fi nancial literacy, an entrepreneurial culture, serving the underserved, and our belief in every Canadian’s right to shelter. Most recently, we partnered with Junior Achievement of Canada, the largest youth business organization in Canada. In December 2013, volunteers participated in a Junior Achievement economics for Success program for Grade 8 students in toronto, which helps prepare today’s young people to succeed in an ever-changing global economy. A Commitment to Our Employees We strive to attract top talent and create a workplace where people feel engaged, inspired, challenged, proud and respected. to that end, we focus on all aspects of the employee experience, including rewards and recognition, communication, leadership, culture, professional and personal growth, accountability and performance, and corporate social responsibility. A recent employee engagement Survey revealed that our employees are motivated by the Company’s senior leadership team and organizational vision, and value the strength of teamwork and opportunity for innovation. At Home Capital, we have an outstanding team that demonstrates integrity and commitment every day, with a focus on customer satisfaction and business success. A Commitment to Our Environment Home Capital is committed to implementing environmentally sustainable business practices that reduce our impact on the environment and encourage our employees to make green choices . the Company supports business practices that reduce energy consumption and participates in initiatives that benefi t the environment in practical and meaningful ways. In 2013, a number of employees took part in an initiative with nature Conservancy Canada, a non-profi t organization that focuses on conservation and protection of natural areas that sustain Canada’s plants and wildlife. through this program, volunteers collected seeds for replanting at the Rice Lake plains natural Area in Ontario, contributing to habitat restoration in this part of the Oak Ridges Moraine. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 11 management’s Discussion and Analysis Bu SI ne SS PRoFIle Business portfolios VISI on, mISSIon, oBjeCt IVeS A nD VAlu eS Risk-taking philosophy 2013 P e RF oRm An Ce An D 2014 S t R Ate GI e S AnD tAR G et S 2013 performance 2013 Strategies and Achievements 2014 Strategic priorities 2014 performance targets 2014 Overall Outlook FI nA nCIA l HIGH lIGH tS Income Statement Highlights for 2013 Balance Sheet Highlights for 2013 FI nA nCIA l P eRF oR mA nC e R eVI e W net Interest Income and Margin non-interest Income provision and Allowance for Credit Losses non-interest expenses taxes Comprehensive Income FI nA nCIA l P oSI tI on R eVI eW Loans under Administration Deposits, Senior Debt and Securitization Liabilities Cash Resources and Securities Other Assets and Liabilities Shareholders’ equity Contingencies and Contractual Obligations Derivatives and Hedging Off-balance Sheet Arrangements Related party transactions Summ ARY o F QuARteRlY ReS ultS FouRtH QuARteR 2013 Income Statement Highlights Financial position Highlights 14 14 15 15 16 16 17 17 17 18 19 20 21 22 22 24 26 27 28 29 29 30 34 35 36 37 37 37 38 39 39 40 40 41 Fou R tH QuARte R FInAnCI Al InFoRmAtIon CA PItAl mAnAGem ent Capital Management Activity Internal Capital Adequacy Assessment process (ICAAp) Credit Ratings Share Information RI SK m AnAG em ent Risk Appetite Risk Governance Stress testing principal Risks Strategic Risk Credit Risk Market Risk Liquidity and Funding Risk upcoming OSFI Liquidity Requirements Operational Risk Legislative and Regulatory Risk Reputational Risk Risk Factors that May Affect Future Results ACC ount I n G S tA nDA RDS AnD PolIC Ie S ACCountInG DeVeloPme nt S ContRolS oVeR FI nA nCI Al ReP oRtInG Disclosure Controls and Internal Control over Financial Reporting Disclosure Controls and procedures Internal Control over Financial Reporting Changes in Internal Control over Financial Reporting Comparative Consolidated Financial Statements non -GA AP me AS uRe S A n D G lo SSA RY non-GAAp Measures Glossary of terms Acronyms 42 50 52 52 53 53 54 54 54 57 57 57 57 62 64 65 65 66 66 67 68 68 69 69 69 69 69 69 70 70 72 72 12 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 mA n AG emen t’ S DISC u SSI on An D An A lYS IS This Management’s Discussion and Analysis (MD&A) is provided to enable readers to assess the financial condition and results of operations of Home Capital Group Inc. (the “Company” or “Home Capital”) for the year ended December 31, 2013. The discussion and analysis relates principally to the Company’s subsidiary Home Trust Company (Home Trust), which provides residential mortgage lending, non-residential commercial mortgage lending, consumer and credit card lending and deposit-taking services. This MD&A should be read in conjunction with the audited consolidated financial statements and notes. Unless otherwise indicated, this MD&A has been prepared in accordance with International Financial Reporting Standards (IFRS or GAAP) and all amounts are presented in Canadian dollars. This MD&A is current as of February 12, 2014. A glossary of Non-GAAP measures and terms used in this MD&A and financial statements is presented in the last section of this report. The Company’s continuous disclosure materials, including interim filings, annual Management’s Discussion and Analysis and audited consolidated financial statements, Annual Information Form, Notice of Annual Meeting of Shareholders and Proxy Circular are available on the Company’s website at www.homecapital.com, and on the Canadian Securities Administrators’ website at www.sedar.com. Caution Regarding Forward-looking Statements From time to time Home Capital makes written and verbal forward-looking statements. these are included in the Annual Report, periodic reports to shareholders, regulatory filings, press releases, Company presentations and other Company communications. Forward-looking statements are made in connection with business objectives and targets, Company strategies, operations, anticipated financial results and the outlook for the Company, its industry, and the Canadian economy. these statements regarding expected future performance are “financial outlooks” within the meaning of national Instrument 51-102. please see the risk factors, which are set forth in detail in the Risk Management and Other Risks sections of this report, as well as its other publicly filed information, which are available on the System for electronic Document Analysis and Retrieval (SeDAR) at www.sedar.com, for the material factors that could cause the Company’s actual results to differ materially from these statements. these risk factors are material risk factors a reader should consider, and include credit risk, funding and liquidity risk, structural interest rate risk, operational risk, investment risk, strategic and business risk, reputational risk and regulatory and legal risk along with additional risk factors that may affect future results. Forward-looking statements can be found in the Report to the Shareholders and the Outlook sections in the Annual Report. Forward-looking statements are typically identified by words such as “will,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “forecast,” “may,” and “could” or other similar expressions. By their very nature, these statements require the Company to make assumptions and are subject to inherent risks and uncertainties, general and specific, which may cause actual results to differ materially from the expectations expressed in the forward-looking statements. these risks and uncertainties include, but are not limited to, global capital market activity, changes in government monetary and economic policies, changes in interest rates, inflation levels and general economic conditions, legislative and regulatory developments, competition and technological change. the preceding list is not exhaustive of possible factors. these and other factors should be considered carefully and readers are cautioned not to place undue reliance on these forward-looking statements. the Company does not undertake to update any forward-looking statements, whether written or verbal, that may be made from time to time by it or on its behalf, except as required by securities laws. Assumptions about the performance of the Canadian economy in 2014 and its effect on Home Capital’s business are material factors the Company considers when setting its objectives and outlook. In determining expectations for economic growth, both broadly and in the financial services sector, the Company primarily considers historical and forecasted economic data provided by the Canadian government and its agencies. In setting and reviewing its target, objectives and outlook for 2014, management’s expectations assume: > the Canadian economy will continue to produce modest growth in 2014 with stable to modestly improving employment conditions in most regions, and inflation will generally be within the Bank of Canada’s target of 1% to 3%, leading to stable credit losses and strong demand for the Company’s lending products. > the Canadian economy will continue to be influenced by the economic conditions in the united States and global markets; as such, the Company is prepared for the variability to plan that may result. > the Bank of Canada continues to indicate that increases to its target overnight interest rate are not imminent and, as such, the Company is assuming the rate will remain at its current rate into 2014, with the potential for modest increases later in 2014. this is expected to continue to support relatively low mortgage interest rates for the foreseeable future. > the housing market will likely remain stable with balanced supply and demand conditions in most regions supported by continued low interest rates, stable to improving employment, and immigration. there will be modest declines in housing starts and resale activity with stable prices throughout most of Canada. this supports stable credit losses and strong demand for the Company’s lending products. > Consumer debt levels will remain serviceable by Canadian households. > the Company will have access to the mortgage and deposit markets through broker networks. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 13 management’s Discussion and Analysis management’s Discussion and Analysis B uSI ne SS PRoFIle Home Capital is a holding company that operates primarily through its principal, federally regulated subsidiary, Home trust, which offers insured and uninsured deposits, residential and non-residential commercial mortgage lending and consumer lending. the Company’s subsidiary payment Services Interactive Gateway Inc. (pSiGate) provides payment card services. Licensed to conduct business across Canada, Home trust has offices in Ontario, Alberta, British Columbia, nova Scotia, Quebec and Manitoba. Business Portfolios the Company’s management views the business as a single business with separately identified lending portfolios, deposits and other activities, as described below. Mortgage Lending this portfolio comprises single-family residential lending, residential commercial lending, including multi-unit residential properties, as well as non-residential commercial lending. the single-family residential portfolio includes the Company’s traditional or “Classic” mortgage loans and “Accelerator” mortgages. the Company’s traditional mortgage portfolio consists of mortgages with loan to value ratios of 80% or less, serving selected segments of the Canadian financial services marketplace that are not the focus of the major financial institutions. these mortgages are funded by the Company’s deposit products. Accelerator mortgages are insured, with loan to value ratios generally exceeding 80% at the time of origination, and are generally funded through Canada Mortgage and Housing Corporation (CMHC) sponsored mortgage-backed security (MBS) and Canada Mortgage Bond (CMB) securitization programs. Residential commercial lending comprises insured and uninsured multi-unit residential mortgage loans and other residential commercial loans that are secured by residential property. non-residential commercial lending includes store and apartment mortgages and commercial mortgages. Insured multi-unit residential mortgages are generally funded by the CMHC-sponsored securitization programs and other loans are funded by deposits. Consumer and Credit Card Lending this portfolio includes credit card lending and other consumer retail lending for durable household goods, such as water heaters and larger-ticket home improvement items. Consumer loans are supported by holdbacks or guarantees from the distributors of such items and/or collateral charges on real property. the Company’s equityline Visa product, secured by residential property, represents almost all of the credit card portfolio. the Company also offers cash-secured Visa products and preferred unsecured Visa cards to current mortgage customers with good credit history. Consumer and credit card loans are funded by deposits. Deposits the Company’s uninsured assets are largely funded by its deposit activities. Deposits are generally taken for fixed terms, varying from 90 days to five years and carry fixed rates of interest over the full term of the deposit. the Company also offers high interest savings accounts. the Company is a member of the Canada Deposit Insurance Corporation (CDIC) and its retail deposit products are eligible for CDIC coverage, up to the applicable limits. Other Activities In addition to its lending portfolios, the Company manages a treasury portfolio to support liquidity requirements and invest excess capital. the Company’s operations also include pSiGate, the Company’s subsidiary involved in payment processing. As management views its business as a single segment with a variety of product and service activities, the financial statements and the MD&A are prepared on that basis. 14 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 V ISI on, mISSIon, oBjeCtIVeS AnD VAlu eS It is the vision of the Company to be recognized as the leading alternative lender in the Canadian financial market place. the Company’s mission is to deliver superior shareholder value by focusing on well-defined niches in the Canadian lending and deposit- taking market place that generate above-average returns, have acceptable residual risk profiles and are not adequately served by traditional financial institutions, while protecting the depositors and operating within regulatory guidelines and the Company’s risk appetite. the Company’s progress toward its objectives will be measured by: > A return on common equity of at least 20% > Capital aligned with the risk profile of the business and the needs of the Company’s depositor base the Company has a set of values that are integral to its day-to-day business. these values are the cornerstone of Home Capital’s vision and play a key role in the Company achieving both its strategic and financial performance goals: > Respect, trust and integrity > the highest level of customer service to our clients and business partners > A nimble, entrepreneurial culture with our enthusiasm, teamwork and desire for continuous improvement > Community and environmental improvement through fundraising, community involvement and sustainable environmental initiatives the Company’s key long-term objective is to deliver superior shareholder value. the Company seeks to achieve a return on common equity of at least 20%, and has exceeded this benchmark in each of the past 16 years. Management also seeks to align its capital with the risk profile of the business through an understanding of the nature and level of risks being taken and how these risks attract regulatory and risk-based capital. the Company consistently maintains high levels of regulatory capital as compared to other financial institutions. Risk-taking Philosophy the Company’s core strategy focuses on serving segments of the Canadian financial services market that traditionally have not been adequately served by larger financial institutions. the Company’s strategy provides the opportunity for higher returns but carries an inherently different risk profile than one serving the broader market and requires an integrated risk management strategy. the Company recognizes this risk and proactively seeks to reduce overall risk exposure to an acceptable level through: > Active Board and senior management oversight, monitoring and timely revision of corporate strategies, risk appetite and risk mitigation activities; > promotion of a sound risk management culture and awareness throughout the entire organization; > Adoption of a conservative financial risk profile, comprising prudent levels of liquidity, capital levels in excess of regulatory and risk- based minimums, and reserves that account for all incurred losses; > extensive, customized risk evaluation practices and controls at the transactional level executed by experienced personnel and supported by effective and efficient processes and technology; > proactive, independent and timely monitoring and assessment of all risk exposures, regardless of the source, by the business units, with enterprise risk management, credit, corporate compliance and finance functions acting as second lines of defence and the internal audit function acting as the third line of defence; and > Ongoing efforts to diversify funding sources. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 15 management’s Discussion and Analysis management’s Discussion and Analysis the Company’s acceptable business and risk-taking activities can be substantially characterized by the following: > the Company conducts business with individuals, other businesses and borrowers that are well understood, including, but not limited to, confirmation of identity, credit profile, employment and willingness and ability to repay debts; > new products and initiatives are subject to a new initiative review process and undertaken only after complete risk identification and control infrastructure has been established. All acquisitions will be subject to a due diligence process that ensures alignment with the Company’s risk appetite; > For any material lending, the Company requires strong collateral against the loan, specifically where legal and equity rights can be held against the collateral asset. unsecured credit exposures must fit within the Company’s risk appetite framework and have appropriate risk management processes in place to mitigate the associated risk; > the Company conducts business in geographies that are well known and understood, particularly when lending against properties; > the Company employs various risk mitigation techniques and actions to reduce inherent business risks to acceptable residual levels, including trusted asset appraisals and valuations, limited loan to value lending, and risk-based pricing; > the Company will not pursue profits through trading activities and will limit the use of derivatives to hedging purposes only; and > the Company will manage interest rate gaps within its risk appetite. 201 3 PeRFoRmAnCe AnD 20 14 S tRAteGIeS A nD tA RG etS 2013 Performance the table below summarizes the Company’s 2013 targets and performance. table 1: 2013 targets and Performance Growth in net income Growth in diluted earnings per share Growth in total loans under administration1 Return on shareholders’ equity efficiency ratio (teB)2 provision as a percentage of gross loans 1 Includes loans held for sale. 2 See definition of teB under non-GAAp Measures in this report. For the year ended December 31, 2013 2013 targets 13%–18% 13%–18% 10%–15% 20.0% 28.0%–34.0% 0.10%–0.18% Actual Results Amount 15.6% $ 256,542 $ 7.32 14.7% 10.5% 19,941,832 23.9% 28.7% 0.09% Increase over 2012 34,559 0.94 1,900,248 the Company applies IFRS, which are the GAAp for Canadian publicly accountable enterprises. non-GAAp measures are discussed in the non-GAAp Measures and Glossary section located at the end of this MD&A. the Company was successful in meeting or exceeding all of its performance targets in 2013. 16 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 2013 Strategies and Achievements the Company consistently employs three strategic priorities to achieve its long-term objectives: Strategic Priority 2013 Strategies and Achievements Focused marketplace Growth Build and maintain Canada’s leading alternative financial institution > Sustained focus on underserved niches and market-leading position > Continued to offer “one-stop” convenience to borrowers and brokers, while focusing on the high-value alternative mortgage segment > Maintained industry-leading service levels to clients and mortgage brokers Prudent Balance Sheet management Improve the financial strength of the Company so that it is capable of absorbing market events and position the Company for strong shareholder returns > Maintained a strong capital position, with Common equity tier 1 capital ratio of 16.80% at the end of 2013 and the increase in total capital of Home trust, through retained earnings of $216 million > Maintained the prudent credit risk profile of the loan portfolio, with improving credit scores and continued low loan to value > Maintained and managed strong liquidity positions, ending the year with more than $1.4 billion in liquid assets > Maintained a flexible supply of funding through the deposit broker network; continued to utilize funding through securitization markets and high interest savings; initiated an institutional deposit note program, raising $300 million on the initial offering; and launched a direct-to-consumer brand, Oaken Financial operational and Governance excellence Invest in robust corporate governance, risk management and efficient customer- focused processes and systems > Continued to achieve industry-leading returns on shareholders’ equity > Further enhanced risk measurement, monitoring and reporting capabilities > Maintained a low level of credit losses through strong underwriting, active portfolio monitoring and collections activities > Maintained leading cost efficiencies through tight cost controls > Strengthened the capabilities of the risk management, compliance and internal audit functions with additional experienced staff and more robust processes 2014 Strategic Priorities Strategic priorities for 2014 will continue to include the three priorities previously noted, along with strategies that comprise increased presence in the insured prime single-family mortgage market, launching of an e-banking platform for direct-to-consumer deposit business and continued enhancements to the information technology infrastructure. 2014 Performance targets the following table summarizes the Company’s 2014 performance targets. table 2: Performance targets for 2014 Growth in net income Growth in diluted earnings per share Growth in total loans under administration Return on shareholders’ equity efficiency ratio (teB)1 provision as a percentage of gross uninsured loans 1 Refer to the definition of teB under the non-GAAp Measures section of this report. 2014 targets 13%–18% 13%–18% 15%–20% 20.0% 28.0%–32.0% 0.15%–0.25% Amount $289.9 million–$302.7 million $8.27 per share–$8.64 per share $22.93 billion–$23.93 billion Home CAPItAl GRouP InC. AnnuAL RepORt 2013 17 management’s Discussion and Analysis management’s Discussion and Analysis the Company’s loan growth target is based on loans under administration, which includes off-balance sheet loans, reflecting the increased use of off-balance sheet transactions. Key assumptions underlying the Company’s targets are related to interest rates, unemployment levels, inflation, economic growth, and consumer debt levels. these assumptions are set out in the Caution Regarding Forward-Looking Statements in this report. Developments within the general Canadian economy and the real estate market have been, and are expected to be, consistent with these assumptions. 2014 overall outlook Supported by the stable Canadian economy and healthy real estate market in 2013, the Company continued to grow its traditional mortgage loan portfolio and market share, taking advantage of the attractive returns available in the alternative mortgage space. this business, which is the Company’s historical core business, provides superior returns on the allocated capital. the continued expansion of the traditional business was accompanied by commensurate strengthening of governance, risk management and control processes through further investment in tools, technology and people. the Company maintained very low loss ratios, even with a continued shift to the traditional portfolio which carries inherently higher credit risk than the insured Accelerator products. the Company expects continued growth of the traditional mortgage loan portfolio and will continue to strengthen risk management and control processes to manage the business within its risk appetite. In the third quarter of 2013, the Company received a favourable ruling from the Office of the Superintendent of Financial Institutions Canada (OSFI) with respect to the Company’s initiative to structure its Accelerator lending and securitization activity in a manner that allows off-balance sheet treatment of securitized loans and effectively expands the Company’s capacity and appetite for prime insured single-family mortgage lending. In this connection, the Company will increase its efforts and focus on Accelerator lending and anticipates renewed growth of this portfolio, which will be included in assets under administration and will reinforce the Company’s “one–stop” and “flexible lending solutions” strategies. the Company will also continue to increase its presence in suitable urban and suburban markets across Canada. Additional focus will be placed on growth of the Company’s high-margin non-residential and consumer lending portfolios within the Company’s risk tolerance. the Company expects supply and demand in the real estate market to remain balanced in 2014, with moderating conditions in most markets when compared to the activity levels of recent years. the tightening of mortgage underwriting requirements and changes in mortgage insurance qualification that have occurred over the past few years can be expected to continue to dampen the level of new and resale residential transaction activity in 2014, reducing the risk of a major disruption of the real estate market. the Company believes that slowing housing activity will lead to healthier real estate markets overall that are supported by continued low interest rates, stable to improving employment and stable net immigration. Should interest rates increase modestly over the next year, there will be no disruption to the Company’s business plans. the Company expects continued strong demand for its traditional mortgage and other retail products, reflecting the balanced real estate markets and an increasing market share. the Company will continue to maintain relatively high levels of liquidity and low overall leverage, as measured by the assets to capital multiple (ACM), to provide safety and soundness for depositors. the Company expects that the rate of growth in the Company’s non- securitized loan portfolio in 2014 will be relatively consistent with the growth rate experienced in 2013. the Company expects that loans under administration will grow in the range of 15% to 20% in 2014. the relative growth of the traditional mortgage portfolio will moderate compared to 2013 as the Company achieves the balance in the portfolios to support sustained growth in earnings and returns on equity. the Company will expand offerings of insured mortgages through the Accelerator insured mortgage program, supporting the “one–stop” and “flexible lending solutions” lender strategies. the traditional mortgage business is expected to maintain strong net interest margin and net interest income levels, while net interest margins on securitized assets continue to decline as older securitization programs reach maturity. the securitized portfolio carried on-balance sheet will decline as older portfolios mature and are replaced by portfolios that qualify for off-balance sheet accounting treatment. Consequently, the contribution to net interest income from these portfolios will become less significant and the Company will record more gains as securitized portfolios are sold. the Company will also record increased revenue from the servicing of such portfolios. the Company will increase its marketing and sales activities related to the development of more diversified sources of deposits, including its Oaken Financial business which will include an e-banking platform for direct-to-consumer business and additional costs will be incurred in connection to this. Increases in net interest income and gains on sales of securitized portfolios will tend to mitigate these increases in costs, and the Company expects that its efficiency ratio for 2014 will be in the target range of 28% to 32%. 18 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 FI n An CIA l HIGH lIGH tS table 3: Key Performance Indicators For the years ended December 31 (000s, except % and per share amounts) FInAnCIAl PeRFoRmAnCe meASuReS total revenue net income earnings per Share – Basic earnings per Share – Diluted Dividends per share Return on shareholders’ equity Return on average total assets net interest margin (teB)2 net interest margin non-securitized assets (teB)2 net interest margin securitized assets efficiency ratio (non-interest expense as a % of net revenue) efficiency ratio (teB) (non-interest expense as a % of net revenue)2 FInAnCIAl ConDItIon meASuReS 2013 IFRS 2012 IFRS 2011 IFRS 2010 IFRS 2009 Cdn GAAp1 $ 949,547 $ 887,685 $ 790,274 $ 687,249 $ 489,179 256,542 221,983 190,080 154,752 144,493 7.40 7.32 1.08 23.9% 1.3% 2.17% 3.01% 0.73% 6.40 6.38 0.90 25.5% 1.2% 2.09% 3.10% 0.93% 5.48 5.46 0.76 27.1% 1.1% 2.06% 3.04% 1.24% 4.46 4.45 0.66 27.3% 1.2% 2.07% 2.82% 1.23% 4.19 4.15 0.58 28.2% 2.2% 2.80% – – 28.9% 28.1% 28.5% 30.0% 27.2% 28.7% 27.7% 27.9% 29.3% 26.5% total assets $ 20,075,850 $ 18,800,079 $ 17,696,471 $ 15,518,818 $ 7,360,874 total assets under administration3 21,997,781 19,681,750 17,696,471 15,518,818 11,508,585 Cash and securities-to-total assets 5.7% 3.8% 5.2% 7.6% 20.6% total loans4, 5 $ 18,019,901 $ 17,159,913 $ 16,089,648 $ 14,091,755 $ 5,468,540 Securitized loans on-balance sheet5 5,210,021 6,706,160 8,243,350 8,116,636 – total loans under administration4,5,6 19,941,832 18,041,584 16,089,648 14,091,755 9,616,251 Common equity tier 1 capital ratio7 tier 1 capital ratio7 total capital ratio7 Assets to regulatory capital multiple7,8 Credit quality provision for credit losses as a % of gross loans net non-performing loans as a % of gross loans Allowance as a % of gross non-performing loans 16.80% 16.80% 19.69% 13.19 0.09% 0.35% 52.4% n/A 17.01% 20.68% 13.39 0.09% 0.33% 57.0% n/A 17.29% 20.46% 14.44 0.05% 0.25% 74.9% n/A 18.08% 19.37% 10.50 0.07% 0.24% 88.1% n/A 16.43% 18.00% 12.70 0.21% 0.85% 62.1% 1 Figures prior to 2010 represent previous Canadian GAAp balances and have not been restated to IFRS. prior to 2010, all securitizations were off-balance sheet. 2 See definition of taxable equivalent Basis (teB) under non-GAAp Measures in this report. 3 total assets under administration include total on-balance sheet assets and off-balance sheet loans. 4 total loans include loans held for sale. 5 In 2013, the Company classified Home trust mortgages used as CMB replacement assets as securitized mortgages. previously, these were classified as pledged securities. prior periods have been restated to reflect the current classification. 6 Loans under administration include total loans and off-balance sheet loans. 7 these figures relate to the Company’s operating subsidiary, Home trust Company. the figures prior to 2011 have not been restated to IFRS. For 2013, figures are calculated under Basel III, and for 2012 and earlier, under Basel II. 8 Commencing in Q3 2013, the Company excluded from its assets, for the purpose of calculating the assets to regulatory capital multiple, mortgages that are off-balance sheet as a result of sales of residual interests in light of regulatory communications confirming this treatment. the comparative multiple for 2012 has been restated to reflect this treatment. the Company did not enter into these transactions prior to 2012. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 19 management’s Discussion and Analysis management’s Discussion and Analysis the Company reported another year of increased net income at $256.5 million or $7.32 diluted earnings per share for 2013. Return on shareholders’ equity was solid at 23.9% for the year. Subsequent to the end of the year, the Board approved a stock dividend of one common share per each outstanding common share effecting a two-for-one split. the efficiency ratio, on a taxable equivalent basis (teB), remained favourable at 28.7%. Loan originations in the traditional portfolio increased year over year, while Accelerator (insured) mortgage originations increased later in 2013 and ancillary products continued to generate positive returns. the Company’s total customer accounts, including all loan and deposit accounts, reached 711,346 at the end of 2013 compared to 587,356 last year. the Company maintained its prudent credit profile in the loan portfolio and its strong capital base. the Company’s key financial highlights for 2013 are summarized below. Income Statement Highlights for 2013 > net income of $256.5 million in 2013 increased by $34.6 million or 15.6% from net income of $222.0 million in 2012, reflecting higher loan balances in the traditional mortgage portfolio, improved net interest margin, continued low credit provisions and a consistently low efficiency ratio. Adjusted net income, as defined in table 4, was $257.7 million in 2013, representing an increase of 14.8% over 2012. > Diluted earnings per share increased to $7.32, up $0.94 or 14.7% from the diluted earnings per share of $6.38 earned in 2012. > Return on average shareholders’ equity of 23.9% for 2013 exceeded 20% for the sixteenth consecutive year. > net interest income increased to $422.0 million, up $40.5 million or 10.6% over the $381.5 million earned in 2012, reflecting higher average loan balances of $18.22 billion compared to $17.39 billion in 2012 and improved net interest margin (teB) of 2.17% compared to 2.09% in 2012. > Gains on the sale of residual interests were $5.4 million compared to $4.8 million last year. In Q3 2013, the Company received a favourable regulatory ruling confirming that the underlying mortgages in these residual interest transactions can be excluded from the calculation of the Company’s ACM. this provides the Company with significant flexibility with respect to growth of the portfolio of insured prime residential mortgages, which are now being actively originated and renewed by the Company. the Company began to increase insured Accelerator originations later in 2013 and expects that gains on sales of residual interests will increase in 2014. > Gains on securitization of multi-unit residential mortgages were $5.7 million compared to $3.3 million last year. > Fees and other income increased $17.4 million or 39.6% as more accounts were affected by fees in 2013, combined with an increase in the number of accounts under administration. > net realized and unrealized loss on derivatives of $1.4 million in 2013 compared to a net gain of $3.8 million in 2012. the loss in 2013 included charges of $8.0 million related to the maturity of certain derivative positions that were restructured at the time of adoption of IFRS, compared to a charge of $3.5 million in 2012. > provisions for credit losses were $15.9 million for the year, a marginal increase over the $14.7 million recorded last year. this represents 0.09% of gross loans, consistent with 2012 despite the increased weighting of uninsured lending. net write-offs were $15.5 million for 2013, representing 0.09% of gross loans compared to $12.4 million and 0.07% of gross loans in 2012. the increase in net write- offs over 2012 resulted from a net principal loss of $3.0 million associated with the settlement of the disputed loans to commercial condominium corporations discussed last year. In the absence of this unusual write-off, the net write-offs as a percentage of gross loans would have been consistent with 2012 at 0.07%. > non-interest expenses, which include salaries, premises and other operating expenses, were $143.7 million in 2013, up 17.1% over the $122.7 million recorded in 2012 and in line with business growth and strategic investments. the Company continues to invest in people, business development, infrastructure and technology to support future asset and revenue growth. the Company’s efficiency ratio (teB) remains low at 28.7% compared to 27.7% in 2012, an indication of a high level of operating efficiency. 20 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Balance Sheet Highlights for 2013 > the Company’s total on-balance sheet assets surpassed $20 billion, reaching $20.08 billion, an increase of 6.8% compared to $18.80 billion at the end of 2012. total assets under administration, which includes $1.92 billion of mortgages accounted for off- balance sheet, reached $22.00 billion, an increase of 11.8% over 2012. Loans under administration increased to $19.94 billion, an increase of 10.5% over $18.04 billion last year. > the Company sold residual interests in securitization transactions of $519.3 million which, combined with amortization of MBS liabilities and maturity of CMB liabilities, reduced both the securitized mortgage loans and securitization liabilities. As discussed above, the underlying mortgages associated with the sold residual interests are removed from the balance sheet and excluded from assets used in the calculation of the Company’s ACM based on the favourable regulatory ruling received during the year. > Mortgage originations were $6.92 billion in 2013 compared to the $6.01 billion originated in 2012. the Company’s originations reflect continued focus on the traditional mortgage portfolio, which accounted for 69.0% of originations and a significant portion of the overall increase in originations. Insured multi-unit residential mortgage originations of $693.5 million increased by $437.2 million from 2012 as the Company ramped up its origination and securitization activity late in the year. > While the Company increased the traditional portfolio, it maintained credit quality. net non-performing loans as a percentage of the gross loan portfolio ended the year at 0.35%, up slightly from 0.33% one year ago. At the end of 2013, 97.6% of the loan portfolio was current, consistent with the end of 2012. > Liquid assets at December 31, 2013 were $1.49 billion, compared to $771.8 million at December 31, 2012. part of the increase was due to proceeds received from the issuance of a $300 million institutional deposit note late in 2013. these funds will be deployed in the first half of 2014. the Company maintains a prudent level of liquidity, given the current level of operations and the Company’s obligations. > Home trust’s capital levels were strong throughout 2013, as indicated by the Common equity tier 1 ratio of 16.80% and the tier 1 and total capital ratios of 16.80% and 19.69%, respectively, at December 31, 2013. Home trust’s ACM ended 2013 at 13.19 compared to 13.39 at the end of 2012. > Deposits reached $12.77 billion, up from $10.14 billion at December 31, 2012. the increase in deposit liabilities has funded the increase in the non-securitized portfolio and liquidity. the Company initiated new deposit diversification strategies in late 2012 and 2013, including the new Oaken brand and related direct-to-consumer products, a high interest savings account and an institutional deposit note program. these programs reflect $634.8 million of the total deposits at the end of 2013. > Securitization liabilities were $5.77 billion at the end of 2013, down from $7.34 billion last year. While originations increased in the Accelerator portfolio, which is typically funded by way of securitization, amortization of MBS liabilities and maturities of CMB combined with loans removed from the balance sheet on the sale of residual securitization interests exceeded the Accelerator originations, resulting in the overall decline in the securitization liabilities. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 21 management’s Discussion and Analysis management’s Discussion and Analysis FI n An CIA l P e RF oR m A nC e R eVI e W table 4: Income Statement Highlights (000s, except % and per share amounts) total net interest income provision for credit losses non-interest income non-interest expenses Income before income taxes Income taxes net income Basic earnings per share Diluted earnings per share Reconciliation of net Income to Adjusted net Income net income per above Adjustment for derivative restructuring – IFRS conversion (net of tax) Adjustment for disputed loans to condominium corporations (net of tax) Adjustment for investment tax credit benefits (net of tax) Adjusted net Income1 Adjusted basic earnings per share1 Adjusted diluted earnings per share1 2013 421,979 $ 15,868 406,111 75,059 143,738 337,432 80,890 256,542 $ 7.40 $ 7.32 $ 2012 381,472 14,720 366,752 55,902 122,735 299,919 77,936 221,983 6.40 6.38 256,542 $ 5,873 1,508 (6,190) 257,733 $ 7.43 $ 7.36 $ 221,983 2,602 – – 224,585 6.47 6.45 $ $ $ $ $ $ $ $ Change 10.6% 7.8% 10.7% 34.3% 17.1% 12.5% 3.8% 15.6% 15.6% 14.7% 15.6% 125.7% – – 14.8% 14.8% 14.1% 1 Adjusted net income and adjusted earnings per share are defined in the non-GAAp Measures section of this MD&A. net Interest Income and margin presented in tables 5 and 6 are analyses of average rates, net interest income and net interest margin. net interest income is the difference between interest and dividends earned on loans and investments and the interest paid on deposits and borrowings to fund those assets. the net interest margin is net interest income divided by the Company’s average total assets. Dividend income has been converted to teB (refer to the non-GAAp Measures and Glossary section of this report for a definition of teB) for comparison purposes. table 5: net Interest margin net interest margin non-securitized interest-earning assets (non-teB) net interest margin non-securitized interest-earning assets (teB) net interest margin securitized assets total net interest margin (non-teB) total net interest margin (teB) Spread of non-securitized loans over deposits only 2013 2.98% 3.01% 0.73% 2.15% 2.17% 3.14% 2012 3.05% 3.10% 0.93% 2.07% 2.09% 3.13% total net interest margin (teB), including the securitized portfolio, was 2.17% for 2013 compared to 2.09% in 2012, reflecting a greater proportion of higher-yielding, non-securitized assets in the on-balance sheet portfolio as the Company continued its focus on traditional products relative to insured mortgages. As such, over the period the portfolio weighting of securitized mortgages and assigned assets, which earn a lower net interest margin, decreased to 28.6% at December 31, 2013 from 38.8% at December 31, 2012. Despite relatively stable interest spreads of non-securitized loans over deposits, net interest margin on non-securitized assets (teB) declined to 3.01% from 3.10% on a higher proportion of liquid assets held during the year and declining rates on the liquidity portfolio. net interest margin on securitized assets declined as expected on the structured maturity of high-yielding mortgage pools. 22 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 6: net Interest Income by Product and Average Rate (000s, except %) Assets Cash resources and securities traditional single-family residential mortgages Accelerator single-family residential mortgages Residential commercial mortgages2 non-residential commercial mortgages Credit card loans Other consumer retail loans total non-securitized loans taxable equivalent adjustment total on non-securitized interest-earning assets Securitized single-family residential mortgages Securitized multi-unit residential mortgages Assets pledged as collateral for securitization total securitized residential mortgages Other assets total Assets liabilities and Shareholders’ equity Deposits Senior debt Securitization liabilities Other liabilities and shareholders’ equity total liabilities and Shareholders’ equity net Interest Income (teB) tax equivalent Adjustment net Interest Income per Financial Statements Average Balance1 Income/ expense 2013 Average Rate1 Average Balance1 Income/ expense 2012 Average Rate1 $ 1,149,994 $ 19,448 1.69% $ 807,022 $ 18,190 2.25% 9,116,538 482,491 5.29% 6,961,740 381,971 5.49% 446,636 263,447 15,044 12,954 975,217 307,310 308,155 11,417,303 – 62,681 28,966 27,111 629,247 4,016 3.37% 4.92% 6.43% 9.43% 8.80% 5.51% – 540,610 202,027 17,440 11,000 985,089 361,808 206,978 9,258,252 – 61,229 34,722 19,360 525,722 5,031 3.23% 5.44% 6.22% 9.60% 9.35% 5.68% – 12,567,297 652,711 5.19% 10,065,274 548,943 5.45% 4,559,463 144,702 3.17% 5,651,599 200,679 3.55% 1,780,245 73,712 4.14% 1,985,035 80,757 4.07% 467,481 6,807,189 257,386 $ 19,631,872 $ 7,379 225,793 – 878,504 1.58% 3.32% – 497,312 8,133,946 260,470 4.47% $ 18,459,690 $ 6,435 287,871 – 836,814 $ 11,327,983 $ 149,899 6,849,261 268,233 6,612 177,664 2.37% $ 9,004,518 $ 4.41% 2.59% 153,285 8,170,337 230,006 6,831 213,474 1.29% 3.54% – 4.53% 2.55% 4.46% 2.61% 1,304,729 – – 1,131,550 – – $ 19,631,872 $ 452,509 2.30% $ 18,459,690 $ 450,311 2.44% $ 425,995 (4,016) $ 421,979 $ 386,503 (5,031) $ 381,472 1 the average is calculated with reference to opening and closing monthly asset and liability balances. 2 Residential commercial mortgages include non-securitized multi-unit residential mortgages and commercial mortgages secured by residential property types. net interest income increased 10.6% over 2012, reflecting an increase of $1.17 billion or 6.3% in average asset balances and an increase in total net interest margin (teB) of 8 basis points year over year. the average yield on non-securitized loans declined to 5.51% from 5.68% in 2012 as mortgage rates declined, but this was offset by a decline in average deposit rates to 2.37% from 2.55% in 2012. the declines in average rates primarily reflect lower average Government of Canada bond yields in 2013, upon which deposit and traditional mortgage rates are set. Strong demand for the Company’s loans products helped maintain the average spread of the deposit-funded loans portfolio at 3.14%, up from 3.13% last year. the impact of lower average rates on cash and securities was larger this year, given the increased proportion of these assets in the portfolio. the average rate for residential commercial mortgage loans declined, reflecting the maturity of higher-yielding loans and originations and renewals at current lower rates. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 23 management’s Discussion and Analysis management’s Discussion and Analysis the net interest margin on securitized assets also declined year over year, reflecting the maturity of higher yielding MBS and CMB pools and the use of lower-yielding assets as replacement assets in the CMB program. the average assets in this portfolio declined by $1.33 billion in 2013, reflecting the sale of residual interests and maturities. As such, this portfolio has had a reduced impact on the total Company net interest margin and the relative impact can be expected to continue to decline through 2014. 2014 outlook for net Interest Income the Company expects net interest income on the non-securitized portfolio to grow relative to loan portfolio growth in 2014. the Company will continue to carefully employ its growth strategy for the traditional mortgage portfolio, which should continue to favourably influence net interest income in 2014. tempering this influence on net interest income will be lower net interest margin on insured securitized mortgages, which have lower interest margins. As the Company sells residual interests, net interest income from this portfolio is replaced with gains on sale. the Company expects the net interest margin on non-securitized assets to remain relatively stable at 2013 levels but is prepared for modest declines and slight variations quarter over quarter. the Company’s strategy is to manage the average spread between deposits and traditional mortgages at approximately 3.0%. the Company anticipates continued declines in the net interest margin on the securitized portfolio in 2014 as higher-yielding mortgage pools mature. this will have relatively less of an impact on total Company net interest margin as the on-balance sheet portfolio is expected to decline. the Company is prepared for moderate volatility in the net interest margin trend depending on the replacement assets available and the level of interest rates. Overall net interest margin is expected to remain stable as the relative proportion of non-securitized assets continues to increase. the Company continually reviews pricing, funding costs and product structures to maximize spread returns, including diversification and growth of the consumer lending segment. the Company will continue to balance prudent liquidity with investment return options to optimize the risk/return relationship while considering economic and credit conditions. Increased levels of liquidity tend to reduce net interest spread of the overall asset portfolio. non-interest Income table 7: non-interest Income (000s, except %) Fees and other income Securitization income net realized and unrealized gains (losses) on securities net realized and unrealized (loss) gain on derivatives table 8: Securitization Income (000s, except %) Gain on sale of Insured multi-unit residential mortgages Residual interests in securitized single-family residential mortgages total gain on sale net hedging impact Servicing income total securitization income 2013 61,252 $ 12,648 2,589 (1,430) 75,059 $ 2012 43,863 8,306 (55) 3,788 55,902 Change 39.6% 52.3% 4,807.3% (137.8%) 34.3% 2013 2012 Change 5,687 $ 5,354 11,041 109 1,498 12,648 $ 3,300 4,845 8,145 44 117 8,306 72.3% 10.5% 35.6% 147.7% 1,180.3% 52.3% $ $ $ $ Fees and other income, which include mortgage and Visa account administration fees, net of direct servicing expenses, generally increase as the size of the loan portfolio increases and, in 2013, also included an increase related to fee adjustments. Fee income is also influenced by the overall mix of the portfolio and has grown at a slightly faster pace than the overall loan portfolio growth due to the focus on the Company’s traditional mortgage portfolio. 24 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Securitization income increases reflect the increased activity in the multi-unit residential mortgage securitizations through the MBS program. Gains on sales of retained interests were relatively flat year over year as the Company awaited a regulatory ruling on the asset to capital treatment of the underlying assets. In both of these programs, mortgages have been removed from the calculation of the Company’s ACM. In the case of single-family residential mortgage sales, the Company will service the loans and record related fee revenue over the remaining term of the underlying mortgages. In the case of multi-unit residential mortgages, the Company outsources the servicing activity and no further servicing revenue or fees will be recorded. Servicing income increases as the size of the single-family residential mortgage portfolio under administration increases. the Company recognized a net gain of $2.8 million on the sale of certain available for sale securities in 2013, compared to gains of $1.8 million in 2012. the Company takes advantage of improvements in securities markets and will rebalance the investment portfolio as market conditions warrant. the Company also recognized $0.2 million in impairments through profit and loss on certain available for sale equity securities in 2013 compared to $1.8 million in 2012. net realized and unrealized gains on derivatives include several components: > On an ongoing basis, the Company calculates and records the financial amount of ineffectiveness in its hedging programs that are designated for hedge accounting. the 2013 amount included $6.4 million in unrealized hedge ineffectiveness gains associated with its accounting program. this compares to $7.0 million in unrealized gains in 2012. Ineffectiveness can vary from gains to losses, depending on the underlying conditions. > Additionally, there was $8.0 million ($5.9 million, after tax) in charges against income related to the maturity of certain derivative positions that were restructured at the time of adoption of IFRS, compared to $3.5 million ($2.6 million, after tax) in 2012. these amounts are charged to income as the related CMB liabilities mature. the amounts involved in future periods will generally be less significant and are not expected to exceed the charge recognized in 2013. > Derivative positions outside hedge accounting relationships were marked to market for realized and unrealized gains of $0.2 million compared to $0.3 million in 2012. these positions are also subject to gains and losses depending on underlying economic conditions. please see the Derivative Financial Instruments note in the consolidated financial statements included in this report and the Derivatives and Hedging section of this MD&A for further information. 2014 outlook for non-interest Income the Company anticipates that fees and other income will increase over 2013 levels in line with loan portfolio growth. the Company expects to continue to securitize and sell off-balance sheet insured multi-unit residential mortgages on an ongoing basis and expects that these transactions will continue to add to profitability at levels relatively consistent with 2013. the Company also anticipates selling an increased volume of residual interests in insured, single-family residential mortgages in 2014, leading to higher gains on sale. Higher gains on sale will be offset partly by lower net interest income but, on a combined basis, will exceed 2013 as the Company increases originations of insured mortgages. through 2014, the Company will continue to record smaller charges to income through derivative gains and losses related to the implementation of IFRS, as discussed above. Charges of approximately $1.4 million will be recorded in the first quarter and $1.1 million in the second quarter of 2014. the amounts in future periods will not be significant. the Company will continue to hedge its interest rate risk associated with the loan commitments and fixed-rate assets and liabilities through the use of bond forward contracts and interest rate swaps. the Company expects to continue to apply hedge accounting to most of such instruments, thus reducing earnings volatility from derivatives gains and losses. the impact of hedge accounting ineffectiveness and fair value changes on derivatives held outside of hedge accounting relationships can be expected to continue to create some moderate volatility quarter over quarter. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 25 management’s Discussion and Analysis management’s Discussion and Analysis Provision and Allowance for Credit losses table 9: Provision for Credit losses (000s, except %) As at December 31, 2013 net non-performing loans For the year ended December 31, 2013 net Write-offs Provision1 Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages total (000s, except %) Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages total $ Amount 51,636 1,8362 7,1893 2,584 – % of Gross loans 0.48% $ 0.93% 0.72% 0.88% – Amount 11,766 2,783 274 679 366 % of Gross loans 0.11% $ 1.41% 0.03% 0.23% 0.11% – – – – 230 589 345 – Amount 11,165 3,199 % of Gross loans 0.10% 1.62% – 63,245 $ – 0.35% $ – 15,868 – 0.09% $ – 15,528 0.02% 0.20% 0.10% – – 0.09% As at December 31, 2012 net non-performing Loans For the year ended December 31, 2012 net Write-offs provision1 $ Amount 47,788 4,527 501 3,505 – % of Gross Loans 0.55% $ 2.93% 0.05% 1.07% – Amount 12,581 340 241 1,291 267 % of Gross Loans 0.14% $ 0.22% 0.02% 0.39% 0.10% Amount 10,148 – 319 1,572 342 % of Gross Loans 0.12% – 0.03% 0.48% 0.13% – – – – – – – 56,321 $ – 0.33% $ – 14,720 – 0.09% $ – 12,381 – 0.07% 1 provisions include both individual and collective provisions. 2 the non-performing residential commercial amount comprises one loan. 3 the non-performing non-residential commercial amount includes $6.4 million related to one loan. the provision for credit losses is charged to the statement of income by an amount that brings the individual and collective allowances for credit losses to the level determined by management to be adequate to cover incurred losses and identified credit events in the portfolio, including losses that are not yet individually identifiable. Factors which influence the provisions for credit losses include the formation of new non-performing loans, the level of individual write-offs and management’s assessment of the level of collective and individual allowances required based on available data, including the collateral supporting specific non-performing loans. In addition, management considers current and historical credit performance of the portfolio, external economic factors, the composition of the portfolio, and the overall growth in the loans portfolio. provisions as a percentage of gross loans of 0.09% for 2013 are consistent with 2012 and are better than the target range of 0.10% to 0.18%. provisions as a percentage of gross uninsured loans were 0.14% (2012 – 0.15%). net write-offs were up $3.1 million and represented 0.09% of gross loans compared to 0.07% in 2012. this increase reflects a net principal loss of $3.0 million associated with the settlement of the disputed loans to commercial condominium corporations discussed last year. In the absence of this disputed loans write-off, the net write-offs as a percentage of gross loans would have been consistent with 2012 at 0.07%. net non-performing loans as a percentage of gross loans increased to 0.35% at the end of 2013 from 0.33% at the end of 2012. the increase reflects a larger proportion of uninsured mortgages in the portfolio compared to prior years and the inclusion of one commercial loan for $6.4 million on which the Company expects no losses. net non-performing loans as a percentage of gross uninsured mortgages was 0.55% compared to 0.58% at 2012. the levels of non-performing loans are within the Company’s expectations and, considering the increase in the proportion of traditional mortgages in the loans portfolio, have remained quite low. the increase in non-performing loans from 2012 did not translate into higher write-offs, other than the write-offs associated with the disputed loans. 26 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 the level of individual allowances at the end of 2013 decreased by $1.2 million over 2012, while gross non-performing loans increased by $5.9 million to $64.9 million from $59.0 million. As discussed above, the non-performing loans include one commercial loan for $6.4 million on which no losses are expected. the amount set aside for individual allowances can be influenced by specific local real estate markets and the amount of time to sell when required. the collective allowance balance at December 31, 2013 increased $1.5 million over December 31, 2012, reflecting the increase in the traditional mortgage portfolio and representing close to two times the current year write-offs. the Company remains satisfied with the credit performance in the loans portfolio. please see the Credit Risk section of this MD&A for further discussion. 2014 outlook for Provision and Allowance for Credit losses the Company’s provision for credit losses in 2014 will be influenced by the strength of the Canadian economy and the resulting impact on employment and housing markets. there remains uncertainty related to the growth prospects for certain sectors of the economy, reflecting continued uncertainty in international markets; however, the Company continues to expect housing markets in most of the country to remain balanced in 2014. the Company also expects that Canadian consumers will continue to service and manage debt levels. While the Company is cautiously optimistic that credit losses will remain stable, it is prepared for moderate volatility in this trend. the Company’s 2014 objective for the provision for credit losses is 0.15% to 0.25% of gross uninsured loans. the previous target for 2013 was 0.10% to 0.18% of gross loans. the Company believes provisions as a percentage of gross uninsured loans better reflect the credit performance of uninsured loans. Individual allowances will continue to be determined and reviewed monthly on an account-by-account basis. the collective allowance for credit losses reflects an ongoing assessment of the strength of the portfolio at any given time, and will continue to be reviewed at least on a quarterly basis. non-interest expenses table 10: non-interest expenses (000s, except % and number of employees) Salaries and employee benefits Premises and equipment Rent – premises equipment rental and repairs other operating expenses Consulting and professional services Outsourced services Computer services Advertising and business development General and administration Amortization and depreciation total non-interest expenses Average total assets under administration As a % of assets under administration efficiency ratio calculation net interest income Other income total revenue, net of interest expense teB adjustment total revenue teB, net of interest expense As a % of total revenue, net of interest expense As a % of total revenue teB, net of interest expense target efficiency ratio teB number of active employees 2013 70,954 $ 2012 58,956 $ Change 20.4% 6,994 2,907 9,901 5,961 2,872 8,833 12,740 10,004 5,179 8,857 14,735 11,368 62,883 143,738 $ 12,717 9,591 5,202 6,637 10,965 9,834 54,946 122,735 $ $ 20,839,766 $ 18,689,111 0.66% 0.69% $ $ 421,979 $ 75,059 497,038 4,016 501,054 $ 28.9% 28.7% 381,472 55,902 437,374 5,031 442,405 28.1% 27.7% 28.0%–34.0% 28.0%–34.0% 17.3% 1.2% 12.1% 0.2% 4.3% (0.4%) 33.4% 34.4% 15.6% 14.4% 17.1% 10.6% 34.3% 13.6% 13.3% 692 611 13.3% Home CAPItAl GRouP InC. AnnuAL RepORt 2013 27 management’s Discussion and Analysis management’s Discussion and Analysis In 2013, the Company continued to operate at a low efficiency ratio that was at the low end of the 2013 target range, reflecting continued low costs compared to revenues, net of interest expense. non-interest expense as a percentage of average total assets under administration increased marginally year over year. the Company continues to manage expenses in a disciplined and measured manner and aligns its expense management strategy with its growth targets and strategic objectives. enhancing the Company’s operational effectiveness and efficiency, combined with cost management, remains a strategic priority for the Company and this focus is expected to contribute to a continued low and relatively stable efficiency ratio. Salaries and employee benefits increased over last year due to a combination of the increase in active employees and an increase in average salaries. Active employees have increased to support business growth and the enhancement of risk management, governance and compliance functions. Included in the increase in active employees are former consultants and contractors who have joined the Company as permanent employees, resulting in the level of consulting and professional services remaining consistent with last year despite the business growth. Higher average salaries reflect merit increases combined with some realignment in staffing structures and the enhancement of the functions mentioned above. premises expense increased due to the expansion of the toronto head office. Advertising and business development expenses have increased to support business growth and include increases in volume bonuses paid to the Company’s mortgage broker channel. General and administrative expenses have increased with business growth and also include an increase in the deposit insurance premium paid to CDIC. there was a one-time premium rebate in 2012 for an early system implementation. the increased amortization and depreciation expenses resulted primarily from the amortization of the Company’s software development costs, which have increased as the development of certain projects was completed during the year. the Company continues to invest in developing enhanced technology to support the Company’s strategic initiatives and control enhancements. 2014 outlook for non-interest expenses the Company expects continued low efficiency ratios within a target range of 28.0% to 32.0% in 2014. Investment in technology is expected to continue in 2014 along with some increase in headcount in business functions and continued strengthening of governance, risk and control functions in line with business growth. the Company will increase its marketing and sales activities related to the development of more diversified sources of deposits, including its Oaken Financial business which will include an e-banking platform for direct-to-consumer business and additional costs will be incurred in connection to this. taxes table 11: Income taxes (000s, except %) Current Deferred total income taxes effective income tax rate $ $ 2013 82,128 $ (1,238) 80,890 $ 2012 82,176 (4,240) 77,936 23.97% 25.99% Change (0.1%) 70.8% 3.8% the provision for income taxes for the year ended December 31, 2013 amounted to $80.9 million, resulting in an effective tax rate of 23.97% ($77.9 million and 25.99% in 2012). the effective tax rate of the Company is lower than the statutory rate primarily due to the benefits recorded in the accounts attributed to Scientific Research and experimental Development (SR&eD) credits recognized throughout the year. the Company has claimed $8.4 million in SR&eD credits for the years 2009 to 2012. the Company has capital losses of $2.8 million ($2.8 million in 2012), which are available to reduce capital gains in future years and have no expiry date. the Company has not recognized the tax benefit of these capital losses. note 16 to the consolidated financial statements included in this report provides more information about the Company’s current income taxes, deferred income taxes and provisions for income taxes. 28 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 2014 outlook for taxes the Company expects that the effective income tax rate in 2014 will increase to within the range of 25.7% to 26.2%, excluding the impact of any SR&eD credits that may be realized. the Company is currently assessing the likelihood of future credits. In the event that claims are submitted, the effective tax rate will decrease accordingly. Management believes that its current unrecognized credits may result in an after-tax adjustment to its current income tax expense in the range of $0.9 million to $1.4 million. the expected effective tax rate is lower than statutory rates due to the impact of various permanent differences. Comprehensive Income table 12: Comprehensive Income (000s, except %) net income net unrealized (losses) gains on securities and retained interests available for sale, net of reclassifications to net income and taxes net unrealized gains on cash flow hedges, net of reclassifications to net income and taxes total other comprehensive (loss) income Comprehensive income 2013 256,542 $ 2012 221,983 $ Change 15.6% (16,255) 4,573 (455.5%) 1,521 (14,734) 241,808 $ 873 5,446 227,429 $ 74.2% (370.5%) 6.3% Comprehensive income is the aggregate of net income and other comprehensive income (OCI). OCI includes changes in unrealized gains or losses on available for sale securities and retained interests, transfers of previously unrealized net gains and losses to net income, once they have been realized, plus the impact of cash flow hedges and transfers to income of unrealized losses on investments considered impaired. OCI included pre-tax net unrealized losses on available for sale securities and retained interests before reclassifications to net income and taxes of $19.5 million, compared to net unrealized gains of $6.5 million in 2012. the unrealized losses in 2013 principally reflect changes in the fair value of rate-reset preferred shares in the available for sale securities category. In the Company’s judgement, the decline in fair value is due primarily to changes in interest rates and is expected to be recovered when the dividend rates on the underlying shares are reset. Included in the transfer to net income for the year was $0.2 million in impairment losses on available for sale securities, compared to $1.8 million in 2012. FInAnCIA l PoSItIon ReVI eW table 13: Balance Sheet Highlights (000s, except %) Cash resources and available for sale securities total loans Collective allowance for credit losses Other assets total assets Deposits Senior debt Securitization liabilities Other liabilities total liabilities Shareholders’ equity total liabilities and shareholders’ equity Loans as a % of total assets 2013 2012 716,207 17,159,913 (30,000) 17,129,913 953,959 $ 20,075,850 $ 18,800,079 $ 1,152,741 $ 18,019,901 (31,500) 17,988,401 934,708 $ 12,765,954 $ 10,136,599 150,684 7,335,895 208,688 17,831,866 968,213 $ 20,075,850 $ 18,800,079 147,343 5,773,064 211,792 18,898,153 1,177,697 89.6% 91.1% Change 61.0% 5.0% 5.0% 5.0% (2.0%) 6.8% 25.9% (2.2%) (21.3%) 1.5% 6.0% 21.6% 6.8% Home CAPItAl GRouP InC. AnnuAL RepORt 2013 29 management’s Discussion and Analysis management’s Discussion and Analysis loans under Administration Figure 1: Portfolio Composition by Product type 54.3% 48.2% 30.0% 24.1% 12.0% 11.7% 12 13 12 13 12 13 Securitized Single-Family Residential Mortgages Securitized Multi-Unit Residential Mortgages Single-Family Residential Mortgages 1.0% 12 1.7% 13 Residential Commercial Mortgages 5.5% 5.0% 12 13 Non-residential Commercial Mortgages 1.8% 12 1.5% 13 Credit Card Loans 1.5% 12 1.7% 13 Other Consumer Retail Loans Figure 2: Insured versus uninsured mortgages under Administration Figure 2: Insured versus Uninsured Mortgages 2013 Insured 43.5% 2012 Uninsured 52.2% Uninsured 56.5% Insured 47.8% 60 50 40 60 50 40 60 50 40 Figure 3: loans under Administration Composition by Province Figure 3: Portfolio Composition by Province 30 30 20 10 0 20 10 0 30 78.2% 20 78.4% 10 0 60 50 40 30 20 10 0 60 50 40 30 20 10 0 60 50 40 30 20 10 0 12 13 12 13 12 13 12 13 12 13 12 13 12 13 2012 2013 30.0% 24.1% 2012 2013 12.0% 11.7% Insured 2012 2013 48.2% 54.3% 2012 2013 1.0% 1.7% 2012 2013 5.5% 5.0% 2012 2013 1.8% 1.5% Insured 2012 2013 1.5% 1.7% 7.0% 6.8% 5.7% Uninsured 5.2% 5.9% 6.3% 3.2% Uninsured 3.3% 12 13 12 13 12 13 12 13 12 13 British Columbia Alberta Ontario Quebec Other 30 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 60 50 40 30 20 10 0 90 80 70 60 50 40 30 20 10 0 90 80 70 60 50 40 30 20 10 0 90 80 70 60 50 40 30 20 10 0 90 80 70 60 50 40 30 20 10 0 90 80 70 60 50 40 30 20 10 0 1467 pg lending x prod 2010.eps 12 13 12 13 12 13 12 13 12 13 2012 2013 7.0% 6.8% 2012 2013 5.7% 5.2% 2012 2013 78.2% 78.4% 2012 2013 5.9% 6.3% 2012 2013 3.2% 3.3% table 14: loans Portfolio (000s, except % and number of loans) Securitized single-family residential mortgages Securitized multi-unit residential mortgages Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans total loan portfolio Loans held for sale total on-balance sheet loans Off-balance sheet loans Single-family residential mortgages Multi-unit residential mortgages total off-balance sheet loans total loans under administration number of loans outstanding Mortgages Credit card loans Other consumer retail loans total number of loans outstanding 2013 2012 $ 3,720,097 $ 4,763,757 1,942,403 8,689,446 154,477 988,416 327,516 271,977 17,137,992 21,921 17,159,913 1,489,924 10,847,367 196,880 994,210 293,485 339,963 17,881,926 137,975 18,019,901 1,088,066 833,865 1,921,931 650,508 231,163 881,671 $ 19,941,832 $ 18,041,584 59,031 28,892 266,515 354,438 55,686 26,840 207,867 290,393 Change (21.9%) (23.3%) 24.8% 27.4% 0.6% (10.4%) 25.0% 4.3% 529.4% 5.0% 67.3% 260.7% 118.0% 10.5% 6.0% 7.6% 28.2% 22.1% the total on-balance sheet loans portfolio amounted to $18.02 billion at the end of 2013, up $0.86 billion or 5.0% over the $17.16 billion at the end of 2012. the off-balance sheet insured mortgages under administration were $1.92 billion at the end of 2013, up $1.04 billion or 118.0% over the $0.88 billion at the end of 2012. Much of the on-balance sheet loans portfolio growth was in the traditional mortgage portfolio, which is consistent with the Company’s strategy to increase focus on this more profitable residential portfolio for on-balance sheet lending. Growth in the off-balance sheet mortgage portfolio reflects an increase of $602.7 million in insured multi-unit residential mortgages and $437.6 million in insured single-family mortgages. As illustrated in Figure 1, the Company’s single-family residential lending represents the most significant component of the Company’s loans portfolio, at 54.3% of the total loans under administration, an increase from 48.2% in 2012, reflecting an increase in the traditional mortgage portfolio. Securitized mortgages continued to be a significant component of the Company’s loan portfolio in 2013 at 35.8%, although the proportion declined from 42.0% in 2012. the Company expects the securitized proportion to increase in 2014 as Accelerator originations increase. the on-balance sheet securitized mortgage portfolio declined by $1.50 billion in 2013, reflecting net maturities in the securitized portfolio and the sale of residual interests related to $519.3 million in securitized single-family mortgages. total securitized mortgages, including the off-balance sheet portfolio, also decreased $455.9 million in 2013 as maturities exceeded new originations in the insured single-family mortgages. All new multi-unit residential securitizations in 2013 were off-balance sheet. the favourable regulatory ruling on the sale of residual interests in Q3 2013 reduced the previous capital constraints that were associated with carrying insured, securitized single-family mortgages on-balance sheet. Consequently, the Company has recently increased its activity in insured lending and expects growth in this portfolio in 2014, with a significant volume carried off-balance sheet. total insured, securitized multi-unit residential mortgages were up $150.2 million on increased originations. the single-family residential mortgage portfolio increased by $2.16 billion or 24.8% to $10.85 billion from $8.69 billion at the end of 2012, supported by the Company’s strategy to increase its focus on the traditional mortgage portfolio, which has been the Company’s core business. Credit losses experienced in 2013 on the traditional portfolio are consistent with the Company’s historical experience and are well supported by the profitability of this portfolio. the Company focused the portfolio’s growth in its traditional target markets and employed additional caution in certain geographic areas where the housing markets and employment levels were relatively weaker. the non-residential commercial mortgage portfolio increased $5.8 million to $994.2 million from $988.4 million at the end of 2012. the Company continues to carefully increase the loan balances in this segment while maintaining its relative proportion of the total on-balance sheet loan portfolio at about 6%. the Company will continue to manage this portfolio in a conservative manner and grow the portfolio when assets of appropriate quality within the Company’s risk appetite are available. Included in the non-residential commercial category are store and apartment structures, office buildings, residential and non-residential construction, retail stores, hotels and industrial properties. Residential commercial mortgages primarily include uninsured multi-unit residential mortgages. the Company manages this portfolio conservatively. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 31 management’s Discussion and Analysis management’s Discussion and Analysis the credit card loan portfolio declined by $34.0 million to $293.5 million from $327.5 million at the end of 2012. new originations in this portfolio began to decline in 2012 when new underwriting guidelines were contemplated and the outstanding balances continued to decline through 2013. Recently, the origination volumes have increased with additional marketing focus by the Company. the Company’s retail credit portfolio continues to be an integral part of the loans portfolio generating above average returns for the Company. the portfolio increased by 25.0% to $340.0 million from $272.0 million at the end of 2012. Water heater loans, a financing product introduced into the Company’s portfolio in 2010, are the largest component of the retail lending portfolio, amounting to $209.1 million or 61.5% of the retail loans outstanding at the end of 2013. the Company’s lending activities remained concentrated in the Ontario market in 2013 but included expansion into new Ontario markets through the mortgage broker channel as well as cautious expansion into other provinces. the increase in the total loan proportion in Ontario reflected strong mortgage origination volumes in 2013 that grew 10.3% year over year. At the same time new origination growth in other provinces increased by 46.5% to $1.18 billion in 2013 from $0.81 billion last year and was 17.1% of total originations compared to 13.4% last year. please see table 15 below. the Company continues to employ strategies to increase its geographic diversification while remaining responsive to local economic conditions. table 15: mortgage Production by type and Province (000s, except %) Single-family residential mortgages traditional Accelerator Residential commercial mortgages Multi-unit uninsured residential mortgages Multi-unit insured residential mortgages Other1 non-residential commercial mortgages Stores and apartments Commercial total mortgage advances (000s, except %) British Columbia Alberta Ontario Quebec Other total mortgage advances 2013 % of total 2012 % of total Change $ 4,770,773 1,011,650 69.0% 14.6% $ 4,487,473 804,692 129,738 693,461 31,479 1.9% 10.0% 0.5% 30,605 256,274 68,906 99,951 180,131 $ 6,917,183 1.4% 2.6% 100.0% 118,689 238,728 $ 6,005,367 74.7% 13.4% 0.5% 4.3% 1.1% 2.0% 4.0% 100.0% 6.3% 25.7% 323.9% 170.6% (54.3%) (15.8%) (24.5%) 15.2% 2013 % of total $ 395,879 180,998 5,735,648 454,064 150,594 $ 6,917,183 5.7% 2.6% 82.9% 6.6% 2.2% 100.0% 2012 $ 269,946 144,587 5,198,703 289,970 102,161 $ 6,005,367 % of total Change 4.5% 2.4% 86.6% 4.8% 1.7% 100.0% 46.7% 25.2% 10.3% 56.6% 47.4% 15.2% 1 Other residential commercial mortgages include mortgages such as builders’ inventory. new mortgage production continued its weighting to the Company’s traditional single-family loans. Origination volumes reflect the continued solid and increased demand for the Company’s traditional product in the marketplace and strong broker relationships. Consistent with 2012, the Company’s strategic shift increased its focus on the traditional portfolio for most of 2013. the Company observed strong credit profiles and lower than average credit risk across the traditional portfolio in 2013, as evidenced by higher average beacon scores (credit scores) compared with 2012 combined with lower debt service ratios, as well as consistent average loan to value ratios on new originations. In the latter part of 2013 the Company renewed focus on the Accelerator product, leading to a 25.7% increase year over year in new mortgage production and an increase in the relative proportion. Insured multi-unit residential mortgages are up, reflecting increased availability of product with favourable off-balance sheet treatment, which reduces the cost of capital for this product class. the multi-unit residential mortgage market is relatively limited and the Company participates in appropriate transactions as they come available through various origination channels. As a result, origination volumes, sales and resultant securitization gains can vary quarter to quarter. non-residential and store and apartment originations, while a smaller proportion of overall mortgage production, remained an important complementary source of loan assets, with attractive returns in 2013. 32 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 16: Credit Card and other Consumer Retail loan Production (Amount in 000s, except %) 2013 2012 Credit card loans equityline Visa credit cards Other credit cards Other consumer retail loans Water heaters Other retail lending number of new Accounts Amount1 number of new Accounts Amount1 number of new Accounts 3,484 $ 3,915 80,088 4,130 3,390 $ 5,467 86,934 6,657 59,239 5,177 113,249 27,315 116,297 4,758 164,669 26,375 2.8% (28.4%) (49.1%) 8.8% Change Amount1 (7.9%) (38.0%) (31.2%) 3.6% 1 For credit cards, the amount represents the authorized credit limits. For water heaters and other retail lending, the amount represents the advanced amount. Credit cards and other consumer retail loans continue to be an important source of loan assets, with attractive returns. While representing 3.5% of the total on-balance sheet loan portfolio, these assets generate 6.6% of the interest income. Other consumer retail loans continue to experience growth supported by strong volumes in water heater and HVAC loans. Loan production was down year over year as 2012 included the purchase of a portfolio. the Company has been successful in expanding relationships with business partners and diversifying its geographic footprint in this category of lending. While credit card loan production was down year over year, production volumes began to increase in the latter half of 2013. the number of new accounts increased, while the average credit limits declined. the Company has observed higher credit card repayments in 2013 as consumers remain cautious and conservative with their debt levels. the Company continues to expect modest growth in this portfolio to return as it launches new marketing efforts to attract new customers. 2014 outlook for loan Portfolios the Company expects that loans under administration will grow in the range of 15% to 20% in 2014. the relative growth of the traditional mortgage portfolio will moderate compared to 2013 as the Company achieves the balance in the portfolios to support sustained growth in earnings and returns on equity. the Company will expand offerings of insured mortgages through the Accelerator insured mortgage program, supporting the “one–stop” and “flexible lending solutions” lender strategies. the Company sells mortgages only through CMHC-sponsored securitization programs. CMHC has recently announced limitations on those programs and the availability of insurance for certain types of mortgages and securitization. Based on the announcements made to date and the Company’s plans for insured lending and securitization, these limits are not expected to curtail the Company’s origination or sales activities and the Company expects that it will be active in mortgage securitization and sales in 2014. this was a significant portion of the Company’s business during the period from 2008 to 2010 and the Company expects to return to this level over the next two years. the Company will also continue to increase its geographic expansion, taking advantage of opportunities within its risk profile outside of Ontario. Multi-unit residential mortgages are expected to continue to offer opportunities for securitization and off-balance sheet sales at about the same pace as 2013. non-residential mortgages are expected to grow at a pace consistent or modestly higher than 2013 to maintain a consistent proportion in the total portfolio, if appropriate assets with attractive returns within the Company’s risk appetite are available in the market. Growth of the consumer loan portfolio at the current rate is expected for 2014. the equityline Visa credit card portfolio will continue to be the primary contributor to the credit card loan portfolio supported by the “one-stop” bundled mortgage program and other marketing efforts. the Visa portfolio is expected to grow at a pace consistent with the overall loan portfolio. the Company anticipates continued growth in the water heater line of business and growth rates in the consumer lending portfolio should be consistent or moderately higher when compared to 2013. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 33 management’s Discussion and Analysis management’s Discussion and Analysis Deposits, Senior Debt and Securitization liabilities table 17: Deposits, Senior Debt and Securitization liabilities (000s, except % and number of accounts) Deposits payable on demand High interest savings accounts Other deposits payable on demand Deposits payable on fixed dates Guaranteed investment certificates Short-term certificates and savings Registered Retirement Savings plans Registered Retirement Income Funds tax-free Savings Accounts Institutional deposit notes Senior debt Securitization liabilities Mortgage-backed security liabilities Canada Mortgage Bond liabilities total total number of deposit accounts 2013 2012 Change $ 337,239 $ 92,030 429,269 19,819 86,104 105,923 1,601.6% 6.9% 305.3% 10,576,166 1,023,983 216,317 145,862 77,981 296,376 12,336,685 147,343 8,399,655 1,259,739 186,515 130,404 54,363 – 10,030,676 150,684 660,964 5,112,100 5,773,064 1,301,693 6,034,202 7,335,895 $ 18,686,361 $ 17,623,178 356,908 296,963 25.9% (18.7%) 16.0% 11.9% 43.4% – 23.0% (2.2%) (49.2%) (15.3%) (21.3%) 6.0% 20.2% the Company’s deposit portfolio increased primarily to provide funding for the non-securitized loan portfolio. the Company’s deposit portfolio primarily comprises fixed-term deposits, which represent 96.6% of all deposits, thereby reducing the risk of untimely withdrawal of funds by retail clients. the Company continued to source deposits primarily through deposit brokers and investment dealers. Other deposits payable on demand include amounts collected for real estate tax accounts which are generally paid out in accordance with each municipality’s payment frequency requirements. please see note 11 to the consolidated financial statements included in this report for a breakdown of the Company’s deposit portfolio by remaining contractual term to maturity and yield. In 2012 the Company launched a high interest savings account as part of its longer-term strategy to diversify its sources of funding and expand its deposit broker network. the balance of $337.2 million at the end of 2013 has risen significantly from the $19.8 million balance at the end of 2012 reflecting the success of the Company’s efforts in developing this program. the Company initiated other programs and projects in late 2012, including new supporting information technology platforms that are aimed at further increasing its direct deposit channel. During Q4 2013, Home trust launched a new direct-to-consumer brand, Oaken Financial, offering a line of consumer deposit products, including Guaranteed Investment Certificates (GICs) and a new Oaken Savings Account as part of its strategy to provide customers with a secure alternative to managing their savings independently and to continue to diversify funding sources. Additionally, further funding diversification was accomplished in Q4 2013 with the successful close of Home trust’s initial issue of institutional five-year deposit notes in the principal amount of $300 million. the Company expects that Home trust will be a regular issuer of deposit notes, likely on a semi-annual basis. Strong investor demand was evident with an oversubscription in excess of 70%. Securitization liabilities, including MBS and CMB liabilities, declined $1.56 billion from the end of 2012 due to the settlement of MBS liabilities and the maturity of CMB liabilities of $919.6 million in the year. CMB liabilities are bullet bonds and only decline when the underlying bonds mature. In addition, the Company sold residual interests in certain pools of single-family mortgages securitized through the national Housing Authority Mortgage-Backed Security (nHA MBS) program that resulted in the derecognition of mortgages and the associated securitization liability of $518.5 million. the Company also securitized and sold into the market $644.4 million of MBS in the year that did not qualify for off-balance sheet accounting and which increased the MBS liabilities. 34 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 2014 outlook for Deposits and Securitization liabilities the Company will continue to source deposits from the public through investment dealers and deposit brokers and will place further emphasis on growing its direct-to-consumer business and the Oaken Financial brand. the Company will seek to strengthen its funding capability through agreements with additional deposit brokers, growth of its high-interest savings account, and by enhancing its direct channel sales and service capabilities. Following the launch of the Company’s first ever wholesale institutional deposit note in the fourth quarter, the Company expects it will continue to access this market on a semi-annual basis. the rate of growth of the deposit portfolio is expected to mirror the growth of the Company’s non-securitized loan portfolio, while securitization will continue to support the current stock of insured mortgages. new originations and renewals of insured mortgages will continue to be funded by securitization. the Company will continue developing multiple sources of deposits to fund operations and liquidity reserves and this will remain a key objective for the Company. table 18: liquidity Resources (000s, except %) Cash and cash equivalents per balance sheet Available for sale securities per balance sheet Add: MBS included in residential mortgages Less: securities held for investments Liquid assets at carrying value Liquid assets at fair value Liquid assets at carrying value as a % of total assets Cash Resources and Securities $ 2013 728,469 $ 424,272 614,903 1,767,644 (274,667) $ 1,492,977 $ $ 1,495,191 $ 7.4% 2012 301,863 414,344 365,078 1,081,285 (309,513) 771,772 771,993 4.1% Change 141.3% 2.4% 68.4% 63.5% (11.3%) 93.4% 93.7% 81.2% Combined cash resources and securities as at December 31, 2013 increased by $436.5 million compared to December 31, 2012 comprising mostly an increase in cash as the securities portfolio was relatively flat compared to last year. Liquidity was relatively higher at the end of December 2013 due to the receipt of funds in December from the institutional deposit note issuance of $300 million and securitization proceeds from participation in a CMB issuance. In addition to cash and securities, the Company maintains prudent liquidity by investing a portion of the liquid assets in Company-originated MBS. Although these securities are available for liquidity purposes, they are classified as residential mortgages on the balance sheet, as required by GAAp. the securities portfolio consists of bonds, common and preferred shares and mutual funds. At December 31, 2013, the preferred share portfolio was $273.0 million or 64.3% of the Company’s securities compared to $299.6 million or 72.3% in 2012. the Company divested most of its preferred shares of financial institutions in 2012 ahead of Basel III changes that require deductions of these investments from capital over a threshold. Investment-grade preferred shares represent 55.7% of the preferred share portfolio (56.3% in 2012). Bonds represent 35.3% of the securities portfolio compared to 25.3% in 2012. the entire bond portfolio of $149.6 million ($104.8 million in 2012) is investment grade. Common shares and mutual funds combined represent 0.4% of the securities compared to 2.4% in 2012. the Company continues to invest in conservative assets while seeking appropriate returns. During the year, the Company took advantage of market opportunities and sold certain securities, realizing a net pre-tax gain of $2.8 million compared to $1.8 million during 2012. the Company recognized $0.2 million in impairment losses on securities in 2013 compared to $1.8 million in 2012. Additional details related to the Company’s securities portfolio can be found in note 4 to the consolidated financial statements included in this report. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 35 management’s Discussion and Analysis management’s Discussion and Analysis 2014 outlook for Cash Resources and Securities the Company will continue to target a conservative level of liquid assets while maintaining financial flexibility. the securities portfolio should increase in line with growth in total assets. A significant proportion of excess funds arising through the Company’s retail deposit channel and securitization activities will be deployed into short-term, highly liquid investments while management continues to invest the balance in securities that provide attractive returns. other Assets and liabilities table 19: other Assets and liabilities (000s, except %) Other assets Restricted cash non-Home trust MBS and treasury bills assigned as replacement assets Derivative assets Accrued interest receivable prepaid CMB coupon Securitization receivable and retained interest Capital assets Income taxes recoverable Other prepaid assets and deferred items Goodwill Intangibles Other liabilities Derivative liabilities Accrued interest payable Income taxes payable Other liabilities Deferred tax liabilities 2013 2012 Change $ $ $ $ 122,836 $ 530,150 29,886 62,961 7,168 54,556 10,875 9,519 17,600 15,752 73,405 934,708 $ 137,424 588,069 45,388 61,481 12,486 10,714 6,578 – 9,724 15,752 66,343 953,959 3,809 $ 127,075 – 46,483 34,425 211,792 $ 2,386 113,451 21,912 35,139 35,800 208,688 (10.6%) (9.8%) (34.2%) 2.4% (42.6%) 409.2% 65.3% – 81.0% – 10.6% (2.0%) 59.6% 12.0% (100.0%) 32.3% (3.8%) 1.5% the decline in other assets reflects a decline of $57.9 million in non-Home trust MBS and treasury bills assigned as replacement assets in the CMB program, as $919.6 million of CMB liabilities matured during the year. Restricted cash and prepaid CMB coupon also declined with the CMB maturities. the decline in derivative assets also contributed to the overall decline in other assets. Derivative assets and liabilities are discussed in the Derivatives and Hedging section of this MD&A. the decline in these other assets was partially offset by increases in securitization receivables and retained interest on securitization as the Company increased its sales of insured multi-unit residential mortgages and sold residual interests in insured residential mortgages. Other assets include income taxes recoverable of $9.5 million at the end of 2013 compared to income taxes payable of $21.9 million at the end of 2012. the income tax recoverable reflects SR&eD investment tax credits related to the development of the core banking system. Continued development of the core banking system along with other software development resulted in growth of intangible assets. Further information on the Company’s securitization activity, intangible assets and income taxes can be found in notes 6, 9 and 16 to the consolidated financial statements included in this report. the increase in other liabilities resulted primarily from an increase in accrued deposit interest payable on higher deposit balances, an increase in the servicing liability related to the increased sales of insured multi-unit residential mortgages and an increase in accounts payable and accrued liabilities, which have increased in line with business growth. the increase in other liabilities was partially offset by the decrease in accrued interest payable on securitization liabilities, reflecting the lower balance of securitization liabilities at the end of 2013, combined with income taxes payable becoming a recoverable balance at the end of 2013. 2014 outlook for other Assets and liabilities Other assets and liabilities are expected to grow in line with growth in total loans and general business growth. 36 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Shareholders’ equity table 20: Shareholders’ equity (000s, except %) Shareholders’ equity at the beginning of the year net income Other comprehensive income (loss) Amounts related to stock-based compensation Repurchase of shares Dividends Shareholders’ equity at the end of the year $ 2013 968,213 $ 256,542 (14,734) 8,160 (2,302) (38,182) $ 1,177,697 $ 2012 774,785 221,983 5,446 7,439 (8,117) (33,323) 968,213 Change 25.0% 15.6% (370.5%) 9.7% (71.6%) 14.6% 21.6% the increase in total shareholders’ equity was primarily internally generated from net income during the year. Also contributing to the increase were amounts related to stock-based compensation. these increases were partially offset by the increase in accumulated other comprehensive loss, amounts related to the repurchase of the Company’s common shares and dividends. the increase in accumulated other comprehensive loss reflects decreases in the fair value of available for sale securities. Details related to the repurchase of shares and stock-based compensation are provided in notes 14 and 17 to the consolidated financial statements included in this report. At December 31, 2013, the book value per common share was $33.90, compared to $27.96 at December 31, 2012. Strong earnings contributed to continuing robust returns on shareholders’ equity. Return on equity when combined with dividends of $1.08 per common share in fiscal 2013 ($0.90 per common share in 2012) confirms the Company’s continued commitment to total shareholder return. Contingencies and Contractual obligations In the normal course of its activities, the Company enters into various types of contractual agreements. the main obligations result from the acceptance of deposits from retail investors to finance lending activities. the Company ensures that sufficient cash resources are available to meet these contractual obligations when they become due. In addition to the obligations related to deposits, securitization liabilities and senior debt previously discussed, the following table presents a summary of the Company’s other contractual obligations as at December 31, 2013. table 21: Contractual obligations (000s) premises and equipment 2014 2015 2016 2017 2018 thereafter total $ 8,806 $ 7,287 $ 6,724 $ 6,581 $ 6,524 $ 21,770 $ 57,692 the Company had no material contingencies in 2013. the Company also has outstanding commitments for future advances on mortgages and unutilized and available credit on its credit card products. Refer to the Off-balance Sheet Arrangements section of this report and note 18 to the consolidated financial statements for a description of those commitments. Derivatives and Hedging From time to time, the Company enters into derivative transactions primarily to hedge interest rate exposure resulting from outstanding loan commitments and requirements to replace assets in the CMB program, as well as interest rate risk on fixed-rate mortgages, debt and deposits, such as CMB liabilities and senior debt. Where appropriate, the Company will apply hedge accounting to minimize volatility in reported earnings from interest rate changes. All derivative contracts are over-the-counter contracts with highly rated Canadian financial institutions. please see the non-interest Income section of this MD&A and the Derivative Financial Instruments note to the consolidated financial statements included in this report for further information. table 22 summarizes the impact of derivatives and hedge accounting on the Company’s financial results. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 37 management’s Discussion and Analysis management’s Discussion and Analysis table 22: Derivatives Gains and losses (000s) Cash flow hedging ineffectiveness Fair value hedging ineffectiveness Swaps marked to market Derivative restructuring: IFRS conversion net realized and unrealized (loss) gain on derivatives cash flow Hedging 2013 13 $ 6,387 160 (7,990) (1,430) $ 2012 - 7,006 318 (3,536) 3,788 $ $ the Company uses Government of Canada bond forwards and interest rate swaps to hedge the impact of movements in interest rates between the time that mortgage commitments are made and the time that those mortgages are funded and/or securitized. Hedges are structured such that the fair value movements of the hedge instruments offset, within a reasonable range, the changes in the fair value of the pool of fixed-rate mortgages due to interest rate fluctuations between commitment and funding. the term of these hedges is generally 60 to 150 days. these hedge instruments are settled or unwound at the time of funding or securitization of the underlying mortgages. the Company applies cash flow hedge accounting to the Government of Canada bond forwards and certain interest rate swaps. the intent of hedge accounting is to recognize the effective matching of the gain or loss on the Government of Canada bond forwards and interest rate swaps with the recognition of the related interest expense on the resulting funding. fair Value Hedging the Company is exposed to interest rate risk through fixed-rate financial assets and liabilities and its participation in the CMB program due to reinvestment risk between the amortizing fixed-rate MBS and the bullet maturity fixed-rate CMB. to hedge these risks, the Company enters into interest rate swaps and applies fair value hedge accounting. the intent of fair value hedge accounting is to have the fair value changes in the interest rate swap offset, within a reasonable range, the changes in the fair value of the fixed-rate borrowing resulting from changes in the interest rate environment. Any unmatched fair value change is recorded in income as hedge ineffectiveness through net realized and unrealized gain or loss on derivatives. economic Hedge of Loans Held for securitization and sale the Company may enter into bond forwards to hedge interest rate risk on loans held for securitization and sale through nHA MBS securitization programs. the underlying loans are classified as held for trading for accounting purposes and held at fair value on the balance sheet. the loans are insured mortgages on multi-unit residential properties. the derivatives used to hedge these loans are not designated in hedge accounting relationships. the fair value changes of these derivatives are mostly offset by the fair value changes related to loans held for trading. the fair value changes reflect changes in interest rates. the net unrealized gain as at December 31, 2013 for fair value changes in both the outstanding derivatives and the loans held for trading was $109 thousand (2012 – $44 thousand) and is recorded in securitization income. other interest rate swaps the Company also has certain interest rate swaps that are not designated in hedge accounting relationships and, therefore, are adjusted to fair value without an offsetting hedged amount. these swaps are economic hedges of the Company’s general interest rate risk. please see note 19 of the consolidated financial statements for further information. off-balance Sheet Arrangements the Company offers credit products to meet the financial needs of its customers and has outstanding commitments for future advances on mortgage loans that amounted to $754.6 million at December 31, 2013 ($571.8 million – December 31, 2012). Included within the outstanding commitments are unutilized non-residential loan advances of $157.2 million at December 31, 2013 ($46.0 million – December 31, 2012). Commitments for the loans remain open for various periods. As at December 31, 2013, unutilized credit card balances amounted to $80.8 million ($75.7 million – December 31, 2012). Outstanding commitments for future advances for the equityline Visa portfolio were $5.8 million at December 31, 2013 ($4.8 million – December 31, 2012). these commitments are in the normal course of business and are considered through the Company’s liquidity and capital management processes. the Company has $1.92 billion (2012 – $0.88 billion) of loans under administration that are accounted for off-balance sheet (see table 14). 38 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Related Party transactions the Company has no related party transactions in the years ended December 31, 2013 and December 31, 2012, other than key management personnel, as disclosed in note 23 of the consolidated financial statements. Summ ARY o F QuARteRlY ReSultS table 23: Summary of Quarterly Results (000s, except per share and %) Q4 Q3 Q2 2013 Q1 Q4 Q3 Q2 2012 Q1 net interest income (teB1) Less: teB adjustment net interest income per financial statements non-interest income non-interest expense total revenues net income Return on common shareholders’ equity Return on average total assets earnings per common share Basic Diluted Book value per common share efficiency ratio (teB1) efficiency ratio Common equity tier 1 ratio2 tier 1 capital ratio2 total capital ratio2 net non-performing loans as a % of gross loans Annualized provision as a % of gross loans $ 111,888 $ 107,536 $ 103,537 $ 103,034 $ 101,151 $ 100,617 $ 95,109 $ 89,626 1,407 1,243 1,126 1,255 1,005 1,148 921 942 110,967 21,827 37,862 246,365 68,827 106,594 19,624 37,635 239,433 66,417 102,532 16,431 34,272 232,555 61,573 101,886 17,177 33,969 231,194 59,725 99,908 14,537 31,620 227,649 58,965 99,491 13,449 32,065 226,603 57,254 93,854 12,426 29,882 218,751 53,230 88,219 15,490 29,168 214,682 52,534 23.9% 1.4% 24.3% 1.3% 23.6% 1.3% 24.0% 1.3% 25.0% 1.2% 25.6% 1.2% 25.1% 1.2% 26.2% 1.2% $ $ $ 1.98 $ 1.97 $ 33.90 $ 28.3% 28.5% 16.80% 16.80% 19.69% 1.91 $ 1.90 $ 32.27 $ 29.6% 29.8% 16.72% 16.72% 19.72% 1.78 $ 1.77 $ 30.83 $ 28.6% 28.8% 16.63% 16.63% 19.74% 1.72 $ 1.72 $ 29.53 $ 28.3% 28.5% 16.57% 16.57% 19.82% 1.70 $ 1.70 $ 27.96 $ 27.3% 27.6% n/A 17.01% 20.68% 1.65 $ 1.65 $ 1.54 $ 1.54 $ 26.53 $ 25.05 $ 28.1% 28.4% n/A 16.97% 20.78% 27.8% 28.1% n/A 17.09% 21.09% 1.52 1.52 23.83 27.7% 28.1% n/A 17.49% 21.62% 0.35% 0.32% 0.31% 0.32% 0.33% 0.28% 0.31% 0.28% 0.09% 0.06% 0.10% 0.11% 0.09% 0.10% 0.05% 0.11% 1 teB – taxable equivalent Basis: see definition under non-GAAp Measures in this report. 2 these figures relate to the Company’s operating subsidiary, Home trust Company, and are calculated under Basel III for 2013 and Basel II for 2012. the Company’s key financial measures for each of the last eight quarters are summarized in the table above. these highlights illustrate the Company’s profitability, return on equity, as well as efficiency measures and capital ratios. the quarterly results are modestly affected by seasonal factors, with first quarter mortgage advances typically impacted by winter weather conditions, while the second and third quarters have traditionally experienced higher levels of advances. First quarter credit statistics may experience a decline reflecting post-holiday arrears increases. the Company continues to achieve positive financial results driven by strong net interest margins, continued low efficiency ratios and favourable non-interest income. Capital ratios over the last eight quarters reflect the Company’s prudent capital management strategies and the proactive approach to maintaining a strong capital base. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 39 management’s Discussion and Analysis management’s Discussion and Analysis F ou Rt H QuARteR 20 13 the Company continued its strong performance in the fourth quarter of 2013. Key results for the fourth quarter of 2013 are as follows: Income Statement Highlights > net income of $68.8 million was 16.7% higher than the $59.0 million net income recorded in the Q4 2012 and 3.6% over the $66.4 million in Q3 2013. Adjusted net income, as defined in the non-GAAp Measures and Glossary section under Adjusted net Income, was $68.2 million in Q4 2013, representing an increase of 10.8% over Q4 2012 and 5.6% over Q3 2013. > Basic and diluted earnings per share for the fourth quarter were $1.98 and $1.97, respectively. these represent increases of 16.5% and 15.9% over the $1.70 basic and diluted earnings per share in Q4 2012 and an increase of 3.7% over both the $1.91 basic and $1.90 diluted earnings per share recorded in Q3 2013. > Return on equity was 23.9% in the quarter compared to 25.0% in the comparable quarter of 2012 and 24.3% in Q3 2013. > the Company recorded $3.5 million in gains on the sale of residual interests in Q4 2013 compared to $4.8 million in gains in Q4 2012 and $1.9 million in Q3 2013. In Q3 2013, the Company received a favourable regulatory ruling confirming that the underlying mortgages in these transactions can be excluded from the regulatory assets to capital multiple, allowing the Company to continue generating stable income from this source going forward. the Company also recorded gains on the securitization of multi-unit residential mortgages of $1.2 million in the quarter, compared to $0.9 million in Q4 2012 and $2.9 million in Q3 2013. the Company expects these transactions to provide ongoing income. > net interest income rose to $111.0 million in Q4 2013, up 11.1% over Q4 2012 and 4.1% over Q3 2013. these increases in net interest income reflect the higher average asset balance during the quarter of $20.19 billion compared to $19.01 billion for Q4 2012 and $19.89 billion for Q3 2013, combined with higher net interest margin (teB) of 2.22% for the quarter compared to 2.13% for Q4 2012 and 2.16% for Q3 2013. net interest income growth is lower than net income growth as the gain on sale of residual interest replaces net interest income on certain securitized assets. > net interest margin (teB) remained strong at 2.22% in the quarter, up from 2.13% Q4 2012 and 2.16% in Q3 2013. total net interest margin has been positively influenced by the mix of the loan portfolio between non-securitized and securitized mortgages and the net interest margin on each of these portfolios. Beginning in 2011 and continuing through 2013, the weighting of lower-yielding securitized mortgages in the total portfolio declined, generally leading to higher total net interest margins. the net interest margin on the non-securitized portfolio also generally remained strong over that period, with some fluctuations quarter to quarter with relatively stable interest rate spreads. net interest margin for non-securitized assets in Q4 2013 was 2.94%, a decline from 2.99% in the third quarter, primarily reflecting a larger proportion of lower-yielding insured mortgages awaiting securitization as the Company began to increase originations of insured mortgages, while spreads of the traditional portfolio over deposit rates improved marginally in Q4 2013 compared to Q3 2013. > Fees and other income of $15.4 million in Q4 2013 were up 40.9% from the $10.9 million recorded in Q4 2012 as more accounts were affected by fees in 2013 and there was an increase in the number of accounts under administration. Fees and other income were down marginally from the $15.5 million recorded in Q3 2013. > net derivative gains of $0.5 million were reported in Q4 2013 compared to net losses of $1.7 million in Q4 2012 and a marginal amount in Q3 2013. the change over Q4 2012 reflects a decrease in the charge related to the maturity of certain derivative positions that were restructured at the time of adoption of IFRS from $3.5 million in Q4 2012 to $1.2 million in Q4 2013. > During the quarter, the Company sold certain available for sale securities realizing a gain of $190 thousand and recognized additional impairment losses of $42 thousand resulting in a net gain on securities of $148 thousand compared to net losses of $457 thousand in Q4 2012 and $668 thousand in Q3 2013. > the credit performance of the loans portfolio remained strong in the quarter and for the year and was better than the Company’s objectives. the annualized credit provision as a percentage of gross loans (pCL ratio) was 0.09% in the quarter and for the year, consistent with the comparable periods of 2012 and up from 0.06% in Q3 2013. the Company’s objective was a pCL ratio of between 0.10% and 0.18% for 2013. net non-performing loans ended 2013 at 0.35% of the total loans portfolio compared to 0.33% at the end of 2012 and 0.32% at the end Q3 2013, with the marginal increase primarily reflecting a specific commercial loan that fell into default, but no losses are expected. excluding this commercial loan would result in net non-performing loans ending 2013 at 0.31% of the total loans portfolio. the ratio has remained stable despite the relatively higher proportion of uninsured mortgages in the total portfolio. > the efficiency ratio declined to 28.5% in Q4 2013, as expenses were relatively flat quarter over quarter. the Company has been reducing consulting costs while increasing permanent employees, leading to increased efficiencies. 40 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Financial Position Highlights > Home trust’s Common equity tier 1 (Cet 1) and total capital ratios remained very strong at 16.80% and 19.69%, respectively, at December 31, 2013, and well above Company and regulatory minimum targets. Home trust’s ACM was 13.19 at December 31, 2013 compared to 13.39 at December 31, 2012 and 13.34 at September 30, 2013. ACM declined from one year ago as the Company completed sales of residual interests and removed underlying mortgage loans from the calculation of the ACM. > total loans increased by $860.0 million in 2013 to $18.02 billion, representing growth of 5.0% over the $17.16 billion at the end of 2012 and decreased by 0.4% or $64.5 million from the $18.08 billion at the end of Q3 2013. the decline from Q3 2013 reflects the sale of residual interest in $327.5 million in insured single-family mortgages. total loans under administration (which includes all loans carried on the balance sheet plus off-balance sheet securitized loans) increased by $1.90 billion in 2013 to $19.94 billion, representing growth of 10.5% over the $18.04 billion at the end of 2012 and 2.1% or $411.2 million from the $19.53 billion at the end of Q3 2012. Loan growth over 2012 was within the Company’s 2013 objective of 10% to 15%. > the total value of mortgages originated in Q4 2013 was $1.91 billion, compared to $1.47 billion in Q4 2012 and $1.99 billion in Q3 2013. the year-over-year increase in originations reflects continued demand for the Company’s traditional mortgage products, combined with increased originations for the Company’s Accelerator product and insured multi-unit residential mortgages, most of which are securitized and sold in transactions that qualify for off-balance sheet accounting. the increase in Accelerator mortgage originations reflects the favourable regulatory ruling received in Q3 2013 that permits the removal of underlying mortgages in qualifying residual interest transactions from assets used in the ACM calculation. Compared to the third quarter, the decline in originations reflects normal and expected seasonal factors. > the Company originated $1.23 billion of traditional mortgages in Q4 2013, compared to $1.16 billion in Q4 2012 and $1.31 billion in Q3 2013. > Accelerator (insured) mortgage originations were $357.1 million in Q4 2013, compared to $174.2 million in Q4 2012 and $272.6 million in Q3 2013. > Multi-unit residential originations were $239.9 million in the quarter, compared to $57.2 million in the same period of 2012 and $326.3 million last quarter. As indicated above, a significant portion of the multi-unit residential mortgage originations are insured and securitized through programs that qualify for off-balance sheet accounting. the Company sold $177.7 million through these programs in the fourth quarter and recognized $1.2 million in gains compared to $64.6 million of mortgages for $0.9 million in gains during Q4 2012 and $235.5 million of mortgages and $2.6 million in gains during Q3 2013. > Commercial mortgage advances were $56.1 million in Q4 2013, compared to $52.4 million in the comparable period of 2012 and $49.3 million in Q3 2013. the Company continues to maintain a cautious approach to increases in this portfolio. > Store and apartment advances were $24.5 million for the fourth quarter, compared to $24.8 million in the same period of 2012 and $24.3 million in the third quarter of 2013. > the consumer retail portfolio, which includes durable household goods, such as water heaters and larger-ticket home improvement items, reached $340.0 million in Q4 2013, up 25.0% from $272.0 million one year ago and 3.7% from $328.0 million in Q3 2013. > In Q4 2013, Home trust launched a new direct-to-consumer brand, Oaken Financial, offering a line of consumer deposit products, including Guaranteed Investment Certificates (GICs) and a new Oaken Savings Account as part of its strategy to continue to diversify funding sources and provide customers with a secure alternative to managing their savings independently. > Additionally, further funding diversification was accomplished in Q4 2013 with the successful close of Home trust’s initial issue of institutional five-year deposit notes in the principal amount of $300 million. the Company expects that Home trust will be a regular issuer of institutional deposit notes, likely on a semi-annual basis. Strong investor demand was evident with an oversubscription in excess of 70%. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 41 management’s Discussion and Analysis management’s Discussion and Analysis F ou Rt H QuARteR FIn An CIAl InFoRm AtIon table 24: Fourth Quarter Review of Financial Performance For the three months ended Change December 31 2013 September 30 2013 December 31 2012 $ 168,045 $ 2,556 2,663 173,264 71,744 1,793 99,727 159,573 $ 2,621 2,386 164,580 67,911 1,635 95,034 144,310 3,502 949 148,761 61,873 1,825 85,063 51,274 40,034 55,229 43,669 11,240 110,967 4,004 106,963 11,560 106,594 2,768 103,826 15,402 5,770 15,472 4,864 64,351 49,506 14,845 99,908 3,685 96,223 10,928 5,761 December 31, 2013– September 30, 2013 December 31, 2013– December 31, 2012 5.3% (2.5%) 11.6% 5.3% 5.6% 9.7% 4.9% (7.2%) (8.3%) (2.8%) 4.1% 44.7% 3.0% (0.5%) 18.6% 16.4% (27.0%) 180.6% 16.5% 16.0% (1.8%) 17.2% (20.3%) (19.1%) (24.3%) 11.1% 8.7% 11.2% 40.9% 0.2% 148 (668) (457) (122.2%) (132.4%) 507 21,827 128,790 (44) 19,624 123,450 (1,695) 14,537 110,760 (1,252.3%) 11.2% 4.3% (129.9%) 50.1% 16.3% 19,563 2,610 15,689 37,862 90,928 17,768 2,407 17,460 37,635 85,815 22,337 (236) 22,101 68,827 $ 20,258 (860) 19,398 66,417 $ 14,991 2,562 14,067 31,620 79,140 22,649 (2,474) 20,175 58,965 1.98 $ 1.97 $ 1.91 $ 1.90 $ 1.70 1.70 $ $ $ 34,745 34,969 34,744 34,703 34,953 34,746 $ 33.90 $ 32.27 $ 34,655 34,779 34,630 27.96 10.1% 8.4% (10.1%) 0.6% 6.0% 10.3% (72.6%) 13.9% 3.6% 3.7% 3.7% 0.1% – – 5.1% 30.5% 1.9% 11.5% 19.7% 14.9% (1.4%) (90.5%) 9.5% 16.7% 16.5% 15.9% 0.3% 0.5% 0.3% 21.2% (000s, except per share amounts and %) net Interest Income non-securitized Assets Interest from loans Dividends from securities Other interest Interest on deposits Interest on senior debt net interest income non-securitized assets net Interest Income Securitized loans and Assets Interest income from securitized loans and assets Interest expense on securitization liabilities net interest income securitized loans and assets total net Interest Income provision for credit losses non-interest Income Fees and other income Securitization income net realized and unrealized gains (losses) on securities net realized and unrealized gain (loss) on derivatives non-interest expenses Salaries and benefits premises Other operating expenses Income Before Income taxes Income taxes Current Deferred net InCome net InCome PeR Common SHARe Basic Diluted AVeRAGe numBeR oF Common SHAReS outStAnDInG Basic Diluted total number of outstanding common shares Book value per common share 42 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 25: Fourth Quarter Review of Comprehensive Income (000s, except %) net InCome otHeR ComPReHenSIVe (loSS) InCome Available for Sale Securities and Retained Interest net unrealized (losses) gains net (gains) losses reclassified to net income Income tax (recovery) expense Cash Flow Hedges net unrealized gains (losses) on cash flow hedges net losses reclassified to net income Income tax expense total other comprehensive (loss) income ComPReHenSIVe InCome $ $ For the three months ended Change December 31 2013 September 30 2013 December 31 2012 December 31, 2013– September 30, 2013 December 31, 2013– December 31, 2012 $ 68,827 $ 66,417 $ 58,965 3.6% 16.7% (5,320) (147) (5,467) (1,449) (4,018) (10,638) 671 (9,967) (2,640) (7,327) 897 247 1,144 303 841 (3,177) $ 65,650 $ (195) 376 181 48 133 (7,194) $ 59,223 $ 1,471 457 1,928 509 1,419 – 376 376 99 277 1,696 60,661 (50.0%) (121.9%) (45.1%) (45.1%) (45.2%) (560.0%) (34.3%) 532.0% 531.3% 532.3% (55.8%) 10.9% (461.7%) (132.2%) (383.6%) (384.7%) (383.2%) – (34.3%) 204.3% 206.1% 203.6% (287.3%) 8.2% Home CAPItAl GRouP InC. AnnuAL RepORt 2013 43 management’s Discussion and Analysis management’s Discussion and Analysis table 26: Fourth Quarter Review of Financial Position (000s, except for %) ASSetS Cash and Cash equivalents Available for Sale Securities loans Held for Sale loans Securitized mortgages non-securitized mortgages and loans Collective allowance for credit losses other Restricted assets Derivative assets Other assets Goodwill and intangible assets lIABIlItIeS AnD SHAReHolDeRS’ eQuItY liabilities Deposits Deposits payable on demand Deposits payable on a fixed date Senior Debt Securitization liabilities Mortgage-backed security liabilities Canada Mortgage Bond liabilities other Derivative liabilities Other liabilities Deferred tax liabilities Shareholders’ equity Capital stock Contributed surplus Retained earnings Accumulated other comprehensive loss 44 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 As at December 31 2013 September 30 2013 Change $ 728,469 $ 424,272 137,975 774,591 441,689 77,655 5,210,021 12,671,905 17,881,926 (31,500) 17,850,426 6,164,544 11,842,183 18,006,727 (30,900) 17,975,827 652,986 29,886 162,679 89,157 934,708 303,410 32,731 148,548 86,346 571,035 $ 20,075,850 $ 19,840,797 $ 429,269 $ 12,336,685 12,765,954 147,343 281,348 11,655,299 11,936,647 149,822 660,964 5,112,100 5,773,064 913,103 5,495,144 6,408,247 3,809 173,558 34,425 211,792 18,898,153 2,378 187,301 35,040 224,719 18,719,435 70,233 5,984 1,119,959 (18,479) 1,177,697 70,237 5,412 1,061,015 (15,302) 1,121,362 $ 20,075,850 $ 19,840,797 (6.0%) (3.9%) 77.7% (15.5%) 7.0% (0.7%) 1.9% (0.7%) 115.2% (8.7%) 9.5% 3.3% 63.7% 1.2% 52.6% 5.8% 6.9% (1.7%) (27.6%) (7.0%) (9.9%) 60.2% (7.3%) (1.8%) (5.8%) 1.0% (0.0%) 10.6% 5.6% 20.8% 5.0% 1.2% table 27: Fourth Quarter net Interest margin net interest margin non-securitized interest-earning assets (non-teB) net interest margin non-securitized interest-earning assets (teB) net interest margin securitized assets total net interest margin (non-teB) total net interest margin (teB) Spread of non-securitized loans over deposits only table 28: Fourth Quarter net Interest Income by Product and Average Rate For the three months ended December 31 2013 2.92% 2.94% 0.74% 2.20% 2.22% 3.11% September 30 2013 2.96% 2.99% 0.69% 2.14% 2.16% 3.16% December 31 2012 3.07% 3.11% 0.79% 2.11% 2.13% 3.13% (000s, except %) Assets Cash resources and securities traditional single-family residential mortgages Accelerator single-family residential mortgages Residential commercial mortgages2 non-residential commercial mortgages Credit card loans Other consumer retail loans total non-securitized loans taxable equivalent adjustment total on non-securitized interest-earning assets Securitized single-family residential mortgages Securitized multi-unit residential mortgages Assets pledged as collateral for securitization total securitized residential mortgages Other assets total Assets liabilities and Shareholders’ equity Deposits Senior debt Securitization liabilities Other liabilities and shareholders’ equity total liabilities and Shareholders’ equity net Interest Income (teB) tax equivalent Adjustment net Interest Income per Financial Statements For the three months ended December 31, 2013 For the three months ended September 30, 2013 Average Balance1 Income/ expense Average Rate1 Average Balance1 Income/ expense Average Rate1 $ 1,292,322 $ 5,219 1.62% $ 1,248,482 $ 5,007 1.60% 9,819,720 128,659 5.24% 9,331,924 122,329 5.24% 617,356 327,988 5,282 4,043 3.42% 4.93% 407,046 280,565 3,604 3,393 987,049 295,315 333,521 12,380,949 – 15,749 6,934 7,378 168,045 921 965,285 6.38% 300,776 9.39% 8.85% 318,300 5.43% 11,603,896 – – 15,932 7,147 7,168 159,573 942 3.54% 4.84% 6.60% 9.50% 9.01% 5.50% – 13,673,271 174,185 5.10% 12,852,378 165,522 5.15% 4,151,111 33,112 3.19% 4,605,786 35,943 3.12% 1,639,678 16,429 4.01% 1,795,004 17,715 3.95% 440,539 6,231,328 282,816 $ 20,187,415 $ 1,733 51,274 – 225,459 1.57% 3.29% – 379,419 6,780,209 254,310 4.47% $ 19,886,897 $ 1,571 55,229 – 220,751 $ 12,383,947 $ 148,725 6,271,332 71,744 1,793 40,034 2.32% $ 11,629,822 $ 4.82% 2.55% 149,025 6,785,334 67,911 1,635 43,669 1.66% 3.26% – 4.44% 2.34% 4.39% 2.57% 1,383,411 – – 1,322,716 – – $ 20,187,415 $ 113,571 2.25% $ 19,886,897 $ 113,215 2.28% $ 111,888 (921) $ 110,967 $ 107,536 (942) $ 106,594 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 45 management’s Discussion and Analysis management’s Discussion and Analysis table 28: Fourth Quarter net Interest Income by Product and Average Rate (continued) (000s, except %) Assets Cash resources and securities traditional single-family residential mortgages Accelerator single-family residential mortgages Residential commercial mortgages2 non-residential commercial mortgages Credit card loans Other consumer retail loans total non-securitized loans taxable equivalent adjustment total on non-securitized interest-earning assets Securitized single-family residential mortgages Securitized multi-unit residential mortgages Assets pledged as collateral for securitization total securitized residential mortgages Other assets total Assets liabilities and Shareholders’ equity Deposits Senior debt Securitization liabilities Other liabilities and shareholders’ equity total liabilities and Shareholders’ equity net Interest Income (teB) tax equivalent Adjustment net Interest Income per Financial Statements For the three months ended December 31, 2012 Average Balance1 Income/ expense Average Rate1 $ 817,669 $ 7,919,965 582,728 205,425 981,483 334,778 243,338 10,267,717 – 11,085,386 5,136,096 1,949,071 541,946 7,627,113 294,020 $ 19,006,519 $ 9,944,774 152,283 7,661,311 1,248,151 $ 19,006,519 $ $ $ 4,451 107,692 4,470 2,790 15,789 7,998 5,571 144,310 1,243 150,004 43,081 19,704 1,566 64,351 – 214,355 61,873 1,825 49,506 – 113,204 101,151 (1,243) 99,908 2.18% 5.44% 3.07% 5.43% 6.43% 9.56% 9.16% 5.62% – 5.41% 3.36% 4.04% 1.16% 3.37% – 4.51% 2.49% 4.79% 2.58% – 2.38% 1 the average is calculated with reference to opening and closing monthly asset and liability balances. 2 Residential commercial mortgages include non-securitized multi-unit residential mortgages and commercial mortgages secured by residential property types. table 29: Fourth Quarter mortgage Production For the three months ended December 31 2013 September 30 2013 December 31 2012 $ 1,227,462 $ 1,312,648 $ 1,159,387 174,214 357,125 272,576 62,276 177,632 4,411 19,475 306,863 9,000 7,786 49,459 4,650 24,514 56,134 24,835 52,417 $ 1,909,554 $ 1,994,229 $ 1,472,748 24,347 49,320 (000s) Single-family residential mortgages traditional Accelerator Residential commercial mortgages Multi-unit uninsured residential mortgages Multi-unit insured residential mortgages Other1 non-residential commercial mortgages Stores and apartments Commercial total mortgage advances 1 Other residential commercial mortgages include mortgages such as builders’ inventory. 46 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 30: Fourth Quarter Provision for Credit losses (000s, except %) As at December 31, 2013 net non-performing loans For the three months ended December 31, 2013 net Write-offs Annualized % of Gross loans 0.12% 0.34% Amount 3,135 168 Provision1 Annualized % of Gross loans 0.13% $ 0.10% % of Gross loans 0.48% $ 0.93% Amount 3,560 49 $ Amount 51,636 1,8362 7,1893 2,584 – Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages total 0.72% 0.88% – 99 183 113 – 0.04% 0.25% 0.13% – 79 293 94 – – – – 63,245 $ – 0.35% $ – 4,004 – 0.09% $ – 3,769 (000s, except %) As at September 30, 2013 net non-performing Loans For the three months ended September 30, 2013 net Write-offs Annualized % of Gross Loans 0.07% – Amount 1,734 – provision1 Annualized % of Gross Loans 0.11% $ 0.24% % of Gross Loans 0.50% $ 0.71% Amount 2,704 152 $ Amount 50,224 1,8362 1,576 3,603 – Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages total 0.16% 1.21% – – – (38) (99) 49 – (0.02%) (0.13%) 0.06% – 153 96 96 – – 57,239 $ – 0.32% $ – 2,768 – 0.06% $ – 2,079 (000s, except %) As at December 31, 2012 net non-performing Loans For the three months ended December 31, 2012 net Write-offs Annualized % of Gross Loans 0.12% – Amount 2,546 – provision1 Annualized % of Gross Loans 0.16% $ 0.12% % of Gross Loans 0.55% $ 2.93% Amount 3,470 48 $ Amount 47,788 4,527 501 3,505 – Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages total 0.05% 1.07% – 146 (5) 26 – 0.06% (0.01%) 0.04% – 146 512 90 – – – – 56,321 $ – 0.33% $ – 3,685 – 0.09% $ – 3,294 1 provisions include both individual and collective provisions. 2 the non-performing residential commercial amount comprises one loan. 3 the non-performing non-residential commercial amount includes $6.4 million related to one loan. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 47 0.03% 0.40% 0.11% – – 0.08% 0.06% 0.13% 0.12% – – 0.05% 0.06% 0.63% 0.13% – – 0.08% management’s Discussion and Analysis management’s Discussion and Analysis table 31: Fourth Quarter Allowance for Credit losses (000s) For the three months ended December 31, 2013 Single-family Residential mortgages Residential Commercial mortgages non-residential Commercial mortgages Credit Card loans other Consumer Retail loans total Individual allowances Allowance on loan principal Balance at the beginning of the period provision for credit losses Write-offs Recoveries Allowance on accrued interest receivable Balance at the beginning of the period provision for credit losses total individual allowance Collective allowance Balance at the beginning of the period provision for credit losses total allowance total provision (000s) Individual allowances Allowance on loan principal Balance at the beginning of the period provision for credit losses Write-offs Recoveries Allowance on accrued interest receivable Balance at the beginning of the period provision for credit losses total individual allowance Collective allowance Balance at the beginning of the period provision for credit losses $ 1,441 $ 2,895 (3,259) 124 1,201 813 (54) 759 1,960 17,313 719 18,032 – $ – $ 168 (376) 208 – 25 – 25 25 79 (87) 8 – 24 20 44 44 – – – 201 446 (119) 327 9,300 – 9,300 3,541 – 3,541 311 $ 183 (314) 21 201 219 $ 111 (118) 24 236 1,971 3,436 (4,154) 385 1,638 10 2 12 248 300 – 300 872 (32) 840 2,478 30,900 600 31,500 33,978 4,004 $ $ 19,992 $ 3,560 $ 352 $ 49 $ 9,344 $ 99 $ 3,742 $ 183 $ 548 $ 113 $ Single-family Residential Mortgages Residential Commercial Mortgages non-residential Commercial Mortgages Credit Card Loans Other Consumer Retail Loans total For the three months ended September 30, 2013 $ 929 $ 2,246 (2,123) 389 1,441 628 185 813 2,254 17,040 273 17,313 – $ – – – – 170 $ (17) (154) 1 – 506 $ (99) (106) 10 311 262 $ 53 (111) 15 219 1,867 2,183 (2,494) 415 1,971 – 25 25 25 319 127 446 45 (21) 24 24 – – – 311 9,300 – 9,300 3,541 – 3,541 14 (4) 10 229 300 – 300 687 185 872 2,843 30,500 400 30,900 33,743 2,768 total allowance total provision $ $ 19,567 $ 2,704 $ 471 $ 152 $ 9,324 $ (38) $ 3,852 $ (99) $ 529 $ 49 $ 48 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 31: Fourth Quarter Allowance for Credit losses (000s) For the three months ended December 31, 2012 Single-family Residential Mortgages Residential Commercial Mortgages non-residential Commercial Mortgages Credit Card Loans Other Consumer Retail Loans total Individual allowances Allowance on loan principal Balance at the beginning of the period provision for credit losses Write-offs Recoveries Allowance on accrued interest receivable Balance at the beginning of the period provision for credit losses total individual allowance Collective allowance Balance at the beginning of the period provision for credit losses $ 1,660 $ 3,267 (2,699) 153 2,381 – $ – – – – – $ 146 (149) 3 – 628 $ (5) (685) 173 111 291 $ 13 (109) 19 214 2,579 3,421 (3,642) 348 2,706 503 (16) 487 2,868 16,304 219 16,523 365 67 432 432 355 (19) 336 – – – – – – – 111 9,300 – 9,300 3,541 – 3,541 – 13 13 227 300 – 300 868 64 932 3,638 29,800 200 30,000 33,638 3,685 total allowance total provision $ $ 19,391 $ 3,470 $ 768 $ $ 48 9,300 $ 146 $ 3,652 $ (5) $ 527 $ 26 $ table 32: Securitization Activity (000s) December 31, 2013 For the three months ended September 30, 2013 Single-family Residential mBS multi-unit Residential mBS Single-family Residential MBS Multi-unit Residential MBS total mBS total MBS $ 327,500 $ 177,700 $ 505,200 $ 191,761 $ 235,483 $ 427,244 3,460 – – 1,189 7,983 1,186 4,649 7,983 1,186 1,894 – – 2,647 11,146 1,809 4,541 11,146 1,809 Carrying value of underlying mortgages derecognized Gains on sale of mortgages or residual interest1 Retained interests recorded Servicing liability recorded (000s) Carrying value of underlying mortgages derecognized Gains on sale of mortgages or residual interest1 Retained interests recorded Servicing liability recorded 1 Gains on sale of mortgages are net of hedging impact. For the three months ended December 31, 2012 Single-family Residential MBS Multi-unit Residential MBS total MBS $ 662,153 $ 64,634 $ 726,787 4,845 – – 891 2,447 487 5,736 2,447 487 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 49 management’s Discussion and Analysis management’s Discussion and Analysis CA PI tAl mAnAGement Capital is a key factor in the safety and soundness of a financial institution. A strong capital position assists the Company in promoting confidence among depositors, creditors, regulators and shareholders. the Company’s Capital Management policy governs the quantity and quality of capital held. the objective of the Capital Management policy is to ensure that adequate capital is available to the Company to support its strategic and business objectives, absorb potential unexpected losses, meet minimum regulatory capital requirements as stipulated by the Office of the Superintendent of Financial Institutions Canada (OSFI), and enable the allocation of capital for maximum economic benefit. the Capital Management Committee reviews compliance with the policy at minimum on a monthly basis while the Risk and Capital Committee and the Board of Directors review compliance with the policy on a quarterly basis. two regulatory capital requirements are addressed in the Company’s policy: the Assets to Regulatory Capital Multiple (ACM) and the risk-based capital ratios. the Capital Management Committee reviews these ratios on a regular basis while the Board of Directors reviews them quarterly. the Company’s principal subsidiary, Home trust, calculates capital ratios and regulatory capital based on the capital adequacy requirements issued by OSFI, which are based on International Convergence of Capital Measurement and Capital Standards – A Revised Framework (Basel II) and Basel III: A global regulatory framework for more resilient banks and banking systems – A Revised Framework (Basel III). As Home trust, a wholly owned subsidiary of the Company, is regulated under the trust and Loan Companies Act (Canada), its ability to accept deposits is limited primarily by its permitted ACM. this is defined as the ratio of total regulatory assets to total regulatory capital of Home trust. under Basel II and Basel III, Home trust calculates risk-weighted assets for credit risk using the Standardized Approach and for operational risk using the Basic Indicator Approach. Home trust’s capital structure and risk-weighted assets were as follows: table 33: Basel III Regulatory Capital (Based only on the subsidiary, Home trust Company) (000s, except ratios and multiples) Common equity tier 1 capital (Cet 1) Capital stock Contributed surplus Retained earnings Accumulated other comprehensive loss Cash flow hedge reserves Regulatory deductions from Cet 11 total Cet 1 capital Additional tier 1 capital total tier 1 capital tier 2 capital Collective allowance for credit losses2 Subordinated debentures total tier 2 capital total regulatory capital Risk-weighted assets for Credit risk Operational risk total risk-weighted assets Regulated capital to risk-weighted assets Cet 1 ratio tier 1 capital ratio total regulatory capital ratio Assets to regulatory capital multiple national regulatory minimum Cet 1 ratio (required January 1, 2013) tier 1 capital ratio (required January 1, 2014) total regulatory capital ratio (required January 1, 2014) December 31, 2013 All-in Basis transitional Basis $ 38,497 $ 951 1,130,517 (18,490) 2,656 (62,927) 1,091,204 – 1,091,204 38,497 951 1,130,517 (18,166) 2,656 (8,964) 1,145,491 – 1,145,491 31,500 156,000 187,500 31,500 156,000 187,500 $ 1,278,704 $ 1,332,991 $ 5,702,192 $ 5,756,155 793,575 $ 6,495,767 $ 6,549,730 793,575 17.49% 17.49% 20.35% 13.19 16.80% 16.80% 19.69% n/A 7.00% 8.50% 10.50% 1 Regulatory deductions on the all-in basis include intangible assets related to software development and unrealized multi-unit residential mortgage securitization gains, net of deferred taxes. 2 the Company is allowed to include its collective allowance for credit losses up to a prescribed percentage of 1.25% of credit risk-weighted assets in tier 2 capital. At December 31, 2013, the Company’s collective allowance represented 0.55% of risk-weighted assets. 50 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Home trust adopted certain Basel III capital requirements beginning January 1, 2013, as required by OSFI. the primary impact at adoption was the deduction from Common equity tier 1 capital on an all-in basis of $51.1 million of intangible assets, net of deferred taxes, related to It development costs as well as the inclusion of all its accumulated other comprehensive income, net of cash flow hedge reserves. the transitional basis allows for the transition of certain capital deductions over a period ending January 1, 2018, whereas the all-in basis includes all applicable deductions immediately. For Home trust, the transitional basis is applied to the deduction from capital of intangible assets related to development costs. Deductions for transitional calculations will commence in 2014. For the purposes of meeting minimum regulatory capital ratios prescribed by OSFI, the all-in basis is required. ACM is calculated and evaluated on a transitional basis. the tier 1 and total capital ratios as at December 31, 2012, calculated prior to the adoption of Basel III changes, were 17.01% and 20.68%. In the third quarter of 2013, the Company received confirmation that, in certain circumstances, off-balance sheet, insured single-family residential mortgages could be excluded from the ACM. the ACM of 13.98 as at December 31, 2012, calculated prior to the adoption of Basel III changes, would have been 13.39 had this treatment been applied. In the first quarter of 2013 the terms of all subordinated debt were restructured, all of which is intercompany between parent and subsidiary, to comply with the non-viability contingent capital requirements in Basel III. this allowed for the inclusion of the subordinated debt in tier 2 capital. under Basel III this subordinated debt will be subject to straight-line amortization out of capital in the final five years prior to maturity. the principal amounts of the subordinated debt currently mature in 2021 and 2022 in the amounts of $100 million and $56 million, respectively. under Basel III, Home trust’s Common equity tier 1, total tier 1 and total capital ratios significantly exceed OSFI’s “All-in” regulatory targets of 7.0% for Common equity tier 1, 8.5% for total tier 1 and 10.5% for total capital, as well as Home trust’s internal capital targets. table 34: Risk-Weighted Assets (RWA) (Based only on the subsidiary, Home trust Company) 2013 (000s, except %) Cash and cash equivalents Restricted assets Available for sale securities Insured residential mortgages uninsured single-family residential mortgages uninsured residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Other assets total assets subject to risk rating Intangible assets Collective allowance for credit losses total assets Off-balance sheet items Loan commitments total credit risk Operational risk total $ Balance Sheet Amounts 715,342 648,283 424,226 6,484,974 9,728,804 178,465 994,210 293,485 339,963 191,634 19,999,386 73,405 (31,500) 20,041,291 835,368 20,876,659 – $ 20,876,659 effective Risk Weight1 20.0% $ 3.6% 71.8% 0.6% Risk- weighted Amount 143,068 23,627 304,579 40,459 35.4% 3,441,510 179,383 100.5% 997,805 100.4% 130,781 44.6% 254,973 75.0% 59.0% 113,159 28.1% 5,629,344 – – 28.1% 5,629,344 – – 8.7% 72,848 5,702,192 793,575 $ 6,495,767 1 the effective risk weight represents the weighted average of the risk weights for each asset category prescribed by OSFI weighted based on the Company’s balance sheet classification. Risk-weighted assets are determined by applying the OSFI-prescribed rules to on-balance sheet and off-balance sheet exposures. the Company’s securitization activities are not subject to the Basel II securitization framework as they are all within the nHA MBS program and do not involve tranching of credit risk. Risk-weighted assets as at December 31, 2012, which were calculated prior to the adoption of Basel III requirements, were $5.49 billion comprising $4.87 billion for credit risk and $0.62 billion for operational risk. Over the year, risk-weighted assets increased by $1.01 billion primarily due to growth in the Company’s traditional uninsured single-family residential mortgages. the operational risk factor in the calculation also increased as the Company’s gross income, on which the calculation is based, increased. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 51 management’s Discussion and Analysis management’s Discussion and Analysis capital and Lending capacity the Company has continuously maintained high levels of regulatory capital, as compared to its peers and larger institutions. this has provided additional protection to depositors and shareholders against losses that might be caused by severely unfavourable business developments, economic trends or other shocks. this is in addition to the collective allowance for credit losses, which currently exceeds the total write-offs recorded over the past two years. Currently, the Company exceeds its minimum regulatory capital requirement for the Common equity tier 1 capital ratio by a factor of more than two. In addition to its high levels of regulatory capital, Home trust has maintained a relatively low level of leverage as measured by its ACM. the ACM is the most constraining regulatory factor on the Company’s capacity to lend. this factor is calculated based on total balance sheet assets without regard to any risk weighting and includes adjustments (permitted by OSFI) such as grandfathered mortgages that were securitized through CMHC-sponsored programs prior to March 31, 2010. under IFRS, certain assets which had previously been securitized, sold and removed from the Company’s balance sheet were returned to the balance sheet. these items were returned to the balance sheet primarily because the Company remained exposed to the risk of unscheduled repayments, or prepayments by borrowers. this reduces the Company’s total lending capacity and potentially its capacity to renew the underlying insured mortgages with a reasonable return on the capital required to support such mortgages on the Company’s balance sheet. In 2012 and 2013 the Company completed transactions that transferred the risk of prepayments to third-party investors and the underlying mortgages were removed from the Company’s balance sheet. In 2013, the treatment of these mortgages for the purpose of calculating the ACM was clarified, allowing the Company to make a similar adjustment to its calculation of ACM. Consequently, the Company’s borrowing capacity increased without requiring any additional regulatory capital. this provides capacity for Home trust to renew its significant portfolio of insured mortgages that will reach the end of their contractual terms but have a number of years until fully amortized to repayment. this represents a significant opportunity for future loan servicing revenue and gains on sales of securitized pools. the table below provides a summary of the maturity profile of the Company’s securitized insured mortgages: table 35: maturity Profile of Securitized mortgages (000s) Securitized single-family residential mortgages Securitized multi-unit residential mortgages total securitized mortgages 2014 2015 $ 919,119 $ 1,418,344 $ 482,849 278,145 $ 1,401,968 $ 1,696,489 $ As at December 31, 2013 thereafter total 2016 569,388 $ 3,720,097 813,246 $ 71,281 1,489,924 657,649 884,527 $ 1,227,037 $ 5,210,021 In addition to the renewal opportunities, this also presents an opportunity for the Company to increase its level of lending to prime borrowers on insured loans, without the need to allocate substantial amounts of capital. this will further enable the Company to pursue its “one-stop-shop” mortgage lender strategy, which was embraced by mortgage brokers in earlier years and provided considerable advantages in the market. During the year, the Company recorded $11.1 million of gains on mortgage sales. these gains include gains of $5.7 million on sales of $617.2 million of insured multi-unit residential mortgages and gains of $5.4 million on sales of $519.3 million of single-family residential mortgages. the principal values of mortgages being administered by the Company and excluded from the balance sheet are summarized in table 14. Capital management Activity During the third quarter of 2013, the Company filed a new normal Course Issuer Bid through the toronto Stock exchange, which allows it to purchase over a 12-month period up to 10% of the public float outstanding on September 12, 2013. the Company believes that, from time to time, the market price of its common shares does not fully reflect the value of its business and the repurchase of shares may represent an appropriate and desirable business decision. During 2013, the Company repurchased 39,100 common shares (2012 – 163,500 common shares) for $2.3 million, thereby reducing retained earnings by $2.2 million and share capital by $0.1 million (2012 – $7.8 million and $0.3 million, respectively). Internal Capital Adequacy Assessment Process (ICAAP) under the Company’s capital and risk management policies, and OSFI’s guidelines, the Company is required to assess the adequacy of current and projected capital resources under expected and stressed conditions. this involves evaluating the Company’s strategy, financial plan and risk appetite; assessing the effectiveness of its risk and capital management practices (including Board and senior management oversight); subjecting the Company’s plans to a range of stress tests; and drawing conclusions about its capital adequacy (including a rigorous review and challenge). Based on the Company’s ICAAp, management has concluded that Home trust is adequately capitalized. 52 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 table 36: Credit Ratings Long-term rating Short-term rating Outlook Share Information table 37: Share Information (000s) Common shares issued and outstanding1 employee stock options outstanding2 employee stock options exercisable3 Credit Ratings the following table presents the credit ratings for the Company and its subsidiary Home trust. these investment-grade credit ratings would allow the Company to obtain institutional debt financing should the need arise for additional capital. Home Capital Group Inc. Home trust Company DBRS BBB R2 (middle) Stable Standard & poor’s BBB- A-3 Stable Fitch Rating BBB F2 negative DBRS BBB (high) R2 (high) Stable Standard & poor’s BBB A-2 Stable Fitch Rating BBB F2 negative number of Shares 34,744 $ 825 524 2013 Amount 70,233 n/A 19,287 number of Shares 34,630 $ 783 557 2012 Amount 61,903 n/A 19,647 1 no shares were issued, other than through employee stock options exercised. 2 please see note 17(C). Amount for employee stock options is not applicable. 3 For employee stock options exercisable, the amount refers to proceeds payable to the Company upon exercise. 2014 outlook for Capital management the Company remains committed to maintaining its financial strength, strong regulatory capital ratios and growing its capital base through earnings in 2014 and beyond. the inclusion of mortgages securitized after March 31, 2010 in the ACM makes this measure the Company’s primary capital constraint; however, the favourable ruling on the sale of residual interest makes this less of a constraint going forward. the Company will continue to proactively monitor and assess its ACM on an ongoing basis. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 53 management’s Discussion and Analysis management’s Discussion and Analysis RIS K mA nAG ement the shaded areas of this section of the MD&A represent a discussion of risk management policies and procedures relating to credit, market and liquidity risks that are required under IFRS 7 Financial Instruments: Disclosures, which permits these specific disclosures to be included in the MD&A. therefore, the shaded areas presented in this Risk Management section form an integral part of the audited consolidated financial statements for the year ended December 31, 2013. Risk management is an essential component of the Company’s strategy, contributing directly to the Company’s profitability and consistently high return on equity. the Company continues to invest significantly in risk management practices and resources. the Company’s business strategies and operations expose the Company to a wide range of risks that could adversely affect its operations, financial condition, or financial performance, and which may influence an investor to buy, hold, or sell the Company’s shares. When evaluating risks, the Company makes decisions about which risks it accepts, which risks it mitigates, offsets or hedges, and which risks it will avoid. these decisions are guided by the Company’s risk appetite framework. the types of risk to which the Company is subject include, among others, credit, funding and liquidity, market, and operational risks. Risk Appetite the Company has adopted a risk appetite framework that sets out the amount and types of risk the Company will accept in pursuit of its business objectives and strategies. the Company’s risk appetite framework provides the structure to link the objectives of the Company’s key stakeholders with the level of risk the Company can, and is willing to, take. the risk appetite framework comprises five major components. 1. Clear articulation of the Company’s overall mission and objectives, given key stakeholder concerns. the level of risk inherent in these objectives drives the level of risk the Company may accept. 2. Identification of the Company’s risk capacity by identifying the supply of capital capable of supporting risk and absorbing loss. Risk capacity is limited by other factors including regulatory constraints. 3. Identification of the risks inherent in the corporate strategy supporting the mission and the governing objectives of the Company and establishment of a risk-taking philosophy that sets out the key principles that guide how the Company may take and mitigate risk. 4. Documentation of the amount and types of risk the Company may accept given its mission, risk capacity, strategy and risk-taking philosophy. the Company explicitly articulates its Balance Sheet risk appetite (how much of the Company’s capital it will put at risk), earnings Volatility risk appetite, portfolio Composition risk appetite (the types of risk the Company will take) and non-financial risk appetite (expressions of risk appetite that are difficult to quantify). Among others, the Company has established risk appetite statements addressing: > maximum capital at risk and minimum capital ratios; > maximum leverage or asset to capital multiple; > maximum amount of top-level individual risk types; and > reputational risk. 5. establishment of risk limits as an expression of the Company’s risk appetite for individual risks or factors that contribute to risk levels. Risk Governance the Company’s strategies and management of risk are supported by an overall enterprise risk management (eRM) framework including policies, guidelines, and procedures for each major category of risk to which it is exposed (strategic, credit, market, funding and liquidity, operational, legislative and regulatory, and reputational). the Company defines eRM as an ongoing process involving its Board of Directors (the “Board”), management and other personnel in the identification, measurement, assessment and management of risks that may positively or negatively impact the organization as a whole. eRM is applied in strategy setting across the enterprise and is designed to provide reasonable assurance that the Company’s objectives can be realized given its stated risk appetite. the goal of eRM is to help maximize, within the Company’s risk appetite, the benefit to the enterprise, shareholders and other stakeholders from a portfolio of risks that the Company is willing to accept. Supporting the Company’s eRM structure is a risk culture and a governance framework, including Board and senior management oversight and an increasingly robust set of risk policies and guidelines reflective of the Company’s risk appetite, that set boundaries for acceptable business strategies, exposures and activities. the Company’s governance structure is supported by the industry standard three lines of defence model. Authority is delegated by the Board through the Chief executive Officer to business units that are responsible for managing the risks they take in the pursuit of their business objectives. the eRM group, along with the Credit, Finance and Corporate Compliance groups, represents the second line of defence, and provides policy guidance to business units and helps ensure that all risks are identified, monitored, measured, assessed and reported to senior management and the Board. Internal Audit, the third line of defence, provides objective and independent reviews of the risk management process, its controls, and the effectiveness of governance, risk management and controls. 54 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 the governance structure as depicted in the following figure ensures that there is a framework in place for risk oversight and accountability across the organization. Risk owners are responsible for developing and executing strategies for controlling risk. Board of Directors Board of Directors Audit Committee Governance, Nominating and Conduct Review Committee Human Resources and Compensation Committee Risk and Capital Committee Management CEO and Executive Committee Credit Risk Committee Asset/Liability Committee Operational Risk Committee Governance, Risk and Compliance Committee Executive Project Review Committee Senior Leadership Committee Capital Management Committee 3rd Line 2nd Line Internal Audit Finance Corporate Compliance Credit Enterprise Risk Management 1st Line (Line of Business) Deposits Residential Mortgage Lending Commercial Mortgage Lending Consumer Lending and Retail Credit Treasury S E E T T I M M O C E C N E F E D F O S E N I L Home CAPItAl GRouP InC. AnnuAL RepORt 2013 55 management’s Discussion and Analysis management’s Discussion and Analysis the Board is accountable for establishing the overall vision, mission, objectives and strategies of the Company and setting the Company’s risk appetite and risk-bearing capacity. It challenges management’s proposals and plans to ensure that the forecasted results and risk assessments are reasonable and in line with the Company’s capabilities, objectives and risk appetite. these risk management responsibilities are primarily carried out through the Risk and Capital Committee of the Board. In this oversight role the Committee is designed to ensure that all significant risks to the Company, regardless of source, are proactively identified and effectively managed. this is accomplished by reviewing and approving, on at least an annual basis, all key risk policies; monitoring, on at least a quarterly basis, the Company’s actual exposures versus Board-approved risk appetite and limits; and providing direction to management where deemed necessary. It further monitors to ensure that the eRM function is independent of the business activities it oversees and that an appropriate, independent monitoring and reporting framework is in place and operating effectively, so as to deliver accurate, timely and meaningful risk information for its review and evaluation. the executive Committee (eC), chaired by the Chief executive Officer, is responsible for recommending corporate strategy to the Board and for overseeing its execution. A critical component of this mandate is recommending to the Risk and Capital Committee of the Board a risk appetite that aligns with the objectives and strategy of the Company. the eC is accountable for establishing an appropriate “risk aware” culture and proactively monitoring actual exposures and business activities in comparison to risk appetite. the eC reviews and validates the Company’s portfolio of key risk exposures through comprehensive risk reporting as well as by an ongoing risk identification and assessment process. through this process, significant risks are identified in light of current business, market, and economic conditions, ensuring that the risks the Company manages and monitors are not static but evolving in context with the greatest likelihood of impact on the Company at any given point in time. the most significant risks to the Company, described as principal risks and as reflected in the following diagram, are subject to more specific review, monitoring and assessment under the mandates of supporting risk committees. these committees (Credit Risk, Asset/Liability, Capital Management, Operational Risk, Governance, Risk and Compliance, executive project Review, and Senior Leadership) recommend policies and guidelines for approval as proposed by the lines of business, with review by the eRM group, and proactively monitor and assess the specific risks under their mandates compared to the approved risk appetite. In addition to the executive Committee and the supporting risk committees, the Company’s risk governance is supported by: > the Chief Risk Officer and the eRM group. the eRM group is mandated to work with the executive team and the Board of Directors of the Company to support sustainable business performance through the independent identification, measurement, assessment and monitoring of all significant risks to the Company, regardless of source. Working closely with the Risk and Capital Committee of the Board, the eRM group recommends the Company’s overall risk appetite and limits. It develops policies to address significant risks and recommends Board and/or management approval. eRM independently maintains a current view of the Company’s risk profile by monitoring actual exposure and practice against approved risk appetite, limits, policies and guidelines. > the Chief Compliance Officer (CCO) and Chief Anti-Money Laundering Officer (CAMLO) and the Corporate Compliance group. the CCO/Corporate Compliance group is mandated to establish and maintain an independent enterprise-wide Compliance Framework (a set of controls and oversight processes) designed to mitigate the Company’s Legislative and Regulatory Risk. the CCO/Corporate Compliance group is mandated to promote a sound compliance culture; report to the Company’s senior management and the Board about compliance with the Company’s legislative and regulatory requirements; follow up with Senior Management on breaches; and make recommendations related to the Compliance Framework activities. the CCO and CAMLO are responsible for expressing an independent opinion to the Audit Committee on the status, adequacy and effectiveness of the Company’s state of compliance on a periodic basis. > the Senior Vice president, Internal Audit, and the Internal Audit department. Internal Audit is mandated to independently assess and report to the Audit Committee, the Board and management on the effectiveness of governance, risk management and internal control processes. > the Chief Financial Officer and the Finance group. the Finance group compiles the Company’s financial and capital plan for recommendation to the executive Committee and Board, and reports to the Board, shareholders and regulators on the performance of the Company against these plans. the Finance group also updates the plan with periodic forecasts, advises the Board of anticipated outcomes, and recommends revisions to capital plans and structures as appropriate. In order to align the Company’s risk and control processes, management has formed the Governance, Risk and Compliance Committee to review and align the management structure, resources, processes and controls to match the size, complexity, scope, and risk profile of the organization. this committee makes recommendations to the executive Committee to improve, operate and sustain all aspects of governance, risk and compliance. 56 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Stress testing In addition to the day-to-day risk management practices, a key component of the eRM framework is stress testing and scenario analysis. Management conducts regular stress testing, including stress testing through its internal capital adequacy assessment process and ad hoc stress testing to evaluate a range of extreme but plausible scenarios. Stress tests are conducted to determine the potential impact of these events, the effectiveness of management’s contingency plans to deal with these unlikely but possible events, and management’s ability to mitigate the potential risk. A common set of scenarios is developed to assess the impact on the Company’s financial results, capital and liquidity position, operational capabilities and the Company’s ability to respond to the event. In particular, management has evaluated a range of economic scenarios, including a real estate-driven recession. Management analyzes the outcomes from stress testing and, where applicable, takes proactive measures to mitigate potential risks to the business. Principal Risks the Company has identified seven principal risks that are material to the business: strategic, credit, market, funding and liquidity, operational, legislative and regulatory, and reputational risk. In addition to these principal risks, the Company employs a risk register to outline risk sub-categories and provide more detailed linkages to the specific risks inherent to, or taken by, the business. these risks are identified, measured, assessed, and monitored on an ongoing basis, with regular reporting to both management and the Board of Directors. Where appropriate, principal and sub-category risks are mitigated through various actions to reduce the inherent risk to acceptable residual levels, as defined by the Company’s risk appetite. Strategic and reputational risks are considered overarching risks, as substantial outcomes from other principal risks could pose significant second order impact to the Company’s reputation or ability to execute strategic objectives. Strategic Risk k s i R t i d e r C k s i R t e k r a M d n a i y t i d u q i L k s i R g n d n u F i k s i R l a n o i t a r e p O d n a e v i t a l s i g e L k s i R y r o t a u g e R l Reputational Risk Strategic Risk Strategic and business risk is the risk of loss due to changes in the external business environment, the failure of management to adjust its strategies and business activities for external events or business results, or the inability of the business to change its cost levels in response to those changes. Strategic and business risk is managed by the eC. On a regular basis, the eC reviews the current environment, the business results and the actions of the Company’s competitors and adjusts business plans accordingly. the Board approves the Company’s strategies at least annually and reviews results against those strategies at least quarterly. Credit Risk Credit risk is the risk of the loss of principal and/or interest from the failure of debtors and/or counterparties to honour their financial or contractual obligations to the Company, for any reason. the Company’s overall exposure to credit risk is governed by a defined credit-specific risk appetite, limits and a Board-approved Credit Risk policy. the Credit Risk Committee establishes, implements and monitors credit risk related policies and guidelines enterprise-wide, taking into account business objectives, risk appetite, planned financial performance and risk profile. Credit risk limits are established for all types of credit exposures, with geographic, product, property and security type limits established to cover all material classes of exposure. the Company’s risk management policy limits the total aggregate exposure to any entity or connection. the lines of business are responsible for managing the Company’s credit risks in accordance with approved policies and guidelines, and assessing overall credit conditions and exposures on an ongoing basis. the Credit Risk Committee, the eRM group, and the Risk and Capital Committee of the Board oversee the credit portfolio through ongoing reviews of credit-risk management policies, lending practices, portfolio composition and risk profile, the adequacy of the loan loss allowances and the allocation of credit risk-based capital. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 57 management’s Discussion and Analysis management’s Discussion and Analysis At a transactional level, loans are independently approved by credit staff commensurate with their experience and expertise to extend credit within the bounds of the Company’s credit risk policies. A foundation of the Company’s approach to credit is a high level of due diligence on each individual transaction with oversight from a management team with strong industry experience. All transactions are subject to detailed reviews of the underlying security, an assessment of the applicant’s ability to service the loan, and the application of a standard risk rating or credit score. enhanced due diligence is conducted on transactions deemed to be higher credit risks based on pre-defined parameters. transactions in excess of individual authority are approved by the Credit Risk transactional Sub-Committee of the Credit Risk Committee and ultimately by the Risk and Capital Committee of the Board as required. table 38: Credit Risk Portfolio monitors (000s, except % and number of credit cards issued) total loans balance (net of individual allowances) mortgage Portfolio1 total mortgage portfolio balance (net of individual allowance) Residential mortgages as a percentage of total mortgages non-residential mortgages as a percentage of total mortgages percentage of insured residential mortgages2 percentage of mortgages current percentage of mortgages over 90 days past due percentage of insured residential mortgage originations Loan to value ratio of residential mortgages (current uninsured)3 Credit Card Portfolio total credit card portfolio balance percentage of equityline Visa credit cards percentage of secured credit cards percentage of credit cards current percentage of credit cards over 90 days past due Loan to value ratio of equityline Visa (current)3 Visa card security deposits total authorized limits of credit cards total number of credit cards issued Average balance authorized 2013 2012 $ 17,881,926 $ 17,137,992 $ 17,248,478 $ 16,538,499 94.0% 6.0% 44.8% 97.6% 0.4% 19.3% 65.5% 94.2% 5.8% 37.6% 97.6% 0.5% 25.1% 65.9% $ $ $ $ 293,485 $ 95.7% 3.8% 97.8% 0.9% 66.1% 15,997 $ 373,702 $ 28,892 13 $ 327,516 96.9% 3.0% 96.6% 1.1% 69.9% 14,345 403,110 26,840 15 1 Residential mortgages include multi-unit residential and other residential commercial mortgages. 2 Insured loans are loans insured against default by CMHC or another approved insurer either individually at origination or by portfolio. 3 Loan to value ratio is calculated as the current balance outstanding to the appraised value at origination. Mortgage Lending As part of credit risk management of the loan portfolio, senior management and the eRM group monitor various characteristics including the characteristics in the above table. Credit risk mitigation is a key component of the Company’s approach to credit risk management. the composition of the mortgage portfolio is well within the policy limits. Senior management and the eRM group closely monitor the credit performance of the mortgage loan portfolio. the portfolio continues to perform well, with arrears that are well within expected levels. the Company mitigates credit risk on residential mortgages through collateral in the form of real property and, as such, loan to value (LtV) is a key credit metric. please see tables 43 and 44 for further information. Due to the level of activity and price appreciation in the high-rise condominium market in certain cities, the Company continues to closely monitor market conditions and the performance of this portfolio. High-rise condominiums represent less than 8% of the residential mortgage portfolio and, of these, 36.4% are insured. the average current LtV of the condominium portfolio was 69.6% at the end of 2013. the credit performance of the condominium portfolio is strong and within the Company’s expectations, with 98.1% of the portfolio current and 0.4% over 90 days. the level of non-residential mortgages was relatively stable over the last 12 months and the Company anticipates that the non-residential portfolio will remain relatively stable. the Company slowly began increasing its exposure to non-residential lending in 2010 through 2012 in proportion with growth in the overall asset portfolio. the proportion is well within the policy limits. 58 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 other Lending Credit card balances were $293.5 million at the end of the year, virtually all of which are secured by either cash deposits or residential property. Within the credit card portfolio, equityline Visa accounts, which are secured by residential property, represent the principal driver of receivable balances. the equityline Visa portfolio had a weighted-average LtV at origination of 66.1% at the end of the year compared to 69.2% at the end of 2012. the LtV includes both the first mortgage and the secured equityline Visa balance. Senior management and the eRM group closely monitor the credit performance of the credit card portfolio. the portfolio continues to perform well, with arrears well within expected levels. As of December 31, 2013, $2.6 million or 0.9% of the credit card portfolio was over 90 days in arrears, compared to $3.6 million or 1.1% at December 31, 2012. In late 2012 the Company launched its preferred Visa card program, which offers unsecured Visa cards with relatively low authorized limits to the Company’s mortgage clients with good credit performance. the preferred Visa portfolio represents 0.4% of the outstanding credit card balances at the end of the year. Retail credit is secured by charges on financed assets, primarily improvements to residential property or fixtures, such as water heaters. Water heater loans are also guaranteed by the gas supplier. Refer to the Loans note in the consolidated financial statements included in this report for a breakdown of the overall loan portfolio by geographic region. While the Company’s strategy is to increase the geographic diversification of the loan portfolio, this has been tempered by credit conditions in local markets. table 39: non-Performing loans and Allowances (000s, except %) Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans non-performing loans total gross loans net non-performing loans as a % of gross loans total allowance for credit losses total allowance as a % of gross loans total allowance as a % of gross non-performing loans Write-offs, as a % of gross loans $ Gross 52,837 $ 1,836 2013 net1 51,636 $ 1,836 Gross 50,169 $ 4,527 7,189 2,785 236 64,883 $ 17,883,564 7,189 2,584 – 63,245 501 3,616 214 59,027 $ 17,140,698 2012 net1 47,788 4,527 501 3,505 – 56,321 Gross 5.3% (59.4%) 1,334.9% (23.0%) 10.3% 9.9% 4.3% Change net1 8.1% (59.4%) 1,334.9% (26.3%) – 12.3% – $ 0.35% 33,978 0.19% 52.37% 0.09% $ 0.33% 33,638 0.20% 56.99% 0.07% 1 non-performing loans are net of individual allowances as shown in table 40, Allocation of Allowance for Credit Losses. net non-performing loans remain within expected and acceptable ranges. As part of the Company’s ongoing business strategy, experienced employees undertake reviews of delinquent and non-performing loans to analyze patterns and drivers and then modify, where appropriate, the Company’s lending guidelines. this analytical approach and attention to emerging trends have resulted in continued low write-offs relative to the gross loans portfolio. Write-offs, net of recoveries, totalled $15.5 million or 0.09% of gross loans in 2013, compared to $12.4 million or 0.07% of gross loans in 2012. the Company continually monitors arrears and write-offs and deals effectively with non- performing loans. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 59 management’s Discussion and Analysis management’s Discussion and Analysis table 40: Allocation of Allowance for Credit losses (000s) Individual allowances Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Collective allowance Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans total allowance for credit losses (000s) Individual allowances Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Collective allowance Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans total allowance for credit losses 2013 opening Balance Write-offs net of Recoveries Provision for Credit losses 2013 ending Balance 2,868 $ 432 – 111 227 3,638 (11,165) $ (3,199) (230) (589) (345) (15,528) 10,257 $ 2,792 274 679 366 14,368 16,523 336 9,300 3,541 300 30,000 33,638 $ – – – – – – (15,528) $ 1,509 (9) – – – 1,500 15,868 $ 2012 Opening Balance Write-offs net of Recoveries provision for Credit Losses 1,087 $ – 78 392 302 1,859 (10,148) $ – (319) (1,572) (342) (12,381) 15,871 428 9,300 3,541 300 29,440 31,299 $ – – – – – – (12,381) $ 11,929 $ 432 241 1,291 267 14,160 652 (92) – – – 560 14,720 $ 1,960 25 44 201 248 2,478 18,032 327 9,300 3,541 300 31,500 33,978 2012 ending Balance 2,868 432 – 111 227 3,638 16,523 336 9,300 3,541 300 30,000 33,638 $ $ $ $ the Company maintains credit allowances that, in management’s judgement, are sufficient to cover incurred losses and identified credit events in the loans portfolio. Individual allowances represent the amount on identified non-performing loans required to reduce the carrying value of those loans to their estimated realizable amount. the balance will fluctuate from time to time and is driven by the performance of individual loans and the realizable value of the underlying security. the collective allowance for credit losses is established for incurred losses inherent in the portfolio that are not presently identifiable on a loan-by-loan basis and reflects the relative risk of the various loan portfolios that the Company manages. At December 31, 2013, the Company held a collective allowance of $31.5 million, compared to $30.0 million held at December 31, 2012. the Company has security in the form of real property or cash deposits for virtually the entire loans portfolio. the Company’s evaluation of the adequacy of the collective allowance takes into account asset quality, borrower creditworthiness, property location, past loss experience, current and forecasted probability of default and exposure at default based on product, risk ratings and credit scores, and current economic conditions. the Company periodically reviews the methods utilized in assessing the collective allowance, giving consideration to changes in economic conditions, interest rates and local housing market conditions. the principal factors impacting the assessment of the adequacy of the collective allowance are the stable economic environment in the Company’s markets, the increased weighting of uninsured mortgages and the low loan to value of the uninsured mortgage portfolio. For the most part, these factors tend to offset each other and, accordingly, the collective allowance has been increased marginally and continues to exceed two years of current year write-offs. 60 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 2014 outlook for Credit Risk please refer to the 2014 Outlook for provision and Allowance for Credit Losses section included in the Financial performance Review section of this MD&A. additional information: residential Loans and equityline Visa Home equity Line of credit (HeLoc) the tables below provide additional information on the composition of the Company’s single-family residential mortgage portfolio by province and insured status, as well as contractual remaining amortization periods and loan to value by province. table 41: Single-Family Residential loans by Province (000s, except %) British Columbia Alberta Ontario Quebec Other (000s, except %) British Columbia Alberta Ontario Quebec Other $ Insured Residential mortgages 399,055 339,525 3,707,836 245,272 146,971 $ 4,838,659 Percentage of total for Province uninsured Residential mortgages 471,668 45.5% $ 52.9% 284,456 29.7% 8,519,799 308,136 44.2% 50.0% 144,746 32.6% $ 9,728,805 Percentage of total for Province 53.8% $ 44.3% 68.3% 55.6% 49.2% 65.5% $ $ Insured Residential Mortgages 484,925 415,596 4,136,699 308,007 139,793 $ 5,485,020 percentage of total for province uninsured Residential Mortgages 369,557 56.2% $ 58.6% 270,563 36.3% 6,979,420 227,617 57.3% 53.0% 121,026 39.8% $ 7,968,183 percentage of total for province 42.9% $ 38.1% 61.2% 42.4% 45.9% 57.9% $ 2013 Percentage of total for Province total 876,586 0.7% $ 2.8% 641,683 2.0% 12,481,366 554,668 0.2% 0.8% 294,026 1.9% $ 14,848,329 2012 percentage of total for province total 862,303 0.9% $ 3.3% 709,698 2.5% 11,397,664 537,155 0.3% 1.1% 263,619 2.3% $ 13,770,439 equityline Visa1 5,863 17,702 253,731 1,260 2,309 280,865 equityline Visa1 7,821 23,539 281,545 1,531 2,800 317,236 1 equityline Visa is an uninsured product. table 42: Insured and uninsured Single-Family Residential mortgages by Contractual Remaining Amortization Period (000s, except %) Balance outstanding percentage of total (000s, except %) ≤ 20 Years > 20 and ≤ 25 Years > 25 and ≤ 30 Years > 30 and ≤ 35 Years $ 520,436 $ 1,579,125 $ 7,944,270 $ 4,471,217 $ 3.6% 10.8% 54.5% 30.7% ≤ 20 Years > 20 and ≤ 25 Years > 25 and ≤ 30 Years > 30 and ≤ 35 Years Balance outstanding percentage of total $ 585,304 $ 1,566,157 $ 6,713,556 $ 4,412,537 $ 4.4% 11.6% 49.9% 32.8% 2013 > 35 Years total 52,416 $ 14,567,464 100.0% 0.4% 2012 > 35 Years total 175,649 $ 13,453,203 100.0% 1.3% Home CAPItAl GRouP InC. AnnuAL RepORt 2013 61 management’s Discussion and Analysis table 43: Weighted-average loan to Value (ltV) Ratios for uninsured Single-family Residential mortgages originated During the Year British Columbia Alberta Ontario Quebec Other total uninsured Residential mortgages1 67.4% 69.1% 73.7% 67.7% 67.2% 73.0% 2013 equityline Visa1 55.7% 49.0% 57.3% 52.9% 53.2% 57.2% 1 Weighted-average LtV is calculated by dividing the sum of the products of LtVs and loan balances by the sum of the loan balances. An economic downturn is generally characterized by reduced growth or declines in gross domestic product, often combined with reduced rates of employment and declines in real estate values. the probability of delinquency in the residential mortgage portfolio is most closely correlated with changes in employment. Consequently, during an economic downturn, the Company would expect an increased rate of delinquency and also an increase in credit losses. the total single-family residential mortgage portfolio including HeLOC was $14.85 billion as of December 31, 2013, of which $4.84 billion was insured against credit losses. the Company would expect to recover lost principal, interest and direct collection costs associated with this insured portion of the portfolio. Management monitors these risks carefully on an ongoing basis, including stress testing of the portfolio. the Company’s key mitigant against credit losses in the uninsured portfolio is the excess of the value of the collateral over the outstanding loan amount (expressed as loan to value ratio or LtV). As at December 31, 2013, the weighted-average LtV of the uninsured portfolio against the estimated current market value was 67.9% compared to 64.2% at the end of 2012. these LtVs were estimated using the teranet-national Bank House price Index and the most recent appraisals. If an economic downturn involved reduced real estate values, the margin of value over loan amounts would be eroded and the extent of loan losses could increase. the distribution of LtV around the mean for each significant market is indicated below. table 44: Weighted-Average loan to Value Ratios for uninsured Residential mortgages British Columbia Alberta Ontario Quebec Other total Weighted- average Current ltV1 65.4% 63.8% 68.4% 64.3% 62.5% 67.9% 2013 Percentage of total Value of outstanding mortgages with Current ltV less than or equal to 75% 86.9% 91.0% 70.8% 93.2% 92.1% 73.2% 65% 40.2% 47.3% 29.8% 45.3% 55.9% 31.7% 1 Weighted-average LtV is calculated by dividing the sum of the products of LtVs and loan balances by the sum of the loan balances. market Risk For the Company, market risk consists primarily of investment risk and structural interest rate risk. A summary of these risks is as follows: investment risk Investment risk is the risk of loss due to impairment in the fair value of investments. the Company’s investment risk management framework includes investment policies that are approved by the Asset/Liability Committee (ALCO) and the Risk and Capital Committee of the Board. the ALCO is responsible for defining and monitoring the Company’s investment portfolio and identifying investments that may be at risk of impairment. the treasury group is responsible for managing the Company’s investment portfolio in accordance with approved policies and assesses the impact of market events on potential implications to its total value. eRM recommends prudential policies, reviews procedures and guidelines, and provides enterprise-wide oversight of investment risk, including valuations. 62 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 structural interest rate risk Structural interest rate risk is the risk of lost earnings or capital due to changes in interest rates. the objective of interest rate risk management is to ensure that the Company is able to realize stable and predictable earnings over specific time periods despite interest rate fluctuations. the Company has adopted an approach to the management of its asset and liability positions to prevent interest rate fluctuations from materially impacting future earnings, and seeks to organically match liabilities to assets in terms of maturity and interest rate repricing through its actions in the deposit market in priority to accessing off-balance sheet solutions. the Company’s market risk management framework includes interest rate risk policies that are approved by the ALCO and the Risk and Capital Committee of the Board. the ALCO is responsible for defining and monitoring the Company’s structural interest rate risk and reviewing significant maturity and/or duration mismatches, as well as developing strategies that allow the Company to operate within its overall risk appetite. In addition, the ALCO oversees stress testing of structural interest rate risk using a number of interest rate scenarios. the treasury group is responsible for managing the Company’s interest rate gaps in accordance with approved policies and assesses the impact of market events on the Company’s net interest income and economic value of shareholders’ equity. the eRM group recommends prudential policies and guidelines, and provides independent enterprise-wide oversight of all interest rate risk. From time to time, the Company enters into interest rate derivative transactions in order to hedge its structural interest rate risk. the use of derivative products has been approved by the Board; however, permitted usage is governed by specific policies. Derivatives are only permitted in circumstances in which the Company is hedging asset-liability mismatches, or loan commitments, or as a result of hedging requirements under the terms of its participation in the CMB program. Moreover, the policy expressly articulates that the use of derivatives is not permitted for transactions that are undertaken to potentially create trading profits through speculation on interest rate movements. the interest rate sensitivity position as at December 31, 2013 is presented under note 21 in the consolidated financial statements. the table in note 21 represents positions at a point in time, and the gap represents the difference between assets and liabilities in each maturity category. this note summarizes assets and liabilities in terms of their contractual amounts. Over the lifetime of certain assets, some contractual obligations such as residential mortgages will be terminated prior to their stated maturity at the election of the borrower, by way of prepayments. Similarly, some contractual off-balance sheet mortgage commitments may be made but may not materialize. In measuring its interest rate risk exposure, the Company makes assumptions about these factors and monitors these against actual experience. to assist in matching assets and liabilities, the Company utilizes a variety of metrics including two interest rate risk sensitivity metrics that measure the relationship between changes in interest rates and the resulting estimated impact on both the Company’s future net interest income and economic value of shareholders’ equity. the Company measures these metrics over a number of different yield curve scenarios. the following table provides measurements of interest rate sensitivity and the potential after-tax impact of an immediate and sustained 100 basis point increase and decrease in interest rates on net interest income and on the economic value of shareholders’ equity. table 45: Impact of Interest Rate Shifts (000s) 100 basis point shift Impact on net interest income, after tax (for the next 12 months) Impact on net present value of shareholders’ equity Increase in interest rates Decrease in interest rates December 31 2013 December 31 2012 December 31 2013 December 31 2012 $ 12,601 $ 16,555 12,614 $ 9,746 (12,601) $ (18,003) (12,614) (11,447) As illustrated in the above table, an increase in interest rates will have a positive impact on net interest income after tax and the economic value of shareholder’s equity in the event of a 100 basis point movement in rates without management action. A positive gap exists when interest-sensitive assets exceed interest-sensitive liabilities on specific maturity or repricing periods. As these gaps widen, the fluctuation in the sensitivity becomes more pronounced and, for this reason, the Company’s ALCO manages this to within authorized limits. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 63 management’s Discussion and Analysis liquidity and Funding Risk this is the risk that the Company is unable to generate or obtain cash or equivalents in a timely manner and at a reasonable cost to meet its commitments (both on- and off-balance sheet) as they become due. this risk will arise from fluctuations in the Company’s cash flows associated with lending, securitization, deposit-taking, investing and other business activities. the Company’s liquidity risk management framework includes liquidity and funding risk policies, and a Contingency Funding plan that are approved by the ALCO and the Risk and Capital Committee of the Board. the mandate of the ALCO includes establishing and recommending to the Board an enterprise-wide liquidity risk appetite. In addition, the ALCO reviews the composition and term structure of assets and liabilities, reviews liquidity and funding risk policies and strategies and regularly monitors compliance with those policies. the ALCO also oversees the stress testing of liquidity and funding risk and the testing of the Company’s Contingency Funding plan. the treasury group is responsible for managing the Company’s liquidity and funding risk positions in accordance with approved policies and assesses the impact of market events on liquidity requirements on an ongoing basis. the eRM group recommends liquidity policies and guidelines, and provides independent oversight of all liquidity and funding risk. the Company’s liquidity and funding risk policies are designed to ensure that cash balances and the inventory of other liquid assets are sufficient to meet all cash outflows both in ordinary market conditions and during periods of extreme market stress. the Company’s policies address several key elements, such as the minimum levels of liquid assets to be held at all times; the composition of types of liquid assets to be maintained; daily monitoring of the liquidity position by treasury, senior management, and the eRM group; monthly reporting to the ALCO; and quarterly reporting to the Risk and Capital Committee of the Board. the Company uses a liquidity horizon as its main liquidity metric. using maturity gap analysis, the Company projects a time horizon when its net cumulative cash flow turns negative, after taking into account the market value of its stock of liquid assets. the Company’s liquidity horizon is calculated daily and is based upon contractual and behavioural cash flows. Forecasts are made using normal market conditions and a number of stressed liquidity scenarios, including ability to fund, deposit runoff, loan growth, liquidity portfolio valuation, loan arrears and write-downs. In addition, the Company regularly monitors a number of other structural funding and liquidity ratios in its overall funding and liquidity risk management framework. the Company holds liquid assets in the form of cash, bank deposits, securities issued or guaranteed by the Government of Canada, securities issued by provincial governments, and highly rated short-term money market securities, corporate bonds and debentures. At December 31, 2013, eligible liquid assets amounted to $1.49 billion, compared to $771.8 million at December 31, 2012. the Company’s main sources of funding come from retail deposits and securitization. Retail deposits are primarily sourced through the deposit broker network and the Company relies heavily on this channel. the majority of these deposits are received through channels that are controlled by several of the major Canadian banks. the broker network provides the Company with access to a very large volume of potential deposits, which are sourced almost entirely from individual investors or small businesses. the bulk of deposits raised are CDIC- insured fixed-term Guaranteed Investment Certificates (GICs) that are not subject to early redemption. the Company has contractual agreements with most major national investment dealers and a large number of independent brokers. the Company continues to add new investment dealers and independent brokers in order to diversify its sources of funds. In 2012, Home trust launched a high interest savings account (HISA) offered only through financial advisors and investment and mutual fund dealers. In 2013, the Company was successful in building national distribution of the HISA, with the balance growing to $337.2 million (2012 – $19.8 million). In 2012, Home trust commenced a multi-year project aimed at further diversifying its funding sources by building a direct-to-consumer deposit business. In november 2013, this business was re-branded Oaken Financial. All existing direct deposit customers were migrated to the Oaken brand. In conjunction with the launch of Oaken, Home trust launched the Oaken Savings Account to complement Oaken’s suite of GICs. In addition, in December 2013, the Company initiated an institutional deposits program, attracting $300 million of deposits in the initial offering. this is intended to be an ongoing program with deposit offerings twice annually. the offering was well received, with an oversubscription rate of 70% and an interest yield that is attractive to the Company. the Company is an approved nHA MBS issuer and an approved seller into the CMB program, which are securitization initiatives sponsored by CMHC. Securitization funding provides the Company with long-term matched funding at attractive interest rates. traditionally, the Company has used securitization markets to fund its Accelerator mortgages and insured multi-unit residential mortgages and, to a lesser extent, its traditional mortgages that qualified for bulk portfolio insurance. On-balance sheet Accelerator mortgages and multi-unit residential mortgages classified as held for sale are generally held for securitization and are funded with deposits until securitized. When mortgages are securitized, the Company receives principal and interest payments on its underlying mortgage loans before the required payments are passed through to MBS investors. However, as a part of its servicing obligations, the Company must pass-through any payments that are not collected due to arrears on a timely basis. In the case of defaults, the Company would make required payments to investors and place the mortgage/property through the insurance claims process to recoup any losses. this could result in cash flow timing mismatches that could marginally increase funding and liquidity risk. 64 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 upcoming oSFI liquidity Requirements In november 2013, OSFI issued for comment a draft of the Liquidity Adequacy Requirements (LAR) Guideline that is applicable to banks and federal trust and loan companies. the draft LAR Guideline is part of the ongoing rollout of Basel III in Canada and sets out the new standards OSFI will use to assess the adequacy of the Company’s liquidity. new standards include: Liquidity Coverage Ratio (LCR) – effective January 1, 2015. the LCR establishes a common measure of liquidity risk and requires institutions to maintain sufficient liquid assets to cover a minimum of 30 days of cash flow requirements in a stress situation. Net Stable Funding Ratio (NSFR) – effective January 1, 2018. the nSFR establishes a minimum acceptable amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one-year time horizon. Although OSFI is still in the process of finalizing the LAR Guideline, Home trust believes it is well positioned to comply with the new liquidity requirements. 2014 outlook for liquidity and Funding Risk the Company will continue to diversify its funding sources in 2014. While retail deposits sourced from the deposit broker channel will continue to provide the majority of the Company’s core funding, more reliance will be placed on the Company’s HISA, Oaken Financial, and the issuance of wholesale deposit notes in the institutional capital markets. It is anticipated that issuer competition for broker-sourced deposits may increase, possibly resulting in increased funding costs, whereby the Company would look to adjust its lending rates. It is also likely that the Company’s funding diversification strategy will result in higher funding costs as the Company looks to deepen its penetration directly with customers and establish a presence in wholesale funding markets. the rate of growth in the deposit portfolio is expected to mirror the growth of the Company’s non-insured loan portfolio, while securitization will continue to support insured mortgages. ensuring a reliable and sufficient source of deposits to fund operations and liquidity reserves will remain a key objective for the Company. operational Risk Operational risk, which is inherent in all business activities, is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Operational risk includes legal risk, but excludes strategic and reputational risk. the impact of operational risk may include financial loss, loss of competitive position, or regulatory enforcement actions, among others. It is an integral and unavoidable part of the Company’s business as it is inherent in every business and support activity, product and service. While operational risk cannot be eliminated, the Company has taken proactive steps to mitigate this risk. Strategies to manage operational risk include avoidance, transfer, acceptance and mitigation by controls. the Company continues to strengthen its operational risk framework with the addition of staff, introduction of enhanced risk tools and methodologies including key risk indicators, and improvement in its risk analytics. the Company’s investment in its business continuity program was integral to a nimble and effective response to the 2013 Alberta and toronto floods. Geo-spatial tools, using inputs from StatsCan census data, are being used to better inform the Company’s understanding of exposure to natural disasters and have the potential to be used for customer analytics, portfolio performance analysis, and to inform underwriting decisions in areas at high risk of natural disasters. the financial services sector, including the Company, remains exposed to cyber-crime risk. threats are increasing in scale, scope and complexity. the Company is enhancing its information security program. Despite the Company’s commitment to information and cyber security, the Company and its third-party service providers may not be able to fully mitigate all risks associated with the increased complexity and high rate of change in the threat landscape. Key elements of the Company’s operational risk framework include: Governance the Company maintains a system of comprehensive policies and an internal control framework designed to provide a sound and well- controlled operational environment. Operational risk policies are approved by the Operational Risk Committee and the Risk and Capital Committee of the Board. A three lines of defence model is used to manage operational risk, as described under Risk Governance. Oversight over the Company’s operational risk exposures is also provided by the Operational Risk Committee. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 65 management’s Discussion and Analysis risk identification and assessment A risk and control self-assessment program proactively identifies the Company’s exposure to key operational risks and assesses the effectiveness of mitigating controls. Risk assessments are also performed on significant new initiatives (e.g., products, services and systems) by business and support areas and other internal subject matter experts to ensure that associated risks are identified, assessed and approved, and that the Company’s control infrastructure can support the initiative prior to implementation. risk Measurement the Company has adopted the Basic Indicator Approach for operational risk under Basel II. In addition, scenario analysis and stress testing are used to assess the possible impact of extreme but plausible operational risk loss events. Scenario analysis and stressing testing provide a forward-looking basis for managing exposures within and potentially beyond the Company’s risk appetite. risk Monitoring and reporting the Company monitors key risk indicators to gain assurance that it remains within its stated risk appetite and to identify early warning signals of changes in the risk environment, control effectiveness and potential risk issues before they crystallize and result in financial loss or other negative impact. Operational losses, including near misses, are collected, analyzed and reported in order to reduce the likelihood of future recurrences and to strengthen risk management practices. the Company also proactively analyzes operational events in the industry and external environment to understand its exposure, if any, to similar events and takes steps to prevent such occurrences. Operational risk issues and action plans across the Company are centrally captured, classified, monitored and reported upon. Reporting and monitoring forms an integral part of the Company’s operational risk management processes, which are designed to ensure that risks and issues are identified, escalated and managed on a timely basis. Regular reporting is in place with respect to the Company’s current and emerging operational risks, key risk indicators, operational loss events, external event analyses, issues management, new initiative risk assessment, crisis management preparedness and third-party risk management. Business continuity and crisis Management the Company has implemented an all hazards based business continuity and crisis management strategy to minimize the impact on the Company’s clients and operations in the event of a disruption or other adverse event. corporate insurance the Company maintains insurance coverage through a financial institution bond policy, which is reviewed at least annually for changes to coverage and the Company’s operations. legislative and Regulatory Risk Legislative and regulatory risk refers to the risk of non-compliance with an applicable legislative or regulatory requirement (law, regulation, guideline, an undertaking to a regulatory authority or provision, section, subsection, order, term or condition). this includes requirements that have been identified by the Governance, Risk and Compliance Committee and senior management that require the Company to do certain things, including conducting its affairs in a particular manner, and where non-compliance could have an impact on the Company’s reputation and/or safety and soundness. While all business units of the Company (as the first line of defence) are responsible for ensuring that legislative and regulatory risk is mitigated, the independent oversight of legislative and regulatory risk is principally managed by the CCO, CAMLO and the Corporate Compliance group as part of the Company’s Compliance Framework. Reputational Risk Reputational risk is the risk that shareholders or the public will, with or without basis, judge the Company’s operations or practices negatively, potentially resulting in a decline in its value, brand, liquidity, or customer base. the Company views reputational risk as an exposure to earnings and/or capital from the consequence or failure to adequately manage any risk, regardless of the source, rather than a specific risk. Failure to effectively manage these risks can result in reduced market capitalization, loss of client loyalty, and the inability to achieve the Company’s strategic objectives. the Company aims to safeguard its public reputation through its governance, compliance and risk management processes. 66 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Risk Factors that may Affect Future Results In addition to the risks described in this Risk Management section, there are numerous other risk factors: in particular macroeconomic and industry factors beyond the Company’s control, which could cause the Company’s results to differ significantly from the Company’s plans, objectives and estimates. All forward-looking statements, including those in this MD&A, are subject to inherent risks and uncertainties, general and specific, which may cause the Company’s actual results to differ materially from the expectations expressed in the forward- looking statements. Some of these external factors are discussed below. Monetary and fiscal Policy the Company’s earnings are affected by the monetary policy of the Bank of Canada and the fiscal policy of the federal government of Canada and other governments in Canada and abroad. Changes in the supply of money, government spending and the general level of interest rates can affect the Company’s profitability. A change in the level of interest rates affects the interest spread between the Company’s deposits and loans and, as a result, impacts the Company’s net interest income. Changes in monetary and fiscal policy and in the financial markets are beyond the Company’s control and are difficult to predict or anticipate. Level of competition the Company’s performance is impacted by the level of competition in the markets in which it operates. the Company currently operates in a highly competitive industry. Customer retention can be influenced by many factors, such as the pricing of products or services, changes in customer service levels, changes in products or services offered, and general trends in consumer demand. changes in Legislation and regulations Changes in legislation and regulation, including interpretation or implementation, could affect the Company by limiting the scale and scope of its products and services. Also, the Company’s failure to comply with its legislative and regulatory requirements could result in sanctions and financial penalties that could adversely impact the Company’s earnings and damage its reputation and ability to operate as a regulated entity. information systems and technology the Company is highly dependent upon its information technology systems. the Company uses third-party software and software that it has developed or modified for its main operations and relies on third parties for credit card processing, Internet connections and access to external networks. Should the Company experience any major disruptions in operations or connections of software, Internet or telecommunications for voice or data, this would impair its ability to provide service to clients. the longer and more severe the disruption, the more the Company’s ability to conduct business would be impaired. accounting Policies and estimates Used by the company the accounting policies and estimates the Company utilizes determine how the Company reports its financial condition and results of operations, and they may require management to make estimates or rely on assumptions about matters that are inherently uncertain. Such estimates and assumptions may require revisions, and changes to them may materially adversely affect the Company’s results of operations and financial condition. More discussion is included in the Accounting Standards and policies section and within the notes to the consolidated financial statements. ability to attract and retain employees and executives the Company’s future performance depends to a large extent on its ability to attract and retain key personnel. there is strong competition for the best people in the financial services sector. there is no assurance that the Company will be able to continue to attract and retain key personnel, although this remains a fundamental corporate priority. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 67 management’s Discussion and Analysis ACC ount In G S tAnDARDS An D PolICIeS the significant accounting policies are outlined in note 2 to the consolidated financial statements included in this report. these policies are critical as they refer to material amounts and require management to make estimates. Critical accounting estimates that require management to make significant judgements, some of which are inherently uncertain, are outlined in note 2 to the consolidated financial statements included in this report. these estimates are critical as they involve material amounts and require management to make determinations that, by their very nature, include uncertainties. the preparation of consolidated financial statements in accordance with GAAp requires management to make estimates and assumptions, mainly concerning the valuation of items, which affect the amounts reported. Actual results could differ from those estimates. Key areas where management has made estimates and applied judgement include allowance for credit losses, fair values and impairment of financial instruments, goodwill and intangible assets, income taxes, fair value of stock options and useful lives of capital assets and intangible assets. In addition, the Company’s management has applied judgement in the application of its accounting policy with respect to derecognition of the loans and other assets used in current securitization programs. Most loans and other assets are not derecognized, based on management’s judgement that the Company has not transferred substantially all of the risks and rewards of ownership of the loans and other assets. Certain loans are recognized only to the extent of the Company’s continuing involvement, based on management’s judgement that it cannot be determined whether substantially all the risks and rewards of ownership have been transferred while control has been retained as defined by IAS 39 Financial Instruments: Recognition and Measurement (IAS 39). Certain loans where residual interests in securitized transactions are sold are derecognized based on management’s judgement that substantially all the risks and rewards of ownership have been transferred. Further information can be found under notes 4, 5, 6, 9, 10, 14, 16, 19 and 22 to the consolidated financial statements. ACC ount In G D eV elo P ment S the following new IFRS pronouncements have been issued but are not yet effective and may have a future impact on the Company: ifrs 9 Financial Instruments the Company will be required to adopt IFRS 9, Financial Instruments (IFRS 9), which is the first phase of the IASB’s project to replace IAS 39. On november 19, 2013, the IASB decided that the previously set mandatory effective date of January 1, 2015 would not allow sufficient time for entities to prepare to apply IFRS 9, and that a new date should be determined when IFRS 9 is closer to completion. IFRS 9 will provide new requirements for the way in which an entity should classify and measure financial assets and liabilities that are in the scope of IAS 39, with a final standard targeted in the first half of 2014. the standard requires all financial assets to be classified on the basis of the entity’s business model for managing such financial assets and the contractual cash flow characteristics of the financial assets. On november 19, 2013, the IASB introduced a new hedge accounting model. the general hedge accounting standard is intended to provide better links between an entity’s risk management activities, the rationale for hedging and the impact of hedging on the financial statements. the standard will potentially simplify the Company’s hedge accounting strategies. the impairment phase of the IASB’s financial instruments project is currently under development, with a review draft of the standard issued in March 2013 and a final standard targeted in the first half of 2014. Management is currently evaluating the potential impact that the adoption of IFRS 9 will have on the Company’s consolidated financial statements. 68 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 C ont RolS oVeR FInAnCIAl RePoRtI nG Disclosure Controls and Internal Control over Financial Reporting Management is responsible for establishing the integrity and fairness of financial information presented in the consolidated financial statements prepared in accordance with Canadian generally accepted accounting principles. As such, management has established disclosure controls and procedures and internal controls over financial reporting to ensure that the Company’s consolidated financial statements and Management’s Discussion and Analysis present fairly, in all material respects, the financial position of the Company and the results of its operations. Disclosure Controls and Procedures Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the Chief executive Officer and Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosure. An evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was conducted as of December 31, 2013. Based on that evaluation, the Company’s management, including the Chief executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures, as defined by national Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings, were effective as of December 31, 2013. Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAp. the Company’s internal control over financial reporting includes policies and procedures that: > pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; > provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAp, and receipts and expenditures are being made in accordance with authorizations of management and the Board of Directors of the Company; and > provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Due to inherent limitations, internal controls over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. As a result, the Company’s management acknowledges that its internal control over financial reporting will not prevent or detect all misstatements due to error or fraud. Furthermore, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of a change in conditions, or that the degree of compliance with the policies and procedures may deteriorate. the Company has used the Committee of Sponsoring Organizations of the treadway Commission (COSO) framework and COBIt, an It governance framework, to evaluate the design of the Company’s internal controls over financial reporting. An evaluation of the design and operating effectiveness of internal controls over financial reporting was conducted as of December 31, 2013. Based on that evaluation, the Company’s management, including the Chief executive Officer and Chief Financial Officer, concluded that the Company’s internal controls over financial reporting were operating effectively as of December 31, 2013. Changes in Internal Control over Financial Reporting there were no significant changes in 2013 that have affected or could reasonably be expected to materially affect internal control over financial reporting. Comparative Consolidated Financial Statements the comparative audited consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2013 audited consolidated financial statements. please see note 2 for further information. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 69 management’s Discussion and Analysis no n -GAAP me AS u Re S A n D G lo SSA RY non-GAAP measures the Company uses a number of financial measures to assess its performance. Some of these measures are not calculated in accordance with GAAp, are not defined by GAAp, and do not have standardized meanings that would ensure consistency and comparability between companies using these measures. the non-GAAp measures used in this MD&A are defined as follows: adjusted Net income and adjusted earnings per share After-tax changes that are associated with derivative restructuring related to IFRS conversion, after-tax charges related to the resolution of disputed loans to commercial condominium corporations and after-tax investment tax credit benefits are adjusted against net income to present adjusted net income. the reconciliation of net income to adjusted net income and the resulting adjusted earnings per share are presented in table 4 to this MD&A. Reconciliation of Net Income to Adjusted Net Income (000s, except % and per share amounts) Q4 2013 Q3 2013 $ 68,827 $ 66,417 850 net income Adjustment for derivative restructuring – IFRS conversion (net of tax) Adjustment for disputed loans to condominium corporations (net of tax) Adjustment for investment tax credit benefits (net of tax) (2,735) Adjusted net Income $ 68,207 $ 64,613 (1,470) 931 – – % Change Q4 2012 3.6% $ 58,965 Quarter % Change 2012 2013 16.7% $ 256,542 $ 221,983 Year to date % Change 15.6% (8.7%) 2,602 (67.3%) 5,873 2,602 125.7% – – – 1,508 – – (46.3%) – 5.6% $ 61,567 – – (6,190) 10.8% $ 257,733 $ 224,585 – 14.8% Adjusted Basic earnings per Share $ Adjusted Diluted earnings per Share $ 1.96 $ 1.86 5.4% $ 1.78 10.1% $ 7.43 $ 6.47 14.8% 1.95 $ 1.85 5.4% $ 1.77 10.2% $ 7.36 $ 6.45 14.1% allowance as a Percentage of Gross Loans Allowance as a percentage of gross loans is calculated as the total allowance divided by the gross on-balance sheet loans outstanding, which includes all on-balance sheet loans except for loans held for sale. assets to capital Multiple (acM) the ACM provided in this MD&A is that of the Company’s wholly owned subsidiary Home trust Company. the calculations are in accordance with guidelines issued by OSFI. the multiple reflects total regulatory assets, including specified off-balance sheet items net of other specified deductions, divided by total regulatory capital. common equity tier 1, tier 1, and total capital ratios the capital ratios provided in this MD&A are those of the Company’s wholly owned subsidiary Home trust Company. the calculations are in accordance with guidelines issued by OSFI. Refer to note 14(e) to the consolidated financial statements included in this report. efficiency or Productivity ratio Management uses the efficiency ratio as a measure of the Company’s efficiency in generating revenue. this ratio represents non-interest expenses as a percentage of total revenue, net of interest expense. the Company also looks at the same ratio on a taxable equivalent basis and will include this adjustment in arriving at the efficiency ratio, on a taxable equivalent basis. A lower ratio indicates better efficiency. 70 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Liquid assets Liquid assets are unencumbered high-quality assets for which there is a broad and active secondary market available to the Company to sell these assets without incurring a substantial discount. Liquid assets are a dependable source of cash used by the Company when it experiences short-term funding shortfalls. Market capitalization Market capitalization is calculated as the closing price of the Company’s common shares multiplied by the number of common shares of the Company outstanding. Net interest Margin (teB) net interest margin is a measure of profitability of assets. net interest margin (teB) is calculated by taking net interest income, on a taxable equivalent basis, divided by the average total assets generating the interest income. Net interest Margin (Non-teB) net interest margin is calculated by taking net interest income divided by the average total assets generating the interest income. Net Non-Performing Loans as a Percentage of Gross Loans (NPL ratio) the npL ratio is calculated as the total net non-performing loans divided by the gross on-balance sheet loans, which includes all on-balance sheet loans except for loans held for sale. Provision as a Percentage of Gross Loans (PcL ratio) the pCL ratio is calculated as the total individual and collective provision expense divided by the gross on-balance sheet loans outstanding, which includes all on-balance sheet loans except for loans held for sale. return on assets (roa) Return on assets is a profitability measure that presents the annualized net income as a percentage of the average total assets for the period deployed to earn the income. return on shareholders’ equity (roe) Return on equity is a profitability measure that presents the net income available to common shareholders as a percentage of the capital deployed to earn the income. the Company calculates its return on shareholders’ equity using average common shareholders’ equity, including all components of shareholders’ equity. risk-Weighted assets (rWa) the risk-weighted assets reported in this MD&A are those of the Company’s wholly owned subsidiary Home trust Company. the calculations are in accordance with guidelines issued by OSFI. Refer to note 14(e) to the consolidated financial statements included in this report. taxable equivalent Basis (teB) Most banks and trust companies analyze and discuss their financial results on a taxable equivalent basis (teB) to provide uniform measurement and comparison of net interest income. net interest income (as presented in the consolidated statements of income) includes tax-exempt income principally from preferred and common equity securities. the adjustment to teB used in this MD&A increases income and the provision for income taxes to what they would have been had the income from tax-exempt securities been taxed at the statutory tax rate. teB adjustments of $4.0 million for 2013 ($5.0 million – 2012) increased interest income as used in the calculation of net interest margin. net interest margin is discussed on a teB throughout this MD&A. See table 6 for the calculation of net interest income on a tax equivalent basis. total assets under administration (aUa) total assets under administration refers to all on-balance sheet assets plus all off-balance sheet loans that qualify for derecognition under IFRS. total Loans under administration (LUa) total loans under administration refers to all on-balance sheet loans plus all off-balance sheet loans that qualify for derecognition under IFRS. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 71 management’s Discussion and Analysis Glossary of terms Assets or loans under Administration refer to assets or loans administered by a financial institution that are beneficially owned by clients and therefore not reported on the balance sheet of the administering financial institution, plus all assets or loans beneficially owned by the Company and carried on the balance sheets. Average earning Assets represent the monthly average balance of deposits with other banks and loans and securities over a relevant period. Basis Point is one-hundredth of a percentage point. Canada Deposit Insurance Corporation (CDIC) is a Canadian federal Crown corporation created to protect qualifying deposits made with member financial institutions in case of their failure. Collective Allowance (previously referred to as the General Allowance) is established for incurred losses inherent in the portfolio that are not presently identifiable on a loan-by-loan basis and reflects the relative risk of the various loan portfolios that the Company manages. Derivatives used by the Company are contracts whose value is “derived” from movements in interest rates. Derivatives allow for the transfer, modification or reduction of current or expected risks from changes in rates. Forwards used by the Company are contractual agreements to either buy or sell a specified amount of an interest-rate-sensitive financial instrument or security at a specific price and date in the future. Forwards are customized contracts transacted in the over-the-counter market. Hedging is a risk management technique used by the Company to neutralize, manage or offset interest rate, equity, or credit exposures arising from normal banking activities. Impaired or non-performing loans are loans for which there is no longer reasonable assurance of the timely collection of principal or interest. Individual Allowances (previously referred to as Specific Allowances) reduce the carrying value of individual credit assets to the amount expected to be recovered if there is evidence of deterioration in credit quality. Insured loans are loans insured against default by CMHC or another approved insurer either individually at origination or by portfolio. the Company’s insured lending includes single-family homes and multi-unit residential properties. net Interest Income includes earnings on assets, such as loans and securities, including interest and dividend income, less interest expense paid on liabilities, such as deposits. notional Amount refers to the principal used to calculate interest and other payments under derivative contracts. the principal does not change hands under the terms of a derivative contract. office of the Superintendent of Financial Institutions Canada (oSFI) is the government agency responsible for regulation and supervision of banks, insurance companies, trust companies, loan companies and pension plans in Canada. Provision for Credit losses is a charge to income that represents an amount deemed adequate by management to fully provide for impairment in a portfolio of loans and other credit instruments, given the composition of the portfolio, the probability that default has occurred, the economic environment and the allowance for credit losses already established. Securitization is the practice of selling pools of contractual debts, such as residential or commercial mortgages, to third parties. Swaps are contractual agreements between two parties to exchange a series of cash flows. the only type of swap agreements used by the Company are interest rate swaps in which counterparties generally exchange fixed-rate and floating-rate interest payments based on a notional value in a single currency. Acronyms AlCo – Asset/Liability Committee IASB – International Accounting Standards Board AoCI – Accumulated Other Comprehensive Income IFRS – International Financial Reporting Standards CDIC – Canada Deposit Insurance Corporation ltV – Loan to Value (ratio expressed as a percentage) CmB – Canada Mortgage Bond mBS – Mortgage-Backed Security CmHC – Canada Mortgage and Housing Corporation mD&A – Management’s Discussion and Analysis CoSo – Committee of Sponsoring Organizations of the nCCF – net Cumulative Cash Flow treadway Commission eRm – enterprise Risk Management GAAP – Generally Accepted Accounting principles GIC – Guaranteed Investment Certificate nHA – national Housing Authority oCI – Other Comprehensive Income oSFI – Office of the Superintendent of Financial Institutions Canada teB – taxable equivalent Basis 72 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Consolidated Financial Statements Con S ol IDAte D FI n AnCI A l StAte m en tS Management’s Responsibility for Financial Information Independent Auditors’ Report Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Shareholders’ equity Consolidated Statements of Cash Flows note S to t H e C on Sol I DAte D FIn An CI Al StAte mentS 1. Corporate Information 2. Summary of Significant Accounting policies 3. Future Changes in Accounting policies 4. Cash Resources and Securities 5. Loans 6. Securitization Activity 7. Restricted Assets 8. Other Assets 9. Intangible Assets 10. Goodwill 11. Deposits by Remaining Contractual term to Maturity 12. Senior Debt 13. Other Liabilities 14. Capital 15. Accumulated Other Comprehensive Income 16. Income taxes 17. employee Benefits 18. Commitments and Contingencies 19. Derivative Financial Instruments 20. Current and non-current Assets and Liabilities 21. Interest Rate Sensitivity 22. Fair Value of Financial Instruments 23. Related party transactions 24. Risk Management p. 74 p. 75 p. 76 p. 77 p. 78 p. 78 p. 79 p. 80 p. 80 p. 87 p. 87 p. 89 p. 93 p. 95 p. 95 p. 96 p. 96 p. 97 p. 97 p. 97 p. 97 p. 99 p. 99 p. 100 p. 102 p. 103 p. 105 p. 106 p. 108 p. 111 p. 111 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 73 management’s Responsibility for Financial Information the consolidated financial statements of Home Capital Group Inc. were prepared by management, which is responsible for the integrity and fairness of the financial information presented. the consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles for publicly accountable enterprises, which are International Financial Reporting Standards as issued by the International Accounting Standards Board, including the accounting requirements specified by the Office of the Superintendent of Financial Institutions Canada that apply to its subsidiary Home trust Company. the consolidated financial statements reflect amounts which must, of necessity, be based on the best estimates and judgement of management with appropriate consideration as to materiality. the financial information presented elsewhere in this report is consistent with that in the consolidated financial statements. Management is responsible for ensuring the fairness and integrity of the financial information. It is also responsible for the implementation of the supporting accounting systems. In discharging its responsibilities, management maintains the necessary internal control systems designed to provide assurance that the transactions are properly authorized, assets are safeguarded and proper accounting records are held. the controls include quality standards in hiring and training of employees, written policies, authorized limits for managers, procedure manuals, a corporate code of business conduct and ethics and appropriate management information systems. Management has formed a disclosure committee, chaired by the CFO, which reviews all of the Company’s financial disclosures for fairness before release to the Board or shareholders. the internal control systems are further supported by a compliance function, which ensures that the Company and its employees comply with all regulatory requirements, as well as by an enterprise risk management function that ensures proper risk control, related documentation and the measurement of the financial impact of risks. In addition, the internal audit function periodically assesses various aspects of the Company’s operations and makes recommendations to management for, among other things, improvements to the control systems. every year, the Office of the Superintendent of Financial Institutions Canada makes such examinations and inquiries as deemed necessary to satisfy itself that Home trust Company is in a sound financial position and that it complies with the provisions of the trust and Loan Companies Act (Canada). ernst & Young LLp, independent auditors, appointed by the shareholders, perform an annual audit of the Company’s consolidated financial statements and their report follows. the internal auditors, the chief compliance officer, the external auditors and the Office of the Superintendent of Financial Institutions Canada meet periodically with the Audit Committee, with management either present or absent, to discuss all aspects of their duties and matters arising therefrom. the Board of Directors is responsible for reviewing and approving the consolidated financial statements and Management’s Discussion and Analysis of results of operations and financial condition appearing in the Annual Report. It oversees the manner in which management discharges its responsibilities for the presentation and preparation of financial statements, maintenance of appropriate internal controls, risk management as well as assessment of significant transactions and related party transactions through its Audit Committee. the Audit Committee is composed solely of Directors who are not Officers or employees of the Company. Gerald m. Soloway Chief Executive Officer toronto, Canada February 12, 2014 Robert j. Blowes, FCPA, FCA Chief Financial Officer 74 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Independent Auditors’ Report to the Shareholders of Home Capital Group Inc. We have audited the accompanying consolidated financial statements of Home Capital Group Inc., which comprise the consolidated balance sheets as at December 31, 2013 and 2012, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years ended December 31, 2013 and 2012, and a summary of significant accounting policies and other explanatory information. management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. the procedures selected depend on the auditors’ judgement, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Home Capital Group Inc. as at December 31, 2013 and 2012, and its financial performance and its cash flows for the years ended December 31, 2013 and 2012 in accordance with International Financial Reporting Standards. toronto, Canada February 12, 2014 Chartered Accountants Licensed public Accountants Home CAPItAl GRouP InC. AnnuAL RepORt 2013 75 December 31 2013 $ 728,469 424,272 137,975 5,210,021 12,671,905 17,881,926 (31,500) 17,850,426 652,986 29,886 162,679 89,157 934,708 $ 20,075,850 $ 429,269 12,336,685 12,765,954 147,343 660,964 5,112,100 5,773,064 3,809 173,558 34,425 211,792 18,898,153 70,233 5,984 1,119,959 (18,479) 1,177,697 $ 20,075,850 As at December 31 2012 $ 301,863 414,344 21,921 6,706,160 10,431,832 17,137,992 (30,000) 17,107,992 725,493 45,388 100,983 82,095 953,959 $ 18,800,079 $ 105,923 10,030,676 10,136,599 150,684 1,301,693 6,034,202 7,335,895 2,386 170,502 35,800 208,688 17,831,866 61,903 6,224 903,831 (3,745) 968,213 $ 18,800,079 Consolidated Balance Sheets thousands of Canadian dollars ASSetS Cash and Cash equivalents (note 4(A)) Available for Sale Securities (notes 4(B) and (C)) loans Held for Sale loans (note 5) Securitized mortgages (note 6) non-securitized mortgages and loans Collective allowance for credit losses (note 5(e)) other Restricted assets (note 7) Derivative assets (note 19) Other assets (note 8) Goodwill and intangible assets (notes 9 and 10) lIABIlItIeS AnD SHAReHolDeRS’ eQuItY liabilities Deposits (note 11) Deposits payable on demand Deposits payable on a fixed date Senior Debt (note 12) Securitization liabilities (note 6) Mortgage-backed security liabilities Canada Mortgage Bond liabilities other Derivative liabilities (note 19) Other liabilities (note 13) Deferred tax liabilities (note 16(C)) Shareholders’ equity Capital stock (note 14) Contributed surplus Retained earnings Accumulated other comprehensive loss (note 15) Commitments and Contingencies (note 18) the accompanying notes are an integral part of these consolidated financial statements. On behalf of the Board: Gerald m. Soloway Chief Executive Officer Robert A. mitchell Chair of Audit Committee 76 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Consolidated Statements of Income thousands of Canadian dollars, except per share amounts net Interest Income non-Securitized Assets Interest from loans (note 5(F)) Dividends from securities Other interest Interest on deposits Interest on senior debt net interest income non-securitized assets net Interest Income Securitized loans and Assets Interest income from securitized loans and assets (note 5(F)) Interest expense on securitization liabilities net interest income securitized loans and assets total net Interest Income provision for credit losses (note 5(e)) non-interest Income Fees and other income Securitization income (note 6(C)) net realized and unrealized gains (losses) on securities net realized and unrealized (loss) gain on derivatives (note 19) non-interest expenses Salaries and benefits premises Other operating expenses Income Before Income taxes Income taxes (note 16(A)) Current Deferred net InCome net InCome PeR Common SHARe (note 14(D)) Basic Diluted AVeRAGe numBeR oF Common SHAReS outStAnDInG (note 14(D)) Basic Diluted total number of outstanding common shares (note 14(B)) Book value per common share the accompanying notes are an integral part of these consolidated financial statements. December 31 2013 For the year ended December 31 2012 $ $ $ $ $ 629,247 11,165 8,283 648,695 268,233 6,612 373,850 225,793 177,664 48,129 421,979 15,868 406,111 61,252 12,648 2,589 (1,430) 75,059 481,170 70,954 9,901 62,883 143,738 337,432 82,128 (1,238) 80,890 256,542 7.40 7.32 34,670 35,023 34,744 33.90 $ $ $ $ $ 525,722 14,171 4,019 543,912 230,006 6,831 307,075 287,871 213,474 74,397 381,472 14,720 366,752 43,863 8,306 (55) 3,788 55,902 422,654 58,956 8,833 54,946 122,735 299,919 82,176 (4,240) 77,936 221,983 6.40 6.38 34,692 34,820 34,630 27.96 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 77 Consolidated Statements of Comprehensive Income thousands of Canadian dollars net InCome otHeR ComPReHenSIVe (loSS) InCome Available for Sale Securities and Retained Interests net unrealized (losses) gains net gains reclassified to net income Income tax (recovery) expense Cash Flow Hedges (note 19) net unrealized gains (losses) net losses reclassified to net income Income tax expense total other comprehensive (loss) income ComPReHenSIVe InCome the accompanying notes are an integral part of these consolidated financial statements. December 31 2013 $ 256,542 For the year ended December 31 2012 $ 221,983 (19,530) (2,584) (22,114) (5,859) (16,255) 702 1,362 2,064 543 1,521 (14,734) $ 241,808 6,462 (114) 6,348 1,775 4,573 (370) 1,462 1,092 219 873 5,446 $ 227,429 Consolidated Statements of Changes in Shareholders’ equity thousands of Canadian dollars, except per share amounts Capital Stock Contributed Surplus Retained earnings net unrealized Gains (losses) on Securities and Retained Interests Available for Sale, After tax net unrealized losses on Cash Flow Hedges, After tax total Accumulated other Comprehensive loss total Shareholders’ equity – – (70) 8,400 $ 61,903 $ Balance at December 31, 2012 Comprehensive income Stock options settled (notes 14(B), 17(C)) Amortization of fair value of employee stock options Repurchase of shares (note 14(C)) Dividends ($1.08 per share) Balance at December 31, 2013 $ 70,233 $ Balance at December 31, 2011 $ 55,104 $ Comprehensive income Stock options settled (notes 14(B), 17(C)) Amortization of fair value of employee stock options Repurchase of shares (note 14(C)) Dividends ($0.90 per share) Balance at December 31, 2012 – 61,903 $ 7,088 (289) – – – $ 6,224 $ 903,831 $ 432 $ – 256,542 (16,255) (4,177) $ 1,521 (3,745) $ 968,213 241,808 (14,734) (2,202) 1,962 – – – – (2,232) (38,182) – – – – 5,984 $1,119,959 $ (15,823) $ (4,141) $ 5,873 $ 722,999 $ 4,573 221,983 – – – – – – – 6,198 1,962 (2,302) – – (38,182) (2,656) $ (18,479) $ 1,177,697 (9,191) $ 774,785 (5,050) $ 227,429 5,446 873 (1,408) 1,759 – – – – (7,828) (33,323) 6,224 $ 903,831 $ – – – – – – – – – 5,680 1,759 (8,117) – 432 $ – (4,177) $ – (33,323) (3,745) $ 968,213 the accompanying notes are an integral part of these consolidated financial statements. 78 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Consolidated Statements of Cash Flows thousands of Canadian dollars CASH FloWS FRom oPeRAtInG ACtIVItIeS net income for the year Adjustments to determine cash flows relating to operating activities: Deferred income taxes Amortization of capital assets Amortization of intangible assets Amortization of net premium on securities Amortization of securitization and senior debt transaction costs provision for credit losses Change in accrued interest payable Change in accrued interest receivable net realized and unrealized (gains) losses on securities Realized gain on securitization Settlement of derivatives Loss (gain) on derivatives net increase in mortgages net decrease (increase) in restricted assets net increase in credit card loans and other consumer retail loans net increase in deposits Activity in securitization liabilities proceeds from sale of mortgage-backed securities derecognized proceeds from sale of mortgage-backed securities Settlement and repayment of securitization liabilities Amortization of fair value of employee stock options Changes in taxes payable and other Cash flows provided by (used in) operating activities CASH FloWS FRom FInAnCInG ACtIVItIeS Repurchase of shares exercise of employee stock options Dividends paid to shareholders Cash flows used in financing activities CASH FloWS FRom InVeStInG ACtIVItIeS Activity in securities purchases proceeds from sales purchases of capital assets Capitalized intangible development costs Cash flows used in investing activities net increase (decrease) in cash and cash equivalents during the year Cash and cash equivalents at beginning of the year Cash and Cash equivalents at end of the Year (note 4(A)) Supplementary Disclosure of Cash Flow Information Dividends received on investments Interest received Interest paid Income taxes paid the accompanying notes are an integral part of these consolidated financial statements. December 31 2013 For the year ended December 31 2012 $ 256,542 $ 221,983 (1,238) 3,504 7,864 2,562 18,729 15,868 13,624 (1,388) (2,589) (12,648) 3,816 1,643 (1,980,163) 72,507 (35,002) 2,629,355 602,948 635,101 (1,686,739) 1,962 (31,475) 514,783 (2,302) 6,198 (37,458) (33,562) (182,382) 150,494 (7,801) (14,926) (54,615) 426,606 301,863 $ 728,469 $ 9,022 853,125 443,646 98,724 (4,240) 3,118 6,715 2,460 13,396 14,720 13,519 (5,434) 55 (8,306) (370) (3,788) (1,943,195) (252,493) (40,845) 2,214,475 242,576 407,848 (1,044,674) 1,759 (7,194) (167,915) (8,117) 5,680 (31,244) (33,681) (335,218) 317,748 (4,324) (9,141) (30,935) (232,531) 534,394 301,863 12,626 807,870 438,026 79,887 $ $ Home CAPItAl GRouP InC. AnnuAL RepORt 2013 79 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 1 CoRPoRAte InF oRmAtIon Home Capital Group Inc. (the Company) is a public corporation traded on the toronto Stock exchange. the Company is incorporated and domiciled in Canada with its registered and principal business offices located at 145 King Street West, Suite 2300, toronto, Ontario. the Company operates primarily through its federally regulated subsidiary, Home trust Company (Home trust), which offers deposits, residential and non-residential mortgage lending, securitization of insured residential first mortgage products, consumer lending and credit card products. the Company’s subsidiary, payment Services Interactive Gateway Inc. (pSiGate), provides payment card services. Licensed to conduct business across Canada, Home trust has branch offices in Ontario, Alberta, British Columbia, nova Scotia, Quebec and Manitoba. the Company is the ultimate parent of the group. these consolidated financial statements for the year ended December 31, 2013 were authorized for issuance by the Board of Directors (the Board) of the Company on February 12, 2014. the Board has the power to amend the consolidated financial statements after their issuance only in the case of discovery of an error. Subsequent to the end of the year and before the date these consolidated financial statements were authorized for issuance, the Board of Directors declared a quarterly cash dividend of $11.1 million or $0.32 per common share payable on March 1, 2014 to shareholders of record at the close of business on February 24, 2014. In addition, on February 12, 2014 the Board approved a stock dividend of one common share per outstanding common share. note 2 SummARY oF SIGnIFICAnt ACCoun tInG P o lI C Ie S the consolidated financial statements of the Company have been prepared in accordance with Canadian generally accepted accounting principles (GAAp) for publicly accountable enterprises, which are International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). the accounting policies were consistently applied to all periods presented unless otherwise noted. the significant accounting policies used in the preparation of these consolidated financial statements are summarized below. Comparative Consolidated Financial Statements the comparative consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2013 consolidated financial statements. the primary change was the reclassification of Home trust mortgage-backed securities used as Canada Mortgage Bond replacement assets as securitized mortgages. In prior periods, these mortgage-backed securities were classified as pledged securities. Restricted cash and pledged securities have been reclassified to restricted assets on the consolidated balance sheets. previously, they were included with cash resources and securities, respectively. Fair value changes in loans held for sale and the derivative gains or losses on bond forwards entered into to hedge interest rate risk on these loans have been reclassified to securitization income on the consolidated statements of income. In addition, the Company’s disclosure of earnings by business segment has been replaced by disclosure of interest income by product group, as this was determined to be a better reflection of how the business is managed. use of judgement and estimates Management has exercised judgement in the process of applying the Company’s accounting policies. In particular, the Company’s management has applied judgement in the application of its accounting policy with respect to derecognition of the loans and other assets used in current securitization programs. Most loans and other assets that have been securitized are not derecognized, based on management’s judgement that the Company has not transferred substantially all of the risks and rewards of ownership of the loans and other assets. Certain securitized loans are recognized only to the extent of the Company’s continuing involvement, based on management’s judgement that it cannot be determined whether substantially all the risks and rewards of ownership have been transferred while control has been retained as defined by IAS 39 Financial Instruments: Recognition and Measurement (IAS 39). When residual interests in securitized transactions are sold, the underlying securitized loans are derecognized based on management’s judgement that substantially all the risks and rewards of ownership have been transferred through the two transactions. the preparation of consolidated financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet dates and the reported amounts of revenue and expenses during the reporting periods. Key areas where management has made estimates include allowance for credit losses, fair values and impairment of financial instruments, goodwill and intangible assets, income taxes, fair value of stock options and useful lives of capital assets and intangible assets. Actual results could differ from those estimates. 80 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Principles of Consolidation the consolidated financial statements include the assets, liabilities and results of operations of the Company and all of its subsidiaries, after the elimination of intercompany transactions and balances. Subsidiaries are entities the Company controls. the Company has control when it has power over the entity, has exposure or rights to variable returns from its involvement and has the ability to use its power over the entity to affect returns. the subsidiaries included in the consolidated financial statements are Home trust and pSiGate, both of which are wholly owned. Cash and Cash equivalents For the purposes of the consolidated financial statements, cash and cash equivalents comprise balances with less than 90 days to maturity from the date of acquisition, including cash and deposits with regulated financial institutions, treasury bills and other eligible deposits. Cash and deposits are carried at amortized cost, which approximates fair value due to the short-term nature of the instruments. Interest income is recognized using the effective interest rate method and, to the extent not received at year end, recorded as a receivable in other assets on the consolidated balance sheets. Securities Securities are classified as either held for trading or available for sale, based on management’s intentions. On the trade date, all securities are recognized at their fair value, which is normally the transaction price. Held for trading securities are financial assets purchased for resale, generally within a short period of time and primarily held for liquidity purposes. Interest earned is included in other interest income. Held for trading securities are measured at fair value, using published bid prices, as at the consolidated balance sheet dates. All realized and unrealized gains and losses are reported in income under non-interest income. transaction costs are expensed as incurred. the Company has not elected under the fair value option to designate any financial asset or liability as held for trading, nor does the Company have any securities classified as held for trading. Available for sale securities are financial assets purchased for longer-term investment that may be sold in response to or in anticipation of changes in market conditions. Dividends and interest earned are included in dividends from securities or other interest income. Available for sale securities are measured at their fair value, using published bid prices, as at the consolidated balance sheet dates. unrealized gains and losses, net of related taxes, are included in accumulated other comprehensive income (AOCI) until the security is sold or an impairment loss is recognized, at which time the cumulative gain or loss is transferred to net income. transaction costs are capitalized. At the end of each reporting period, the Company conducts a review to assess whether there is any objective evidence that an available for sale security is impaired. Objective evidence of impairment results from one or more events that occur after the initial recognition of the security and which event (or events) has an impact that can be reliably estimated on the estimated future cash flows of the security. Such objective evidence includes observable data that comes to the attention of the Company such as significant financial difficulty of the issuer of the security. In the case of equity securities, objective evidence of impairment includes a significant or prolonged decline in the fair value of the security below its cost. the determination of what is significant or prolonged is based on management’s judgement. Generally, management considers a significant decline to be 20% or more and a prolonged decline to be 12 months or more. When there is objective evidence of an impairment of an available for sale security, any cumulative loss that has been recognized in other comprehensive income (OCI) is reclassified from AOCI to net income. the amount of the cumulative loss reclassified is the difference between the acquisition cost (net of any principal repayment, amortization and cumulative losses recognized in net income) and current fair value. In the case of debt securities, subsequent increases in fair value that can be objectively related to an event occurring after the impairment loss was recognized result in a reversal of the impairment loss through net income. Impairment losses on equity securities are not subsequently reversed through net income. obligations Related to Securities Sold under Repurchase Agreements the purchase and sale of securities under sale and repurchase agreements are accounted for as collateralized lending and borrowing transactions and are recorded at cost. the related interest income and interest expense are recorded on an accrual basis in the consolidated statements of income. the Company does not have any obligations related to securities sold under repurchase agreements in 2013 or 2012. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 81 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) loans Held for Securitization and Sale When identifiable, loans for which the Company has the intention of securitizing and derecognizing from the consolidated balance sheets in the near term are classified as held for trading for accounting purposes and are carried at fair value. unrealized gains and losses resulting from the change in fair value of these loans are reported as securitization income in non-interest income on the consolidated statements of income. Interest income earned on these loans is included in interest from loans. the fair value of loans held for trading is determined by discounting the expected future cash flows of the loans at market rates for financial instruments with similar terms and credit risk. loans Loans are recorded at amortized cost using the effective interest rate method. Interest income is allocated over the expected term of the loan by applying the effective interest rate to the carrying amount of the loan. the effective interest rate is the rate that exactly discounts estimated future cash receipts over the expected life of the loan. Origination revenues and costs are applied to the carrying amount of the loan. Loans are carried net of the individual allowance for credit losses and any unearned income. Interest income is accrued as earned with the passage of time and continues to accrue when a loan is considered impaired (with an appropriate allowance for credit loss as discussed below). A loan is recognized as being impaired (non-performing) when the Company is no longer reasonably assured of the timely collection of the full amount of principal and interest. As a matter of practice, an uninsured residential or commercial mortgage, a retail loan, or equityline Visa loan is deemed to be impaired at the earlier of the date it has been individually provided for or when it has been in arrears for 90 days. Single-family and multi-unit residential mortgages (including securitized mortgages) guaranteed by the Government of Canada are not considered impaired until payment is contractually 365 days past due. Credit losses are not anticipated on insured mortgages. Secured and unsecured credit card balances that have a payment that is contractually 120 days in arrears are individually provided for, and those that have a payment that is 180 days in arrears are written off. When loans are classified as impaired, the book value of such loans is adjusted to their estimated realizable value based on the fair value of any security underlying the loan, net of any costs of realization, by totally or partially writing off the loan and/or establishing an allowance for loan losses as described below. An impaired loan is not returned to an unimpaired status unless all principal and interest payments are up to date, and management is reasonably assured of the recoverability of the loan. Allowance for Credit losses An allowance for credit losses is maintained at an amount that, in management’s opinion, is considered adequate to absorb all credit-related losses that have occurred in the portfolio whether or not detected at the period end, including accrued interest on impaired loans. Allowances are mainly related to loans but may also apply to other assets. the allowance consists of accumulated individual and collective allowances, each of which is reviewed at least quarterly. the collective allowance is deducted from total loans on the consolidated balance sheets. individual allowances Individual allowances are determined on an item-by-item basis and reflect the associated estimate of credit loss. In the case of loans and equityline Visa credit cards, the individual allowances are the amounts required to reduce the carrying value of an impaired asset, including accrued interest, to its estimated realizable amount. the fair value of the underlying security is used to estimate the realizable amount of the receivable. the allowance is the difference between the receivable’s carrying value, including accrued interest, and its estimated realizable amount. For secured and unsecured credit card receivables, individual allowances are provided for arrears over 120 days. collective allowances Collective allowances are established to absorb credit losses on the aggregate exposures in each of the Company’s loan portfolios for which losses have been incurred but not yet individually identified. the collective allowance is based upon statistical analysis of past performance, level of allowance already in place and management’s judgement. the collective allowance, based on the historical loss experience adjusted to reflect changes in the portfolios and credit policies, is applied to each pool of loans with common risk characteristics. this estimate includes consideration of economic and business conditions. the provision for credit losses that is charged to the consolidated statements of income is the amount required to establish a balance in the allowance for credit losses account that the Company’s management considers adequate to absorb all credit-related losses in its portfolio of balance sheet items after charging amounts written off during the year, net of any recoveries, to the allowance for credit losses account. 82 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Securitized loans and Securitization liabilities the Company periodically securitizes mortgages and sells the securities to investors or Canada Mortgage and Housing Corporation (CMHC) sponsored entities. Mortgage loan securitization is part of the Company’s liquidity and funding strategy. the Company securitizes through to CMHC sponsored programs. In the absence of sales of retained interests (see below), most transfers of pools of mortgages under the current programs do not result in derecognition of the mortgages from the Company’s consolidated balance sheets. As such, these transactions result in the recognition of securitization liabilities when cash is received from the securitization entities. Such mortgages are reclassified to securitized residential mortgages on the consolidated balance sheets and continue to be accounted for as loans, as described above. the securitization liabilities are recorded at amortized cost using the effective interest rate method. Interest expense is allocated over the expected term of the borrowing by applying the effective interest rate to the carrying amount of the liability. the effective interest rate is the rate that exactly discounts estimated future cash outflows over the expected life of the liability. transaction costs and premiums or discounts are applied to the carrying amount of the liability. Also included in securitization liabilities on the consolidated balance sheets are amounts related to fair value hedge accounting that increase or decrease the carrying amount of the securitization liability. please see note 19 for more information. In certain cases, the Company’s remaining involvement is quite limited, although it has not transferred substantially all of its risks and rewards in the underlying loans and it has retained control, as defined by IAS 39. Such mortgages are securitized and sold and the Company has residual interest and servicing responsibilities for the assets sold, with very little exposure to variable cash flows. the Company accounts for its continuing involvement as retained interests and servicing liabilities on the consolidated balance sheets. Gains or losses on these transactions are recognized as securitization income in non-interest income on the consolidated statements of income and are dependent in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests, based on their relative fair value at the date of transfer and net of transaction costs. Retained interests are classified as available for sale assets and are stated at their fair value with unrealized gains and losses reported in AOCI. the fair value of the retained interests is estimated using discounted cash flow methodology. Retained interests are revalued quarterly to assess for impairment. In certain circumstances, the Company sells its residual interest arising from securitization transactions. When this results in the Company transferring substantially all of the risks and rewards of ownership associated with the underlying mortgages, the mortgages are derecognized and a resulting gain or loss is recorded. these gains or losses are recognized as securitization income in non-interest income on the consolidated statements of income and are dependent in part on the previous carrying amount of the financial assets involved in the transfer. Restricted Assets Restricted assets include cash or cash equivalents and securities that are contractually restricted, such as collateral associated with derivative transactions and participation in securitization programs. Restricted assets also include cash, non–Home trust MBS or treasury bills pledged as Canada Mortgage Bond replacement assets. the accounting treatment for cash and securities is described above. Derivatives Held for Risk management Purposes the Company utilizes derivatives to manage interest rate risk. Derivatives are carried at fair value and are reported as assets if they have a positive fair value and as liabilities if they have a negative fair value. the Company applies hedge accounting to derivatives that meet the criteria for hedge accounting in accordance with IAS 39. the Company utilizes two types of hedge relationships for accounting purposes, fair value hedges and cash flow hedges. If derivative instruments do not meet all of the criteria for hedge accounting, the changes in fair value of such derivatives are recognized in net income. In order to qualify for hedge accounting, a hedge relationship must be designated and formally documented in accordance with IAS 39. the Company’s documentation, in accordance with the requirements, includes the specific risk management objective and strategy being applied, the specific financial asset or liability or cash flow being hedged and how hedge effectiveness is assessed. to qualify for hedge accounting, the Company has decided that there must be a correlation of between 80% and 125% in the changes in fair values or cash flows between the hedged and hedging items. Hedge effectiveness is assessed at the inception of the hedge and on an ongoing basis, at least quarterly. Hedge ineffectiveness occurs when the changes in the fair value of the hedging item (derivative) differ significantly from the fair value changes in the hedged risk in the hedged item. Hedge ineffectiveness is recognized immediately in income. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 83 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) Fair Value Hedges Fair value hedges generally use interest rate swap derivatives to hedge changes in the fair value of fixed-rate assets or liabilities (“the hedged items”) attributable to interest rate risk. Changes in fair value of the hedged items are recorded as part of the carrying value of the hedged items and are recognized in “net realized and unrealized gain (loss) on derivatives”. Changes in fair value of the hedging item (interest rate swap) are also recognized in “net realized and unrealized gain (loss) on derivatives”. If the hedging instrument expires, or is settled or sold, or if the hedge no longer meets the criteria for hedge accounting under IAS 39, the hedge relationship is terminated and the fair value adjustment on the hedged item is then amortized over the remaining term of the hedged item. If the hedged item is settled, the unamortized fair value adjustment is recognized in income immediately. Cash Flow Hedges Cash flow hedges generally use bond forwards or interest rate swaps to hedge changes in future cash flows attributable to interest rate fluctuations arising on highly probable forecasted issuances of fixed-rate liabilities. the effective portion of the change in fair value of the derivative instrument is recognized in OCI until the forecasted cash flows being hedged are recognized in income in future accounting periods. When the forecasted cash flows are recognized in income, an appropriate amount of the fair value changes of the derivative instrument is reclassified from AOCI into income. Any hedge ineffectiveness is immediately recognized in non-interest income. If the forecasted issuance of fixed-rate liabilities is no longer expected to occur, the related cumulative gain or loss in AOCI is immediately recognized in income. Capital Assets Capital assets, which comprise office furniture and equipment, computer equipment and software, and leasehold improvements, are recorded at cost and amortized over their estimated useful lives on a straight-line basis. the ranges of useful lives for each asset type are as follows: Office furniture and equipment 5 to 10 years Computer equipment and software 3 to 7 years Leasehold improvements are amortized on a straight-line basis over the remaining term of the lease. the Company assesses, at each reporting period date, whether there is an indication that a capital asset may be impaired. If any indication of impairment exists, the Company performs an impairment test to determine whether an impairment loss is required to be recognized. the impairment tests are performed in accordance with the steps discussed in the accounting policy note below entitled Impairment of Capital Assets and Intangible Assets. Goodwill Goodwill is initially measured as the excess of the price paid for the acquisition of a consolidated entity over the fair value of the net identifiable tangible and intangible assets acquired. Goodwill is allocated to the cash-generating units (CGus) or groups of CGus that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units. A CGu is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. each unit to which the goodwill has been allocated represents the lowest level within the Company at which the goodwill is monitored for internal management purposes. Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is evaluated for impairment annually or more often if events or circumstances indicate there may be impairment. Impairment is determined for goodwill by assessing whether the carrying amount of a CGu, including the allocated goodwill, exceeds its recoverable amount. the recoverable amount is determined as the greater of the estimated fair value less the costs of disposal or the value in use. Impairment losses recognized in respect of a CGu are first allocated to the carrying amount of goodwill and any excess is allocated pro rata to the carrying amount of other assets in the CGu, on the basis of the carrying amount of each asset in the unit. Any goodwill impairment is charged to income in the period in which the impairment is identified. Impairment losses on goodwill are not subsequently reversed. 84 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Intangible Assets An intangible asset is recognized only when its cost can be measured reliably and it is probable that the expected future economic benefits that are attributable to the asset will flow to the Company. Following initial recognition, intangible assets are carried at cost less any accumulated amortization and any accumulated impairment losses. the Company’s intangible assets comprise software development costs. the Company’s software development costs are considered to have finite useful lives and are amortized on a straight-line basis over their useful lives, generally not exceeding 10 years. the amortization period and the amortization method are reviewed at least at each financial year end. Changes in the expected useful lives are accounted for by changing the amortization period, as appropriate, and treated as changes in accounting estimates. Amortization expense is included in other operating expenses in the consolidated statements of income. the Company capitalizes eligible development costs related to software projects. eligible costs include external direct costs for materials and services, as well as payroll and payroll-related costs for employees directly associated with development. the Company commences amortization of these costs over the appropriate useful life when development of the asset is substantially complete and the asset becomes available for use in the manner intended by management. Overhead costs, costs incurred during the research phase, costs to train staff to operate the asset and costs incurred after the software was substantially completed and available for use are expensed as incurred. the Company assesses, at each reporting period date, whether there is an indication that an intangible asset may be impaired. If any indication of impairment exists, the Company performs an impairment test to determine whether an impairment loss is required to be recognized. In relation to development costs for software that is not yet available for use, the Company performs an impairment test on an annual basis as well as when indications of impairment exist. Such annual impairment tests will continue until the software is available for use. the impairment tests are performed in accordance with the steps discussed in the accounting policy note below entitled Impairment of Capital Assets and Intangible Assets. Impairment of Capital Assets and Intangible Assets the Company assesses at each reporting date whether there is an indication that an asset may be impaired. If any indication exists, or when annual impairment testing for an asset is required, the Company estimates the asset’s recoverable amount. If it is not possible to determine the recoverable amount of the individual asset, the Company determines the recoverable amount of the CGu to which the asset belongs. the recoverable amount of an asset or a CGu is the higher of its fair value less costs of disposal and its value in use, where value in use is the present value of the future cash flows expected to be derived from the asset or the CGu. Where the carrying amount of the asset or the CGu exceeds its recoverable amount, the asset is considered impaired and written down to its recoverable amount. the Company evaluates impairment losses for potential reversals when events or changes in circumstances warrant such consideration. Deposits Deposits are financial liabilities that are measured at cost using the effective interest rate method. Deposit origination costs are included in deposits on the consolidated balance sheets as incurred and amortized to interest expense over the term of the deposit. Senior Debt Senior debt is carried at amortized cost, including the principal amount received on issue, plus accrued interest and costs incurred on issue, less repayments of principal and interest, amortization of issue costs and any premium or discount to the face amount of the debt. Issue costs and premiums or discounts are amortized to income using the effective interest rate method. Also included in senior debt on the consolidated balance sheets are amounts related to fair value hedge accounting which increase or decrease the carrying amount of the senior debt. please see note 19 for more information. Income taxes the Company follows the asset and liability method of accounting for income taxes, whereby deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted or substantively enacted tax rates applicable to taxable income in the period in which those temporary differences are expected to be recovered or settled. Deferred tax assets are only recognized for deductible temporary differences, carry forward of unused tax credits and losses to the extent that it is probable that taxable profit will be available and the carry forward of unused tax credits and losses can be utilized. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 85 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) Fair Value Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is measured using the principal market or most advantageous market that is accessible to the Company for the asset or liability. Valuation techniques used to determine fair value maximize the use of relevant observable inputs and minimize the use of unobservable inputs. If the asset or liability measured at fair value has a bid price and an ask price, the price within the bid-ask spread that is most representative of fair value in the circumstances is used to measure the fair value. please see note 22 for more information on the specific valuation techniques used to determine fair value and the related inputs for each class of assets or liabilities where fair value is disclosed. Inputs for valuation techniques used to measure fair value are categorized into three levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that are accessible at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. please see note 22 for more information. When inputs used to measure the fair value of an asset or liability are categorized within different levels of the fair value hierarchy, the fair value measurement is categorized in its entirety in the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement. Fee Income Fee income is accrued and recognized as income as the associated services are rendered. Stock-based Compensation Plans the Company has stock-based compensation plans, which are described in note 17. the Company’s employee Stock Option plan provides for the granting of stock options to certain employees of the Company. In some cases, stock appreciation rights are also granted in tandem with the stock option, providing the Company with, at its sole discretion, the alternative of settling the award in cash at an amount equal to the excess of the market price of the shares to which the option relates over the exercise price of the option. the Company accounts for stock options, including those with tandem stock appreciation rights, as equity- settled transactions where the fair value of options granted is charged to salary expense over the option vesting period, with the offsetting amount recognized in contributed surplus. For awards with graded vesting, the fair value of each tranche is recognized separately over its respective vesting period. For each reporting period, the Company reassesses its estimates of the number of awards that are expected to vest and recognizes the impact of any revision in the consolidated statements of income with a corresponding adjustment to equity. the fair value of the options granted is determined using a Black-Scholes option pricing model. the Company offers a deferred share unit (DSu) plan that is only open to non-employee Directors of the Company who annually elect to accept remuneration in the form of cash, cash and DSus or DSus. the Company accounts for the DSus as cash-settled transactions. under the plan, the obligations for the DSus are accrued quarterly based on the Directors’ remuneration for the quarter. the obligations are periodically adjusted for fluctuations in the market price of the Company’s common shares and allow for dividend equivalents. Changes in obligations under the plan are recorded as salaries and benefits in the consolidated statements of income, with a corresponding increase in other liabilities on the consolidated balance sheets. the Company grants restricted share units (RSus) to certain key members of management. RSus are settled in cash equivalents of common shares. RSus earn dividend equivalents in the form of additional RSus at the same rate as dividends on common shares. Changes in the obligation resulting from changes in the market price of common shares are recognized in the consolidated statements of income as compensation expense, proportionally to the amount of the reward recognized. the Company grants performance share units (pSus) to certain key members of management. pSus are settled in cash equivalents of common shares. pSus earn dividend equivalents in the form of additional pSus at the same rate as dividends on common shares. Changes in the obligation resulting from changes in the market price of common shares are multiplied by a performance factor ranging from 0% to 200% and are recognized in the consolidated statements of income as compensation expense, proportionally to the amount of the reward recognized. employee Benefit Plans under both the employee Share Ownership plan and the employee Retirement Savings plan, the Company’s contribution is expensed when paid. please see note 17 for more information. 86 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 earnings per Share Both basic and diluted earnings per share (epS) are presented for the Company’s common shares. Basic income per common share is determined as net income for the year divided by the average number of common shares outstanding for the year. Diluted income per common share is determined as net income for the year divided by the average number of common shares outstanding plus the stock options potentially exercisable for the year, as determined under the treasury stock method. the treasury stock method determines the net number of incremental common shares that could be purchased with the assumption that all in-the-money stock options are exercised and the proceeds are used to purchase common shares at the average market price during the year. note 3 FutuRe CHA nGeS In ACC o untI nG Po lI C Ie S the following accounting pronouncements issued by the IASB were not effective as at December 31, 2013 and therefore have not been applied in preparing these consolidated financial statements. IFRS 9 financial instruments the Company will be required to adopt IFRS 9, Financial Instruments (IFRS 9), which is the first phase of the IASB’s project to replace IAS 39. On november 19, 2013, the IASB decided that the previously set mandatory effective date of January 1, 2015 would not allow sufficient time for entities to prepare to apply IFRS 9, and that a new date should be determined when IFRS 9 is closer to completion. IFRS 9 will provide new requirements for the way in which an entity should classify and measure financial assets and liabilities that are in the scope of IAS 39, with a final standard targeted in the first half of 2014. the standard requires all financial assets to be classified on the basis of the entity’s business model for managing such financial assets and the contractual cash flow characteristics of the financial assets. On november 19, 2013, the IASB introduced a new hedge accounting model. the general hedge accounting standard is intended to provide better links between an entity’s risk management activities, the rationale for hedging and the impact of hedging on the financial statements. the standard will potentially simplify the Company’s hedge accounting strategies. the impairment phase of the IASB’s financial instruments project is currently under development, with a review draft of the standard issued in March 2013 and a final standard targeted in the first half of 2014. Management is currently evaluating the potential impact that the adoption of IFRS 9 will have on the Company’s consolidated financial statements. note 4 CASH ReS ouRCeS AnD S e CuR I tI eS (A) Cash Resources thousands of Canadian dollars Cash and Cash equivalents Deposits with regulated financial institutions Cash resources unrestricted to Company use December 31 2013 December 31 2012 $ $ 728,469 $ 728,469 $ 301,863 301,863 the Company has a revolving term credit facility with a Canadian chartered bank in the amount of $50 million, which is available to the Company subject to meeting certain financial ratio requirements. As at December 31, 2013, all ratio requirements have been met and no amounts have been drawn against the borrowing facility. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 87 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (B) Available for Sale Securities at Fair Value by type and Remaining term to maturity and Rate Reset Date December 31 2013 December 31 2012 thousands of Canadian dollars Debt securities Common shares preferred shares Mutual funds Within 1 Year $ 1 to 3 Years 3 to 5 Years over 5 Years 134,573 $ 60 65,128 1,655 201,416 $ 14,986 $ – 114,669 – 129,655 $ – $ – 77,512 – 77,512 $ – $ – 15,689 – 15,689 $ $ total Fair Value total Fair Value 149,559 $ 104,832 8,836 299,557 1,119 414,344 60 272,998 1,655 424,272 $ (C) Available for Sale Securities – net unrealized Gains and losses thousands of Canadian dollars, except % Debt securities Common shares preferred shares Mutual funds thousands of Canadian dollars, except % Debt securities Common shares preferred shares Mutual funds As at December 31, 2013 Gross unrealized Gains Gross unrealized losses 58 $ 25 – 654 737 $ – $ – (21,715) – (21,715) $ total Fair Value 149,559 60 272,998 1,655 424,272 Cost 149,501 $ 35 294,713 1,001 445,250 $ Weighted- Average Yield 1.4% 2.5% 4.7% – As at December 31, 2012 Gross unrealized Gains Gross unrealized Losses 120 $ 2,100 4,163 118 6,501 $ – $ (1,271) (4,646) – (5,917) $ total Fair Value 104,832 8,836 299,557 1,119 414,344 Cost 104,712 $ 8,007 300,040 1,001 413,760 $ Weighted- Average Yield 2.5% 4.6% 4.7% – $ $ $ $ net unrealized gains and losses (excluding impairment losses which are transferred to net income) are included in AOCI and presented in the table above. these unrealized gains and losses are not included in net income. please see note 15 for more information. the unrealized gains or losses included above represent the differences between the cost of a security and its current fair value. the Company regularly monitors its investments and market conditions for indications of impairment. For the year ended December 31, 2013, the Company recognized $0.2 million (2012 – $1.8 million) of impairment losses on available for sale securities. 88 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 note 5 loAn S (A) loans by Geographic Region and type (net of individual allowances for credit losses) thousands of Canadian dollars, except % Securitized single-family residential mortgages Securitized multi-unit residential mortgages total securitized mortgages Single-family residential mortgages Residential commercial mortgages1 non-residential commercial mortgages Credit card loans Other consumer retail loans total non-securitized mortgages and loans2 British Columbia Alberta ontario Quebec other total As at December 31, 2013 $ 334,511 $ 256,770 $ 2,835,878 $ 192,751 $ 100,187 $ 3,720,097 201,181 535,692 536,212 8,897 191,910 448,680 367,211 16,192 706,883 3,542,761 9,391,757 135,133 7,753 7,230 899 38,660 19,324 1,256 881,702 262,016 334,652 186,521 379,272 360,657 28,689 16,234 1,260 2,900 560,991 $ 1,096,683 $ 442,643 891,323 $ 14,548,021 $ 11,005,260 409,740 789,012 $ 203,429 303,616 191,530 7,969 1,489,924 5,210,021 10,847,367 196,880 49,861 3,655 256 994,210 293,485 339,963 253,271 12,671,905 556,887 $ 17,881,926 100.0% 3.1% As at December 31, 2012 As a % of portfolio 6.1% 5.0% 81.4% 4.4% thousands of Canadian dollars, except % Securitized single-family residential mortgages Securitized multi-unit residential mortgages total securitized mortgages Single-family residential mortgages Residential commercial mortgages1 non-residential commercial mortgages Credit card loans Other consumer retail loans total non-securitized mortgages and loans2 British Columbia Alberta Ontario Quebec Other total $ 433,529 $ 343,318 $ 3,616,877 $ 256,953 $ 113,080 $ 4,763,757 258,757 692,286 420,953 5,642 3,521 9,104 975 203,081 546,399 342,841 19,380 908,513 4,525,390 7,499,242 102,674 25,953 25,062 787 860,703 287,877 269,594 339,477 596,430 278,671 25,201 61,691 1,532 – 440,195 $ 1,132,481 $ 414,023 960,422 $ 13,545,480 $ 9,020,090 367,095 963,525 $ 232,575 345,655 147,739 1,580 1,942,403 6,706,160 8,689,446 154,477 36,548 3,941 621 988,416 327,516 271,977 190,429 10,431,832 536,084 $ 17,137,992 100.0% 3.1% As a % of portfolio 6.6% 5.6% 79.1% 5.6% 1 Residential commercial mortgages include non-securitized multi-unit residential mortgages and commercial mortgages secured by residential property types. 2 Loans exclude mortgages held for sale. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 89 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (B) Past Due loans that are not Impaired A loan is recognized as being impaired (non-performing) when the Company is no longer reasonably assured of the timely collection of the full amount of principal and interest. As a matter of practice, an uninsured residential or commercial mortgage, or retail loan, or equityline Visa loan is deemed to be impaired at the earlier of the date it has been individually provided for or when it has been in arrears for 90 days. Single-family and multi-unit residential mortgages (including securitized mortgages) guaranteed by the Government of Canada are not considered impaired until payment is contractually 365 days past due. Credit losses are not anticipated on insured mortgages. Secured and unsecured credit card balances that have a payment that is contractually 120 days in arrears are individually provided for, and those that have a payment that is 180 days in arrears are written off. thousands of Canadian dollars Securitized single-family residential mortgages Securitized multi-unit residential mortgages Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans thousands of Canadian dollars Securitized single-family residential mortgages Securitized multi-unit residential mortgages Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans As at December 31, 2013 61 to 90 Days over 90 Days 265 $ – 6,804 – – 963 31 8,063 $ 4,9821 $ 9,9191 6,1591 –1 – 23 – 21,083 $ total 37,139 9,919 305,324 1,768 9,587 6,571 131 370,439 As at December 31, 2012 61 to 90 Days 453 $ – 6,100 – – 1,965 21 8,539 $ Over 90 Days 4,6791 $ –1 8,4741 –1 – 8 – 13,161 $ total 49,956 – 278,178 544 9,247 7,550 181 345,656 31 to 60 Days 4,370 $ – 48,540 573 902 1,932 30 56,347 $ 31 to 60 Days 6,581 $ – 49,935 544 – 1,731 48 58,839 $ 1 to 30 Days $ 27,522 $ – 243,821 1,195 8,685 3,653 70 284,946 $ $ $ 1 to 30 Days $ 38,243 $ – 213,669 – 9,247 3,846 112 265,117 $ 1 Insured residential mortgages are considered impaired when they are 365 days past due. (C) Impaired loans and Individual Allowances for Credit losses Residential mortgages guaranteed by the Government of Canada are not considered impaired until payment is contractually 365 days past due. As securitized residential mortgages are all fully insured, credit losses are not anticipated. As at December 31, 2013 thousands of Canadian dollars Single-Family Residential mortgages Residential Commercial mortgages non- Residential Commercial mortgages Gross amount of impaired loans Individual allowances on principal net amount of impaired loans $ $ 52,837 $ (1,201) 51,636 $ 1,836 $ – 1,836 $ 7,189 $ – 7,189 $ Credit Card loans 2,785 $ (201) 2,584 $ other Consumer Retail loans 236 $ (236) – $ total 64,883 (1,638) 63,245 As at December 31, 2012 thousands of Canadian dollars Single-Family Residential Mortgages Residential Commercial Mortgages non- Residential Commercial Mortgages Gross amount of impaired loans Individual allowances on principal net amount of impaired loans $ $ 50,169 $ (2,381) 47,788 $ 4,527 $ – 4,527 $ 501 $ – 501 $ Credit Card Loans 3,616 $ (111) 3,505 $ Other Consumer Retail Loans 214 $ (214) – $ total 59,027 (2,706) 56,321 Included in the gross amount of impaired loans are foreclosed loans with an estimated realizable value of $2.2 million (2012 – $1.7 million). 90 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 (D) Collateral the fair value of collateral held against mortgages is based on appraisals at the time a loan is originated. Appraisals are only updated should circumstances warrant it or if a mortgage becomes impaired. At December 31, 2013, the total appraised value of the collateral held for mortgages past due that are not impaired, as determined when the mortgages were originated, was $539.7 million (2012 – $502.1 million). For impaired mortgages, the total appraised value of collateral at December 31, 2013 was $86.0 million (2012 – $153.9 million). (e) Allowance for Credit losses thousands of Canadian dollars Single-family Residential mortgages Residential Commercial mortgages non- Residential Commercial mortgages Credit Card loans other Consumer Retail loans 2013 total Individual allowances Allowance on loan principal Balance at the beginning of the year $ provision for credit losses Write-offs Recoveries Allowance on accrued interest receivable Balance at the beginning of the year provision for credit losses total individual allowance Collective allowance Balance at the beginning of the year provision for credit losses total allowance total provision 111 $ 679 (1,129) 540 201 214 $ 367 (436) 91 236 2,706 14,460 (17,261) 1,733 1,638 2,381 $ 9,985 (12,048) 883 1,201 487 272 759 1,960 – $ – $ 3,199 (3,407) 208 – 432 (407) 25 25 230 (241) 11 – – 44 44 44 – – – 201 16,523 1,509 18,032 19,992 $ 11,766 $ $ $ 336 (9) 327 352 $ 2,783 $ 9,300 – 9,300 9,344 $ 274 $ 3,541 – 3,541 3,742 $ 679 $ thousands of Canadian dollars Single-family Residential Mortgages Residential Commercial Mortgages non- Residential Commercial Mortgages Credit Card Loans Other Consumer Retail Loans Individual allowances Allowance on loan principal Balance at the beginning of the year $ provision for credit losses Write-offs Recoveries Allowance on accrued interest receivable Balance at the beginning of the year provision for credit losses total individual allowance Collective allowance Balance at the beginning of the year provision for credit losses total allowance total provision 760 $ 11,769 (10,598) 450 2,381 – $ – – – – 327 160 487 2,868 – 432 432 432 60 $ 392 $ 259 (322) 3 – 18 (18) – – 1,291 (1,914) 342 111 – – – 111 15,871 652 16,523 19,391 $ 12,581 $ $ $ 428 (92) 336 768 $ 340 $ 9,300 – 9,300 9,300 $ 241 $ 3,541 – 3,541 3,652 $ 1,291 $ there were no provisions, allowances or net write-offs on securitized residential mortgages. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 91 13 (1) 12 248 300 – 300 548 $ 366 $ 932 (92) 840 2,478 30,000 1,500 31,500 33,978 15,868 2012 total 290 $ 266 (419) 77 214 1,502 13,585 (13,253) 872 2,706 12 1 13 227 300 – 300 527 $ 267 $ 357 575 932 3,638 29,440 560 30,000 33,638 14,720 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (F) Interest Income by Product thousands of Canadian dollars traditional single-family residential mortgages Accelerator single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans total interest income on non-securitized loans Securitized single-family residential mortgages Securitized multi-unit residential mortgages Assets pledged as collateral for securitization total interest income on securitized loans (G) loans by Remaining Contractual term to maturity thousands of Canadian dollars Within 1 Year 1 to 3 Years 3 to 5 Years over 5 Years 2013 482,491 $ 15,044 12,954 62,681 28,966 27,111 629,247 144,702 73,712 7,379 225,793 855,040 $ 2012 381,971 17,440 11,000 61,229 34,722 19,360 525,722 200,679 80,757 6,435 287,871 813,593 $ $ December 31 2013 December 31 2012 total Book Value total Book Value Securitized single-family residential mortgages Securitized multi-unit residential mortgages Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans Other consumer retail loans Collective allowance for credit losses $ 919,119 $ 2,231,590 $ 569,388 $ – $ 3,720,097 $ 4,763,757 482,849 7,155,829 121,719 349,426 2,928,154 68,509 258,343 696,735 3,904 399,306 66,649 2,748 1,489,924 10,847,367 196,880 1,942,403 8,689,446 154,477 590,201 293,485 13,642 9,576,844 – 315,971 – 42,765 5,936,415 – 88,038 – 135,460 1,751,868 – $ 9,576,844 $ 5,936,415 $ 1,751,868 $ – – 148,096 616,799 – 994,210 988,416 293,485 327,516 339,963 271,977 17,881,926 17,137,992 (30,000) (31,500) 616,799 $ 17,850,426 $ 17,107,992 92 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 note 6 SeCuRItIZAt Ion ACtIVItY (A) Securitized Assets and liabilities the Company’s wholly owned subsidiary, Home trust, securitizes insured single-family residential and multi-unit residential mortgage loans by participating in the national Housing Authority mortgage-backed securities (nHA MBS) program. through the program, the Company issues securities backed by residential mortgage loans that are insured against borrowers’ default. Once the mortgage loans are securitized, the Company assigns underlying mortgages and/or related securities to CMHC. As an issuer of the MBS, Home trust is responsible for advancing all scheduled principal and MBS interest payments to CMHC, whether or not the amounts have been collected on the underlying transferred mortgages. Amounts advanced but not recovered will ultimately be recovered from the insurer. the securitized activity includes the Company’s participation in the Canada Mortgage Bond (CMB) program. under the CMB program, CMHC guarantees the bonds of a special purpose trust, Canada Housing trust (CHt). CHt uses the proceeds of its bond issuance to finance the purchase of nHA MBS issued by Home trust. As the CMB is a bullet bond, the Company must provide eligible replacement assets to re-collateralize the CMB as the underlying mortgages amortize or are prepaid. In many securitization activities, the Company retains certain prepayment and/or interest rate risks and rewards related to the transferred mortgages. Due to retention of these risks and rewards, transferred mortgages are not derecognized and the securitization proceeds are accounted for as secured borrowing transactions. there are no expected credit losses on the securitized mortgage assets as the mortgages are insured against default. Further, the investors and CMHC have no recourse to other assets of either the Company or Home trust in the event of failure of debtors to pay when due. In other securitization activities, derecognition or continuing involvement accounting is applied. please see note 6(B) for further information. the following table presents the gross carrying amounts of mortgages and other assets assigned during the year, which are recorded on the consolidated balance sheets as securitized residential mortgages or restricted assets, or recorded off-balance sheet as loans under administration. thousands of Canadian dollars Mortgages assigned in new securitizations Mortgage assets assigned as replacements of repaid amounts to CHt through repurchase agreement Mortgage assets total assets assigned as replacements of repaid amounts to CHt net (reduction) addition of non–Home trust MBS and treasury bills Gross carrying amount of mortgages and other assets assigned Off-balance sheet portion of mortgages assigned 2013 $ 1,261,660 $ 2012 646,785 336,113 592,811 928,924 (57,884) 2,132,700 $ 617,244 $ 255,478 224,584 480,062 246,446 1,373,293 233,892 MBS securitization liabilities are repaid on a monthly basis as the principal payments are collected from securitized loans. CMB liabilities are bullet bond liabilities with fixed maturities. Any principal collected against securitized assets underlying CMB liabilities is used to purchase replacement assets. Interest accrued on securitization liabilities is recorded in other liabilities on the consolidated balance sheets and is based on the underlying MBS and CMB coupon. Securitization liabilities recorded on the consolidated balance sheets represent the funding received on securitization of insured mortgages and other assets assigned under the nHA MBS and the CMB programs when the transaction does not qualify for off-balance sheet treatment for the assets. Accrued interest on these liabilities is classified in other liabilities as accrued interest payable on securitization liabilities. the following table presents the new securitization liabilities added during the year, which are secured by insured mortgages and other pledged assets. thousands of Canadian dollars Addition to securitization liabilities as a result of on-balance sheet activity Buyback, maturity and amortization of securitization liabilities Residual interest sales Other1 net on-balance sheet securitization activity proceeds received for mortgages assigned in new securitizations 1 Other includes premiums, discounts and transaction costs. 2013 644,416 $ $ (1,686,791) (518,488) (1,968) (1,562,831) $ 1,242,991 $ 2012 412,893 (1,048,123) (662,402) (15,548) (1,313,180) 639,968 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 93 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (B) Securitization liabilities by Remaining Contractual term to maturity December 31 2013 December 31 2012 thousands of Canadian dollars, except % Mortgage-backed security liabilities Contractual yield Canada Mortgage Bond liabilities Contractual yield (C) Securitization Income 1 to 3 Years 3 to 5 Years over 5 Years Within 1 Year $ 85,087 $ 2.6% 225,860 $ 350,017 $ 1.7% 2.2% $ 1,277,150 $ 2,944,031 $ 398,763 $ 2.9% 2.3% 3.1% $ 1,362,237 $ 3,169,891 $ 748,780 $ – $ – total Book Value total Book Value 660,964 $ 1,301,693 2.1% 492,156 $ 5,112,100 $ 6,034,202 2.7% 492,156 $ 5,773,064 $ 7,335,895 2.6% 2.1% 3.8% the Company securitizes and sells through the nHA MBS program certain insured multi-unit residential mortgages with no pre-payment privileges. these mortgages are recognized on the Company’s consolidated balance sheets only to the extent of the Company’s continuing involvement in the mortgages (continuing involvement accounting). the Company’s continuing involvement is limited to its retained interest and its obligations for mortgage servicing. there is no prepayment or credit risk associated with the retained interest or the cost of servicing. the mortgages are effectively derecognized as a result of this transaction. the retained interest and servicing liability are recorded on the consolidated balance sheets in other assets and other liabilities, respectively. the Company sells residual interests in certain pools of insured single-family residential mortgages securitized through the nHA MBS program. the sales result in the Company transferring substantially all of the risks and rewards of ownership associated with the underlying mortgages and the mortgages are derecognized. the gain on these transactions is included in non-interest income under securitization income in the consolidated statements of income. the following tables provide quantitative information about these securitization and sales activities. thousands of Canadian dollars Carrying value of underlying mortgages derecognized Gains on sale of mortgages or residual interest1 Retained interests recorded Servicing liability recorded 2013 Single-Family Residential mBS multi-unit Residential mBS Single-Family Residential MBS Multi-unit Residential MBS total mBS 2012 total MBS $ 519,261 $ 617,244 $ 1,136,505 $ 662,153 $ 233,892 $ 896,045 5,354 – – 5,687 26,131 4,563 11,041 26,131 4,563 4,845 – – 3,300 9,691 1,786 8,145 9,691 1,786 1 Gains on sale of mortgages are net of hedging impact. thousands of Canadian dollars Gain on sale of mortgages or residual interest Change in unrealized gain or loss on Mortgages held for sale Bond forwards marked to market net change in unrealized gain or loss Servicing income total securitization income 2013 11,041 $ $ (815) 924 109 1,498 12,648 $ $ 2012 8,145 (16) 60 44 117 8,306 the bond forwards included in the above table are entered into to hedge interest rate risk on loans held for sale. these derivatives are not designated in hedge accounting relationships. As shown in the above table, the gains or losses on these derivatives are mostly offset by the fair value changes related to the loans held for sale, which are classified as held for trading for accounting purposes. (D) Assets Assigned as Collateral As a requirement of the nHA MBS and CMB programs, the Company assigns to CMHC all of its interest in existing mortgage pools. If the Company fails to make timely payment under an nHA MBS or CMB security, CMHC may enforce the assignment of the mortgages included in all the mortgage pools as well as other assets backing the mortgage-backed securities issued. 94 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 the following table presents the principal value of the Company’s on-balance sheet mortgage loans and other assets assigned as collateral. the mortgages are recorded as securitized single-family or multi-unit residential mortgages, and assets assigned as CMB replacement assets are recorded as restricted assets. thousands of Canadian dollars Carrying value of insured mortgages assigned as collateral, including replacement mortgages non–Home trust MBS and treasury bills assigned as collateral total securitized assets assigned as collateral December 31 2013 December 31 2012 $ 5,210,021 $ 6,706,160 588,069 $ 5,740,171 $ 7,294,229 530,150 non–Home trust MBS and treasury bills assigned as collateral are accounted for as available for sale assets and included in restricted assets on the consolidated balance sheets. please see note 7 for more information. note 7 ReSt RICte D ASSetS thousands of Canadian dollars Restricted cash Restricted cash – Canada Mortgage Bond program Restricted cash – interest rate swaps Restricted cash – other programs total restricted cash non–Home trust MBS and treasury bills assigned as replacement assets total restricted assets December 31 2013 December 31 2012 $ $ 91,900 $ 21,482 9,454 122,836 530,150 652,986 $ 100,387 21,655 15,382 137,424 588,069 725,493 Restricted cash – Canada Mortgage Bond program represents deposits held as collateral by CMHC in connection with the Company’s securitization activities. to participate in the nHA MBS programs, the Company is required to maintain an amount of cash in a trust account to cover deposits of unscheduled principal prepayments (upp) and property taxes collected on the securitized loans. the Company is allowed to invest the above amount in eligible securities. Restricted cash – interest rate swaps are deposits held by swap counterparties as collateral for the Company’s interest rate swap transactions. the Company is required to provide collateral against its interest rate swap transactions as part of the agreements with the counterparties. the terms and conditions for the collateral are governed by International Swaps and Derivatives Association (ISDA) agreements. Restricted cash – other programs are reserve accounts held in trust for the water heater financing program and for pSiGate operations. the following table provides the remaining contractual term to maturity of non-Home trust MBS and treasury bills assigned as CMB replacement assets. please see note 6(D) for more information. thousands of Canadian dollars Within 1 Year 1 to 3 Years 3 to 5 Years over 5 Years December 31 2013 December 31 2012 total Fair Value total Fair Value non–Home trust MBS and treasury bills assigned as replacement assets $ 525,430 $ 4,720 $ – $ – $ 530,150 $ 588,069 note 8 ot HeR ASSetS thousands of Canadian dollars Accrued interest receivable prepaid CMB coupon Securitization receivable and retained interest Capital assets Income taxes recoverable Other prepaid assets and deferred items $ December 31 2013 62,961 $ 7,168 54,556 10,875 9,519 17,600 162,679 $ December 31 2012 61,481 12,486 10,714 6,578 – 9,724 100,983 $ Home CAPItAl GRouP InC. AnnuAL RepORt 2013 95 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 9 IntAnGIBle ASSetS Intangible assets comprise internally developed software costs which are principally related to the Company’s core banking system. these costs are amortized over 10 years, commencing December 2011. the following table presents the net carrying amount of software costs for the core banking system and other software costs as at December 31, 2013, and 2012, along with the changes in net carrying amount for the years ended December 31, 2013 and 2012. thousands of Canadian dollars Core Banking System1 other Software Costs2 total Core Banking System1 Other Software Costs2 2013 2012 total Cost Balance at the beginning of the year $ Additions from internal development Balance at the end of the year Accumulated amortization Balance at the beginning of the year Amortization expense Balance at the end of the year Carrying amount at the end of the year $ 67,672 $ 8,285 75,957 7,156 $ 6,641 13,797 74,828 $ 14,926 89,754 62,193 $ 5,479 67,672 3,494 $ 3,662 7,156 65,687 9,141 74,828 6,498 7,586 14,084 61,873 $ 1,987 278 2,265 11,532 $ 8,485 7,864 16,349 73,405 $ 330 6,168 6,498 61,174 $ 1,440 547 1,987 5,169 $ 1,770 6,715 8,485 66,343 1 As at December 31, 2013, there was $14.2 million ($5.2 million – December 31, 2012) in work in progress related to the core banking system that was not being amortized. 2 As at December 31, 2013, there was $3.5 million ($0.8 million – December 31, 2012) in work in progress related to other software costs that was not being amortized. note 10 GooDWIll the carrying amount of goodwill in relation to each of the Company’s subsidiaries is as follows: thousands of Canadian dollars Home trust pSiGate December 31 2013 2,324 $ $ 13,428 15,752 $ $ December 31 2012 2,324 13,428 15,752 there have been no additions, disposals or impairment losses of goodwill during the year. Goodwill is allocated to cash-generating units for the purpose of impairment testing, considering the business level at which goodwill is monitored for internal management purposes. the pSiGate goodwill is allocated to the pSiGate legal entity (the unit). Management has determined that the recoverable amount of the unit exceeds its carrying amount and that no impairment exists. the following information relates to the annual impairment test of the unit that was conducted during the fourth quarter of 2013. the recoverable amount of the unit was determined on the basis of its fair value less costs of disposal. the fair value of the unit was determined using a discounted cash flow methodology where estimated cash flows were projected to December 31, 2017 and assuming a terminal growth rate of 3.0% (2012 – 3.0%) thereafter. A revenue growth rate of 4.9% (2012 – 8.1%) was assumed over the period of projections, with a stable gross margin percentage. Operating expenses considered necessary to support the expected growth were included and increased over the period of projections at an expected inflationary rate. planned capital expenditures, also necessary to support expected growth, were incorporated. A discount rate of 15.5% (2012 – 15.5%) was used, which comprised a risk-free rate, equity risk premium, size premium and company- specific risk premium. the risk-free rate, equity risk premium and size premium were based on data from external sources whereas the company-specific risk premium was based on factors considered by management to be specific to pSiGate. the discounted cash flow methodology used is most sensitive to the discount rate and revenue growth rate used. In consideration of this sensitivity, management determined that either an increase in the discount rate from 15.5% to 18.1% or a decrease in annual revenue growth from 4.9% to a growth rate of 0.1% for each year of the projection, assuming unchanged values for the other assumptions, would have caused the recoverable amount to equal the carrying amount. 96 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 note 11 DePo SItS BY RemAInInG C o ntR AC tuAl teR m to m AtuR I tY Payable December 31 2013 December 31 2012 thousands of Canadian dollars, except % Individuals Businesses effective contractual yield $ $ on Demand Within 1 Year 3 to 5 Years 1 to 3 Years 429,269 $ 7,007,706 $ 4,066,638 $ total 742,381 $ 12,245,994 $ 9,903,666 232,933 519,960 308,818 429,269 $ 7,141,008 $ 4,144,478 $ 1,051,199 $ 12,765,954 $ 10,136,599 2.2% 133,302 77,840 2.3% 2.0% 1.5% 2.1% 2.8% total – Included in deposits are institutional deposit notes in the principal amount of $300 million, with an effective contractual yield of 3.41% and mature in 2018. note 12 SenIoR D eBt the Company issued $150.0 million principal amount of 5.20% debentures on May 4, 2011. the debentures pay interest semi-annually on May 4 and november 4 in each year. the debentures mature on May 4, 2016 and are redeemable at the option of the Company upon 30 days written notice to the registered holder at a redemption price equal to the greater of par and the price that would provide a yield to maturity equal to the Government of Canada bond rate plus 0.66%, plus accrued and unpaid interest to the date of redemption. the carrying amount includes unamortized issue costs and fair value adjustments related to interest rate hedging. note 13 otHeR lIABIlIt IeS thousands of Canadian dollars Accrued interest payable on deposits Accrued interest payable on securitization liabilities Income taxes payable Other, including accounts payable and accrued liabilities note 14 CAPItAl (A) Authorized $ December 31 2013 112,242 $ 14,833 – 46,483 173,558 $ December 31 2012 93,856 19,595 21,912 35,139 170,502 $ An unlimited number of common shares with no par value An unlimited number of preferred shares, issuable in series, to be designated as senior preferred shares An unlimited number of preferred shares, issuable in series, to be designated as junior preferred shares (B) Common Shares Issued and outstanding thousands Outstanding at the beginning of the year Options exercised Repurchase of shares Outstanding at the end of the year 2013 number of Shares 34,630 $ 153 (39) 34,744 $ $ $ Amount 61,903 $ 8,400 (70) 70,233 $ number of Shares 34,625 $ 169 (164) 34,630 $ 2012 Amount 55,104 7,088 (289) 61,903 On February 12, 2014 the Board approved a stock dividend of one common share per each outstanding common share. the Company has no preferred shares outstanding. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 97 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (C) Repurchase of Shares During the year, 39,100 (2012 – 163,500) common shares were purchased for $2.3 million (2012 – $8.1 million). the purchase price of shares acquired through the normal Course Issuer Bid is allocated between share capital and retained earnings. the reduction to share capital for the year ended December 31, 2013 was $0.1 million (2012 – $0.3 million). the balance of the purchase price of $2.2 million (2012 – $7.8 million) was charged to retained earnings. (D) earnings per Common Share (ePS) Basic earnings per common share of $7.40 (2012 – $6.40) is determined as net income for the year divided by the average number of common shares outstanding of 34.7 million (2012 – 34.7 million). Diluted earnings per common share of $7.32 (2012 – $6.38) is determined as net income for the year divided by the average number of common shares outstanding of 34.7 million (2012 – 34.7 million) plus the stock options potentially exercisable, as determined under the treasury stock method, of 353 thousand (2012 – 128 thousand) for a total of 35.0 million (2012 – 34.8 million) diluted common shares. Diluted income per common share excludes contingently assumable average options outstanding of 300,875 with a weighted-average exercise price of $62.07 for December 31, 2013 and contingently assumable average options outstanding of 225,750 with a weighted- average exercise price of $47.17 for December 31, 2012, as not all vesting and performance criteria had been met. (e) Capital management the Company has a Capital Management policy that governs the quantity and quality of capital held. the objectives of the policy are to ensure that capital levels are adequate and that Home trust meets all regulatory capital requirements, while also providing a sufficient return to investors. the Risk and Capital Committee and the Board review the policy annually and monitor compliance with the policy on a quarterly basis. the Company’s subsidiary, Home trust, is subject to the regulatory capital requirements stipulated by the Office of the Superintendent of Financial Institutions Canada (OSFI). these requirements are consistent with international standards (Basel II and Basel III) set by the Bank for International Settlements. Home trust follows the Basel II Standardized Approach for calculating credit risk and Basic Indicatory Approach for operational risk. In addition, Home trust pays dividends subject to any restrictions by OSFI. the regulatory capital position of Home trust was as follows: thousands of Canadian dollars, except ratios and multiples Common equity tier 1 capital (Cet 1)1 Additional tier 1 capital tier 1 capital tier 2 capital2 total regulatory capital Risk-weighted assets for Credit risk Operational risk total risk-weighted assets Regulated capital to risk-weighted assets Cet 1 ratio tier 1 capital ratio total regulatory capital ratio Assets to regulatory capital multiple national regulatory minimum Cet 1 ratio (required January 1, 2013) tier 1 capital ratio (required January 1, 2014) total regulatory capital ratio (required January 1, 2014) December 31 2013 transitional All-In Basis Basis $ 1,091,204 $ 1,145,491 – 1,145,491 187,500 $ 1,278,704 $ 1,332,991 – 1,091,204 187,500 $ 5,702,192 $ 5,756,155 793,575 $ 6,495,767 $ 6,549,730 793,575 17.49% 17.49% 20.35% 13.19 16.80% 16.80% 19.69% n/A 7.00% 8.50% 10.50% 1 Regulatory deductions on the all-in basis include intangible assets related to software development and unrealized multi-unit residential mortgage securitization gains, net of deferred taxes. 2 the Company is allowed to include its collective allowance for credit losses up to a prescribed percentage of 1.25% of credit risk-weighted assets in tier 2 capital. At December 31, 2013, the Company’s collective allowance represented 0.55% of credit risk-weighted assets. 98 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Home trust adopted certain Basel III capital requirements, as required by OSFI, beginning January 1, 2013. the primary impact at adoption was the deduction from Common equity tier 1 capital on an all-in basis of $51.1 million of intangible assets, net of deferred taxes, related to information technology development costs as well as the inclusion of all accumulated other comprehensive income, net of cash flow hedges. the transitional basis allows for the transition of certain capital deductions over a period ending January 1, 2018, whereas the all-in basis includes all applicable deductions immediately. For purposes of meeting minimum regulatory capital ratios prescribed by OSFI, the all-in basis is required. the Assets to Regulatory Capital Multiple (ACM) is calculated and evaluated on a transitional basis. In Q1 2013, Home trust amended the terms of all its subordinated debt, of which all debt is issued to the Company, to comply with the non-viability contingent capital requirements. this allowed for the inclusion of the subordinated debt in tier 2 capital. under Basel III this subordinated debt will be subject to straight-line amortization out of capital in the final five years prior to maturity. the principal amounts of the subordinated debt currently mature in 2021 and 2022 in the amounts of $100 million and $56 million, respectively. Currently, Home trust’s Common equity tier 1, total tier 1, and total capital ratios significantly exceed OSFI’s regulatory targets of 7.0% for Common equity tier 1, 8.5% for total tier 1 and 10.5% for total capital ratios, as well as Home trust’s internal capital targets. note 15 ACCum ulAteD otHeR Co mP R e Hen S IV e I nC o me thousands of Canadian dollars unrealized (losses) gains on Available for sale securities and retained interests Income tax (recovery) expense unrealized losses on Cash flow hedges Income tax recovery Accumulated other comprehensive loss note 16 InCome tAXeS (A) Reconciliation of Income taxes December 31 2013 December 31 2012 $ (21,530) $ (5,707) (15,823) 584 152 432 (3,612) (956) (2,656) (18,479) $ (5,676) (1,499) (4,177) (3,745) $ the combined federal and provincial income tax rate varies each year depending on changes in the statutory tax rate imposed by the federal and provincial governments. the effective rate of income tax in the consolidated statements of income is different from the combined federal and provincial income tax rate of 26.49% (2012 – 26.43%). thousands of Canadian dollars Income before income taxes Income taxes at statutory combined federal and provincial income tax rates Increase (decrease) in income taxes at statutory income tax rates resulting from tax-exempt income non-deductible expenses Future tax rate changes and other Scientific research and experimental development investment tax credits Income tax (B) Reconciliation of Income tax Rates Statutory income tax rate Increase (reduction) in income tax rate resulting from tax-exempt income non-deductible expenses Future tax rate changes and other Scientific research and experimental development investment tax credits effective income tax rate 2013 2012 $ 337,432 $ 299,919 79,254 89,377 (2,956) 568 91 (6,190) 80,890 $ (3,744) 495 1,931 – 77,936 $ 2013 26.49% (0.89)% 0.17% 0.03% (1.83)% 23.97% 2012 26.43% (1.26)% 0.17% 0.65% – 25.99% Home CAPItAl GRouP InC. AnnuAL RepORt 2013 99 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (C) Sources of Deferred tax Balances thousands of Canadian dollars Deferred tax liabilities Commissions Finders’ fees, net of commitment fees Securitization transaction costs Swaps Development costs Other Deferred tax assets Allowance for credit losses Other net deferred tax liability December 31 2013 December 31 2012 $ $ 7,649 $ 5,949 4,008 5,258 19,443 344 42,651 7,534 692 8,226 34,425 $ 6,921 7,905 5,932 5,525 16,656 730 43,669 7,443 426 7,869 35,800 Capital losses totalling $2.8 million are available to reduce capital gains in future years. the future tax benefits arising from application of these losses have not been reflected in the consolidated statements of income and changes in shareholders’ equity. During the year, the Company recognized Scientific Research and experimental Development investment tax credits related to the development of its core banking system. the investment tax credits recognized related to work performed in 2009–2012. the Company recorded the benefit for these years based on information providing assurance that these claims will be accepted. the investment tax credits are recorded as a reduction of tax provisions, net of any tax that would be eligible on such benefit. not e 17 emPloYee BeneFItS (A) employee Share ownership Plan under the employee Share Ownership plan, every year eligible employees can elect to purchase common shares of the Company up to 10% of their annual earnings. the Company matches 50% of the employees’ contribution amount. During each pay period, all contributions are used by the plan’s trustee to purchase the common shares in the open market. the Company’s contributions are fully vested immediately. the Company’s contributions are expensed as paid and totalled $0.9 million for 2013 (2012 – $0.8 million). (B) employee Retirement Savings Plan During the year, Home trust contributed $0.9 million (2012 – $0.8 million) to the employee group registered retirement savings plan. (C) Stock options the details and changes in the issued and outstanding options are as follows: 2013 Weighted- Average exercise Price 38.71 68.91 40.51 48.23 46.04 36.83 61.02 4.0 number of Shares 783 $ 216 (153) (21) 825 $ 524 $ $ 2012 Weighted- Average exercise price 37.16 47.20 33.56 33.74 38.71 35.29 48.48 3.7 number of Shares 929 $ 51 (169) (28) 783 $ 557 $ $ thousands, except per share amounts and years Outstanding at the beginning of the year Granted exercised Forfeited Outstanding at the end of the year exercisable at the end of the year Weighted-average market price per share at date of exercise Weighted-average remaining contractual life in years 100 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 the Company’s stock option plan was approved by the shareholders of the Company on December 31, 1986. the plan was amended in 2002 to conform to the toronto Stock exchange’s Revised policy on Listed Company Share Incentive Arrangements. As at December 31, 2013, the maximum number of options on common shares that may be issued was 5,335,198, representing approximately 15.4% of the aggregate number of common shares. the exercise price of the options is fixed by the Board at the time of issuance at the market price of such shares, subject to all applicable regulatory requirements. the exercise period of any option is limited to a period of seven years from the date of grant of the option. the period within which an option or portion thereof may be exercised by a participant is determined in each case by the Board. Stock options that are currently issued and outstanding vest at a rate of 25% per year over four years on the condition that set earnings per share targets are achieved for each year as established by the Board at the time of the grant. During 2010, the Company approved an amendment to the employee stock option plan to provide stock appreciation rights that allow cash settlement of vested stock options, at the Company’s discretion. no options were settled in cash during 2013 or 2012. As at December 31, 2013, the exercise prices for stock options outstanding to acquire common shares ranged from $16.27 to $79.75. the weighted-average range of exercise prices for stock options outstanding and exercisable are presented below along with the number of options outstanding and exercisable and the weighted-average contractual life remaining. (D) Stock options outstanding Stock options outstanding As at December 31 2013 Stock options exercisable Weighted-Average Contractual life Remaining in Years Weighted- Average exercise Price number exercisable Weighted- Average exercise Price number outstanding 164,750 15,000 420,750 94,000 32,000 98,000 824,500 1.9 $ 2.4 3.6 6.0 6.6 6.9 4.0 $ 16.27 31.87 46.43 57.94 64.01 79.32 46.04 164,750 $ 15,000 320,375 23,500 – – 523,625 $ 16.27 31.87 46.09 57.94 – – 36.83 Range of exercise prices $15.01 – $30.00 $30.01 – $40.00 $40.01 – $50.00 $50.01 – $60.00 $60.01 – $70.00 $70.01 – $80.00 the Company determines the fair value of options granted using a Black-Scholes option pricing model. the weighted-average fair value of the options granted during the year was $22.05 (2012 – $15.37). the following assumptions were used to determine the fair value of each of the following option grants on the date of grant: Canadian dollars, except % and years Fair value of options granted Share price exercise price expected share price volatility Option life expected period until exercise in years1 Forfeiture rate expected dividend yield Risk-free rate of return 1 exercisable upon vesting. December 2013 november 2013 August 2013 February 2013 August 2012 March 2012 February 2012 $ $ $ 26.56 79.29 79.30 $ $ $ 26.55 79.49 79.74 $ $ $ 19.96 $ 62.60 $ 64.01 $ 17.70 $ 57.08 $ 58.86 $ 14.70 $ 45.32 $ 46.39 $ 17.10 $ 49.73 $ 49.55 $ 17.87 51.00 50.23 34.5% 7.0 4.0 6.8% 34.6% 7.0 4.0 6.8% 34.6% 7.0 4.0 6.8% 35.6% 7.0 4.0 6.8% 35.9% 7.0 4.0 6.8% 36.0% 7.0 4.0 6.8% 36.1% 7.0 4.0 6.8% 1.41% 1.41% 1.66% 1.82% 2.03% 1.77% 1.73% 2.19% 2.13% 2.18% 1.77% 1.40% 1.69% 1.73% the above assumptions for expected volatility were determined on the basis of historical volatility. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 101 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) the Company determines the fair value of stock options on the grant date and records this amount as compensation expense over the period that the stock options vest, with a corresponding increase to contributed surplus (2013 – $2.0 million; 2012 – $1.8 million). When these stock options are exercised, the Company records the amount of proceeds, together with the amount recorded in contributed surplus, in capital stock (2013 – $6.2 million; 2012 – $5.7 million). (e) Deferred Share units the Company grants DSus to Directors of the Company. under the plan, the Directors may elect annually to accept remuneration in the form of cash, cash and DSus or DSus prior to the beginning of the year. DSus earn dividend equivalents in the form of additional DSus at the same rate as dividends on common shares. the participant is not allowed to settle the DSus until retirement or termination of directorship. the cash value of the DSus is equivalent to the market value of common shares when settlement takes place. the fair value of the DSu liability as at December 31, 2013 was $1.98 million (2012 – $1.02 million). As of December 31, 2013, there were 24,443 DSus outstanding (2012 – 17,275). (F) Restricted Share units the Company grants RSus to certain key members of management. the RSus vest at a rate of one-third each year over a three-year period. the vested amount is settled on the vesting date. RSus earn dividend equivalents in the form of additional RSus at the same rate as dividends on common shares. the cash value of the RSus is equivalent to the market value of common shares on the vesting date. the fair value of the RSu liability as at December 31, 2013 was $206 thousand (2012 – $34 thousand). As of December 31, 2013, there were 20,940 RSus outstanding (2012 – 4,986 RSus outstanding). (G) Performance Share units the Company grants pSus to certain key members of management. the pSus vest after three years on the condition that certain performance criteria are met. the vested amount is settled on the vesting date. pSus earn dividend equivalents in the form of additional pSus at the same rate as dividends on common shares. the cash value of the pSus is equivalent to the market value of common shares on the vesting date multiplied by a performance factor ranging from 0% to 200%. the fair value of the pSu liability as at December 31, 2013 was $541 thousand and there were 17,159 pSus outstanding. the Company did not grant pSus prior to 2013. (H) Share-Based Compensation expense the expense recognized in the consolidated statements of income in relation to share-based compensation was as follows: thousands of Canadian dollars expense arising from equity-settled share-based payment transactions DSus, RSus and pSus (representing all expenses arising from cash-settled share-based payment transactions) note 18 CommItm entS A nD ContInGenCIeS (A) lease Commitments 2013 1,962 $ 1,348 3,310 $ $ $ 2012 1,759 209 1,968 the Company has entered into commercial leases on premises and property, as well as certain computer hardware and software leases. there are no restrictions imposed by lease arrangements. Future minimum lease payments under non-cancellable operating leases are as follows: thousands of Canadian dollars Within one year After one year but not more than five years More than five years December 31 2013 8,806 $ $ 27,116 21,770 57,692 $ $ December 31 2012 4,562 15,285 15,811 35,658 Lease payments recognized as an expense in the consolidated statements of income amounted to $16.5 million in 2013 (2012 – $12.1 million). 102 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 (B) Credit Commitments Outstanding commitments for funding on mortgages amounted to $754.6 million as at December 31, 2013 (2012 – $571.8 million). Commitments for loans remain open for various periods. the average rate on mortgage commitments is 4.60% (2012 – 4.88%). the Company also has contractual commitments to extend credit to its clients for its credit card products. the contractual commitments for these products represent the maximum potential credit risk, assuming that all the contractual amounts are fully utilized, the clients default and collection efforts are unsuccessful. At December 31, 2013, these contractual commitments in aggregate were $373.7 million (2012 – $403.1 million), of which $80.8 million (2012 – $75.7 million) had not been drawn by customers. Outstanding commitments for future advances for the equityline Visa portfolio were $5.8 million at December 31, 2013 (2012 – $4.8 million). these amounts in aggregate are not indicative of total future cash requirements. Management does not expect any material adverse consequence to the Company’s financial position to result from these commitments. Secured credit cards have spending limits restricted by collateral held by the Company. (C) Directors’ and officers’ Indemnification the Company indemnifies Directors and officers, to the extent permitted by law, against certain claims that may be made against them as a result of their being, or having been, Directors and officers at the request of the Company. the nature of this indemnification prevents the Company from making a reasonable estimate of the maximum potential amount the Company could be required to pay to third parties. Management believes that the likelihood that the Company would incur a significant liability under these indemnifications is remote. the Company has purchased Directors’ and officers’ liability insurance. (D) Contingencies there were no material contingencies identified by the Company in 2013. note 19 DeRIVAt IVe FInA nCIAl InS tRum en tS the Company utilizes interest rate swaps and forward contracts to hedge exposures to interest rate risk. the Company generally uses its derivative instruments in hedge accounting relationships to minimize volatility in earnings caused by changes in interest rates. When a hedging derivative functions effectively, gains, losses, revenues or expenses of the hedging derivative will offset the gains, losses, revenues or expenses of the hedged item. to qualify for hedge accounting treatment, the hedging relationship is formally designated and documented at its inception. the documentation describes the particular risk management objective and strategy for the hedge and the specific asset, liability or cash flow being hedged and how the effectiveness of the hedge is assessed. Changes in the fair value of the derivative instruments must be highly effective at offsetting either the changes in the fair value of the on-balance sheet asset or liability being hedged or the changes in the amount of future cash flows. Fair value represents point-in-time estimates that may change in subsequent reporting periods due to market conditions or other factors. Fair value for derivatives is determined from swap curves adjusted for credit risks. Swap curves are obtained directly from market sources or calculated from market prices. Hedge effectiveness is assessed at the inception of the hedge and on an ongoing basis, retrospectively and prospectively, over the life of the hedge. Any ineffectiveness in the hedging relationship is recognized immediately through non-interest expense in net realized and unrealized gain or loss on derivatives. cash flow Hedging relationships the Company uses bond forward contracts or interest rate swaps to hedge the economic value exposure to movements in interest rates between the time that the Company determines that it will likely incur liabilities pursuant to asset securitization, and the time the securitization transaction is complete and the liabilities are incurred. the intent of the bond forward or interest rate swap is to manage the change in cash flows of the future interest payments on the anticipated secured borrowings through asset securitization. Changes in the fair value of the derivative instrument that occur before the liability is incurred are recorded in AOCI. the fair value changes recorded in AOCI are reclassified into net interest income over the term of the hedged item. the following table presents gains or losses related to cash flow hedges included in the Company’s financial results: thousands of Canadian dollars Fair value gain (loss) recorded in OCI Fair value losses recorded in non-interest income (ineffectiveness) Losses reclassified from OCI to net interest income and securitization gains $ 2013 702 $ 13 (1,362) 2012 (370) – (1,462) Home CAPItAl GRouP InC. AnnuAL RepORt 2013 103 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) fair Value Hedging relationships the Company uses interest rate swaps to hedge changes in the fair value of fixed-rate assets and liabilities, which are associated with changes in market interest rates. Fair value hedges include hedges of fixed-rate mortgages and fixed-rate liabilities, which include deposits, deposit notes, senior debt and securitization liabilities. the following table presents gains or losses related to fair value hedges included in the Company’s financial results: thousands of Canadian dollars Fair value changes recorded on interest rate swaps1 Fair value changes of hedged fixed-rate liabilities for interest rate risk2 Hedge ineffectiveness gain recognized in non-interest income 2013 (16,494) $ 22,881 6,387 $ 2012 (26,609) 33,615 7,006 $ $ 1 unrealized gains and losses on hedging derivatives (interest rate swaps) are recorded as derivative assets or liabilities, as appropriate, on the consolidated balance sheets. 2 unrealized gains and losses on fixed-rate hedged items for the risk being hedged are recorded as part of the associated fixed-rate asset or liability on the consolidated balance sheets. other derivative Gains and Losses From time to time, the Company enters into derivative positions to hedge interest rate risk and such derivatives are not designated as hedges for accounting purposes. the changes in fair value of such derivatives flow directly to the consolidated statements of income. net realized and unrealized gains of $0.2 million (2012 – $0.3 million) were recorded in income through net realized and unrealized gain or loss on derivatives. the Company may also enter into bond forwards or interest rate swaps to hedge interest rate risk on loans held for securitization. Realized and unrealized gains or losses on these derivatives are included in securitization income on the consolidated statements of income. please see note 6 for more information. net realized and unrealized gains or losses on derivatives include amounts related to the restructuring of certain derivative positions upon adoption of IFRS. A charge of $8.0 million was recorded in 2013 (2012 – $3.5 million). As at December 31, 2013 and 2012, the outstanding interest rate swap and bond forward contract positions were as follows: thousands of Canadian dollars As at December 31, 2013 notional Amount Current Replacement Cost Credit equivalent Amount Risk- Weighted Balance Derivative Asset Derivative liability net Fair market Value Year of Maturity Swaps designated as hedges Maturing in 2014 Maturing in 2015 Maturing in 2016 Maturing in 2018 Maturing in 2020 undesignated swaps Maturing in 2016 Bond forwards1 Maturing in 2018 Maturing in 2019 Maturing in 2023 total 3,204 $ 3,204 $ 641 $ 3,204 $ $ 586,000 $ 833,914 207,100 549,200 59,000 2,235,214 50,000 50,000 16,154 4,335 1,616 3,186 28,495 – – 20,324 5,370 4,362 4,071 37,331 250 250 4,065 1,074 872 814 7,466 50 50 16,154 4,335 1,616 3,186 28,495 (69) $ – (251) (2,849) – (3,169) 3,135 16,154 4,084 (1,233) 3,186 25,326 – – (595) (595) 43,700 50,000 122,500 216,200 $ 2,501,414 $ 212 256 923 1,391 29,886 $ 431 1,006 2,760 4,197 41,778 $ 236 201 2,401 2,838 10,354 $ 212 256 923 1,391 29,886 $ – – (45) (45) (3,809) $ (595) (595) 212 256 878 1,346 26,077 104 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 thousands of Canadian dollars As at December 31, 2012 Year of Maturity Swaps designated as hedges Maturing in 2013 Maturing in 2014 Maturing in 2015 Maturing in 2016 Maturing in 2018 Maturing in 2020 undesignated swaps Maturing in 2016 Bond forwards1 Maturing in 2023 total notional Amount Current Replacement Cost Credit equivalent Amount Risk- Weighted Balance Derivative Asset Derivative Liability net Fair Market Value $ 265,200 $ 230,500 798,914 192,200 25,700 59,000 1,571,514 4,305 $ 5,851 21,522 5,954 1,671 6,015 45,318 4,305 $ 7,004 25,484 6,797 2,057 6,900 52,547 100,000 100,000 – – – – 861 $ 1,401 5,097 1,359 411 1,380 10,509 – – 4,305 $ 5,851 21,522 5,954 1,671 6,015 45,318 – $ – (20) (200) – – (220) – – (2,156) (2,156) 17,500 17,500 $ 1,689,014 $ 70 70 45,388 $ 202 202 52,749 $ 40 40 10,549 $ 70 70 45,388 $ (10) (10) (2,386) $ 4,305 5,851 21,502 5,754 1,671 6,015 45,098 (2,156) (2,156) 60 60 43,002 1 the term of the bond forward contracts is based on the term of the underlying bonds. the notional amount represents the amount to which the rate or price is applied in order to calculate the amount of cash exchanged under the contract. notional amounts do not represent an asset or liability recorded on the consolidated balance sheets. note 20 CuRRent AnD non-CuRR en t A SS etS AnD lI AB I l ItI eS the following table presents an analysis of each asset and liability line item by amounts, including prepayment assumptions, expected to be recovered or settled within one year or after one year as at December 31, 2013 and 2012. thousands of Canadian dollars Within 1 Year After 1 Year total Within 1 Year After 1 Year total As at December 31, 2013 As at December 31, 2012 Assets Cash and cash equivalents Available for sale securities Loans held for sale Securitized mortgages non-securitized mortgages and loans Collective allowance for credit losses Restricted assets Derivative assets Other assets Goodwill and intangible assets total assets liabilities Deposits payable on demand Deposits payable on a fixed date Senior debt Mortgage-backed security liabilities Canada Mortgage Bond liabilities Derivative liabilities Other liabilities Deferred tax liabilities total liabilities net $ – $ – $ 728,469 $ 201,416 137,975 1,741,367 9,005,240 (21,000) 648,266 3,204 151,804 – 301,863 414,344 21,921 6,706,160 10,431,832 (30,000) 725,493 45,388 100,983 82,095 $ 12,596,741 $ 7,479,109 $ 20,075,850 $ 9,831,077 $ 8,969,002 $ 18,800,079 728,469 $ 424,272 137,975 5,210,021 12,671,905 (31,500) 652,986 29,886 162,679 89,157 301,863 $ 162,368 21,921 1,684,143 7,037,009 (20,000) 545,063 4,305 94,405 – 222,856 – 3,468,654 3,666,665 (10,500) 4,720 26,682 10,875 89,157 251,976 – 5,022,017 3,394,823 (10,000) 180,430 41,083 6,578 82,095 $ – $ – $ 105,923 $ 429,269 $ 429,269 $ 7,141,008 – 85,087 1,277,150 69 173,558 – 105,923 10,030,676 150,684 1,301,693 6,034,202 2,386 170,502 35,800 $ 9,106,141 $ 9,792,012 $ 18,898,153 $ 7,464,653 $ 10,367,213 $ 17,831,866 968,213 $ 3,490,600 $ (2,312,903) $ 1,177,697 $ 2,366,424 $ (1,398,211) $ 12,336,685 147,343 660,964 5,112,100 3,809 173,558 34,425 5,195,677 147,343 575,877 3,834,950 3,740 – 34,425 4,224,657 150,684 831,903 5,121,783 2,386 – 35,800 5,806,019 – 469,790 912,419 – 170,502 – Home CAPItAl GRouP InC. AnnuAL RepORt 2013 105 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 21 InteReSt RAte S enSItIVItY the Company is exposed to interest rate risk as a result of a difference, or gap, between the maturity or repricing date of interest-sensitive assets and liabilities. the following tables show the gap positions at December 31, 2013 and 2012 for selected period intervals. Figures in parentheses represent an excess of liabilities over assets or a negative gap position. this schedule reflects the contractual maturities of both assets and liabilities, adjusted for assumptions regarding the effective change in the maturity date as a result of a mortgage becoming impaired and for credit commitments and derivatives. Variable rate assets and liabilities are allocated to a maturity category based on their interest repricing date. thousands of Canadian dollars, except % Assets Cash and cash equivalents Weighted-average interest rate Available for sale securities Weighted-average interest rate Loans held for sale Weighted-average interest rate Securitized mortgages Weighted-average interest rate non-securitized mortgages and loans Weighted-average interest rate Other assets Weighted-average interest rate total Weighted-average interest rate Liabilities and shareholders’ equity Deposits payable on demand Weighted-average interest rate Deposits payable at a fixed rate Weighted-average interest rate Senior debt Weighted-average interest rate Securitization liabilities Weighted-average interest rate Other liabilities Weighted-average interest rate Shareholders’ equity Weighted-average interest rate total Weighted-average interest rate Credit commitments Weighted-average interest rate Interest rate sensitivity gap Cumulative gap Cumulative gap as a percentage of total assets Floating Rate 0 to 3 months 3 to 6 months 6 to 12 months 1 to 3 Years over 3 Years non- interest Sensitive total As at December 31, 2013 $ 50,526 $ 677,943 $ 1.0% 1.0% – $ – – $ – – $ – – $ – – – – – 37,818 68,784 94,814 129,655 93,201 2.0% 2.5% 3.0% 4.2% 4.5% – – – – – – – – 137,975 3.7% – 2,154,530 421,987 603,121 957,023 1,073,360 – 2.8% 3.9% 4.1% 3.6% 4.1% – $ 728,469 – – – – – 1.0% 424,272 3.5% 137,975 3.7% – 5,210,021 – 3.4% – 2,057,497 1,722,058 4,501,134 3,301,711 1,067,311 (9,306) 12,640,405 – 5.3% 5.1% 122,836 447,079 138,123 1.2% 0.9% 1.5% 5.3% – – 5.1% 4,720 1.6% 5.5% – – – 5.2% 221,950 934,708 – 0.8% $ 173,362 $ 5,374,867 $ 2,350,952 $ 5,199,069 $ 4,393,109 $ 2,371,847 $ 212,644 $ 20,075,850 1.1% 3.4% 4.6% 5.1% 4.7% 4.7% – 4.3% $ 338,381 $ 1.5% – $ – – $ – – $ – – $ – – – $ 90,888 $ 429,269 838,509 1,889,830 4,412,669 4,144,478 1,051,199 1.9% 2.0% 2.1% 2.3% 2.8% – – – – – – 147,343 5.2% – – 2,536,540 499,825 659,953 997,915 1,078,831 3.2% 2.8% 2.9% 3.3% – – – – – – – 1.5% 12,336,685 2.2% 147,343 5.2% 5,773,064 2.6% – – – – – – – – – – – – – – – – 207,983 211,792 – – 1,177,697 1,177,697 – – – – – – – – – – – – 1.9% 3,809 – – – $ 338,381 $ 3,378,858 $ 2,389,655 $ 5,072,622 $ 5,289,736 $ 2,130,030 $ 1,476,568 $ 20,075,850 1.5% 1.9% 2.2% 2.2% 2.5% 3.1% – 2.1% $ (165,019) $ 1,996,009 $ (38,703) $ 126,447 $ (896,627) $ 241,817 $ (1,263,924) $ – – (748,741) 4.6% 305 6.3% 19 5.1% 26,758 721,659 5.0% 4.6% – – $ (165,019) $ 1,247,268 $ (38,398) $ 126,466 $ (869,869) $ 963,476 $ (1,263,924) $ $ (165,019) $ 1,082,249 $ 1,043,851 $ 1,170,317 $ 300,448 $ 1,263,924 $ – $ (0.8)% 5.4% 5.2% 5.8% 1.5% 6.3% – – – – – – – 106 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 thousands of Canadian dollars, except % Assets Cash and cash equivalents Weighted-average interest rate Available for sale securities Weighted-average interest rate Loans held for sale Weighted-average interest rate Securitized mortgages Weighted-average interest rate non-securitized mortgages and loans Weighted-average interest rate Other assets Weighted-average interest rate total Weighted-average interest rate Liabilities and shareholders’ equity Deposits payable on demand Weighted-average interest rate Deposits payable at a fixed rate Weighted-average interest rate Senior debt Weighted-average interest rate Securitization liabilities Weighted-average interest rate Other liabilities Weighted-average interest rate Shareholders’ equity Weighted-average interest rate total Weighted-average interest rate Credit commitments Weighted-average interest rate Interest rate sensitivity gap Cumulative gap Cumulative gap as a percentage of total assets Floating Rate 0 to 3 Months 3 to 6 Months 6 to 12 Months 1 to 3 Years Over 3 Years non- interest Sensitive total As at December 31, 2012 $ 11,858 $ 290,005 $ 1.0% 1.0% – $ – – $ – – $ – – $ – 86,902 52,803 22,663 87,213 164,763 2.6% 2.4% 3.0% 5.2% 4.5% – – – – – – – – 21,921 3.0% 2,488,249 248,657 743,190 1,855,921 1,370,143 2.8% 4.9% 4.9% 4.0% 4.1% – $ 301,863 – – – – – – – 1.0% 414,344 3.9% 21,921 3.0% 6,706,160 3.7% 1,779,351 1,382,405 3,539,715 2,893,053 820,039 (12,731) 10,401,832 6.1% 5.3% 5.5% 5.2% 5.5% – 5.5% 122,042 430,446 30,789 7,174 180,430 1.0% 0.9% 1.3% 1.2% 1.5% – – 183,078 953,959 – 0.9% $ 133,900 $ 5,074,953 $ 1,714,654 $ 4,312,742 $ 5,016,617 $ 2,376,866 $ 170,347 $ 18,800,079 1.0% 3.7% 5.1% 5.4% 4.6% 4.6% – 4.5% $ 19,825 $ 1.7% – $ – – $ – – $ – – $ – – $ 86,098 $ 105,923 – – 1.7% 706,686 1,729,232 3,370,101 3,581,002 643,655 – 10,030,676 2.0% 2.1% 2.0% 2.5% 2.7% – – – – – – – – 150,684 5.2% 2,531,345 387,283 944,636 2,151,375 1,321,256 3.2% 2.9% 2.9% 3.2% – – – – – 2.2% 150,684 5.2% 7,335,895 2.6% 1.9% 2,386 – – – – – – – – – – – – – – – – – – – 206,302 208,688 – – 968,213 968,213 – – – – – – – – – – – – – – – – – – – – $ 19,825 $ 3,240,417 $ 2,116,515 $ 4,314,737 $ 5,732,377 $ 2,115,595 $ 1,260,613 $ 18,800,079 1.7% 1.9% 2.3% 2.2% 2.6% 3.2% – 2.2% $ 114,075 $ 1,834,536 $ (401,861) $ (1,995) $ (715,760) $ 261,271 $(1,090,266) $ – – (567,041) 2,342 4.8% 5.5% – – 20,369 544,330 5.9% 4.8% – – $ 114,075 $ 1,267,495 $ (399,519) $ (1,995) $ (695,391) $ 805,601 $ (1,090,266) $ $ 114,075 $ 1,381,570 $ 982,051 $ 980,056 $ 284,665 $ 1,090,266 $ – $ 0.6% 7.3% 5.2% 5.2% 1.5% 5.8% – – – – – – – Based on the current interest rate gap position at December 31, 2013, the Company estimates that a 100 basis point decrease in interest rates would decrease net interest income after tax and other comprehensive income over the next 12 months by $12.6 million and $0.7 million, respectively, and decrease net present value of shareholders’ equity by $18.0 million. A 100 basis point increase in interest rates would increase net interest income after tax and other comprehensive income over the next 12 months by $12.6 million and $0.7 million, respectively, and increase net present value of shareholders’ equity by $16.6 million. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 107 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 22 FAIR VAlue oF FInAnCIA l InSt Rum en tS the amounts set out in the following table represent the fair values of the Company’s financial instruments. the valuation methods and assumptions are described below. the estimated fair value amounts approximate the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants that are under no compulsion to act at the balance sheet date in the principal or most advantageous market which is accessible to the Company. For financial instruments carried at fair value that lack an active market, the Company applies present value and valuation techniques that use observable market inputs. Because of the estimation process and the need to use judgement, the aggregate fair value amounts should not be interpreted as being necessarily realizable in an immediate settlement of the instruments. thousands of Canadian dollars Financial Assets Held for trading Financial Assets Available for Sale loans and Receivables Financial liabilities at Amortized Cost Carrying Value Fair Value Fair Value over (under) Carrying Value As at December 31, 2013 Assets Cash and cash equivalents Available for sale securities Loans held for sale Securitized mortgages non-securitized mortgages and loans Restricted assets Derivative assets Securitization receivable and retained interest Other total Assets Liabilities Deposits Senior debt Securitization liabilities Derivative liabilities Other total Liabilities $ 728,469 $ – $ – $ – $ 728,469 $ 728,469 $ – – 137,975 – – 122,836 29,886 424,272 – – – – 5,210,021 – 530,150 – 12,640,405 – – – – 31,935 – 22,621 79,648 $ 1,019,166 $ 986,357 $ 17,952,695 $ – – – – – – 424,272 137,975 5,210,021 424,272 137,975 5,256,782 – – 46,761 12,640,405 652,986 29,886 13,100,882 652,986 29,886 460,477 – – 54,556 79,648 170 – – – – $ 19,958,218 $ 20,465,626 $ 507,408 54,726 79,648 $ $ – $ – – 3,809 – 3,809 $ – $ – – – – – $ $ 12,765,954 $ 12,765,954 $ 12,904,296 $ 138,342 – 9,951 – 89,375 – – – – – – $ 18,859,919 $ 18,863,728 $ 19,101,396 $ 237,668 157,294 5,862,439 3,809 173,558 147,343 5,773,064 – 173,558 147,343 5,773,064 3,809 173,558 108 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 thousands of Canadian dollars Financial Assets Held for trading Financial Assets Available for Sale Loans and Receivables Financial Liabilities at Amortized Cost Carrying Value As at December 31, 2012 Fair Value Over (under) Carrying Value Fair Value Assets Cash and cash equivalents Available for sale securities Loans held for sale Securitized mortgages non-securitized mortgages and loans Restricted assets Derivative assets Securitization receivable and retained interest Other total Assets Liabilities Deposits Senior debt Securitization liabilities Derivative liabilities Other total Liabilities $ $ $ $ 301,863 $ – $ – $ – $ 301,863 $ 301,863 $ – – 21,921 – 414,344 – – – – 6,706,160 – 137,424 45,388 – 588,069 – 10,401,832 – – – – 9,172 – 1,542 73,967 506,596 $ 1,011,585 $ 17,183,501 $ – – – – – – 414,344 21,921 6,706,160 414,344 21,921 6,936,657 – – 230,497 10,401,832 725,493 45,388 10,896,860 725,493 45,388 495,028 – – 10,714 73,967 – – – – – $ 18,701,682 $ 19,427,207 $ 725,525 10,714 73,967 – $ – – 2,386 – 2,386 $ – $ – – – – – $ – $ 10,136,599 $ 10,136,599 $ 10,331,151 $ 194,552 9,660 – (128,317) – – – – – – $ 17,793,680 $ 17,796,066 $ 17,871,961 $ 75,895 160,344 7,207,578 2,386 170,502 150,684 7,335,895 2,386 170,502 150,684 7,335,895 – 170,502 the following methods and assumptions were used to estimate the fair values of financial instruments: > Cash and cash equivalents, restricted cash (included in restricted assets), other assets and other liabilities approximate their carrying values due to their short-term nature. > Available for sale securities are valued based on the quoted bid price. third-party MBS are fair valued using average dealer quoted prices. > Fair value of loans held for sale, all of which are insured, is determined by discounting the expected future cash flows of the loans at current market rates imputed by the realized sale of loans with similar terms. > the fair value of the retained interest is determined by discounting the expected future cash flows using the current MBS spread over Government of Canada Bonds imputed from recent sale transactions. > the fair value of securitization receivables is determined by discounting the expected future cash flows using current interest rate swap rates. > Restricted assets include both securities valued based on quoted bid price and securities where fair value is determined using average dealer quoted prices. > Securitized and non-securitized mortgages and loans are carried at amortized cost in the financial statements. For fair value disclosures, the fair value is estimated by discounting the expected future cash flows of the loans, adjusting for credit risk and prepayment assumptions at current market rates for offered loans with similar terms. > Fair value of derivative financial instruments is calculated as described in note 19. > Retail deposits are not transferable by the deposit holders. In the absence of such transfer transactions, fair value of deposits is determined by discounting the expected future cash flows of the deposits at offered rates for deposits with similar terms. the fair value of the institutional deposit notes is determined using current rates of Government of Canada Bonds. the rates reflect the credit risks of similar instruments. > Fair value of securitization liabilities is determined using current market rates for MBS and CMB. > Fair value of the senior debt is determined using current market rates of Government of Canada Bonds. the rates reflect the credit risks of similar instruments. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 109 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) the Company uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique: Level 1: Significant inputs are quoted (unadjusted) prices in active markets for identical assets or liabilities. this level includes cash and cash equivalents, equity securities traded on the toronto Stock exchange and quoted corporate and government-backed debt instruments. Level 2: Significant inputs are observable for the asset or liability, either directly or indirectly and are not quoted prices included within Level 1. this level includes loans held for sale, interest rate swaps, bond forwards, mutual funds, certain corporate debt instruments and senior debt. Level 3: Significant inputs are unobservable for the asset or liability. this level includes retained interest, securitized and non-securitized mortgages and loans, securitization receivables and liabilities, other assets and liabilities, and deposits. the following table presents the fair value of financial instruments across the levels of the fair value hierarchy. level 1 level 2 level 3 total As at December 31, 2013 $ 728,469 $ – $ – – 122,836 149,559 60 272,998 – 381,356 – – – – – $ 1,655,278 $ $ $ – $ – – – – – $ 137,975 29,886 – – – – 1,655 148,794 – – $ – – – 728,469 137,975 29,886 122,836 – – – – – 31,935 149,559 60 272,998 1,655 530,150 31,935 – – – – 5,256,782 5,256,782 13,100,882 13,100,882 22,791 22,791 79,648 79,648 318,310 $ 18,492,038 $ 20,465,626 – $ 12,904,296 $ 12,904,296 157,294 – 5,862,439 5,862,439 173,558 173,558 157,294 – – 3,809 3,809 161,103 $ 18,940,293 $ 19,101,396 – thousands of Canadian dollars Financial assets held for trading Cash and cash equivalents Loans held for sale Derivative assets Restricted assets Financial instruments available for sale Debt securities Common shares preferred shares Mutual funds Restricted assets Retained interest loans and receivables Securitized mortgages non-securitized mortgages and loans Securitization receivables Other total Financial liabilities carried at amortized cost Deposits Senior debt Securitization liabilities Other Financial liabilities at fair value Derivative liabilities total 110 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 thousands of Canadian dollars Financial assets held for trading Cash and cash equivalents Loans held for sale Derivative assets Restricted assets Financial instruments available for sale Debt securities Common shares preferred shares Mutual funds Restricted assets Retained interest Loans and receivables Securitized mortgages non-securitized mortgages and loans Securitization receivables Other total Financial liabilities carried at amortized cost Deposits Senior debt Securitization liabilities Other Financial liabilities at fair value Derivative liabilities total Level 1 Level 2 Level 3 total As at December 31, 2012 $ 301,863 $ – $ – – 137,424 104,832 8,836 299,557 – 369,718 – – – – – $ 1,222,230 $ $ $ – $ – – – – – $ 21,921 45,388 – – – – 1,119 218,351 – – $ – – – 301,863 21,921 45,388 137,424 – – – – – 9,172 104,832 8,836 299,557 1,119 588,069 9,172 – – – – 6,936,657 6,936,657 10,896,860 10,896,860 1,542 1,542 73,967 73,967 286,779 $ 17,918,198 $ 19,427,207 – $ 10,331,151 $ 10,331,151 160,344 – 7,207,578 7,207,578 170,502 170,502 160,344 – – 2,386 2,386 162,730 $ 17,709,231 $ 17,871,961 – During 2013 and 2012, the Company did not transfer any financial instrument from Level 1 or Level 2 to Level 3 of the fair value hierarchy. note 23 RelAteD PARtY tRAnSACtI o nS IFRS considers key management personnel to be related parties. Compensation of key management personnel of the Company is as follows: thousands of Canadian dollars Short-term employee benefits Share-based payment Other long-term benefits 2013 7,626 $ 1,719 241 9,586 $ 2012 6,646 2,147 203 8,996 $ $ the Company had no related party transactions, other than with key management personnel, as described above, for the years ended December 31, 2013 and 2012. note 24 RISK m An AGemen t the Company is exposed to various types of risk owing to the nature of the business activities it carries on. types of risk to which the Company is subject include credit, liquidity and funding, interest rate investment, operational reputational and legislative and regulatory risk. the Company has adopted enterprise risk management (eRM) as a discipline for managing risk. the Company’s eRM structure is supported by a governance framework that includes policies, management standards, guidelines and procedures appropriate to each business activity. the policies are reviewed and approved annually by the Board of Directors. A description of the Company’s risk management policies and procedures is included in the shaded text of the Risk Management section of the MD&A. Significant exposures to credit, liquidity and interest rate risks are described in notes 4, 5, 19 and 21. Home CAPItAl GRouP InC. AnnuAL RepORt 2013 111 Corporate Directory Ho me C API tAl GRouP InC. Directors: Kevin P. D. Smith 3, 4 Chairman of the Board president and Chief executive Officer St. Joseph’s Health System Hamilton, Ontario Hon. William G. Davis P.C., C.C., Q.C. 3, 4 Vice Chair of the Board Counsel Davis Webb LLp Brampton, Ontario james C. Baillie 2, 3 Counsel torys LLp toronto, Ontario William Falk 2, 3 Managing partner pricewaterhouseCoopers LLp Grand Valley, Ontario Diana l. Graham 1, 2 Corporate Director toronto, Ontario john m. e. marsh 1, 4 Corporate Director port Colborne, Ontario Robert A. mitchell, CPA, CA 1, 2, 3 Corporate Director Oakville, Ontario Gerald m. Soloway Chief executive Officer Home Capital Group Inc. toronto, Ontario Bonita then 1, 2 Corporate Director toronto, Ontario leslie thompson 2, 4 president LeSRISK, Debt and Risk Management Inc. toronto, Ontario 1 Member of the Audit Committee 2 Member of the Risk and Capital Committee 3 Member of the Governance, nominating and Conduct Review Committee 4 Member of the Human Resources and Compensation Committee Committees: Audit Committee Robert A. Mitchell Chair Bonita then Vice Chair Risk and Capital Committee Bonita then Chair Leslie thompson Vice Chair Governance, nominating and Conduct Review Committee Hon. William G. Davis Chair James C. Baillie Vice Chair Human Resources and Compensation Committee Kevin p.D. Smith Chair John M.e. Marsh Vice Chair officers: Gerald m. Soloway Chief Executive Officer martin Reid President Brian R. mosko Chief Operating Officer and Executive Vice President Robert Blowes, FCPA, FCA Chief Financial Officer and Executive Vice President Pino Decina Executive Vice President, Residential Mortgage Lending john R. K. Harry Senior Vice President, Commercial Mortgage Lending Chris Ahlvik, ll.B. Senior Vice President, Corporate Counsel and Corporate Secretary David j. novak Senior Vice President, Chief Risk Officer 112 Home CAPItAl GRouP InC. AnnuAL RepORt 2013 Chair emeritus: William A. Dimma marie Holland, CPA, CA Senior Vice President, Internal Audit john Hong Senior Vice President, Chief Compliance Officer and Chief Anti-Money Laundering Officer Stephen Copperthwaite, CmA, oRmP Senior Vice President, Relationship Manager Greg Parker Senior Vice President, Treasurer Fariba Rawhani Senior Vice President, Chief Information Officer Annual meeting notice the Annual Meeting of Shareholders of Home Capital Group Inc. will be held at One King West, Grand Banking Hall, toronto, Ontario, on Wednesday, May 14, 2014 at 11:00 a.m. local time. Shareholders and guests are invited to join Directors and Management for lunch and refreshments following the Annual Meeting. All shareholders are encouraged to attend. Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s, except per share amounts) Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue Net income Book value of common shares Earnings per share – basic Earnings per share – fully diluted 2013 2012 2011 2010 IFRS 2010 GAAP 2009 2008 2007 2006 2005 2004 $ $ $ $ $ $ $ $ $ $ $ $ 20,075,850 21,997,781 18,019,901 19,941,832 5,210,021 12,765,954 1,177,697 949,547 256,542 33.90 7.40 7.32 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 18,041,584 16,089,648 14,091,755 14,028,255 9,616,251 7,145,826 4,505,026 4,436,420 3,284,829 4,085,013 2,813,459 3,613,643 2,568,513 3,069,253 2,257,740 2,758,480 6,706,160 10,136,599 968,213 887,685 221,983 27.96 6.40 6.38 8,243,350 7,922,124 774,785 790,274 190,080 22.38 5.48 5.46 8,116,636 6,595,979 628,585 687,249 154,752 18.14 4.46 4.45 – – – – – – – 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 2,269,157 742,280 533,937 180,944 21.42 5.21 5.20 590,288 489,179 144,493 17.00 4.19 4.15 432,753 454,695 108,687 12.57 3.15 3.13 348,040 368,881 90,241 10.08 2.62 2.59 276,866 282,549 67,815 8.10 1.99 1.95 218,885 234,704 60,861 6.44 1.80 1.72 162,207 181,839 44,551 4.80 1.33 1.27 In 2011, Home Capital Group Inc. implemented International Financial Reporting Standards (IFRS) with a transition date of January 1, 2010. Figures for 2010 have been restated on an IFRS basis. Figures for 2009 and prior years are on a former Canadian Generally Accepted Accounting Principles (GAAP) basis. 23.9% Return on equity was 23.9%, exceeding 20% for the 16th consecutive year $256.5million Net income for 2013 was $256.5 million, an increase of 15.6% over 2012 $19.94billion Total loans under administration grew by 10.5% over 2012 to reach $19.94 billion at the end of 2013 Net Income ($ millions) Earnings per Share (basic in dollars) Return on Equity (percentage) 257 222 181 190 155 144 7.40 6.40 5.48 5.21 4.46 4.19 28.2 27.2 27.3 27.1 25.5 23.9 09 10 10 11 12 13 09 10 10 11 12 13 09 10 10 11 12 13 15.6% 250 200 150 Home Capital reported a 15.6% increase in net income over the $222.0 million attained in 2012, reaching $256.5 million for the year ended 2013. 100 50 Former Canadian GAAP Basis IFRS Basis 0 09 10 10 11 12 13 15.6% 7 6 5 Basic earnings per share rose to $7. 40 for the year ended December 31, 4 2013, a 1 5. 6% increase over the 3 $6. 40 reported for 2012. 2 1 IFRS Basis 0 23.9% Home Capital surpassed 20% return on equity for the 16th consecutive year, reaching 23.9% at December 31, 2013. 30 25 20 15 10 5 0 09 10 10 11 12 13 09 10 10 11 12 12 "09" "10" "10" "11" "12" "13" 144 181 155 190 222 257 "09" "10" "10" "11" "12" "13" 4.19 5.21 4.46 5.48 6.4 7.4 "09" "10" "10" "11" "12" "12" 28.2 27.2 27.3 27.1 25.5 23.9 HOMECap 2736 ENG_2013AR_cover_v2.indd 2 Ten-year Cumulative Total Return on $100 Investment Comparison between S&P/TSX Composite Index (S&P/TSX) and Home Capital Group Inc. (HCG) December 31, 2003–December 31, 2013 Compounded Annual Growth Over 10 Years 19% $7.32 Diluted earnings per share were $7.32 for the year, an increase of 14.7% over 2012 HCG 19% S&P/TSX 8% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $31.25 $34.75 $34.05 $41.90 $19.80 $41.85 $51.79 $49.10 $59.07 $80.93 1,000 800 600 400 200 0 HCG Stock Price Performance Closing Price as of December 31 Share prices have been restated to reflect two-for-one stock split on January 29, 2004. 1000 800 600 400 200 0 “2003” “2004” “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” “2003” . . . . . . . 100 . . . . . . . . . 100 “2004” . . . . . . . 114.48 . . . . . . . 188.91 “2005” . . . . . . . 142.1 . . . . . . . . 211.06 “2006” . . . . . . . 166.63 . . . . . . . 208.59 “2007” . . . . . . . 183.01 . . . . . . . 259.49 “2008” . . . . . . . 122.61 . . . . . . . 124.71 “2009” . . . . . . . 165.59 . . . . . . . 268.84 “2010” . . . . . . . 194.75 . . . . . . . 337.72 “2011” . . . . . . . 177.78 . . . . . . . 324.87 “2012” . . . . . . . 190.56 . . . . . . . 398.06 “2013” . . . . . . . 215.32 . . . . . . . 554.78 Corporate Directory HOME TRUST COMPANY Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Senior Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B Senior Vice President, Corporate Counsel and Corporate Secretary David J. Novak Senior Vice President, Chief Risk Ofﬁ cer Marie Holland, CPA, CA Senior Vice President, Internal Audit John Hong Senior Vice President, Chief Compliance Ofﬁ cer and Chief Anti-Money Laundering Ofﬁ cer Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Greg Parker Senior Vice President, Treasurer Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2013, there were 34,744,090 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada Directors: Kevin P. D. Smith Chairman of the Board Hon. William G. Davis P.C., C.C., Q.C. Vice Chair of the Board James C. Baillie William Falk Diana L. Graham John M. E. Marsh Robert A. Mitchell, CPA, CA Martin Reid Gerald M. Soloway Bonita Then Leslie Thompson Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Blowes, FCPA, FCA Chief Financial Ofﬁ cer and Executive Vice President m o c . r i m b . w w w o s s e d a r I s l l i M n a y r B r i m b y b d e n g i s e D Auditors: Ernst & Young LLP Chartered Accountants Toronto, Ontario Principal Bankers: Bank of Montreal Bank of Nova Scotia Transfer Agent: Computershare Investor Services Inc. 100 University Avenue Toronto, Ontario M5J 2Y1 Tel: 1-800-564-6253 Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG FSC LOGO TO GO HERE. Halifax: 5251 Duke Street Suite 1205, Duke Tower Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Rue University Suite 2420 Montreal, Quebec H3A 2A5 Tel: 514-843-0129 1-866-542-0129 Fax: 514-843-7620 1-866-620-7620 Winnipeg: 201 Portage Avenue 18th Floor Winnipeg, Manitoba R3B 3K6 Tel: 204-942-1619 Fax: 204-942-1638 Fariba Rawhani Senior Vice President, Chief Information Ofﬁ cer Branches: Toronto: 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 Calgary: 10655 Southport Road SW Suite 920 Calgary, Alberta T2W 4Y1 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 2500 2000 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1500 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 1000 500 0 2000 For Shareholder Information, Please Contact: 1999 Chris Ahlvik Senior Vice President, Corporate Counsel Home Capital Group Inc. 145 King Street West Suite 2300 Toronto, Ontario M5H 1J8 Tel: 416-360-4663 2001 2002 2003 2004 2005 2006 2007 2008 2009 an eleventh hour change before we printed the report with 2008 on the cover resulted in the styled graph losing one year and being stretched to accommodate, the rough graph below was not edited at the time due to short scheduling, this year’s graph will be created the same way (again… short scheduling) 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca 14-03-21 12:37 PMFri, Mar 21, 2014 Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 CANADA’S ONE-STOP MORTGAGE LENDER A CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2013 The Right Strategy Record Results H O M E C A P I T A L G R O U P I N C . A N N U A L R E P O R T 2 0 1 3 Business Profile Home Capital Group Inc., together with its operating subsidiary Home Trust Company, has developed a track record of success as Canada’s leading alternative lender. Building on the demonstrated strength of its core residential mortgage lending business, the Company also offers complementary lending services, as well as highly competitive deposit investment products. MISSION STATEMENT Home Capital’s mission is to deliver superior shareholder value by focusing on well-deﬁ ned niches in the Canadian lending and deposit- taking market place that generate above average returns, have acceptable residual risk proﬁ les and are not adequately served by traditional ﬁ nancial institutions, while protecting the depositors and operating within regulatory guidelines and the Company’s risk appetite. Home Trust Branches MORTGAGE LENDING Home Trust is one of Canada’s leading mortgage lenders, focusing on homeowners who typically do not meet all the lending criteria of traditional ﬁ nancial institutions. By offering a range of mortgage products, Home Trust is uniquely positioned to provide ﬁ nancial solutions to meet the needs of thousands of Canadians. With a proprietary lending approach, comprehensive borrower proﬁ ling and ﬂ exible alternative options, Home Trust is a one-stop shop for borrowers and mortgage brokers. Home Trust is also a provider of commercial ﬁ rst mortgages to high-quality borrowers in selected markets across Canada. CONSUMER LENDING Home Trust’s Equityline Visa program brings the advantages to cardholders of accessing the equity they have built in their homes together with the features and convenience of a Gold Visa card. The Company also offers deposit-secured credit cards for individuals who wish to build or re-establish a positive credit history. Home Trust’s Retail Credit Services provides installment ﬁ nancing for customers making purchases from established businesses. PSiGate, a wholly owned subsidiary, offers electronic card-based payment services to merchants who conduct business primarily on the Internet. DEPOSIT INVESTMENTS Home Trust provides a broad range of deposit investment services through its extensive deposit broker network. In addition, Home Trust recently launched its direct-to-consumer brand, Oaken Financial, which offers a competitive suite of deposit products, including a daily interest savings account, to provide customers with a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust offers a number of solutions to meet the long -term and short -term needs of investors looking to diversify their portfolios. CONTENTS 1 Report to Shareholders 6 Proven Results 7 Performance vs. Target 8 Corporate Governance at Home Capital 11 Corporate Social Responsibility 12 Management’s Discussion and Analysis 73 Consolidated Financial Statements 80 Notes to the Consolidated Financial Statements HOMECap 2736 ENG_2013AR_cover_v2.indd 1 14-03-21 12:37 PMFri, Mar 21, 2014

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