Home Capital Group Annual Report 2014

Plain-text annual report

CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2014 Business Profile Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 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 4 Another Great Year. CANADA’S ONE-STOP MORTGAGE LENDER HomeCap 2899 AnnualReport_Front-v2.indd 1 Front Panel 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 marketplace 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 beneﬁ t of 1% cash back on all purchases and 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’s direct-to-consumer brand, Oaken Financial, offers a competitive suite of deposit products and convenient online banking to customers as a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust and Oaken Financial offer 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 7 5 Consolidated Financial Statements 82 Notes to the Consolidated Financial Statements 112 Corporate Directory 15-03-17 11:27 AM CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2014 Business Profile Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 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 4 Another Great Year. CANADA’S ONE-STOP MORTGAGE LENDER HomeCap 2899 AnnualReport_Front-v2.indd 1 Front Panel 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 marketplace 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 beneﬁ t of 1% cash back on all purchases and 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’s direct-to-consumer brand, Oaken Financial, offers a competitive suite of deposit products and convenient online banking to customers as a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust and Oaken Financial offer 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 7 5 Consolidated Financial Statements 82 Notes to the Consolidated Financial Statements 112 Corporate Directory 15-03-17 11:27 AM Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s) 2014 – Adjusted 2014 2013 2012 2011 2010 IFRS 2010 CGAAP 2009 2008 2007 2006 2005 Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue1 Net income1 Book value of common shares2 Earnings per share – basic1,2 Earnings per share – fully diluted1,2 $ $ $ $ $ $ $ $ $ $ $ $ 20,082,744 20,082,744 20,075,850 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 24,281,366 24,281,366 21,997,781 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 18,364,910 18,364,910 18,019,901 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 22,563,532 22,563,532 19,941,832 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 3,945,654 3,945,654 5,210,021 6,706,160 13,939,971 13,939,971 12,765,954 10,136,599 1,448,633 1,014,566 288,384 20.67 4.13 4.09 1,448,633 1,042,986 313,172 20.67 4.48 4.45 1,177,697 949,547 256,542 16.95 3.70 3.66 968,213 887,685 221,983 13.98 3.20 3.19 8,243,350 7,922,124 774,785 790,274 190,080 11.19 2.74 2.73 8,116,636 6,595,979 628,585 687,249 154,752 9.07 2.23 2.22 — — — — — — 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 742,280 533,937 180,944 10.71 2.61 2.60 590,288 489,179 144,493 8.50 2.10 2.08 432,753 454,695 108,687 6.28 1.57 1.57 348,040 368,881 90,241 5.04 1.31 1.29 276,866 282,549 67,815 4.05 0.99 0.97 218,885 234,704 60,861 3.22 0.90 0.86 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. 17 years Return on equity1 was 22.0% on an adjusted basis, exceeding 20% for the 17th successive year. $313.2 million Reported net income for 2014 was $313.2 million, an increase of 22.1% over 2013. $22.56 billion Total loans under administration grew by 13.1% over 2013 to reach $22.56 billion at the end of 2014. $1 billion Total Revenue exceeded $1 billion on an adjusted basis, reaching a signiﬁ cant milestone in 2014. Net Income1 ($ millions) 222 190 155 313 288 257 Diluted Earnings per Share1,2 ($) Return on Equity1 (percentage) 4.45 4.09 3.66 3.19 2.73 2.22 27.3 27.1 25.5 23.9 23.8 22.0 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 11.9% Home Capital recorded an 11.9% increase in adjusted net income over 2013, reaching $288.4 million for the year ended 2014. 350 280 210 140 11.1% Adjusted diluted earnings per share rose to $4.09 for the year ended December 31, 2014, an 11.1% increase over the year ended 2013. 5 4 3 2 22.0% Home Capital surpassed 20% return on equity for the 17th consecutive year, reaching 22.0% on an adjusted basis at December 31, 2014. 30 24 18 12 1 70 See deﬁ nition of Adjusted Net Income, Total Adjusted Revenue, Adjusted Earnings per Share and Adjusted Return on Equity in the Non-GAAP Measures and Glossary section of this report and the Reconciliation of Net Income to Adjusted Net Income in Table 3 of this report. 1 6 2 Share prices have been restated to reﬂ ect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted HomeCap 2899 AnnualReport_Front-v2.indd 2 Inside Panel 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, 2004–December 31, 2014 Compounded Annual Growth Over 10 Years 13% HCG 13% S&P/TSX 8% 400 320 240 160 80 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 HCG Stock Price Performance $17.38 $17.03 $20.95 $9.90 $20.93 $25.90 $24.55 $29.54 $40.47 $47.99 Closing Price as of December 31 Share prices have been restated to reflect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 400 320 240 160 80 0 “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” 2014 Corporate Directory HOME TRUST COMPANY 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 Jacqueline Beaurivage William Falk Diana Graham John M. E. Marsh Robert A. Mitchell Martin Reid Gerald M. Soloway Bonita Then Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Morton, CPA, CMA Chief Financial Ofﬁ cer and Executive Vice President Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Executive Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B. Executive Vice President, Corporate Counsel and Corporate Secretary Greg Parker Chief Risk Ofﬁ cer and Executive Vice President Fariba Rawhani Executive Vice President, Chief Information Ofﬁ cer Dinah Henderson Executive Vice President, Operations 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 Halifax: 5251 Duke Street Duke Tower, Suite 1205 Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Boul . Robert-Bourassa 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 Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Carol Ferguson Senior Vice President, Human Resources 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: 507 – 10th Avenue SW Calgary, Alberta T2R 0A8 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 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 FSC LOGO TO GO HERE. Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2014, there were 70,096,330 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada For Shareholder Information, Please Contact: Chris Ahlvik Executive Vice President, Corporate Counsel and Corporate Secretary Home Capital Group Inc. 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca HCG S&P/TSX 15-03-17 11:27 AM Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s) 2014 – Adjusted 2014 2013 2012 2011 2010 IFRS 2010 CGAAP 2009 2008 2007 2006 2005 Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue1 Net income1 Book value of common shares2 Earnings per share – basic1,2 Earnings per share – fully diluted1,2 $ $ $ $ $ $ $ $ $ $ $ $ 20,082,744 20,082,744 20,075,850 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 24,281,366 24,281,366 21,997,781 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 18,364,910 18,364,910 18,019,901 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 22,563,532 22,563,532 19,941,832 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 3,945,654 3,945,654 5,210,021 6,706,160 13,939,971 13,939,971 12,765,954 10,136,599 1,448,633 1,014,566 288,384 20.67 4.13 4.09 1,448,633 1,042,986 313,172 20.67 4.48 4.45 1,177,697 949,547 256,542 16.95 3.70 3.66 968,213 887,685 221,983 13.98 3.20 3.19 8,243,350 7,922,124 774,785 790,274 190,080 11.19 2.74 2.73 8,116,636 6,595,979 628,585 687,249 154,752 9.07 2.23 2.22 — — — — — — 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 742,280 533,937 180,944 10.71 2.61 2.60 590,288 489,179 144,493 8.50 2.10 2.08 432,753 454,695 108,687 6.28 1.57 1.57 348,040 368,881 90,241 5.04 1.31 1.29 276,866 282,549 67,815 4.05 0.99 0.97 218,885 234,704 60,861 3.22 0.90 0.86 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. 17 years Return on equity1 was 22.0% on an adjusted basis, exceeding 20% for the 17th successive year. $313.2 million Reported net income for 2014 was $313.2 million, an increase of 22.1% over 2013. $22.56 billion Total loans under administration grew by 13.1% over 2013 to reach $22.56 billion at the end of 2014. $1 billion Total Revenue exceeded $1 billion on an adjusted basis, reaching a signiﬁ cant milestone in 2014. Net Income1 ($ millions) 222 190 155 313 288 257 Diluted Earnings per Share1,2 ($) Return on Equity1 (percentage) 4.45 4.09 3.66 3.19 2.73 2.22 27.3 27.1 25.5 23.9 23.8 22.0 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 11.9% Home Capital recorded an 11.9% increase in adjusted net income over 2013, reaching $288.4 million for the year ended 2014. 350 280 210 140 11.1% Adjusted diluted earnings per share rose to $4.09 for the year ended December 31, 2014, an 11.1% increase over the year ended 2013. 5 4 3 2 22.0% Home Capital surpassed 20% return on equity for the 17th consecutive year, reaching 22.0% on an adjusted basis at December 31, 2014. 30 24 18 12 1 70 See deﬁ nition of Adjusted Net Income, Total Adjusted Revenue, Adjusted Earnings per Share and Adjusted Return on Equity in the Non-GAAP Measures and Glossary section of this report and the Reconciliation of Net Income to Adjusted Net Income in Table 3 of this report. 1 6 2 Share prices have been restated to reﬂ ect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted HomeCap 2899 AnnualReport_Front-v2.indd 2 Inside Panel 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, 2004–December 31, 2014 Compounded Annual Growth Over 10 Years 13% HCG 13% S&P/TSX 8% 400 320 240 160 80 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 HCG Stock Price Performance $17.38 $17.03 $20.95 $9.90 $20.93 $25.90 $24.55 $29.54 $40.47 $47.99 Closing Price as of December 31 Share prices have been restated to reflect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 400 320 240 160 80 0 “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” 2014 Corporate Directory HOME TRUST COMPANY 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 Jacqueline Beaurivage William Falk Diana Graham John M. E. Marsh Robert A. Mitchell Martin Reid Gerald M. Soloway Bonita Then Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Morton, CPA, CMA Chief Financial Ofﬁ cer and Executive Vice President Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Executive Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B. Executive Vice President, Corporate Counsel and Corporate Secretary Greg Parker Chief Risk Ofﬁ cer and Executive Vice President Fariba Rawhani Executive Vice President, Chief Information Ofﬁ cer Dinah Henderson Executive Vice President, Operations 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 Halifax: 5251 Duke Street Duke Tower, Suite 1205 Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Boul . Robert-Bourassa 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 Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Carol Ferguson Senior Vice President, Human Resources 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: 507 – 10th Avenue SW Calgary, Alberta T2R 0A8 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 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 FSC LOGO TO GO HERE. Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2014, there were 70,096,330 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada For Shareholder Information, Please Contact: Chris Ahlvik Executive Vice President, Corporate Counsel and Corporate Secretary Home Capital Group Inc. 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca HCG S&P/TSX 15-03-17 11:27 AM Report to Shareholders Building Solid Fundamentals. We are pleased to report to shareholders on another exciting and rewarding year for Home Capital Group. In 2014, we continued to leverage our depth of experience and, with the benefits of both a stable real estate sector and steady Canadian economy, 2014 marked the achievement of another year of record operating and financial performance. Home Capital GRoup inC. AnnuAl RepoRt 2014 1 Report to Shareholders (continued) Financial Performance the success of our business model has been established, and year after year we have demonstrated consistent, superior growth in our results. Since Home Capital’s inception over 25 years ago, we have remained disciplined in applying our focused strategies to generate strong financial performance, and thereby generate consistent increases in shareholder value. 1 platform for continued growth Growing Our Core Business We remain focused on building and maintaining Canada’s leading alternative financial institution by serving an established, but underserved and growing market niche. In 2014, Home Capital achieved a major milestone as adjusted revenue exceeded $1 billion for the first time. excluding prepayment income of $32.7 million related to the sale of a water heater loan portfolio, adjusted net income increased 11.9% from the 2013 level. Adjusted diluted earnings per share were up 11.1% to $4.09 and total loans under administration increased 13.1% to $22.56 billion. Adjusted return on shareholders’ equity was 22.0%, which represents the 17th consecutive year that our annual return on equity has exceeded 20%. Mortgage originations increased by a healthy 28.0% during 2014, with traditional mortgages accounting for 66.2% of originations. Concurrently, we achieved a year-over-year reduction in net non-performing loans, which decreased from 0.35% of gross loans to 0.30%, a highly enviable result in our industry. We are very proud of these accomplishments. When looked at together, they underline our ability to continuously leverage our extensive expertise to identify high-quality growth opportunities without compromising our credit standards. looking ahead, by remaining focused on what we do best, we are confident that we will capitalize on what we perceive to be opportunities for steady, sustainable growth in Canada. Investing in Infrastructure In 2014, we continued to invest in upgrades to our technology and back-office support functions. We now have two disaster recovery sites in southern ontario, enhancing our business continuity readiness. We have increased our cyber-security capabilities and continue to strengthen our control functions and the technology that supports the business, and continue to introduce and enhance processes to defend against more sophisticated and complex fraud. While many of these initiatives are not visible on the front lines, they support the long-term growth we are targeting. During the first half of 2015, we will launch a new mortgage origination platform. this new technology will increase efficiency and enhance the effectiveness of our underwriting practices. this is the first phase of a long-term investment to add new features, controls and metrics to our procedures, which supports our goal of continuous improvement in the mortgage process. Shareholder Dividends We continue to prioritize the distribution of profits to our shareholders. Sustainable growth, strong cash flow and a positive outlook led to three separate dividend increases during 2014, resulting in annualized year-over-year dividend growth of 37.5%. With these recent increases, we have now increased our dividend 20 times during the last 10 years. We are dedicated to maintaining this policy of increasing returns to shareholders through 2015 and beyond. In this regard, we recently announced that our Board of Directors has approved an increase to our dividend payout target range from 14%– 21% to 19%–26% of profits – the second such increase in our payout target range in less than a year – underscoring our commitment to shareholder returns. 2 Home Capital GRoup inC. AnnuAl RepoRt 2014 Inside Pages – 8” x 11.75” (each page) Building our Asset Base At $24.3 billion, assets under administration grew 10.4% from $22.0 billion last year. We are particularly pleased with the performance of our traditional mortgage portfolio where we not only generated a year-over-year increase in originations of 22.9%, but at the same time we experienced an improvement in the credit quality of our loan portfolio. We continue to experience very strong demand for these products and anticipate continued growth and increased profitability from this business line in the years ahead. over the course of 2014, we renewed focus on Accelerator, our insured residential mortgage product. As a result of our efforts, originations for this component of our portfolio increased by 76.4% in 2014. this business segment continues to be one of our key offerings and helps to fulfil our mandate to offer a full line of products that meet the needs of our borrowers and brokers. 2 platform for continued growth Achieving Strong Shareholder Returns By maintaining a strong, conservative financial position, we can continue to deliver superior shareholder value with a strong return on equity and increased shareholder dividends. We continue to leverage our expertise in the real estate market to generate high-quality growth in our Retail Credit business line, which provides loans for durable household goods and large-ticket home improvement items. We are pleased with the 13.5% increase this year, which was primarily driven by our ability to continue to build and expand relationships with our business partners. looking ahead, we will continue to identify opportunities to grow this business segment, capitalizing on its attractive returns and excellent risk profile. Rounding out our offering, and in line with our longer-term strategy of diversifying our sources of funding, is our direct- to-consumer brand, oaken Financial. originally launched in 2013 with a line of consumer deposit products, oaken was propelled ahead in 2014 with the launch of online banking. oaken’s online and telephone presence is supported by its sales and service professionals located in Home trust’s Vancouver, Calgary, toronto and Halifax offices. In 2015, oaken will be moving from its Home trust office locations in toronto and Calgary by opening a new downtown retail store in each city. these new retail locations will enhance the consumer experience and provide greater visibility for the oaken brand. Customers are responding to the safe, stable and sound product offering, which furthers our commitment to diversifying our sources of funding. total deposits raised through our deposit diversification initiatives, oaken Financial, high-interest savings accounts and institutional deposits now total $2.42 billion. Maintaining a Strong Balance Sheet At Home Capital, sustainable growth – ensuring that we are well positioned to prosper in both good and bad economic times – is a key focus. We believe that this is achieved through a continuous effort to enhance the quality and strength of our capital base, without negatively impacting our risk profile. At year-end, we had solid Common equity tier 1 and total capital ratios of 18.30% and 20.94%, respectively. Additionally, the credit quality of our loans remains strong and our provision for credit losses remains low. Home Capital GRoup inC. AnnuAl RepoRt 2014 3 Report to Shareholders (continued) Strategic Priorities our first strategic priority is to continue to build and maintain our presence as Canada’s leading alternative financial institution by serving an established, but underserved and growing market niche. We believe that by continuing to offer a full suite of mortgage lending products, complemented by other innovative product offerings in our lending portfolio, we will be able to effectively continue our cautious geographic expansion throughout Canada. our second strategic priority is to maintain a strong and conservative financial position in order to generate consistent returns for our shareholders. By maintaining strong capital and liquidity positions, with capital and leverage ratios exceeding the regulatory minimums by a safe margin, we believe that we can deliver superior shareholder returns as measured by consistently high returns on equity and increased dividends to shareholders. 3 platform for continued growth Building on Operational Excellence We continue to invest in technology and processes that enhance the customer experience, improve efficiencies and strengthen our risk management capabilities. our third strategic priority is to enhance operational excellence by continuing to invest in industry-leading risk oversight and control functions. through investments in technology and processes that enhance the customer experience, we are able to improve efficiencies and contribute to strong risk management and compliance processes, ensuring that growth is managed and prudent. Board of Directors the Hon. William G. Davis will retire from our Board of Directors at the conclusion of the Annual and Special Meeting on May 13, 2015. Bill has been an integral part of our growth since first joining the Board of Home Capital in 1999. He served as Chair of Home trust from 2000 to 2013 and, since that time, served as Vice Chair of Home Capital and Home trust. Bill has provided the highest level of corporate oversight, while consistently impressing everyone in our organization with his commitment, wit and wisdom. our success, both as a growing enterprise and in terms of accountability to shareholders, would not have been as profound without Bill’s involvement. We are honoured that he has consented to serve as Chair emeritus of Home trust Company. on behalf of all stakeholders, we thank Bill for his contribution over the past 15 years and wish him all the best in the years ahead. We are pleased to strengthen our Board as we welcome Robert Blowes, FCpA, FCA, who will be standing as a nominee for election to the Board at the upcoming Annual and Special Meeting. Bob brings significant financial services experience, most recently as executive Vice president and Chief Financial officer of Home Capital and Home trust. prior to working at Home Capital, Bob was a partner at ernst & Young, where he served a number of reporting issuers in the financial services and technology sectors over the course of a 35-year career. We are confident that his strong leadership skills, extensive knowledge and deep understanding of our business will be valuable assets to the Board, the Company and our stakeholders. 4 Home Capital GRoup inC. AnnuAl RepoRt 2014 Inside Pages – 8” x 11.75” (each page) A Positive Outlook for the Future looking ahead, we remain confident that we will continue to generate strong shareholder returns. our view is that the supply and demand dynamics in our established markets will remain balanced in the near-term. In the wake of the current uncertainty resulting from declining oil prices, we will proceed with caution with respect to our geographic and product expansion plans outside of our established ontario base. While we have historically provided annual financial objectives, we believe that sustainable long-term growth is best achieved by having our medium-term objectives guide our decision-making. While not drastically different, we believe that the short-term flexibility inherent in this approach will allow us to maximize value creation for our shareholders over both the mid-term and long-term. In this regard, we have established the following objectives for the mid-term (3 to 5 years): > Achieve, on average, annual growth in diluted earnings per share (adjusted) of 8% to 13%; > Achieve, on average, annual return on equity in excess of 20%; > Maintain strong capital ratios that exceed regulatory minimums by a safe margin commensurate with our risk profile; and > Pay out, on average, 19% to 26% of our profits as dividends to shareholders. to deliver on these objectives, we will continue to adhere to our core competencies and remain focused on our well-defined strategic priorities. By maintaining this focus, we will maintain our track record of delivering long-term value to our customers and to you, our shareholders. our success would not be possible without the dedication and professionalism of everyone on the Home Capital team. on behalf of our Board of Directors and shareholders, we thank them for their contribution to our company. Dr. Kevin P.D. Smith Chairman of the Board Gerald M. Soloway Chief Executive Officer Home Capital GRoup inC. AnnuAl RepoRt 2014 5 proven Results GRowtH Home Capital sustained its strength in key financial measurements. the Company’s core business activities generated strong results, contributing to growth in assets under administration of 10.4% year over year and revenue exceeding $1 billion for the first time. RetuRnS the Company recorded pre-tax return on assets of 2.1% and after-tax return on assets of 1.6%, while shareholders’ equity increased to $1.45 billion, a 23.0% 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. 1 20,076 20,083 18,800 17,696 15,519 24,281 21,998 19,682 17,696 15,519 1,043 1,015 950 888 790 687 10 11 12 13 14 10 11 12 13 14 10 11 12 13 14 14 Adjusted 2.1 1.6 1.6 1.5 1.7 1.6 1.3 1.2 1.2 1.1 1,449 1,178 968 775 629 10 11 12 13 14 10 11 12 13 14 10 11 12 13 14 2 2 18.08 17.29 17.01 16.80 18.30 20.46 20.68 19.69 19.37 20.94 0.35 0.33 0.30 0.24 0.25 10 11 12 13 14 10 11 12 13 14 10 11 12 13 14 1 See definition of Adjusted Revenue in the non-GAAp Measures and Glossary section of this report. 2 these figures are calculated under Basel III for 2013 and 2014 and Basel II for 2012 and earlier. 6 Home Capital GRoup inC. AnnuAl RepoRt 2014 Inside Pages – 8” x 11.75” (each page) performance vs. target RetuRn on eQuitY (Roe) Home Capital again exceeded 20% in return on equity, reaching 22.0% on an adjusted basis for the year ended December 31, 2014, representing the 17th consecutive year in which the Company surpassed 20% Roe. taRGet: 20% adjusted return on equity1 Adjusted return on equity at 22.0% for the year ended December 31, 2014 net inCome the Company reported net earnings of $288.4 million on an adjusted basis for the year ended December 31, 2014, an 11.9% increase over 2013. Reported net income increased by 22.1% over 2013 to $313.2 million in 2014. taRGet: 13% to 18% increase in adjusted net income1 Increase in adjusted net income of 11.9% over 2013 DiluteD eaRninGS peR SHaRe Diluted earnings per share rose to $4.09 on an adjusted basis at December 31, 2014, an 11.1% increase over $3.68 recorded for 2013. Reported diluted earnings per share increased by 21.6% over 2013 to $4.45. total loanS unDeR aDminiStRation total loans under administration grew to $22.56 billion by December 31, 2014, an increase of 13.1% over the $19.94 billion recorded on December 31, 2013. taRGet: 13% to 18% increase in adjusted diluted earnings per share1 taRGet: 15% to 20% increase in total loans under administration Adjusted diluted earnings per share grew 11.1% over 2013 total loans under administration increased 13.1% over 2013 1 See definition of Adjusted net Income, Adjusted earnings per Share and Adjusted Return on equity in the non-GAAp Measures and Glossary section of this report and the Reconciliation of net Income to Adjusted net Income in table 3 of this report. Home Capital GRoup inC. AnnuAl RepoRt 2014 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 Conduct and ethics policy, 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 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 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. 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 control functions. 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 2014 Inside Pages – 8” x 11.75” (each page) 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 the President 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; Home Capital GRoup inC. AnnuAl RepoRt 2014 9 Corporate Governance at Home Capital (continued) > evaluating the contributions of individual Directors; > 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 Ethics Policy. the Senior Vice president, Human Resources meets in camera with the Human Resources and Compensation Committee at least quarterly. Board of Directors SHAREHOLDERS SHAREHOLDERS’ AUDITORS Appoint 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 Independence Standards, Code of Conduct and ethics policy, Disclosure policy, Whistleblower policy and Shareholder Rights plan. 10 Home Capital GRoup inC. AnnuAl RepoRt 2014 Inside Pages – 8” x 11.75” (each page) Corporate Social Responsibility A Commitment to Our Communities Home Capital recognizes the importance of supporting our neighbourhoods 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 – financial literacy, an entrepreneurial culture, serving the underserved and our belief in every Canadian’s right to shelter. In 2014, employee volunteers participated in a number of events including a Junior Achievement of Canada economics for Success program for Grade 8 students in toronto, a Habitat for Humanity construction project to help 21 families move into homes of their own, and a day of providing manual labour and offering support to homeless youth at Covenant House. 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. At Home Capital, we work to foster employee engagement through our shared vision, mission and values, and the promotion of a climate of trust and encouragement. We support our employees through various initiatives, and most recently launched our Bursary program which provides monetary awards to children of employees for post-secondary education and apprenticeships. A Commitment to Our Environment Home Capital is committed to implementing environmentally sustainable business practices that reduce our impact on the environment. We achieve this through employee awareness programs, encouraging employees to make green choices, and supporting business practices and participating in initiatives that benefit the environment in practical and meaningful ways. In 2014, a number of employees took part in an initiative with nature Conservancy Canada, a non-profit organization that focuses on conservation and protection of natural areas that sustain Canada’s plants and wildlife. through this program, volunteers helped build a footpath through part of the oak Ridges Moraine, supporting the preservation of this sensitive and vital ecosystem in southern ontario. Home Capital GRoup inC. AnnuAl RepoRt 2014 11 management’s Discussion and analysis Qu ar terly FinanCial HiGH liGHtS FourtH Quarter 2 014 Items of note Income Statement Highlights Financial position Highlights Fourt H Quarter FinanC ia l inFormation Capi tal manaGem ent Capital Management Activity Internal Capital Adequacy Assessment process (ICAAp) Credit Ratings Share Information ri Sk ma naG em ent Risk Appetite Risk Governance Stress testing principal Risks Strategic Risk Credit Risk Market Risk Funding and liquidity Risk operational Risk legislative and Regulatory Risk Reputational Risk Risk Factors that May Affect Future Results aCCounti nG StanDarDS anD poliCie S Future Change in Accounting Standards Control S oVer Finan Cial rep orti nG 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 -G aap me a S ur e S anD GloSSary non-GAAp Measures Glossary of terms Acronyms 40 41 41 41 42 43 50 53 53 53 53 54 54 54 57 57 57 57 63 66 68 69 69 69 70 70 70 70 71 71 71 71 71 71 74 74 Bu Sine SS pro F ile Business portfolios Vi Sion, miSSion anD ValueS Risk-taking philosophy 2014 Strat e G ie S an D aCHieVem e nt S 2015 StrateGieS 2015 Strategic priorities mi D-ter m FinanCial tarGetS 2015 oVerall outlo ok Market Conditions traditional Single-family Mortgage lending Insured Securitized Mortgage lending Commercial Mortgage lending Credit Card lending Consumer lending Deposits Credit performance and losses non-interest expenses liquidity and Capital Finan C ial H i GH li GH tS Items of note Income Statement Highlights for 2014 Balance Sheet Highlights for 2014 Finan C ial per Forman C e re V i ew net Interest Income and Margin non-interest Income Derivatives and Hedging Cash Flow Hedging Fair Value Hedging economic Hedge of loans Held for Securitization and Sale other Interest Rate Swaps non-interest expenses taxes Comprehensive Income Finan C ial po S ition re View Assets loans under Administration Mortgage lending other lending Cash Resources and Securities liabilities Deposits, Senior Debt and Securitization liabilities Shareholders’ equity Contingencies and Contractual obligations off-balance Sheet Arrangements Related party transactions 14 14 15 15 16 18 18 19 19 19 19 20 20 20 20 20 20 21 21 22 23 23 24 25 25 27 27 28 28 28 28 30 31 31 32 32 33 34 35 36 37 37 38 38 39 39 12 Home Capital Group inC. AnnuAl RepoRt 2014 m anaGement’S Di SCuSSion a nD an aly S 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, 2014. 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 accompanying notes for the year ended December 31, 2014 included in this report. This MD&A has been prepared with reference to the audited consolidated financial statements which are 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 11, 2015. As in prior years, the Company’s Audit Committee reviewed this document and, prior to its release, the Company’s Board of Directors approved it, on the Audit Committee’s recommendation. The Non-GAAP measures used in this MD&A and a glossary of terms used in this MD&A and financial statements are presented in the last section of this MD&A. 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 section of this report, as well as its other publicly filed information, which is 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 2015 and its effect on Home Capital’s business are material factors the Company considers when setting its objectives, targets 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 targets, objectives and outlook for 2015, management’s expectations assume: > While the Canadian economy is expected to produce modest growth in 2015, there is some uncertainty about the effect lower oil prices will have on the broader Canadian economy and specific energy-producing regions in Canada. While the Company has limited exposure in energy-producing regions, it has plans for geographic expansion in Canada. there is some uncertainty as to the timing and extent of expansion given the economic conditions. > Generally the Company expects stable employment conditions in most regions, except potentially for the energy-producing regions, and also expects inflation will generally be within the Bank of Canada’s target of 1% to 3%, leading to stable credit losses and consistent demand for the Company’s lending products in its established regions. Credit losses and delinquencies in the energy-producing regions may see an increase, but given the Company’s limited exposure, this is not expected to be significant to the Company’s credit losses. > the Canadian economy will continue to be influenced by the economic conditions in the united States and global markets and the continued volatility in oil prices; as such, the Company is prepared for the variability to plan that may result. > the Company is assuming that overnight interest rates will remain at the current very low rate for 2015. this is expected to continue to support relatively low mortgage interest rates for the foreseeable future. Home Capital Group inC. AnnuAl RepoRt 2014 13 management’s Discussion and analysis management’s Discussion and analysis > In the Company’s established regions the expectation is the housing market will remain stable with balanced supply supported by continued low interest rates, relatively stable employment, and immigration. there will be modest declines in housing starts and resale activity with stable to modestly declining prices throughout most of Canada. this supports continued stable credit losses and stable demand for the Company’s lending products in its established regions. > Consumer debt levels will remain serviceable by Canadian households. > the Company will have access to the mortgage and deposit markets through broker networks. B uSineSS 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 is primarily conducted in Canadian dollars. 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 Traditional Single-family Lending – $11.73 billion in loans under administration the traditional single-family residential portfolio is the Company’s “Classic” mortgage portfolio which 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. Insured Securitized Lending – $8.25 billion in loans under administration Insured securitized lending includes the Company’s insured single-family, “Accelerator” mortgages and multi-unit residential mortgages. these mortgages are generally funded through Canada Mortgage and Housing Corporation (CMHC) sponsored mortgage-backed security (MBS) and Canada Mortgage Bond (CMB) securitization programs. In some cases these mortgage portfolios may be sold off-balance sheet, resulting in recognition of gains on sale. the Company remains responsible for the administration of these mortgages and includes them in loans under administration. Commercial Lending – $1.35 billion in loans under administration this portfolio comprises uninsured residential commercial lending, including multi-unit residential properties, and non-residential commercial lending. Residential commercial lending comprises 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. these loans are funded by deposits. Credit Card lending – $330.3 million this portfolio includes credit card lending. the Company’s equityline Visa product, secured by residential property, currently 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 acceptable credit history. Credit card loans are funded by deposits. Consumer lending – $186.1 million this portfolio includes 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. Consumer loans are funded with deposits. Deposits – $12.88 billion 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 has three deposit diversification initiatives, including a high-interest savings account, oaken Financial direct to consumer deposit brand and an institutional deposit program. 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. 14 Home Capital Group inC. AnnuAl RepoRt 2014 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. ViSion, miSSion anD Va lueS it is the vision of the Company to be recognized as the leading alternative lender in the Canadian financial marketplace. the Company’s mission is to deliver superior shareholder value by focusing on well-defined niches in the Canadian lending and deposit- taking marketplace 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 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 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. 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 locations 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. Home Capital Group inC. AnnuAl RepoRt 2014 15 management’s Discussion and analysis management’s Discussion and analysis 201 4 Strate Gie S an D aCH ie Vement S the Company consistently employs three value-enhancing strategic priorities to achieve its long-term objectives: Strategic priority 2014 Strategies and achievements Build and maintain Canada’s leading alternative financial institution maintain a strong, conservative financial position Serving an established and growing market niche > Continued to offer “one-stop” convenience to borrowers and brokers, offering both traditional alternative residential lending and prime lending – increasing total originations by 28% over 2013 > Continued offering ancillary consumer lending products with growth in originations of 14% over 2013 > Improved Visa offering with 1% cash back incentive and increasing number of new accounts by 61% over 2013 > Continued to build on oaken Financial and high-interest savings accounts, increasing balances by 160% over 2013 > enhanced oaken Financial presence through the introduction of oaken online Banking > Maintained service levels to clients and mortgage brokers Generating strong shareholder returns in good times and bad > Maintained a strong capital position, with a Common equity tier 1 capital ratio of 18.30% at the end of 2014 and increased total capital of Home trust, through the increase in retained earnings of $262.6 million > Generated an adjusted Roe of 22%, the 17th consecutive year over 20% > Increased dividends paid to shareholders by 37.5% over 2013 > Maintained the prudent credit risk profile of the loan portfolio, with a net non- performing loans as a percentage of gross loans ratio (npl ratio) of 0.30% and low write-offs at 0.06% of gross loans > Maintained and managed strong liquidity positions, ending the year with $1.06 billion in liquid assets > Maintained a flexible supply of funding through the deposit broker network and oaken Financial; continued to utilize funding through securitization markets and high-interest savings accounts; raised additional $500 million through the institutional deposit note program Build on our operational excellence Investing to ensure our growth is managed and prudent > Continued to invest in process and customer experience-enhancing technology and It security > Continued to enhance risk management, internal audit, compliance capabilities, reporting and analytics > Maintained a strong adjusted efficiency ratio of 28.5% 16 Home Capital Group inC. AnnuAl RepoRt 2014 table 1: 2014 targets and performance (000s, except per share and percentage amounts) Growth in adjusted net income1 Growth in adjusted diluted earnings per share1, 2 Growth in total loans under administration3 Adjusted return on shareholders’ equity1 Adjusted efficiency ratio (teB)1, 4 provision as a percentage of gross uninsured loans For the year ended December 31, 2014 2014 targets 13%–18% 13%–18% 15%–20% 20.0% 28.0%–32.0% 0.15%–0.25% actual results amount 288,384 $ 11.9% $ 11.1% 4.09 13.1% 22,563,532 22.0% 28.5% 0.10% increase over 2013 30,651 0.41 2,621,700 1 See definition of Adjusted net Income, Adjusted Diluted earnings per Share, Adjusted Return on Shareholders’ equity, and Adjusted efficiency Ratio under non-GAAp Measures in this report and the reconciliation of net income to adjusted net income in table 3. 2 the Company’s diluted earnings per share have been presented as if the stock dividend was retrospectively applied to all comparative periods presented. 3 Includes loans held for sale. 4 See definition of teB under non-GAAp Measures in this report. 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 met or exceeded its annual targets with respect to return on shareholders’ equity, efficiency ratio and credit performance. the Company’s 2014 earnings were below its target range by $2.9 million or 1.1% of 2013 adjusted net income. Results were affected by a number of factors, but primarily the Company experienced lower than planned insured mortgage originations at lower spreads resulting in lower gains on sale. this experience reflects the very competitive market for prime insured mortgages. Additionally, the Company also had lower net interest income in Q4 due to the prepayment of the water heater loans. As a result, the Company was also below target for growth in loans under administration. the sale of the water heater loans also affected the growth in the loans under administration and, without the sale, growth would have been 14.3% in 2014. Growth and earnings in the traditional mortgage portfolio was positive and within the Company’s expectations, reflective of its strong market position and high level of service quality. Credit performance in 2014 exceeded the Company’s target range based on strong credit profiles of new mortgages combined with stable Canadian economic conditions. the Company’s efficiency ratio remained in the lower end of its target range (the lower the better), demonstrating continued prudent cost management and a high level of efficiency. Home Capital Group inC. AnnuAl RepoRt 2014 17 management’s Discussion and analysis management’s Discussion and analysis 201 5 Strate G ie S 2015 Strategic priorities the Company’s key long-term objective is to deliver superior shareholder value. the Company believes long-term shareholder value can be achieved through consistent focus on its three value-enhancing strategic priorities as follows: Strategic priority 2015 Strategies Build and maintain Canada’s leading alternative financial institution maintain a strong, conservative financial position Serving an established and growing market niche > Continue to offer a full suite of mortgage lending products while maintaining a high level of service to brokers and customers > Cautiously continue geographic expansion of mortgage lending products > Continue to build complementary and innovative product offerings in our credit card and consumer lending portfolios > Continue to grow oaken Financial > launch Home trust Bank, subject to approval from the Minister of Finance Generating strong shareholder returns in good times and bad > Maintain a strong capital position with capital ratios and leverage ratios exceeding the regulatory minimums by a safe margin and sensitive to our risk position > Maintain prudent levels of liquidity that meet regulatory requirements and our own conservative assessments > Maintain the prudent credit risk profile of the loan portfolios > Deliver superior shareholder returns measured by a consistently high return on equity and increased dividends to shareholders Build on our operational excellence Investing to ensure our growth is managed and prudent > Continue to invest in technology and processes that enhance the customer experience, improve efficiencies and contribute to strong risk management and compliance processes > Maintain a relatively low cost structure as measured by the efficiency ratio 18 Home Capital Group inC. AnnuAl RepoRt 2014 m iD -term Fin an C ial tarGetS While the Company has typically provided annual financial targets, management believes that by focusing on our medium-term objectives in our decision-making, we will be well positioned to provide sustainable earnings growth and solid returns to our shareholders. this approach allows management the flexibility to take actions in the short-term to maximize mid-term and long-term value for the Company’s shareholders. the Company will measure its long-term objective of superior shareholder value through three- to five-year mid-term financial targets as follows: measure mid-term target (3–5 years) Diluted earnings per Share Achieve, on average, annual growth in diluted earnings per share (adjusted) of 8% to 13% Return on Shareholders’ equity (Roe) Achieve, on average, annual Roe >20% Capital Ratios Maintain strong capital ratios that exceed regulatory minimums by a safe margin commensurate with our risk profile Dividend payout Ratio payout, on average, 19% to 26% of earnings to shareholders the Company’s mid-term targets for growth in diluted earnings per share are lower than the annual targets provided for 2014. this reflects the Company’s cautious approach to growth in the current uncertain economic environment in Canada and abroad and the potential range of outcomes for income growth that may result. the Company seeks to achieve a return on common equity of at least 20%, and has exceeded this benchmark in each of the past 17 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. Management is committed to returning a superior total return to its shareholders and has increased its target dividend payout ratio to reflect that commitment. the Company’s Board of Directors has approved an increase in the Company’s dividend payout ratio to 19% to 26% from 14% to 21%. the increased dividend payout target range is based on Home Capital’s strong financial performance and liquidity position, and the anticipated formation of capital through future profitability. the Company’s dividend payout target range is subject to the review by the Company’s Board of Directors on a quarterly basis and modified in accordance with the performance of the Company and then current market conditions. 2015 oV era ll outlook looking ahead, the Board of Directors and management expect that Home Capital will continue generating strong shareholder returns in 2015 and beyond. market Conditions Supply and demand in the Company’s key established real estate markets is expected to remain balanced in 2015, with relatively stable to modestly decreasing prices and sales volumes somewhat reduced in most markets, as demand for new homes and resale activity eases moderately. the Company believes that the current and expected levels of housing activity indicate a healthy real estate market overall. there remains some uncertainty about the effect of the recent volatility in oil prices and the potential implications for the energy-producing regions and the broader Canadian economy. In the wake of this uncertainty the Company will be more cautious with its geographic and product expansion plans outside its established regions in ontario. traditional Single-family mortgage lending the Company expects continued strong demand for its traditional mortgages within its established regions, and it will continue to increase its market share. this market share increase reflects the success of the Company’s business model, service levels and strategy, and the Company will continue to expand its traditional lending portfolio to take advantage of the attractive returns available in the alternative mortgage space. As mentioned, the Company has plans to increase business outside the ontario market, and while this is still the case, the Company will move prudently and potentially more slowly, in light of the economic uncertainty. the Company expects the rate of growth in the portfolio to be relatively consistent with 2014. net interest margins in the traditional mortgage portfolio have narrowed over the last two years reflecting both improved credit quality of borrowers and higher relative cost of funds. the Company expects 2015 net interest margin to remain relatively stable on average to the experience of Q4 2014, but is prepared for modest volatility. Home Capital Group inC. AnnuAl RepoRt 2014 19 management’s Discussion and analysis management’s Discussion and analysis insured Securitized mortgage lending the Company will continue to originate and securitize prime insured single-family and insured multi-unit residential mortgages and will generally sell these off-balance sheet, generating gains on sale. the market for both of these products remains very competitive and the Company expects that new origination levels, seasonality, spreads and gains on sale will be similar to levels experienced in 2014, but this is dependent on market conditions. the Company remains committed to offering a range of mortgage products to support its “one-stop” initiative. the Company will continue to actively renew its maturing portfolio of insured prime mortgages as renewed mortgages offer enhanced profitability. net interest income on the on-balance sheet securitized portfolio will decline as older, higher-yielding pools reach maturity and are replaced with pools that qualify for off-balance sheet accounting. the Company expects that sufficient securitization funding is available to meet its planned volumes. Commercial mortgage lending Commercial mortgage lending will remain an important portfolio for the Company, generating high levels of return and providing asset diversification. the Company has been a prudent and conservative lender in this segment, experiencing very low levels of losses and delinquencies. the portfolio grew modestly in 2014 and the Company plans to cautiously grow the portfolio at a slightly higher rate in 2015 if market conditions remain favourable. Credit Card lending equityline Visa credit cards are an important component of the “one-stop” lending strategy, allowing customers the flexibility of a home equity line of credit with the convenience of a credit card and the new 2014 benefit of a cash back incentive. the Company will continue to focus marketing and cross-selling in this product offering and expects growth at similar to modestly higher levels compared to 2014. the Company also has a number of new initiatives underway, including a preferred Visa offering to our best customers, and while these initiatives are not expected to be material to our results in 2015, they are important strategies for mid- to long-term growth. Consumer lending Consumer lending remains an important ancillary business for the Company, with high rates of return for the allocated capital. With the prepayment of the water heater portfolio in late 2014, the portfolio will contribute lower revenue than in 2014 as it seeks to rebuild the portfolio size. origination volumes are expected to be consistent with 2014 with similar levels of spreads. Deposits the Company will continue to source deposits from the public through investment dealers and deposit brokers and will continue to emphasize growth of its direct to consumer business and oaken Financial brand. the Company will continue to strengthen its funding capability through agreements with additional deposit brokers, growth of its high-yield savings accounts and the enhancement of its direct channel sales and service capabilities. the relative cost of deposits is expected to remain consistent with 2014. the Company will continue to issue institutional deposits and, on average, plans to access this market on a semi-annual basis. Credit performance and losses Broadly positive Canadian economic conditions, along with the Company’s underwriting and collection practices, have led to very low levels of credit losses and delinquencies over the past few years. Credit losses and delinquencies are expected to remain low in 2015, consistent with broadly positive Canadian economic conditions in the Company’s established regions; however, the Company is prepared for volatility in this trend if economic conditions are less favourable. Credit performance in the energy-producing regions is expected to deteriorate, but given the Company’s limited exposure in these geographic areas, the effect on credit losses is not expected to be material. 20 Home Capital Group inC. AnnuAl RepoRt 2014 non-interest expenses the continued expansion of the Company’s business will continue to be accompanied by commensurate strengthening of risk management and control processes along with customer service platforms, involving increased spending on people and technology. Increased spending to support the Company’s direct deposit initiative and the security of the Company’s deliberate and increasing exposure to business online, along with increasing costs associated with regulatory requirements, can also be expected. While there will be continued upward pressure on expenses from these sources, the Company will continue to focus on deriving savings from its cost management and efficiency programs and, on an overall basis, expects its efficiency ratio to remain relatively consistent on average. the Company expects that the effective income tax rate in 2015 will remain within the range of 25.7% to 26.2%, excluding the impact of any Scientific Research and experimental Development (SR&eD) investment tax credits that may be realized. the Company expects to submit claims for SR&eD in 2015 that may result in a reduction to the effective tax rate of the Company. In the event that claims are submitted, the effective tax rate will decrease accordingly. liquidity and Capital the Company continues to hold high levels of capital as measured by regulatory risk-based capital ratios and leverage and is currently accumulating capital more rapidly through retained earnings than would be required to support the lending activity. the Company will continue to employ robust capital adequacy stress-testing techniques to ensure that its conservative capital position is maintained and to provide for the flexibility to take advantage of appropriate market opportunities, if available, and to pay its shareholders an appropriate return. the Company will continue to diversify its funding and maintain a strong liquidity position by holding a sufficient stock of unencumbered high-quality liquid assets. the Company complies with the office of the Superintendent of Financial Institutions Canada (oSFI)’s new liquidity Adequacy Requirements Guideline that is effective January 2015. Strong levels of capital and liquidity provide additional safety and soundness to depositors. this outlook section contains forward-looking statements. please see the Caution regarding Forward-looking Statements on page 13 of this report. Home Capital Group inC. AnnuAl RepoRt 2014 21 management’s Discussion and analysis management’s Discussion and analysis F in an Cial H i GH li GH tS table 2: key performance indicators For the years ended December 31 (000s, except %, multiples and per share amounts) FinanCial perFormanCe meaSureS total adjusted revenue1 net income Adjusted net income1 net interest income earnings per share – basic2 Adjusted earnings per share – basic1, 2 earnings per share – diluted2 Adjusted earnings per share – diluted1, 2 Dividends per share2 Return on shareholders’ equity Adjusted return on shareholders’ equity1 Return on average assets net interest margin (teB)3 net interest margin non–securitized assets (teB)3 net interest margin securitized assets efficiency ratio (teB)3 Adjusted efficiency ratio (teB)1, 3 FinanCial ConDition meaSureS 2014 2013 2012 2011 2010 $ 1,014,566 $ 957,537 $ 891,221 $ 792,699 $ 680,107 313,172 256,542 221,983 190,080 154,752 288,384 257,733 224,585 192,505 147,610 459,529 421,979 381,472 333,952 264,030 4.48 4.13 4.45 4.09 0.70 23.8% 22.0% 1.6% 2.25% 2.83% 0.67% 27.2% 28.5% 3.70 3.72 3.66 3.68 0.54 23.9% 24.0% 1.3% 2.17% 3.01% 0.73% 28.7% 28.2% 3.20 3.24 3.19 3.23 0.45 25.5% 25.8% 1.2% 2.09% 3.10% 0.93% 27.7% 27.5% 2.74 2.78 2.73 2.77 0.38 27.1% 27.4% 1.1% 2.06% 3.04% 1.24% 27.9% 27.7% 2.23 2.13 2.22 2.12 0.33 27.3% 26.1% 1.2% 2.07% 2.82% 1.23% 29.3% 29.9% total assets $ 20,082,744 $ 20,075,850 $ 18,800,079 $ 17,696,471 $ 15,518,818 total assets under administration4 Cash and securities-to-total assets total loans5 24,281,366 21,997,781 19,681,750 17,696,471 15,518,818 4.7% 5.8% 3.8% 5.2% 7.6% $ 18,364,910 $ 18,019,901 $ 17,159,913 $ 16,089,648 $14,091,755 total loans under administration4, 5 22,563,532 19,941,832 18,041,584 16,089,648 14,091,755 Common equity tier 1 capital ratio6 tier 1 capital ratio6 total capital ratio6 18.30% 18.30% 20.94% 16.80% 16.80% 19.69% Assets to regulatory capital multiple6, 7 12.47 13.19 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 0.07% 0.30% 64.4% 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% 1 See definition of Adjusted net Income, total Adjusted Revenue, Adjusted Diluted earnings per Share, Adjusted Return on Shareholders’ equity and Adjusted efficiency Ratio under non-GAAp Measures in this report and the reconciliation of net income to adjusted net income in table 3. 2 During Q1 2014, the Company paid a stock dividend of one common share per each issued and outstanding common share. Accordingly, diluted earnings per share is reduced to half and the number of shares disclosed is doubled for all periods prior to the dividend presented for comparative purposes. 3 See definition of taxable equivalent Basis (teB) under non-GAAp Measures in this report. 4 total assets and loans under administration include both on- and off-balance sheet amounts. 5 total loans include loans held for sale. 6 these figures relate to the Company’s operating subsidiary, Home trust Company. the figures prior to 2011 have not been restated to IFRS. For 2014 and 2013, figures are calculated under Basel III, and for 2012 and earlier, under Basel II. 7 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 was restated to reflect this treatment. the Company did not enter into these transactions prior to 2012. 22 Home Capital Group inC. AnnuAl RepoRt 2014 items of note the Company’s results were affected by the following items of note that aggregated to a positive impact of $24.8 million or $0.36 diluted earnings per share in 2014: > $32.7 million prepayment income in Q4 2014 ($24.0 million after tax and $0.34 diluted earnings per share) related to the sale of $234.9 million of water heater loans. the prepayment income compensates the Company in excess of the future net interest margin that will be lost as a result of the sale. > $5.3 million tax benefit recognized in the first nine months of 2014 ($3.9 million after tax and $0.06 diluted earnings per share) related to SR&eD tax credits for the development of the core banking system functionality and other technology. > $4.3 million charge in 2014 ($3.1 million after tax and $0.04 diluted earnings per share) for restructuring of certain derivative positions upon adoption of IFRS in 2011. Also during the year, the Company paid a stock dividend of one common share per each issued and outstanding common share. the Company’s results were affected by the following items of note in 2013: > $8.4 million tax benefit recognized in 2013 ($6.2 million after tax and $0.09 diluted earnings per share in 2013) related to SR&eD tax credits for the development of the core banking system functionality and other technology. > $8.0 million charge in 2013 ($5.9 million after tax and $0.08 diluted earnings per share in 2013) for restructuring of certain derivative positions upon adoption of IFRS in 2011. > $2.0 million provision in 2013 ($1.5 million after tax and $0.02 diluted earnings per share) associated with the settlement of disputed loans to condominium corporations. income Statement Highlights for 2014 > Reported net income of $313.2 million in 2014, an increase of $56.6 million or 22.1% from net income of $256.5 million in 2013. > Adjusted net income of $288.4 million in 2014, as defined in table 3, increased $30.7 million or 11.9% from adjusted net income of $257.7 million in 2013, reflecting higher loan balances in the traditional mortgage portfolio, solid net interest margin, continued low credit provisions and a consistent low efficiency ratio within an accepted range. > Adjusted diluted earnings per share of $4.09 was up $0.41 or 11.1% from the adjusted diluted earnings per share of $3.68 in 2013. > Adjusted revenue exceeded $1 billion for the first time in 2014. > Return on average shareholders’ equity of 23.8% for 2014 (adjusted return on average shareholders’ equity of 22.0%) exceeded 20% for the 17th consecutive year. > total net interest income increased to $459.5 million, up $37.6 million or 8.9% over the $422.0 million earned in 2013, reflecting higher average loan balances of $18.90 billion compared to $18.22 billion in 2013 and improved total net interest margin (teB) of 2.25% compared to 2.17% in 2013. > net interest income on non-securitized assets was $425.3 million in 2014, increasing 13.7% over 2013 on higher average asset balances of $15.17 billion, compared to $12.57 billion in 2013. net interest margin on this portfolio was 2.83% for 2014, down from 3.01% in 2013 reflecting both lower asset yields and relatively higher cost of funds compared to benchmark rates. Asset yields are down due to a combination of factors, including origination of higher credit quality borrowers over the last year and the current low rate environment. > total income earned from securitization, which includes net interest income on the on-balance sheet portfolio and securitization income from off-balance sheet sales was $61.1 million for the year, compared to $60.8 million in 2013. Securitization income was $26.8 million in 2014 on $2.53 billion in notional sales compared to securitization income of $12.6 million on $1.14 billion of notional sales in 2013. Relative gains have declined year over year on lower spreads that reflect a highly competitive market for prime insured mortgages. net interest income on the on-balance sheet securitized portfolio declined to $34.3 million for the year from $48.1 million in 2013. the decline reflects both a decline in net interest margin on the maturity of higher-yielding portfolios along with a net run-off of the portfolio as the Company has sold the residual interests of most newly originated insured mortgages. > Fees and other income increased $10.0 million or 16.3% as a result of portfolio growth during the year. > the credit quality of the loan portfolio remains strong with continued low non-performing loans and credit losses. provisions for credit losses were $13.1 million for the year, a decrease from the $15.9 million recorded last year. this represents 0.10% of gross uninsured loans, down from 0.14% in 2013. net non-performing loans as a percentage of gross loans ended the year at 0.30% compared to 0.35% at the end of last year. the npl ratio for 2013 included one commercial loan of $6.4 million, which was subsequently collected. net write-offs were $10.3 million for 2014, representing 0.06% of gross loans, compared to $15.5 million and 0.09% of gross loans in 2013. Home Capital Group inC. AnnuAl RepoRt 2014 23 management’s Discussion and analysis management’s Discussion and analysis > non-interest expenses, which include salaries, premises and other operating expenses, were $162.3 million in 2014, up 12.9% over the $143.7 million recorded in 2013 and in line with business growth and strategic investments. the Company continues to invest in people, business development, infrastructure and technology to support the Company’s strategic initiatives in mortgage and deposit product development. the Company’s adjusted efficiency ratio (teB) remains low at 28.5% compared to 28.2% in 2013, an indication of a high level of operating efficiency. Balance Sheet Highlights for 2014 > total assets under administration, which includes $4.20 billion of mortgages accounted for off-balance sheet, reached $24.28 billion, an increase of 10.4% over $22.00 billion last year. > the Company sold residual interests in securitization transactions of $1.75 billion, compared with $519.3 million last year, which, combined with amortization of MBS liabilities and maturity of CMB liabilities, reduced both the securitized mortgage loans and securitization liabilities. > Mortgage originations were $8.85 billion in 2014, compared to the $6.92 billion originated in 2013. the Company’s originations reflect continued focus on the traditional mortgage portfolio, which accounted for 66.2% of originations and a significant portion of the overall increase in originations. Accelerator (insured) residential mortgage originations experienced significant growth year over year, increasing 76.4% to $1.79 billion from $1.01 billion one year ago, as the Company focused on the active rebuilding of this line of business. > the credit quality of the loan portfolio remains strong, with continued low non-performing loans. net non-performing loans as a percentage of the gross loan portfolio ended the year at 0.30%, down from 0.35% one year ago. At the end of 2014, 97.9% of the loan portfolio was current, as compared with 97.6% at the end of 2013. > liquid assets at December 31, 2014 were $1.06 billion, compared to $1.50 billion at December 31, 2013. 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 2014, as indicated by the Common equity tier 1 ratio of 18.30% and the tier 1 and total capital ratios of 18.30% and 20.94%, respectively, at December 31, 2014. Home trust’s assets to capital multiple (ACM) ended 2014 at 12.47 compared to 13.19 at the end of 2013. > Deposits reached $13.94 billion, up from $12.77 billion at December 31, 2013. total deposits raised through the Company’s deposit diversification initiatives, oaken Financial, high-interest savings accounts and institutional deposits, now total $2.42 billion, an increase of $1.50 billion or 163.6% over last year. During the year, the Company launched oaken online Banking, providing oaken customers with greater banking convenience, including the continued investment in security features to safeguard client personal and financial information. > Securitization liabilities were $4.30 billion at the end of 2014, down from $5.77 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. 24 Home Capital Group inC. AnnuAl RepoRt 2014 F inan Cial per F orman C e re V iew table 3: income Statement Highlights (000s, except % and per share amounts) net interest income non-securitized assets net interest income securitized loans and assets 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 share1 Diluted earnings per share1 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) Adjustment for prepayment income on portfolio sale (net of tax) Adjusted net Income2 Adjusted Basic earnings per Share1, 2 Adjusted Diluted earnings per Share1, 2 2014 425,250 $ 34,279 459,529 13,134 446,395 133,359 162,252 417,502 104,330 313,172 $ 4.48 $ 4.45 $ 2013 373,850 48,129 421,979 15,868 406,111 75,059 143,738 337,432 80,890 256,542 3.70 3.66 313,172 $ 3,128 – (3,897) (24,019) 288,384 $ 4.13 $ 4.09 $ 256,542 5,873 1,508 (6,190) – 257,733 3.72 3.68 $ $ $ $ $ $ $ $ Change 13.7% (28.8)% 8.9% (17.2)% 9.9% 77.7% 12.9% 23.7% 29.0% 22.1% 21.1% 21.6% 22.1% (46.7)% (100.0)% (37.0)% – 11.9% 11.0% 11.1% 1 the Company’s basic and diluted earnings per share for 2013 have been reduced to half, reflecting the impact of the stock dividend paid in Q1 2014. 2 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 4 and 5 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 4: 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 and other 2014 2.80% 2.83% 0.67% 2.23% 2.25% 2.93% 2013 2.98% 3.01% 0.73% 2.15% 2.17% 3.14% total net interest margin (teB), including the securitized portfolio, was 2.25% for 2014 compared to 2.17% in 2013, reflecting a greater proportion of higher-yielding, non-securitized assets in the on-balance sheet portfolio. the Company has generally sold most of its newly insured originations off-balance sheet, which has reduced the relative proportion on-balance sheet. As such, over the period the portfolio weighting of securitized mortgages and assigned assets, which earn a lower net interest margin, decreased to 21.5% at December 31, 2014 from 29.0% at December 31, 2013. Interest spreads on non-securitized loans over deposits declined in 2014, resulting in net interest margin compression on non-securitized assets (teB) to 2.83% from 3.01% last year. net interest margin on securitized assets declined as expected on the structured maturity of high-yielding mortgage pools. Home Capital Group inC. AnnuAl RepoRt 2014 25 management’s Discussion and analysis management’s Discussion and analysis table 5: net interest income by product and average rate (000s, except %) interest-bearing 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 interest-bearing assets interest-bearing liabilities Deposits and other Senior debt Securitization liabilities other liabilities and shareholders’ equity total interest-bearing liabilities net interest income (teB) tax equivalent adjustment net interest income per Financial Statements average Balance1 income/ expense 2014 average rate1 Average Balance1 Income/ expense $ 1,398,544 $ 25,338 1.81% $ 1,149,994 $ 19,448 10,826,314 552,112 5.10% 9,116,538 482,491 956,519 306,915 1,033,519 310,941 338,777 13,772,985 – 26,746 14,355 64,852 28,529 31,204 717,798 4,117 2.80% 4.68% 6.27% 9.18% 9.21% 5.21% – 446,636 263,447 975,217 307,310 308,155 11,417,303 – 15,044 12,954 62,681 28,966 27,111 629,247 4,016 15,171,529 747,253 4.93% 12,567,297 652,711 2013 Average Rate1 1.69% 5.29% 3.37% 4.92% 6.43% 9.43% 8.80% 5.51% – 5.19% 3,285,467 105,393 3.21% 4,559,463 144,702 3.17% 1,291,643 54,634 4.23% 1,780,245 73,712 4.14% 548,401 5,125,511 308,848 $20,605,888 $ 6,464 166,491 – 913,744 1.18% 3.25% – 467,481 6,807,189 257,386 4.43% $19,631,872 $ 7,379 225,793 – 878,504 $ 13,677,719 $ 146,877 5,194,504 311,494 6,392 132,212 2.28% $ 11,327,983 $ 4.35% 2.55% 149,899 6,849,261 268,233 6,612 177,664 1,586,788 $20,605,888 $ $ – 450,098 463,646 (4,117) – 1,304,729 2.18% $19,631,872 $ $ – 452,509 425,995 (4,016) $ 459,529 $ 421,979 1.58% 3.32% – 4.47% 2.37% 4.41% 2.59% – 2.30% 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. total net interest income of $459.5 million increased 8.9% year over year, reflecting increases in the non-securitized portfolio offset by declines in the securitized portfolio. net interest income on the non-securitized portfolio reached $425.3 million in 2014, an increase of $51.4 million or 13.7% over 2013, reflecting an increase of $2.60 billion or 20.7% in average asset balances offset by a decrease in net interest margin (teB) of 18 basis points year over year. the average yield on non-securitized loans declined 30 basis points to 5.21% from 5.51% in 2013, reflecting a decline in market mortgage rates and improving credit quality in the traditional mortgage portfolio. Additionally, there was some lowering of total asset yield due to an increase in the average level of insured Accelerator mortgages held prior to securitization funding. Average deposit rates also declined 9 basis points to 2.28% from 2.37% in 2013. the declines in average rates primarily reflect lower average Government of Canada bond yields in 2014, upon which deposit and traditional mortgage rates are set. the net impact was a decline in average spreads of non-securitized loans over deposits to 2.93% from 3.14% last year, resulting from lower spreads on mortgages combined with a higher relative cost of deposits primarily due to higher offered rates in the direct deposit market and competitive pricing in the broker channel. the Company expects net interest margin on the non-securitized portfolio to remain relatively stable to the experience in Q4 2014. 26 Home Capital Group inC. AnnuAl RepoRt 2014 the average rate for residential commercial mortgage loans declined, reflecting the maturity of higher-yielding loans and originations and renewals at current lower rates. the net interest income and net interest margin on securitized assets declined year over year, reflecting net run-off and 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 $1.68 billion in 2014, reflecting the sale of residual interests and maturities. As such, this portfolio had a lower impact on the Company’s net interest margin and the relative impact can be expected to continue to decline through 2015. non-interest income table 6: non-interest income (000s, except %) Fees and other income Securitization income prepayment income on portfolio sale net realized and unrealized gains on securities net realized and unrealized loss on derivatives table 7: Securitization income (000s, except %) net gain on sale of mortgages or residual interest net change in unrealized gain or loss on hedging activities Servicing income total securitization income 2014 71,241 $ 26,845 32,675 3,425 (827) 133,359 $ 2013 61,252 12,648 – 2,589 (1,430) 75,059 2014 23,712 $ (177) 3,310 26,845 $ 2013 11,010 140 1,498 12,648 $ $ $ $ Change 16.3% 112.2% – 32.3% (42.2)% 77.7% Change 115.4% (226.4)% 121.0% 112.2% 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. Fee income is also influenced by the overall mix of the portfolio and has grown at a slightly faster pace than the overall loans under administration portfolio due to a higher proportion of traditional mortgages. the Company expects fee income to increase in line with the growth in the loan portfolio in 2015. Securitization income increases reflect the increased sales of residual interests in insured single-family mortgage pools year over year and relatively flat gains on sale of insured multi-unit residential mortgages. In both of these programs, mortgages have been removed from the calculation of the Company’s ACM and, 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 expects gains on sale in 2015 to be relatively consistent with the levels experienced in 2014 but dependent on the level of insured mortgage originations. the Company recognized prepayment income of $32.7 million ($24.0 million after tax and $0.34 diluted earnings per share) in relation to the sale of $234.9 million of water heater loans. the prepayment income compensates the Company in excess of the future net interest margin that will be lost as a result of the sale. this is a non-recurring item. the Company recognized a net gain of $3.5 million on the sale of certain available for sale securities in 2014, compared to a gain of $2.8 million in 2013. the Company takes advantage of improvements in securities markets and will rebalance the investment portfolio as market conditions warrant. the Company also recognized $0.1 million in impairments through profit and loss on certain available for sale equity securities in 2014 compared to $0.2 million in 2013. please see the discussion below on Derivatives and Hedging related to net realized and unrealized loss on derivatives. 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 Derivative Financial Instruments note 19 to the consolidated financial statements included in this report for further information. table 8 below summarizes the impact of derivatives and hedge accounting on the Company’s financial results. Home Capital Group inC. AnnuAl RepoRt 2014 27 management’s Discussion and analysis management’s Discussion and analysis table 8: 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 on derivatives Cash Flow Hedging 2014 $ – $ 5,423 (1,995) (4,255) $ (827) $ 2013 13 6,387 160 (7,990) (1,430) 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. the intent of hedge accounting is to recognize the effective matching of the gain or loss on the Government of Canada bond forwards 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 and assets 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 At times the Company may enter into bond forwards to hedge interest rate risk on loans held for securitization and sale through national Housing Authority Mortgage-Backed Securities (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 loss as at December 31, 2014 for fair value changes in both the outstanding derivatives and the loans held for trading was $177 thousand (2013 – unrealized gain of $140 thousand) and was 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. Amounts related to derivative restructuring upon adoption of IFRS will continue as the underlying hedged instruments mature. the Company expects charges in 2015 that are approximately in the range of 2014. 28 Home Capital Group inC. AnnuAl RepoRt 2014 table 9: provision for Credit losses and net write-offs as a percentage of Gross loans (000s, except %) provision2 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 individual provision total collective provision total provision net write-offs2 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 net write-offs 2014 amount % of Gross loans1 $ $ $ $ 9,507 (1) 270 571 187 – – 10,534 2,600 13,134 9,099 24 202 692 272 – – 10,289 0.08% $ (0.00)% 0.02% 0.17% 0.10% – – 0.06% 0.01% 0.07% $ 0.07% $ 0.01% 0.02% 0.21% 0.15% – – 0.06% $ 2013 % of Gross loans1 0.09% 1.42% 0.03% 0.23% 0.11% – – 0.08% 0.01% 0.09% 0.10% 1.62% 0.02% 0.20% 0.10% – – 0.09% Amount 10,257 2,792 274 679 366 – – 14,368 1,500 15,868 11,165 3,199 230 589 345 – – 15,528 1 Gross loans used in the calculation of total Company ratio include securitized on-balance sheet loans. 2 there were no specific provisions, allowances or net write-offs on securitized mortgages. 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. Favourable credit performance continued through 2014. the provision for credit losses was $13.1 million, as compared with $15.9 million in 2013. provisions as a percentage of gross uninsured loans of 0.10% for 2014 decreased from 0.14% in 2013 and are better than the target range of 0.15% to 0.25%. provisions as a percentage of gross loans (insured plus uninsured) were 0.07% (2013 – 0.09%). Included in the 2013 provision was $3.0 million in individual provision charges related to disputed loans to condominium corporations. excluding this amount, the provisions charges remain reasonably consistent year over year despite an increase of $1.91 billion in uninsured loans. the Company continues to observe strong credit profiles and stable loan-to-value ratios, combined with stable economic conditions, which supports low delinquency and non-performing rates and ultimately low net write-offs. net write-offs were low at $10.3 million and represented 0.06% of gross loans compared to 0.09% in 2013. net non-performing loans as a percentage of gross loans decreased to 0.30% at the end of 2014 from 0.35% at the end of 2013. Included in 2013 is one commercial loan for $6.4 million, which the Company subsequently recovered. Considering the increase in the proportion of traditional mortgages in the loan portfolio, non-performing loans have remained low. the Company remains satisfied with the credit performance of the portfolio, but is prepared for moderate volatility in the trend. the level of individual allowances at the end of 2014 increased by $0.5 million over 2013, while gross non-performing loans decreased by $7.7 million to $57.2 million from $64.9 million. As discussed above, the non-performing loans include one commercial loan for $6.4 million, which the Company subsequently recovered. the amount set aside for individual allowances can be influenced by specific local real estate markets and the amount of time needed to sell when required. the collective allowance balance at December 31, 2014 increased by $2.6 million in 2014 to $34.1 million, reflecting the increase in the traditional mortgage portfolio, and represents over three times the current year write-offs. please see the Credit Risk section of this MD&A for further discussion. Home Capital Group inC. AnnuAl RepoRt 2014 29 management’s Discussion and analysis management’s Discussion and analysis 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 it will continue to be reviewed at least on a quarterly basis, giving consideration to current economic conditions. 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 adjusted efficiency ratio calculation net interest income Adjusted other income total adjusted revenue, net of interest expense teB adjustment total adjusted revenue teB, net of interest expense As a % of total adjusted revenue, net of interest expense As a % of total adjusted revenue teB, net of interest expense target efficiency ratio teB number of active employees 2014 80,769 $ 2013 70,954 $ Change 13.8% 8,490 3,376 11,866 6,994 2,907 9,901 9,577 14,738 4,763 14,797 16,627 9,115 69,617 162,252 $ 12,740 10,004 5,179 8,857 14,735 11,368 62,883 $ 143,738 $ 23,139,574 $ 20,839,766 0.69% 0.70% $ $ 459,529 $ 104,939 564,468 4,117 568,585 $ 28.7% 28.5% 421,979 83,049 505,028 4,016 509,044 28.5% 28.2% 28.0%–32.0% 28.0%–34.0% 21.4% 16.1% 19.8% (24.8)% 47.3% (8.0)% 67.1% 12.8% (19.8)% 10.7% 12.9% 8.9% 26.4% 11.8% 11.7% 783 692 13.2% In 2014, the Company continued to operate at a low efficiency ratio that was at the low end of the 2014 target range on an adjusted basis (see definition of Adjusted efficiency Ratio under non-GAAp Measures in this report). the ratio reflects 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. Maintaining 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 low and relatively stable efficiency ratio. Salaries and employee benefits increased over last year due to the increase in active employees. Active employees have increased to support business growth and include former information technology consultants and contractors who have joined the Company as permanent employees. the resulting decrease in information technology consultants has contributed to the decrease in consulting and professional services despite the business growth. premises expense increased due to the expansion of the toronto head office. the increase in outsourced services reflects the increase in pSiGate costs, which rose in line with revenue and gross margin increases in the Company’s payment card services business (the associated revenues of this line of business are included in fees and other income in the Company’s consolidated statements of income). Advertising and business development expenses have increased to support the Company’s expansion initiatives, including higher loan origination volumes and deposit diversification. General and administrative expenses have increased with business growth. 30 Home Capital Group inC. AnnuAl RepoRt 2014 the decrease in amortization and depreciation expenses resulted from a change in the estimated useful life of the Company’s core banking system from 10 years to 15 years. this change resulted in a reduction in the amortization expense of deferred software development costs of $4.0 million from what the amortization expense would have been in the absence of this change (see note 9 to the consolidated financial statements for more information). Without this reduction, amortization and depreciation expense would have been $13.1 million, reflecting a 15.4% increase over last year resulting from the completion of development of certain software projects during the year. the Company continues to invest in developing enhanced technology and security to support the Company’s strategic initiatives and governance, risk and compliance enhancements. taxes table 11: income taxes (000s, except %) Current Deferred total income taxes effective income tax rate 2014 102,201 $ 2,129 104,330 $ $ $ 2013 82,128 (1,238) 80,890 24.99% 23.97% Change 24.4% 72.0% 29.0% the provision for income taxes for the year ended December 31, 2014 amounted to $104.3 million, resulting in an effective tax rate of 24.99% ($80.9 million and 23.97% in 2013). the effective tax rate of the Company was 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 claimed $5.3 million in SR&eD credits in 2014. note 17 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. the Company expects that the effective income tax rate in 2015 will remain within the range of 25.7% to 26.2%, excluding the impact of any SR&eD credits that may be realized and the receipt of dividends from taxable Canadian corporations. the Company expects to submit claims for SR&eD in 2015 that may result in a reduction to the effective tax rate of the Company. In the event that claims are submitted, the effective tax rate will decrease accordingly. Comprehensive income table 12: Comprehensive income (000s, except %) net income net unrealized losses 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 Comprehensive income 2014 313,172 $ 2013 256,542 $ Change 22.1% (419) (16,255) 97.4% 293 (126) 313,046 $ 1,521 (14,734) 241,808 $ (80.7)% 99.1% 29.5% Comprehensive income is the aggregate of net income and other comprehensive income (oCI). Comprehensive income for the year was $313.0 million compared to $241.8 million in 2013. oCI for the year was a loss of $0.1 million compared to a loss of $14.7 million in 2013. the change in oCI from 2013 resulted primarily from favourable changes in the fair value of the Company’s preferred shareholdings, which are included in available for sale securities. Declines in the fair value of the Company’s preferred shares led to the recognition of increases in unrealized losses in oCI in 2013. In the Company’s judgement, the decline in fair value was due primarily to changes in interest rates. Included in the transfer to net income for the year was $0.1 million in impairment losses on available for sale securities, compared to $0.2 million in 2013. Home Capital Group inC. AnnuAl RepoRt 2014 31 2014 2013 $ 2,990,119 $ 3,720,097 1,489,924 10,047,211 800,156 196,880 994,210 293,485 339,963 17,881,926 137,975 $ 18,364,910 $ 18,019,901 955,535 11,726,970 723,558 243,318 1,106,878 330,327 186,111 18,262,816 102,094 $ 2,613,481 $ 1,088,066 833,865 1,585,141 4,198,622 1,921,931 $ 22,563,532 $ 19,941,832 64,456 33,853 57,412 155,721 59,031 28,892 266,515 354,438 Change (19.6)% (35.9)% 16.7% (9.6)% 23.6% 11.3% 12.6% (45.3)% 2.1% (26.0)% 1.9% 140.2% 90.1% 118.5% 13.1% 9.2% 17.2% (78.5)% (56.1)% management’s Discussion and analysis management’s Discussion and analysis F in an Cial po Sition re View assets table 13: loans portfolio (000s, except % and number of loans) Securitized single-family residential mortgages Securitized multi-unit residential mortgages 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 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 32 Home Capital Group inC. AnnuAl RepoRt 2014 loans under administration Figure 1: portfolio Composition by product type 50.3% 52.0% 24.1% 24.8% 11.7% 11.3% 13 14 13 14 13 14 13 14 13 14 13 14 13 14 4.0% 3.2% 1.7% 1.5% 5.0% 4.9% 1.5% 1.5% 1.7% 13 0.8% 14 Securitized Single-Family Residential Mortgages Securitized Multi-Unit Residential Mortgages Traditional Single-Family Residential Mortgages Accelerator Single-Family Residential Mortgages Residential Commercial Mortgages Non-residential Commercial Mortgages Credit Card Loans Other Consumer Retail Loans Figure 2: insured versus uninsured mortgages under administration Figure 2: Insured versus Uninsured Mortgages 2014 Uninsured 58.6% 2013 Uninsured 56.5% Insured 41.4% Insured 43.5% Figure 3: Portfolio Composition by Province Figure 3: loans under administration Composition by province 78.4% 79.2% 6.8% 6.3% 5.2% 5.1% 6.3% 5.7% 3.3% 3.7% 13 14 13 14 13 14 13 14 13 14 British Columbia Alberta Ontario Quebec Other Home Capital Group inC. AnnuAl RepoRt 2014 33 1467 pg lending x prod 2010.eps management’s Discussion and analysis management’s Discussion and analysis table 14: mortgage advances 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 2014 % of total 2013 % of total Change $ 5,864,562 1,785,032 66.2% $ 4,770,773 1,011,650 20.2% 93,476 624,879 45,615 1.1% 7.1% 0.5% 129,738 693,461 31,479 118,272 319,459 $ 8,851,295 1.3% 3.6% 99,951 180,131 100.0% $ 6,917,183 2014 % of total $ 458,917 436,787 7,382,637 282,089 290,865 $ 8,851,295 2013 395,879 180,998 5,735,648 454,064 150,594 100.0% $ 6,917,183 5.2% $ 4.9% 83.4% 3.2% 3.3% 69.0% 14.6% 1.9% 10.0% 0.5% 1.4% 2.6% 100.0% 22.9% 76.4% (28.0)% (9.9)% 44.9% 18.3% 77.3% 28.0% % of total Change 5.7% 2.6% 82.9% 6.6% 2.2% 100.0% 15.9% 141.3% 28.7% (37.9)% 93.1% 28.0% 1 other residential commercial mortgages include mortgages such as builders’ inventory. loans under administration reached $22.56 billion at the end of 2014, an increase of $2.62 billion or 13.1% from the end of 2013. on-balance sheet loans are up 1.9% over the end of 2013, while off-balance sheet loans are up 118.5% from the end of 2013, comprising most of the growth in loans under administration. off-balance sheet growth is from the increased sales of residual interests in single-family residential mortgages (resulting in removal from the balance sheet of securitized mortgages) and securitization of multi-unit residential mortgages qualifying for off-balance sheet accounting. the increase in loans under administration was supported by mortgage production of $8.85 billion and retail and credit card loan production of $330.9 million in 2014, up from $6.92 billion and $224.8 million, respectively, in 2013. mortgage lending Uninsured Residential Mortgages – “Traditional Mortgages” traditional mortgages of $11.73 billion is the largest component of loans under administration and on-balance sheet loans at 52.0% and 63.9%, respectively, of the total portfolios. the portfolio increased $1.68 billion or 16.7% from the end of 2013. originations of traditional mortgages of $5.86 billion in 2014 were up 22.9% over the same period last year. origination volumes, reflecting 66.2% of total originations, continue to demonstrate the solid and increased demand for the Company’s traditional product in the marketplace and strong broker relationships. the Company continued to observe strong credit profiles and stable ltVs across the traditional portfolio. Insured Securitized Residential Mortgages Insured securitized loans under administration, which include both insured single-family and multi-unit residential mortgages, continued to be a significant part of the Company’s portfolio at 36.1%. the portfolio increased $1.01 billion or 14.2% over 2013 to a balance of $8.14 billion at the end of 2014. of this total, $4.20 billion was accounted for off-balance sheet, up $2.28 billion or 118.5% from the end of 2013. the Company originated $1.79 billion in insured single-family Accelerator mortgages in 2014, up 76.4% from the same period in 2013, and consistent with the renewed focus on this product offering through increased market penetration for the product, and stemming from focused marketing activities. the Company continued to sell residual interests on insured fixed-rate single-family nHA MBS, selling $1.75 billion in 2014 in underlying outstanding principal amounts and generating gains of $18.7 million. the underlying mortgages included mortgages newly originated or renewed during the year along with insured mortgages held in inventory from the prior year. new originations included $324.4 million of variable-rate single-family insured mortgages that have been or will be securitized and remain on-balance sheet. 34 Home Capital Group inC. AnnuAl RepoRt 2014 In 2014, the Company originated $624.9 million of insured multi-unit residential mortgages and sold $784.0 million that qualified for off- balance sheet treatment. the sales included mortgages that were renewed from the on-balance sheet portfolio. this resulted in $5.2 million in gains on sale in 2014 compared to $5.7 million in gains on sale in 2013. the multi-unit residential mortgage market is relatively limited, and in the Company participates in appropriate transactions as they become available through various origination channels. As a result, origination volumes, sales and resultant securitization gains can vary significantly through the year. Most of the Company’s newly insured multi-unit residential originations qualify for off-balance sheet treatment, and the on-balance sheet securitized multi-unit residential portfolio is declining through amortization and maturities. Residential Commercial Mortgages Residential commercial mortgages include commercial mortgages that are secured by residential property such as non-securitized multi-unit residential mortgages and builders’ inventory. the Company increases these portfolios selectively, when appropriate assets are available. Non-residential Commercial Mortgages non-residential commercial mortgages, which include store and apartment mortgages and commercial mortgages, are an important complementary source of loan assets and revenue. the non-residential commercial mortgage portfolio grew 11.3% to $1.11 billion in 2014 from $994.2 million in 2013, supported by originations of $437.7 million, which were up 56.3% over 2013. non-residential mortgage production is affected by the availability of appropriate assets and production trends are variable. this portfolio will continue to be managed conservatively by the Company. Geographic Concentration Mortgage production continued to favour ontario and, in particular, the greater toronto and Hamilton areas, through 2014. the Company will continue to cautiously increase business within other markets in ontario and the rest of Canada to the extent that market conditions remain stable. the increase in the total loan proportion in ontario reflected strong mortgage origination volumes in 2014 that grew 28.7% year over year. new originations in other provinces were 16.6% of total originations, compared to 17.1% last year. please see table 14 above. the concentration of new originations is influenced, in part, by the Company’s credit experience. please see note 5(A) of the consolidated financial statements for the geographic distribution of the portfolio. table 15: Credit Card and other Consumer retail loan production (Amount in 000s) 2014 2013 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 4,374 $ 7,549 159,714 11,587 3,484 $ 3,915 80,088 4,130 45,918 6,028 125,886 33,720 59,239 5,177 113,249 27,315 25.5% 92.8% (22.5)% 16.4% Change Amount1 99.4% 180.6% 11.2% 23.4% 1 For credit cards, the amount represents the authorized credit limits. For water heaters and other retail lending, the amount represents the advanced amount. other lending other lending, comprising credit cards and other consumer loans, continues to be an important source of loan assets with attractive returns. While representing 2.8% of the total on-balance sheet loan portfolio, these assets generated 13.0% of the interest income for the year. During Q4 2014, $234.9 million of water heater loans were prepaid as a result of the sale of a customer’s business. the Company recorded $32.7 million in prepayment income as a result of the transaction. other consumer retail loans experienced solid growth in the year with originations of $159.6 million, an increase of $19.0 million or 13.5% over 2013. Credit card balances increased to $330.3 million from $293.5 million in 2013. equityline Visa accounts (Home equity line of Credit) represent 95.3% of the total credit card balance. originations in 2014 more than doubled 2013 originations at $171.3 million, as compared to $84.2 million last year. the Company continued to cautiously increase focus on the portfolio through new marketing efforts, including a 1% cash back incentive to Visa customers. Home Capital Group inC. AnnuAl RepoRt 2014 35 management’s Discussion and analysis Cash resources and Securities Combined cash resources and securities as at December 31, 2014 decreased by $213.9 million from December 31, 2013, reflecting a decrease in cash of $372.4 million offset by an increase in securities of $158.5 million. Relatively lower liquidity at the end of December 2014 reflects the maturity and repayment of CMB liabilities. the Company maintains sufficient liquidity to meet its future commitments and expected business volumes. the Company has a revolving term credit facility and a committed insured mortgage purchase facility with a Canadian chartered bank. the details of these facilities are disclosed in note 4 to the consolidated financial statements included in this report. In addition to holding 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, residual interests of underlying securitized insured fixed-rate residential mortgages, and common and preferred shares. At December 31, 2014, the preferred share portfolio was $248.0 million or 42.5% of the Company’s securities compared to $273.0 million or 64.3% in 2013. Investment-grade preferred shares represent 51.4% of the preferred share portfolio (55.7% in 2013). Corporate and government bonds represent 55.0% of the securities portfolio compared to 35.3% in 2013. the entire bond portfolio of $320.7 million ($149.6 million in 2013) is investment grade. Residual interests represent 2.4% (2013 – nil) of the securities portfolio and common shares and mutual funds combined represent 0.1% of the securities portfolio compared to 0.4% in 2013. 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 $3.5 million compared to $2.8 million during 2013. the Company recognized $0.1 million in impairment losses on securities in 2014, compared to $0.2 million in 2013. Additional details related to the Company’s securities portfolio can be found in note 4 to the consolidated financial statements included in this report. table 16: other assets (000s, except %) Restricted assets Restricted cash non-Home trust MBS and treasury bills assigned as replacement assets Derivative assets other assets Accrued interest receivable prepaid CMB coupon Securitization receivable and retained interest Capital assets Income taxes recoverable other prepaid assets and deferred items Goodwill and intangible assets Goodwill Intangible assets 2014 2013 Change $ 119,093 $ 301,990 38,534 118,133 530,150 29,886 65,132 4,506 128,522 12,052 – 25,404 62,961 7,168 54,556 10,875 9,519 17,600 15,752 97,384 $ 808,369 $ 15,752 73,405 930,005 0.8% (43.0)% 28.9% 3.4% (37.1)% 135.6% 10.8% (100.0)% 44.3% – 32.7% (13.1)% the decline in other assets primarily reflects a decline of $228.2 million in non-Home trust MBS and treasury bills assigned as replacement assets in the CMB program, as $1.28 billion of CMB liabilities matured during the year. Derivative assets and liabilities are discussed in the Derivatives and Hedging section of this MD&A. the decline in other assets was partially offset by increases in securitization receivables and retained interest as the Company increased its sales of insured multi-unit residential mortgages and sold residual interests in insured residential mortgages. Further information on the Company’s securitization activity can be found in note 6 to the consolidated financial statements included in this report. the increase in intangible assets reflects the continued investment in software development. 36 Home Capital Group inC. AnnuAl RepoRt 2014 liabilities 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 oaken Savings Account other deposits payable on demand Deposits payable on fixed dates Brokered GICs oaken GICs Institutional deposit notes Senior debt Securitization liabilities Mortgage-backed security liabilities Canada Mortgage Bond liabilities total total number of deposit accounts 2014 2013 Change $ 854,501 $ 44,409 165,242 1,064,152 337,239 1,142 90,888 429,269 153.4% 3,788.7% 81.8% 147.9% 11,352,182 720,887 802,750 12,875,819 152,026 11,756,015 284,294 296,376 12,336,685 153,474 471,551 3,831,912 4,303,463 660,964 5,112,100 5,773,064 $ 18,395,460 $ 18,692,492 356,908 395,600 (3.4)% 153.6% 170.9% 4.4% (0.9)% (28.7)% (25.0)% (25.5)% (1.6)% 10.8% 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 92.4% of all deposits, thereby reducing the risk of untimely withdrawal of funds by retail clients. the Company generally matches the terms of its deposits with its assets. please see the Structural Interest Rate and the Funding and liquidity Risk sections of this MD&A for more information. 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. the Company continues its longer-term strategy to diversify its sources of funding. 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 to provide customers with a secure alternative for managing their savings independently. In Q2 2014, the Company successfully launched oaken online Banking, allowing oaken customers to bank at their convenience. In addition to providing customers with greater banking convenience, oaken online Banking provides security features to safeguard client personal and financial information. oaken Financial will open its first store front in toronto in the first half of 2015. together, these initiatives represent oaken’s ongoing aim of becoming the leading alternative for Canadians to securely save and invest their money and the Company’s commitment to diversify its sources of funding. the balance of oaken deposits at the end of the year increased to 168.1% of the balance at the end of 2013. the Home trust high-interest savings account, which is distributed through investment brokers, was launched in 2012 as part of the Company’s deposit diversification strategy. these accounts continue to grow significantly, reaching a balance at the end of the year of $854.5 million, an increase of 153.4% over the $337.2 million at the end of 2013. Further funding diversification was accomplished in Q4 2013 with the successful initial issue of Home trust’s institutional deposit notes in the principal amount of $300 million. An additional issuance of $500 million occurred in Q2 2014. the Company expects that Home trust will be a regular issuer of deposit notes, generally on a semi-annual basis. the Company introduced a prepaid card program in 2014 as part of its payment card services business. prepayments of $73.4 million are included in other deposits payable on demand. Securitization liabilities, including MBS and CMB liabilities, declined $1.47 billion from the end of 2013 due to the settlement of MBS liabilities, the maturity of CMB liabilities of $1.28 billion and planned changes in the asset mix. 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 nHA MBS program that resulted in the derecognition of $1.75 billion of mortgages and the associated securitization liabilities. 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. Home Capital Group inC. AnnuAl RepoRt 2014 37 management’s Discussion and analysis management’s Discussion and analysis table 18: other liabilities (000s, except %) Derivative liabilities other liabilities Accrued interest payable Securitization servicing liability Income taxes payable other liabilities Deferred tax liabilities 2014 2,266 $ 2013 3,809 $ Change (40.5)% 127,135 11,216 11,317 50,163 36,554 238,651 $ 127,075 5,727 – 34,625 34,425 205,661 $ 0.0% 95.8% 100.0% 44.9% 6.2% 16.0% the increase in other liabilities resulted primarily from an increase in accounts payable and accrued liabilities, which have increased in line with business growth, combined with increases in income taxes payable, which was in a recovery position in 2013, and an increase in securitization servicing liability, reflecting increased sales of insured multi-unit residential mortgages. Shareholders’ equity table 19: Shareholders’ equity (000s, except %) Shareholders’ equity at the beginning of the year net income other comprehensive loss Amounts related to stock-based compensation Repurchase of shares Dividends Shareholders’ equity at the end of the year 2014 2013 968,213 256,542 (14,734) 8,160 (2,302) (38,182) $ 1,448,633 $ 1,177,697 $ 1,177,697 $ 313,172 (126) 12,493 (1,390) (53,213) Change 21.6% 22.1% (99.1)% 53.1% (39.6)% 39.4% 23.0% the increase of $270.9 million in total shareholders’ equity since December 31, 2013 was primarily internally generated from net income, net of $53.2 million for dividends to shareholders and $1.4 million related to the repurchase of shares. the amounts related to stock- based compensation arose primarily from the exercise of vested employee stock options. Details related to the repurchase of shares and stock-based compensation are provided in notes 14 and 15 to the consolidated financial statements included in this report. At December 31, 2014, the book value per common share was $20.67, compared to $16.95 at December 31, 2013. the Company has consistently increased the net book value per share through earnings. Return on equity when combined with dividends of $0.70 per common share in 2014 ($0.54 per common share in 2013) 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, 2014. table 20: Contractual obligations (000s) premises and equipment 2015 2016 2017 2018 2019 thereafter total $ 14,212 $ 12,942 $ 11,972 $ 4,452 $ 4,157 $ 14,683 $ 62,418 the Company had no material contingencies in 2014. 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. 38 Home Capital Group inC. AnnuAl RepoRt 2014 off-balance Sheet arrangements the Company offers credit products to meet the financial needs of its customers and has outstanding amounts for future advances on mortgage loans that amounted to $850.1 million at December 31, 2014 ($754.6 million – December 31, 2013). these amounts include offers made but not yet accepted by the customer as of the reporting date. Also included within the outstanding amounts are unutilized non-residential commercial loan advances of $233.8 million at December 31, 2014 ($157.2 million – December 31, 2013). offers for the loans remain open for various periods. As at December 31, 2014, unutilized credit card balances amounted to $100.9 million ($80.8 million – December 31, 2013). Included in the outstanding amounts for future advances of mortgage loans are outstanding future advances for the equityline Visa portfolio of $5.6 million at December 31, 2014 ($5.8 million – December 31, 2013). the unutilized credit and offers to extend credit are in the normal course of business and are considered through the Company’s liquidity and capital management processes. the Company has $4.20 billion (2013 – $1.92 billion) of loans under administration that are accounted for off-balance sheet (see table 13). please refer to note 2 and note 6 of the consolidated financial statements for details of the Company’s securitization activities. related party transactions the Company had no material related party transactions in the years ended December 31, 2014 and December 31, 2013, other than the compensation of key management personnel, as disclosed in note 22 of the consolidated financial statements. Home Capital Group inC. AnnuAl RepoRt 2014 39 management’s Discussion and analysis management’s Discussion and analysis Qu arterly F inanCial HiGHliGHt S table 21: Summary of Quarterly results Q2 Q4 Q4 Q2 Q3 Q3 921 942 984 1.9% 1.4% 1,005 1,044 1,065 1,024 23.1% 23.1% 23.2% 23.1% 20.8% 21.3% 22.0% 23.9% 23.6% 110,967 102,532 106,594 101,886 115,143 117,583 116,416 110,387 2014 Q1 (000s, except per share and %) 17,177 33,969 231,194 233,619 59,725 63,016 16,431 34,272 232,555 235,696 61,573 61,897 21,827 37,862 246,365 247,522 68,827 68,207 25,185 38,940 247,900 249,147 69,736 70,138 24,972 42,901 255,046 255,190 73,755 71,435 26,765 40,522 255,448 256,573 73,745 73,616 19,624 37,635 239,433 240,700 66,417 64,613 24.3% 56,437 39,889 284,592 253,656 95,936 73,195 27.2% 2013 Q1 $ 117,440 $ 118,648 $ 116,187 $ 111,371 $ 111,888 $ 107,536 $ 103,537 $ 103,034 1,148 net interest income (teB1) less: teB adjustment net interest income per financial statements non-interest income non-interest expense total revenues total adjusted revenues2 net income Adjusted net income2 Return on shareholders’ equity Adjusted return on shareholders’ equity2 Return on average total assets 1.3% total assets under administration $24,281,366 $24,226,114 $23,716,585 $22,871,407 $21,997,781 $21,287,095 $20,577,505 $20,377,074 total loans under administration 18,448,493 21,235,234 earnings per common share3 Basic Diluted Adjusted earnings per common share2, 3 Basic Diluted Book value per common share efficiency ratio (teB1) Adjusted efficiency ratio (teB1, 2) Common equity tier 1 ratio4 tier 1 capital ratio4 total capital ratio4 net non-performing loans as a % of gross loans Annualized provision as a % of gross uninsured loans Annualized provision as a % of gross loans 1.04 $ 1.04 $ 20.67 $ 22.9% 27.9% 18.30% 18.30% 20.94% 1.06 $ 1.04 $ 18.74 $ 28.3% 28.1% 17.45% 17.45% 20.20% 0.93 $ 0.93 $ 16.14 $ 29.6% 29.3% 16.72% 16.72% 19.72% 1.01 $ 1.00 $ 17.82 $ 28.5% 28.3% 17.22% 17.22% 20.06% 1.02 $ 1.01 $ 19.57 $ 29.9% 29.8% 17.58% 17.58% 20.24% 0.89 $ 0.89 $ 15.41 $ 28.6% 27.8% 16.63% 16.63% 19.74% 0.98 $ 0.98 $ 16.95 $ 28.3% 28.1% 16.80% 16.80% 19.69% 0.91 0.90 14.77 28.3% 27.7% 16.57% 16.57% 19.82% 1.37 $ 1.36 $ 1.06 $ 1.05 $ 1.05 $ 1.05 $ 1.00 $ 1.00 $ 0.96 $ 0.95 $ 0.99 $ 0.98 $ 0.89 $ 0.88 $ 22,153,408 20,475,143 19,530,680 18,838,967 19,941,832 22,563,532 0.86 0.86 $ $ $ 25.3% 23.6% 23.7% 23.7% 24.0% 0.17% 0.18% 0.32% 0.09% 0.10% 0.11% 0.10% 0.35% 0.31% 0.09% 0.14% 0.32% 0.30% 0.07% 0.09% 0.11% 0.08% 0.10% 0.07% 0.32% 0.27% 0.11% 0.07% 0.33% 1.3% 1.3% 1.4% 1.4% 1.4% $ $ 1 teB – taxable equivalent Basis: see definition under non-GAAp Measures in this report. 2 See definition of Adjusted net Income, Adjusted earnings per Share, Adjusted Return on Shareholders’ equity, and Adjusted efficiency Ratio under non-GAAp Measures in this report and the reconciliation of net income to adjusted net income in table 3 in this report. 3 During Q1 2014, the Company paid a stock dividend of one common share per each issued and outstanding common share. Accordingly, both basic and diluted earnings per common share and book value per common share are reduced to half for all periods prior to 2014 presented. 4 these figures relate to the Company’s operating subsidiary, Home trust Company. 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. non-interest expenses and the efficiency ratio tend to increase in the third quarter, reflecting increased lending activity through the summer period. the Company continues to achieve positive financial results driven by strong net interest margins, continued low operating expenses 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. 40 Home Capital Group inC. AnnuAl RepoRt 2014 F ourt H Quarter 20 14 items of note the Company’s results were affected by the following items of note that aggregated to a positive impact of $22.7 million or $0.32 diluted earnings per share in Q4 2014: > $32.7 million prepayment income ($24.0 million after tax and $0.34 diluted earnings per share) related to the prepayment of $234.9 million of water heater loans and leases and other loans. the prepayment income more than compensates the Company for the future net interest margin that will be lost as a result of the sale. > $1.7 million charge ($1.3 million after tax and $0.02 diluted earnings per share) for restructuring of certain derivative positions upon adoption of IFRS in 2011. the Company’s results were affected by the following items of note in Q4 2013: > $1.2 million charge ($0.9 million after tax and $0.01 diluted earnings per share in 2013) for restructuring of certain derivative positions upon adoption of IFRS in 2011. > $2.0 million tax benefit recognized in Q4 2013 ($1.5 million after tax and $0.02 diluted earnings per share in Q3 2013) related to SR&eD tax credits for the development of the core banking system functionality and other technology. income Statement Highlights > Reported net income of $95.9 million was 39.4% higher than the $68.8 million net income recorded in Q4 2013 and 30.1% over the $73.8 million in Q3 2014. > Adjusted net income, as defined in the non-GAAp Measures and Glossary section, was $73.2 million in Q4 2014, representing an increase of 7.3% over Q4 2013 and 2.5% over Q3 2014. > Adjusted basic and diluted earnings per share for the fourth quarter were both $1.04, compared to adjusted basic and diluted earnings per share of $0.98 in Q4 2013. Adjusted basic and diluted earnings per share were $1.02 and $1.01, respectively, in Q3 2014. > Adjusted return on equity was 20.8% in Q4 2014, compared to 23.7% in Q4 2013, and 21.3% in Q3 2014. > total net interest margin (teB) was 2.27% in the quarter, up from 2.22% in Q4 2013 and down from 2.29% in Q3 2014. net interest margin (teB) continues to be favourably influenced by the overall shift to higher-yielding mortgages on-balance sheet, partially offset by lower spreads on traditional uninsured single-family mortgages. > net interest income on non-securitized assets was $109.6 million in the fourth quarter, increasing 9.9% over Q4 2013 and 1.6% over Q3 2014. net interest margin on this portfolio was 2.79% in Q4, 2014, down from 2.94% in Q4 2013 and consistent with 2.79% in Q3 2014. the decline from last year reflects both lower asset yields and relatively higher cost of funds compared to benchmark rates. Asset yields are down due to a combination of factors, including origination of higher credit quality borrowers over the last year and the current low rate environment. > total income earned from securitization, which includes net interest income on the on-balance sheet portfolio and securitization income from off-balance sheet sales, was $11.8 million in Q4 2014, down from $17.0 million in Q4 2013 and $15.4 million in Q3 2014. Securitization income was $5.0 million in the quarter on $612.8 million in notional sales. this compares to securitization income in Q4 2013 of $5.8 million on $505.2 million of notional sales and $5.7 million on $531.9 million in notional sales in Q3 2014. Relative gains have generally declined year over year on lower spreads, reflecting a highly competitive market for prime insured mortgages. net interest income on the on-balance sheet securitized portfolio declined to $6.8 million in the quarter, declining from $11.2 million in Q4 2013 and $9.7 million in Q3 2014. the decline reflects both a decline in net interest margin on the maturity of higher-yielding portfolios along with a net run-off of the portfolio as the Company has sold the residual interests of most newly originated insured mortgages. > Fees and other income of $18.3 million in Q4 2014 were up 18.6% from the $15.4 million recorded in Q4 2013 as a result of portfolio growth during the year. Fees and other income were up 3.0% from the $17.7 million recorded in Q3 2014. > During the quarter, the Company sold certain available for sale securities, realizing a gain of $1.04 million and recognized additional impairment losses of $76 thousand, resulting in a net gain on securities of $965 thousand compared to net gains of $148 thousand in Q4 2013 and $521 thousand in Q3 2014. Home Capital Group inC. AnnuAl RepoRt 2014 41 management’s Discussion and analysis management’s Discussion and analysis > the credit quality of the loan portfolio remained strong in the quarter and for the year, with continued low non-performing loans and credit losses, and outperformed the Company’s objectives. net non-performing loans as a percentage of gross loans ended 2014 at 0.30% of the total loans portfolio compared to 0.35% at the end of 2013 and 0.27% at the end Q3 2014. the annualized credit provision as a percentage of gross uninsured loans for the quarter of 0.09% decreased from 0.14% in the same quarter last year, and 0.11% in Q3 2014, and remains well below the target range of 0.15% to 0.25% > non-interest expenses were $39.9 million in the fourth quarter, up from $37.9 million in Q4 2013 and down from $42.9 million last quarter. the adjusted efficiency ratio was 27.9% in the fourth quarter, down from 28.1% in Q4 2013 and 29.8% in Q3 2014. lower fourth quarter expenses reflect prudent expense management. In addition, in Q4 2014, amortization expense decreased as a result of an increase in the estimated useful life of the Company’s core banking system. Financial position Highlights > Home trust’s Common equity tier 1 (Cet 1) and total capital ratios remained very strong at 18.30% and 20.94%, respectively, at December 31, 2014, and well above Company and regulatory minimum targets. Home trust’s ACM was 12.47 at December 31, 2014, compared to 13.19 at December 31, 2013 and 12.88 at September 30, 2014. > total loans under administration, which includes securitized mortgages that qualify for off-balance sheet accounting, increased by $2.62 billion in 2014 to $22.56 billion, representing growth of 13.1% over the $19.94 billion at the end of 2013 and 1.9% or $410.1 million from the $22.15 billion at the end of Q3 2014. > total loans increased by $345.0 million in Q4 2014 to $18.36 billion, representing growth of 1.9% over the $18.02 billion at the end of 2013, and decreased by 0.7% or $124.0 million from the $18.49 billion at the end of Q3 2014. the decline from Q3 2014 is due to the sale of loans from the balance sheet exceeding the growth in on-balance sheet loans. > the total value of mortgages originated in Q4 2014 was $2.29 billion, compared to $1.91 billion in Q4 2013 and $2.55 billion in Q3 2014. the year-over-year increase in originations reflects continued demand for the Company’s traditional mortgage products. Compared to the third quarter, the decline in originations reflects normal and expected seasonal factors. > the Company originated $1.48 billion of traditional mortgages in Q4 2014, compared to $1.23 billion in Q4 2013 and $1.78 billion in Q3 2014. > Accelerator (insured) residential mortgage originations were down 1.2% to $353.0 million in Q4 2014, compared to $357.1 million in Q4 2013. originations were down 32.5% compared to $522.9 million in Q3 2014. Decline in originations reflects both seasonal factors and the very competitive market for prime insured mortgages that decreases the relative spread and profitability. > Multi-unit residential originations were $299.5 million in the quarter, compared to $239.9 million in the same period of 2013 and $140.7 million last quarter. Multi-unit residential mortgage originations are mostly insured and subsequently securitized through programs that qualify for off-balance sheet accounting, resulting in a portion of the securitization gains discussed above. > Commercial mortgage and other loan advances were $129.3 million in Q4 2014, compared to $60.5 million in the comparable period of 2013 and $85.2 million in Q3 2014. Store and apartment advances were $24.1 million for the fourth quarter, compared to $24.5 million in the same period of 2013 and $28.8 million in the third quarter of 2014. > the consumer retail portfolio, which includes durable household goods, such as water heaters and larger-ticket home improvement items, was $186.1 million in Q4 2014, down 45.3% from $340.0 million one year ago and 51.6% from $384.8 million in Q3 2014. the decrease from both last year and last quarter resulted from the prepayment during Q4 2014 of $234.9 million of water heater loans discussed previously. > total deposits reached $13.94 billion in Q4 2014, increasing 9.2% year over year, and down 0.6% from last quarter. total deposits raised through the Company’s deposit diversification initiatives, oaken Financial, high-interest savings accounts and institutional deposits totalled $2.42 billion, an increase of $0.35 billion or 16.9% over Q3 2014, and $1.50 billion or 163.6% over the end of 2013. 42 Home Capital Group inC. AnnuAl RepoRt 2014 F ourt H Quarter FinanCial inFormati on table 22: Fourth Quarter review of Financial performance For the three months ended Change (000s, except per share amounts and %) net interest income non-Securitized assets Interest from loans Dividends from securities other interest Interest on deposits and other 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 prepayment income on portfolio sale net realized and unrealized gains on securities net realized and unrealized (loss) gain 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 December 31 2014 September 30 2014 December 31 2013 $ 187,272 $ 2,842 2,482 192,596 81,326 1,660 109,610 183,101 $ 168,045 2,556 2,663 173,264 71,744 1,793 99,727 2,955 3,855 189,911 80,428 1,610 107,873 35,559 28,753 6,806 116,416 3,186 113,230 18,272 4,956 32,675 965 (431) 56,437 169,667 20,156 3,213 16,520 39,889 129,778 40,163 30,453 9,710 117,583 3,511 114,072 17,736 5,665 – 521 1,050 24,972 139,044 20,533 2,884 19,484 42,901 96,143 51,274 40,034 11,240 110,967 4,004 106,963 15,402 5,770 – 148 507 21,827 128,790 19,563 2,610 15,689 37,862 90,928 32,539 1,303 33,842 95,936 $ 20,144 2,244 22,388 73,755 $ 22,337 (236) 22,101 68,827 1.37 $ 1.36 $ 1.05 $ 1.05 $ 0.99 0.98 $ $ $ 70,101 70,462 70,096 70,089 70,480 70,105 $ 20.67 $ 19.57 $ 69,490 69,939 69,488 16.95 December 31, 2014– September 30, 2014 December 31, 2014– December 31, 2013 2.3% (3.8)% (35.6)% 1.4% 1.1% 3.1% 1.6% (11.5)% (5.6)% (29.9)% (1.0)% (9.3)% (0.7)% 3.0% (12.5)% – 85.2% (141.0)% 126.0% 22.0% (1.8)% 11.4% (15.2)% (7.0)% 35.0% 61.5% (41.9)% 51.2% 30.1% 30.5% 29.5% 0.0% (0.0)% (0.0)% 5.6% 11.4% 11.2% (6.8)% 11.2% 13.4% (7.4)% 9.9% (30.6)% (28.2)% (39.4)% 4.9% (20.4)% 5.9% 18.6% (14.1)% – 552.0% (185.0)% 158.6% 31.7% 3.0% 23.1% 5.3% 5.4% 42.7% 45.7% (652.1)% 53.1% 39.4% 38.4% 38.8% 0.9% 0.7% 0.9% 21.9% Home Capital Group inC. AnnuAl RepoRt 2014 43 management’s Discussion and analysis management’s Discussion and analysis table 23: Fourth Quarter review of Comprehensive income For the three months ended Change (000s, except %) net inCome otHer CompreHenSiVe loSS available for Sale Securities and retained interests net unrealized losses net gains reclassified to net income Income tax recovery Cash Flow Hedges net unrealized (losses) gains net losses reclassified to net income Income tax (recovery) expense total other comprehensive loss CompreHenSiVe inCome December 31 2014 95,936 $ September 30 2014 73,755 $ December 31 2013 68,827 $ December 31, 2014– September 30, 2014 30.1% December 31, 2014– December 31, 2013 39.4% (3,862) (965) (4,827) (1,279) (3,548) (2,552) (521) (3,073) (813) (2,260) (608) 365 (243) (64) (179) (3,727) $ 92,209 $ 217 370 587 156 431 (1,829) $ 71,926 $ $ $ (5,320) (147) (5,467) (1,449) (4,018) 897 247 1,144 303 841 (3,177) 65,650 51.3% 85.2% 57.1% 57.3% 57.0% (380.2)% (1.4)% (141.4)% (141.0)% (141.5)% 103.8% 28.2% (27.4)% 556.5% (11.7)% (11.7)% (11.7)% (167.8)% 47.8% (121.2)% (121.1)% (121.3)% 17.3% 40.5% 44 Home Capital Group inC. AnnuAl RepoRt 2014 table 24: Fourth Quarter review of Financial position (000s, except %) 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 As at December 31 2014 September 30 2014 Change $ 360,746 $ 488,101 597,990 582,819 56,561 102,094 3,945,654 14,317,162 18,262,816 (34,100) 18,228,716 4,093,553 14,338,788 18,432,341 (33,500) 18,398,841 421,083 38,534 235,616 113,136 808,369 666,640 32,459 219,407 101,609 1,020,115 $ 20,082,744 $ 20,561,608 $ 1,064,152 $ 12,875,819 13,939,971 152,026 828,982 13,193,150 14,022,132 154,640 471,551 3,831,912 4,303,463 548,640 4,177,521 4,726,161 2,266 199,831 36,554 238,651 18,634,111 1,223 250,216 35,251 286,690 19,189,623 84,687 3,989 1,378,562 (18,605) 1,448,633 84,565 3,650 1,298,648 (14,878) 1,371,985 $ 20,082,744 $ 20,561,608 (26.1)% (2.5)% 80.5% (3.6)% (0.2)% (0.9)% 1.8% (0.9)% (36.8)% 18.7% 7.4% 11.3% (20.8)% (2.3)% 28.4% (2.4)% (0.6)% (1.7)% (14.1)% (8.3)% (8.9)% 85.3% (20.1)% 3.7% (16.8)% (2.9)% 0.1% 9.3% 6.2% 25.1% 5.6% (2.3)% Home Capital Group inC. AnnuAl RepoRt 2014 45 management’s Discussion and analysis table 25: 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 and other table 26: Fourth Quarter net interest income For the three months ended December 31 2014 2.77% 2.79% 0.60% 2.25% 2.27% 2.83% September 30 2014 2.76% 2.79% 0.80% 2.27% 2.29% 2.88% December 31 2013 2.92% 2.94% 0.74% 2.20% 2.22% 3.11% December 31, 2014 September 30, 2014 December 31, 2013 income/ expense average rate1 Income/ expense Average Rate1 Income/ expense Average Rate1 For the three months ended $ 5,324 1.80% $ 6,810 1.86% $ 5,219 1.62% 144,496 4.98% 140,670 5.08% 128,659 5.24% 7,518 3,959 16,566 7,552 7,181 187,272 1,024 2.90% 4.79% 6.16% 9.21% 10.07% 5.11% – 7,107 3,287 16,280 7,273 8,484 183,101 1,065 2.61% 4.93% 6.26% 9.24% 9.08% 5.17% – 5,282 4,043 15,749 6,934 7,378 168,045 921 193,620 4.89% 190,976 4.89% 174,185 3.42% 4.93% 6.38% 9.39% 8.85% 5.43% – 5.10% 22,875 3.12% 25,650 3.33% 33,112 3.19% 10,969 4.09% 13,054 4.29% 16,429 4.01% 1,715 35,559 229,179 81,326 1,660 28,753 111,739 117,440 (1,024) $ $ $ $ 1.22% 3.11% 4.42% $ 1,459 40,163 231,139 2.28% $ 4.55% 2.48% 2.15% $ $ 80,428 1,610 30,453 112,491 118,648 (1,065) 1.06% 3.31% 4.45% $ 1,733 51,274 225,459 2.29% $ 4.40% 2.47% 2.16% $ $ 71,744 1,793 40,034 113,571 111,888 (921) $ 116,416 $ 117,583 $ 110,967 1.57% 3.29% 4.47% 2.32% 4.82% 2.55% 2.25% (000s, except %) interest-bearing 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 total interest-bearing assets interest-bearing liabilities Deposits and other Senior debt Securitization liabilities total interest-bearing liabilities net interest income (teB) tax equivalent adjustment net interest income per Financial Statements 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. 46 Home Capital Group inC. AnnuAl RepoRt 2014 table 27: Fourth Quarter mortgage advances (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 For the three months ended December 31 2014 September 30 2014 December 31 2013 $ 1,484,475 $ 1,775,993 $ 1,227,462 357,125 353,002 522,935 38,519 261,016 14,296 34,649 106,087 13,455 62,276 177,632 4,411 24,144 114,999 24,514 56,134 $ 2,290,451 $ 2,553,752 $ 1,909,554 28,840 71,793 1 other residential commercial mortgages include mortgages such as builders’ inventory. table 28: provision for Credit losses and net write-offs as a percentage of Gross loans on an annualized Basis (000s, except %) amount For the three months ended December 31 2014 % of Gross loans1 September 30 2014 % of Gross loans1 Amount December 31 2013 % of Gross loans1 Amount provision2 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 individual provision total collective provision total provision net write-offs2 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 net write-offs $ 2,263 24 0.07% $ 0.04% 2,646 – 0.09% $ – 2,841 168 81 128 90 – – 2,586 600 3,186 3,054 24 56 114 48 – $ $ 0.03% 0.15% 0.19% – 92 164 9 – 0.03% 0.20% 0.01% – 99 183 113 – – 0.06% 0.01% 0.07% $ – 2,911 600 3,511 – 0.06% 0.01% 0.08% $ – 3,404 600 4,004 0.10% $ 0.04% 1,638 – 0.05% $ – 3,135 168 0.02% 0.14% 0.10% – 107 179 71 – 0.04% 0.22% 0.07% – 79 293 94 – – 3,296 $ – 0.07% $ – 1,995 – 0.04% $ – 3,769 1 Gross loans used in the calculation of total Company ratio include securitized on-balance sheet loans. 2 there were no specific provisions, allowances or net write-offs on securitized mortgages. 0.10% 0.34% 0.04% 0.25% 0.13% – – 0.08% 0.01% 0.09% 0.12% 0.34% 0.03% 0.40% 0.11% – – 0.08% Home Capital Group inC. AnnuAl RepoRt 2014 47 management’s Discussion and analysis management’s Discussion and analysis table 29: Fourth Quarter allowance for Credit losses (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 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 total allowance total provision For the three months ended December 31, 2014 Single-family residential mortgages residential Commercial mortgages non-residential Commercial mortgages Credit Card loans other Consumer retail loans total $ 2,399 $ 2,463 (3,125) 71 1,808 – $ 24 (24) – – 55 $ 56 (56) – 55 66 $ 128 (134) 20 80 118 $ 90 (123) 75 160 2,638 2,761 (3,462) 166 2,103 760 (200) 560 2,368 – – – – 32 25 57 112 – – – 80 3 – 3 163 795 (175) 620 2,723 20,032 600 20,632 23,000 $ 2,863 $ $ $ 327 – 327 327 $ 24 $ 9,300 – 9,300 9,412 $ 81 $ 3,541 – 3,541 3,621 $ 128 $ 300 – 300 463 $ 90 $ 33,500 600 34,100 36,823 3,186 For the three months ended September 30, 2014 Single-family Residential Mortgages Residential Commercial Mortgages non-residential Commercial Mortgages Credit Card loans other Consumer Retail loans total $ 1,418 $ 2,619 (1,843) 205 2,399 – $ – – – – 68 $ 94 (108) 1 55 81 $ 164 (185) 6 66 177 $ 12 (118) 47 118 1,744 2,889 (2,254) 259 2,638 733 27 760 3,159 – – – – 34 (2) 32 87 – – – 66 6 (3) 3 121 773 22 795 3,433 19,432 600 20,032 23,191 $ 3,246 $ $ $ 327 – 327 327 $ – $ 9,300 – 9,300 9,387 $ 92 $ 3,541 – 3,541 3,607 $ 164 $ 300 – 300 421 $ 9 $ 32,900 600 33,500 36,933 3,511 48 Home Capital Group inC. AnnuAl RepoRt 2014 table 29: Fourth Quarter allowance for Credit losses (continued) 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 $ 1,441 $ 2,895 (3,259) 124 1,201 813 (54) 759 1,960 – $ – $ 168 (376) 208 – 25 – 25 25 79 (87) 8 – 24 20 44 44 311 $ 183 (314) 21 201 219 $ 111 (118) 24 236 1,971 3,436 (4,154) 385 1,638 – – – 201 10 2 12 248 872 (32) 840 2,478 17,313 719 18,032 19,992 $ 3,560 $ $ $ 446 (119) 327 352 $ 49 $ 9,300 – 9,300 9,344 $ 99 $ 3,541 – 3,541 3,742 $ 183 $ 300 – 300 548 $ 113 $ 30,900 600 31,500 33,978 4,004 (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 total allowance total provision there were no specific provisions, allowances, or net write-offs on securitized residential mortgages. table 30: Securitization income For the three months ended (000s) net gain on sale of mortgages or residual interest net change in unrealized gain or loss on hedging activities Servicing income total securitization income December 31, 2014 September 30, 2014 4,448 $ 311 906 December 31, 2013 4,598 602 570 5,770 5,665 $ $ 4,362 (591) 1,185 4,956 $ $ $ Home Capital Group inC. AnnuAl RepoRt 2014 49 management’s Discussion and analysis management’s Discussion and analysis table 31: Securitization activity (000s) Carrying value of underlying mortgages derecognized Gains on sale of mortgages or residual interest1 Retained interests recorded Servicing liability recorded December 31, 2014 For the three months ended September 30, 2014 Single-family residential mBS multi-unit residential mBS Single-family Residential MBS Multi-unit Residential MBS total mBS total MBS $ 371,782 $ 241,023 $ 612,805 $ 419,679 $ 112,207 $ 531,886 2,549 – – 1,813 9,289 2,257 4,362 9,289 2,257 3,799 – – 649 5,043 1,034 4,448 5,043 1,034 (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 C a pital manaGement For the three months ended December 31, 2013 $ Single-family Residential MBS 327,500 $ 3,460 – – Multi-unit Residential MBS 177,700 $ 1,138 7,983 1,186 total MBS 505,200 4,598 7,983 1,186 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: 50 Home Capital Group inC. AnnuAl RepoRt 2014 table 32: 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, before CVA3 CVA adjustment for Cet 1 capital total Cet 1 capital risk-weighted assets CVA adjustment for tier 1 capital total tier 1 capital risk-weighted assets CVA adjustment for total capital 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 2014 December 31, 2013 all-in Basis transitional Basis All-In Basis transitional Basis $ 38,497 $ 951 1,393,117 (18,571) 2,362 (101,976) 1,314,380 – 1,314,380 38,497 $ 951 1,393,117 (18,571) 2,362 (44,705) 1,371,651 – 1,371,651 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 34,100 156,000 190,100 31,500 156,000 187,500 $ 1,504,480 $ 1,561,751 $ 1,278,704 $ 1,332,991 34,100 156,000 190,100 31,500 156,000 187,500 $ 6,267,400 $ 6,324,671 $ 5,702,192 $ 5,756,155 793,575 $ 7,171,838 $ 7,229,109 $ 6,495,767 $ 6,549,730 904,438 904,438 793,575 10,581 7,182,419 12,066 7,183,904 14,294 n/a n/a n/a n/a 18,563 $ 7,186,132 $ 7,247,672 18.93% 18.93% 21.55% 12.47 18.30% 18.30% 20.94% n/a 7.00% 8.50% 10.50% 16.80% 16.80% 19.69% n/A 7.00% 8.50% 10.50% 17.49% 17.49% 20.35% 13.19 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 total credit risk-weighted assets, inclusive of total CVA before transitional phase-in adjustments, in tier 2 capital. At December 31, 2014, the Company’s collective allowance represented 0.54% of total credit risk-weighted assets, inclusive of total CVA. 3 CVA – Credit Valuation Adjustment. Home Capital Group inC. AnnuAl RepoRt 2014 51 management’s Discussion and analysis management’s Discussion and analysis Home trust’s regulatory “all-in” capital ratios have increased from the end of 2013 as capital increased at a faster rate than risk-weighted assets. Capital increased principally due to an increase in retained earnings of $262.6 million. Risk-weighted assets increased in line with increases in the loan portfolio. Home trust’s ACM declined from the end of 2013, primarily as a result of increased off-balance sheet activity that limited the growth rate of total assets while capital increased during 2014. Home trust’s Common equity tier 1, total tier 1 and total capital ratios continue to exceed internal capital targets. 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 commenced 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 current ACM will be replaced with the Basel III leverage ratio measure on January 1, 2015. the Company will be required to disclose the leverage ratio and its components for 2015 year-end reporting. like the ACM, the leverage ratio is a non-risk-adjusted view of a Company’s leverage. Compared to the ACM, the leverage ratio has a narrower view of capital, and only includes tier 1 capital. the leverage ratio also includes some off-balance sheet exposures, including potential future exposure amounts on derivatives, credit equivalent amounts of certain commitments and securities financing transactions. oSFI has assigned a minimum leverage ratio to the Company and the Company’s analysis of the leverage ratio suggests that the implementation of the leverage ratio will not affect its business plans. table 33: risk-weighted assets (rwa) (Based only on the subsidiary, Home trust Company) Balance Sheet amounts 338,461 421,083 568,687 4,921,451 (000s, except %) $ 216,845 11,603,298 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 1,037,225 loan commitments 21,066,087 total credit risk operational risk – total risk-weighted assets, before CVA $ 21,066,087 1,106,878 330,327 186,111 272,437 19,965,578 97,384 (34,100) 20,028,862 effective risk weight1 20.0% $ 5.7% 44.1% 0.5% 2014 risk- weighted amount 67,692 $ 23,818 251,018 26,549 Balance Sheet Amounts 715,342 648,283 424,226 6,484,974 effective Risk Weight1 20.0% $ 3.6% 71.8% 0.6% 2013 Risk- weighted Amount 143,068 23,627 304,579 40,459 35.3% 4,096,045 9,728,804 35.4% 3,441,510 100.0% 216,871 178,465 100.5% 179,383 100.1% 1,108,107 137,602 41.7% 139,583 75.0% 157,830 57.9% 31.2% 6,225,115 – – 31.1% 6,225,115 – – 994,210 293,485 339,963 191,634 19,999,386 73,405 (31,500) 20,041,291 4.1% 42,285 6,267,400 904,438 835,368 20,876,659 – $ 7,171,838 $ 20,876,659 997,805 100.4% 130,781 44.6% 254,973 75.0% 113,159 59.0% 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. 52 Home Capital Group inC. AnnuAl RepoRt 2014 Capital management activity During the third quarter of 2014, 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 2.0% of the public float outstanding on September 11, 2014. 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 2014, the Company repurchased 28,000 common shares (2013 – 78,200 common shares) for $1.4 million, thereby reducing retained earnings by $1.4 million and share capital by $34 thousand (2013 – $2.2 million and $70 thousand, 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. 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. table 34: Credit ratings long-term rating Short-term rating outlook Home Capital Group Inc. Standard & poor’s BBB- A-3 Stable DBRS BBB R2 (middle) Stable DBRS BBB (high) R2 (high) Stable Home trust Company Standard & poor’s BBB A-2 Stable the Company no longer obtains ratings from the Fitch rating agency, hence there is no such rating provided in the table above. Share information table 35: Share information (000s) Common shares issued and outstanding1 employee stock options outstanding2 employee stock options exercisable2, 3 1 no shares were issued, other than through employee stock options exercised. 2 please see note 15(C). Amount for employee stock options is not applicable. number of Shares 70,096 $ 1,235 634 2014 amount 84,687 n/a 14,866 number of Shares4 69,488 $ 1,650 1,048 2013 Amount 70,233 n/A 19,287 3 For employee stock options exercisable, the amount refers to proceeds payable to the Company upon exercise. 4 the number of shares has been doubled to reflect the stock dividend of one common share per each issued and outstanding common share paid in Q1 2014. Home Capital Group inC. AnnuAl RepoRt 2014 53 management’s Discussion and analysis management’s Discussion and analysis ri S k manaGement the shaded areas of this section of the MD&A represent a discussion of risk management policies and procedures relating to credit, market, liquidity and operational 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, 2014. 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 assets 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. 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 2014 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 Corporate Social Responsibility Committee Disclosure Committee 3rd Line 2nd Line 1st Line Internal Audit Finance Corporate Compliance Credit Enterprise Risk Management Deposits Residential Mortgage Lending Commercial Mortgage Lending Consumer Lending and Retail Credit Credit Cards PSiGate Treasury Support Functions 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 2014 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, Corporate Social Responsibility, Disclosure, 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 supporting risk committees, the Company’s risk governance is supported by: > 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), the Chief Anti-Money laundering officer (CAMlo) and the Corporate Compliance group are 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 and Corporate Compliance group are 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. > 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 Finance group compiles the Company’s financial statements, budget 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. the Finance group also updates the Company’s financial and capital plans 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 2014 Stress testing In addition to 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 (ICAAp), liquidity and funding planning 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 enterprise scenarios is developed to assess the impact on the Company’s financial results, capital position, operational capabilities and the Company’s ability to respond to the event. In particular, management has evaluated a range of stress scenarios, including a real estate driven recession, a natural disaster, a recession in oil-producing regions, a condominium and commercial downturn, and a reverse stress scenario. 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 a significant second order impact on the Company’s reputation or ability to execute strategic objectives. principal risks 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 g n d n u F k s i R y t i d u q i L 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, and regular independent monitoring and reporting. 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 credit 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 for 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 loan loss allowances and the allocation of credit-risk-based capital. Home Capital Group inC. AnnuAl RepoRt 2014 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 carry 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 36: Credit risk portfolio metrics (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 2014 2012 $ 18,262,816 $ 17,881,926 $ 17,137,992 2013 $ 17,746,378 $ 17,248,478 $ 16,538,499 94.0% 6.0% 44.8% 97.6% 0.4% 19.3% 65.5% 94.2% 5.8% 36.8% 97.6% 0.5% 25.1% 65.9% 93.8% 6.2% 27.7% 97.9% 0.3% 23.7% 66.7% $ $ $ $ 330,327 $ 95.3% 3.8% 97.8% 0.6% 62.4% 18,787 $ 430,906 $ 33,853 293,485 $ 95.7% 3.8% 97.8% 0.9% 66.1% 15,997 $ 373,702 $ 28,892 13 $ 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 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 credit metrics and the performance of the mortgage loan portfolio. the portfolio continues to perform well, with arrears and net write-offs that are well within expected levels. the Company mitigates credit risk by ensuring borrowers have the capacity and willingness to pay and through collateral in the form of real property and, as such, loan to value (ltV) is a key credit metric. please see tables 41 and 42 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. Condominiums represent less than 9% of the residential mortgage portfolio and, of these, 26.8% are insured. the average current ltV of the condominium portfolio was 68.4% at the end of 2014. the credit performance of the condominium portfolio is strong and within the Company’s expectations, with 98.6% of the portfolio current and 0.3% over 90 days. Given the rapid decline in oil prices and the economic uncertainty in the regions most affected by oil prices, the Company is closely monitoring its exposure and the credit performance of mortgages in Alberta, Saskatchewan, and newfoundland and labrador. At December 31, 2014, 4.1% of the uninsured mortgage portfolio was in these regions, with an average ltV of 62.8%, and 98.2% were current. 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 or grow modestly. the proportion is well within the policy limits. 58 Home Capital Group inC. AnnuAl RepoRt 2014 Other Lending Credit card balances were $330.3 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 62.4% at the end of the year, compared to 66.1% at the end of 2013. 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, 2014, $1.9 million or 0.6% of the credit card portfolio was over 90 days in arrears, compared to $2.6 million or 0.9% at December 31, 2013. 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 note 5 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 37: 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 net write-offs as a % of gross loans $ Gross 52,551 $ 54 2014 net1 50,743 $ 54 Gross 52,837 $ 1,836 2,516 1,938 160 57,219 $ 18,264,919 2,461 1,858 – 55,116 7,189 2,785 236 64,883 $ 17,883,564 $ 0.30% 36,823 0.20% 64.35% 0.06% $ 2013 net1 51,636 1,836 7,189 2,584 – 63,245 0.35% 33,978 0.19% 52.37% 0.09% Gross (0.5)% (97.1)% (65.0)% (30.4)% (32.2)% (11.8)% 2.1% Change net1 (1.7)% (97.1)% (65.8)% (28.1)% – (12.9)% – 1 non-performing loans are net of individual allowances as shown in table 38, 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-off rates relative to the gross loans portfolio. Write-offs, net of recoveries, totalled $10.3 million or 0.06% of gross loans in 2014, compared to $15.5 million or 0.09% of gross loans in 2013. the Company continually monitors arrears and write-offs and deals effectively with non- performing loans. Home Capital Group inC. AnnuAl RepoRt 2014 59 management’s Discussion and analysis management’s Discussion and analysis table 38: 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 total individual allowances Collective allowance Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans other consumer retail loans total collective allowance total allowances (000s) Individual allowances Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans other consumer retail loans total individual allowances Collective allowance Single-family residential mortgages Residential commercial mortgages non-residential commercial mortgages Credit card loans other consumer retail loans total collective allowance total allowances 2014 opening Balance write-offs net of recoveries provision for Credit losses 2014 ending Balance 1,960 $ 25 44 201 248 2,478 (9,099) $ (24) (202) (692) (272) (10,289) 9,507 $ (1) 270 571 187 10,534 18,032 327 9,300 3,541 300 31,500 33,978 $ – – – – – – (10,289) $ 2,600 – – – – 2,600 13,134 $ 2013 opening Balance Write-offs net of Recoveries provision for Credit losses 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 $ 2,368 – 112 80 163 2,723 20,632 327 9,300 3,541 300 34,100 36,823 2013 ending Balance 1,960 25 44 201 248 2,478 18,032 327 9,300 3,541 300 31,500 33,978 $ $ $ $ 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, 2014, the Company held a collective allowance of $34.1 million, compared to $31.5 million held at December 31, 2013, reflecting the increase in the traditional single-family residential mortgage lending portfolio. 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 currently exceeds three years of current year write-offs. 60 Home Capital Group inC. AnnuAl RepoRt 2014 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 by remaining contractual amortization periods and loan to value by province. table 39: Single-family residential loans by province (000s, except %) British Columbia Alberta ontario Quebec other $ insured residential mortgages1 301,557 248,418 2,993,336 166,704 127,333 $ 3,837,348 percentage of total for province uninsured residential mortgages 579,031 34.1% $ 38.7% 379,769 22.3% 10,121,442 354,293 31.9% 42.7% 168,764 24.4% $ 11,603,299 percentage of total for province 65.4% $ 59.0% 75.5% 67.8% 56.5% 73.6% $ (000s, except %) British Columbia Alberta ontario Quebec other $ Insured Residential Mortgages1 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% $ 284,456 52.9% 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% $ 1 See definition of insured loans under the Glossary of terms in this report. 2 equityline Visa is an uninsured product. 2014 percentage of total for province total 884,911 0.5% $ 2.3% 642,699 2.2% 13,406,876 522,474 0.3% 0.8% 298,405 2.0% $ 15,755,365 2013 percentage of total for province total 876,586 0.7% $ 641,683 2.8% 2.0% 12,481,366 554,668 0.2% 0.8% 294,026 1.9% $ 14,848,329 equityline Visa2 4,323 14,512 292,098 1,477 2,308 314,718 equityline Visa2 5,863 17,702 253,731 1,260 2,309 280,865 table 40: insured and uninsured Single-family residential mortgages by effective remaining amortization period 2014 (000s, except %) Balance outstanding percentage of total ≤ 20 years > 20 and ≤ 25 years > 25 and ≤ 30 years > 30 and ≤ 35 years $ 677,965 $ 2,220,655 $ 10,905,290 $ 1,621,133 $ 4.4% 14.4% 70.6% 10.5% (000s, except %) Balance outstanding percentage of total ≤ 20 Years > 20 and ≤ 25 Years > 25 and ≤ 30 Years > 30 and ≤ 35 Years $ 548,872 $ 1,816,546 $ 8,972,602 $ 3,192,678 $ 3.8% 12.5% 61.6% 21.9% > 35 years total 15,604 $ 15,440,647 100.0% 0.1% 2013 > 35 Years total 36,766 $ 14,567,464 100.0% 0.2% Home Capital Group inC. AnnuAl RepoRt 2014 61 management’s Discussion and analysis table 41: 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 68.2% 72.3% 74.3% 68.2% 67.4% 73.7% 2014 equityline Visa1 53.5% 54.5% 56.3% 57.3% 51.7% 56.3% 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. the Company actively manages the entire mortgage portfolio and performs stress testing, based on a combination of increasing unemployment, rising interest rates, and a downturn in real estate markets. 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 $15.76 billion as of December 31, 2014, of which $3.84 billion was insured against credit losses. the Company would expect to recover any 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 event of default in the uninsured portfolio is the excess of the value of the collateral over the outstanding loan amount (expressed as ltV ratio). As at December 31, 2014, the weighted-average ltV of the uninsured portfolio against the estimated current market value was 67.8% compared to 67.9% at the end of 2013. these ltVs were estimated using the teranet-national Bank national Composite 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 42: weighted-average loan-to-Value ratios for uninsured residential mortgages 2014 2013 weighted- average Current ltV1 percentage of total Value of outstanding mortgages with Current ltV less than or equal to Weighted- average Current ltV1 percent of total Value of outstanding Mortgages with Current ltV less than or equal to 65.7% 64.9% 68.1% 65.1% 64.9% 67.8% 75% 84.7% 80.6% 72.3% 91.3% 85.3% 73.9% 65% 44.8% 47.7% 32.9% 45.7% 49.3% 34.6% 65.4% 63.8% 68.4% 64.3% 62.5% 67.9% 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% British Columbia Alberta ontario Quebec other total 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. 62 Home Capital Group inC. AnnuAl RepoRt 2014 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 portfolio consists primarily of preferred shares at 42.6% of the portfolio, and corporate and government bonds at 55.0% of the portfolio. the total balance was $582.8 million at December 31, 2014, compared to $424.3 million at the end of 2013. 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. 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 re-pricing 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 prudent policies and guidelines, and provides independent enterprise-wide oversight of all interest rate risk. From time to time, the Company enters into derivative transactions in order 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. 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 Company is exposed to interest rate risk as a result of a difference, or gap, between the maturity or re-pricing date of interest- sensitive assets and liabilities. the following table shows the gap positions at December 31, 2014 and December 31, 2013 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. 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. Variable rate assets and liabilities are allocated to a maturity category based on their interest re-pricing date. Home Capital Group inC. AnnuAl RepoRt 2014 63 management’s Discussion and analysis table 43: interest rate Sensitivity (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 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, 2014 $ 105,750 $ 254,996 $ – $ – $ – $ – $ – $ 360,746 1.0% 1.0% – – – – – 1.0% – – – – – – – 87,430 15,595 9,853 113,860 356,017 64 582,819 2.1% – 4.2% – 4.9% – 4.7% – 2.0% 102,094 – 1,877,406 – 240,434 – 299,317 – 544,644 2.9% 983,853 3.0% 3.9% 3.7% 3.8% 4.3% – – – – – 2.6% 102,094 2.9% 3,945,654 3.5% 2,715,260 2,050,234 5,774,695 3,187,190 562,886 (7,203) 14,283,062 – 118,888 5.5% 336,183 5.0% 4,547 0.9% 1.2% 1.6% 5.0% – – 5.0% – – $ 224,638 $ 5,271,275 $ 2,310,810 $ 6,083,865 $ 3,845,694 $ 2,004,850 $ 6.1% – – 348,751 5.1% 808,369 – – 0.7% 341,612 $ 20,082,744 0.9% 4.0% 4.8% 4.9% 4.8% 4.3% – 4.5% $ 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 – – – – – – – – – – – 898,909 $ 1.5% – $ – $ – $ – $ – $ 165,243 $ 1,064,152 – – – – – – 1.5% 1,484,448 1,765,946 3,627,058 4,117,316 1,881,051 – 12,875,819 1.9% – – 2.1% – – 2.1% – 2.3% 152,026 – 5.2% 2.7% – – – – – 2.2% 152,026 5.2% 2,447,794 294,520 165,740 354,121 1,041,288 – 4,303,463 2.0% 2,266 – – 3.2% – – – 2.6% – – – 2.7% – – – 3.3% – – 236,385 2.5% 238,651 – – – 1,448,633 – 1,448,633 – $ 898,909 $ 3,934,508 $ 2,060,466 $ 3,792,798 $ 4,623,463 $ 2,922,339 $ 1,850,261 $ 20,082,744 – – – – – – – 1.5% 1.9% 2.3% 2.1% 2.4% 2.9% – $ (674,271) $ 1,336,767 $ (842,992) 250,344 $ 2,291,067 $ 12,440 31,448 (777,769) $ 589,823 (917,489) $ (1,508,649) $ 209,281 – 5.9% 6.1% 6.2% 5.1% 3.2% – $ (674,271) $ 493,775 $ 262,784 $ 2,322,515 $ (187,946) $ (708,208) $ (1,508,649) $ Cumulative gap $ (674,271) $ (180,496) $ 82,288 $ 2,404,803 $ 2,216,857 $ 1,508,649 $ – $ Cumulative gap as a percentage of total assets (3.4)% (0.9)% 0.4% 12.0% 11.0% 7.5% – 64 Home Capital Group inC. AnnuAl RepoRt 2014 2.1% – – – – – – table 43: interest rate Sensitivity (continued) (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 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 $ 682,646 $ – $ – $ – $ – $ – $ 733,172 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 – 2,154,530 – 421,987 – 603,121 – 957,023 3.7% 1,073,360 2.8% 3.9% 4.1% 3.6% 4.1% – – – – – – – 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% 5.3% 122,836 442,376 138,123 1.2% 0.9% 1.5% – – 5.1% 4,720 1.6% 5.5% – – $ 173,362 $ 5,374,867 $ 2,350,952 $ 5,199,069 $ 4,393,109 $ 2,371,847 $ – 5.2% 221,950 930,005 – 0.8% 212,644 $ 20,075,850 1.1% 3.4% 4.6% 5.1% 4.7% 4.7% – 4.3% 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 $ 338,381 $ – $ – $ – $ – $ – $ 90,888 $ 429,269 – – – – – – 1.5% 838,509 1,889,830 4,412,669 4,144,478 1,051,199 – 12,336,685 1.5% – – – – 1.9% – – 2.0% – – 2.1% – – 2.3% 153,474 5.2% 2.8% – – – – – 2.2% 153,474 5.2% – – – – – 2,536,540 499,825 659,953 997,915 1,078,831 – 5,773,064 1.9% 3,809 – – 3.2% – – – 2.8% – – – 2.9% – – – 3.3% – – 201,852 2.6% 205,661 – – – 1,177,697 – 1,177,697 – $ 338,381 $ 3,378,858 $ 2,389,655 $ 5,072,622 $ 5,295,867 $ 2,130,030 $ 1,470,437 $ 20,075,850 – – – – – – – 1.5% 1.9% $ (165,019) $ 1,996,009 $ – (748,741) 2.2% (38,703)$ 305 2.2% 2.5% 3.1% – 126,447 $ 19 (902,758) $ 26,758 241,817 $ (1,257,793) $ 721,659 – 2.2% – – – 4.6% 6.3% 5.1% 5.0% 4.6% – $ (165,019) $ 1,247,268 $ (38,398) $ 126,466 $ (876,000) $ 963,476 $ (1,257,793) $ $ (165,019) $ 1,082,249 $ 1,043,851 $ 1,170,317 $ 294,317 $ 1,257,793 $ – $ (0.8)% 5.4% 5.2% 5.8% 1.5% 6.3% – – – – – Home Capital Group inC. AnnuAl RepoRt 2014 65 management’s Discussion and analysis 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 the 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 44: 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 Impact on other comprehensive income Increase in interest rates Decrease in interest rates December 31 2014 December 31 2013 December 31 2014 December 31 2013 $ 8,642 $ 13,953 2,114 12,601 $ 16,555 686 (8,642) $ (14,694) (2,114) (12,601) (18,003) (686) 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 re-pricing 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. Funding and liquidity 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. the Company’s liquid assets are presented in the table below: 66 Home Capital Group inC. AnnuAl RepoRt 2014 table 45: 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 $ 2014 360,746 $ 582,819 362,801 1,306,366 (248,069) 2013 733,172 424,272 614,903 1,772,347 (274,667) $ 1,058,297 $ 1,497,680 $ 1,059,821 $ 1,495,894 7.5% 5.3% Change (50.8)% 37.4% (41.0)% (26.3)% (9.7)% (29.3)% (29.2)% (29.4)% Certain Company-originated MBS are held as liquid assets, but are classified in residential mortgages on the balance sheet, as required by IFRS. the underlying mortgages are insured and the securities are stamped by CMHC. 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 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. the Company continues its longer-term strategy to diversify its sources of funding. During Q4 2013, Home trust launched a new direct to consumer brand, oaken Financial, offering a line of consumer deposit products, including GICs, and a new oaken Savings Account as part of its strategy to provide customers with a secure alternative for managing their savings independently and to continue to diversify funding sources. In Q2 2014, the Company successfully launched oaken online Banking, allowing oaken customers to bank at their convenience. In addition to providing customers with greater banking convenience, oaken online Banking provides security features to safeguard client personal and financial information. together, these initiatives represent oaken’s ongoing aim of becoming a leading alternative for Canadians seeking to securely save and invest their money and furthering the Company’s commitment to diversify its sources of funding. In addition, the Company offers the Home trust high-interest savings account, which is distributed through investment brokers and launched in 2012 as part of the Company’s deposit diversification strategy to diversify its sources of funding and expand its deposit broker network. Further funding diversification was accomplished in Q4 2013 with the successful close of Home trust’s initial issue of institutional fixed- term deposit notes in the principal amount of $300 million and the issuance of a further $500 million in Q2 2014. the Company expects that Home trust will be a regular issuer of deposit notes, generally on a semi-annual basis. 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 or lines of credit 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 on a timely basis any payments that are not collected due to arrears. 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. OSFI Liquidity Requirements effective January 1, 2015, the Company will start reporting its liquidity Coverage Ratio (lCR), which is a new minimum regulatory liquidity standard being adopted by oSFI. the lCR requires regulated financial institutions to maintain a sufficient stock of high-quality liquid assets to cover a minimum of 30 days of net cumulative cash flow requirements in a stressed environment. the Company is well positioned to comply with the new requirements. Home Capital Group inC. AnnuAl RepoRt 2014 67 management’s Discussion and analysis 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. 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. 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, introducing enhanced risk tools and methodologies, including event data monitoring, line-of-business risk and control self-assessments, measurement and monitoring of key risk/performance indicators, a new initiatives risk assessment framework, and stress testing and scenario analytics. 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. In addition to cyber-crime, the Company is continuously exposed to other various types of fraud stemming from the nature of the Company’s business. For example, the Company must often rely on information provided by customers and other third parties in its decisions to enter into transactions such as extending credit. the recent increasing pace of advancement in available technology has increased the sophistication and complexity of potential fraud crimes to which the Company is exposed. the Company continues to introduce and enhance processes to defend against more sophisticated and complex fraud. Despite the Company’s commitment to information and cyber security and fraud prevention, 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. 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 stress 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. 68 Home Capital Group inC. AnnuAl RepoRt 2014 Business Continuity and Crisis Management the Company has implemented an all hazards-based business continuity and crisis management strategy to minimize the impact on our 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. 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 regulations, 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. Home Capital Group inC. AnnuAl RepoRt 2014 69 management’s Discussion and analysis 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. While the Company has well-designed and tested business continuity plans, should the Company experience significant disruptions outside its control 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. While there is no assurance that the Company will be able to continue to attract and retain key personnel, this remains a fundamental corporate priority. aCCountinG StanDarDS 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, 17, 19 and 21 to the consolidated financial statements. Future Change in accounting Standards the new IFRS pronouncements that have been issued but are not yet effective and may have a future impact on the Company are discussed in note 3 of the consolidated financial statements. ControlS oVer FinanCial reportinG 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. 70 Home Capital Group inC. AnnuAl RepoRt 2014 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, 2014. 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, 2014. 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, 2014. 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, 2014. Changes in internal Control over Financial reporting there were no significant changes in 2014 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 2014 audited consolidated financial statements. please see note 2 for further information. non-Gaap meaSureS anD GloSSary 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 revenue, adjusted net income, and adjusted earnings per Share After-tax prepayment income associated with the sale of the water heater loans portfolio, after-tax charges 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 revenue and net income to present adjusted revenue and adjusted net income. the reconciliation of net income to adjusted net income and the resulting adjusted earnings per share are presented below. Return on shareholders’ equity and efficiency ratios are also presented on an adjusted basis. please see the definitions below. Home Capital Group inC. AnnuAl RepoRt 2014 71 management’s Discussion and analysis reconciliation of net income to adjusted net income (000s, except % and per share amounts) 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) Adjustment for sale of loan portfolio (net of tax) Adjusted net Income Adjusted Basic earnings per Share Adjusted Diluted earnings per Share Q4 2014 Q3 2014 $ 95,936 $ 73,755 Change Q4 2013 30.1% $ 68,827 Change 2013 2014 39.4% $ 313,172 $ 256,542 Change 22.1% Quarter Year 1,278 106 1,105.7% 850 50.4% 3,128 5,873 (46.7)% – – – – – – 1,508 (100.0)% – (2,426) (100.0)% (1,470) (100.0)% (3,897) (6,190) (37.0)% (24,019) – $ 73,195 $ 71,435 – – 2.5% $ 68,207 – (24,019) – 7.3% $ 288,384 $ 257,733 – 11.9% $ $ 1.04 $ 1.02 2.0% $ 0.98 6.1% $ 4.13 $ 3.72 11.0% 1.04 $ 1.01 3.0% $ 0.98 6.1% $ 4.09 $ 3.68 11.1% 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 and adjusted 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. In addition, the Company uses the adjusted efficiency ratio calculated using adjusted revenue. A lower ratio indicates better efficiency. 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. 72 Home Capital Group inC. AnnuAl RepoRt 2014 net interest margin (non-teB) net interest margin is a measure of profitability of assets. net interest margin is calculated by taking net interest income divided by the average total assets generating the interest income. 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 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. provision as a percentage of Gross uninsured loans the provision as a percentage of gross uninsured loans ratio is calculated as the total individual and collective provision expense divided by the gross on-balance sheet uninsured loans outstanding. 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) and adjusted return on Shareholders’ equity 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. to calculate adjusted return on shareholders’ equity, the Company uses adjusted net income. 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 $4.1 million for 2014 ($4.0 million – 2013) 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 5 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 2014 73 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 is comprised of 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 where 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 nCCF net Cumulative Cash Flow the treadway Commission CVa Credit Valuation Adjustment erm enterprise Risk Management Gaap Generally Accepted Accounting principles GiC Guaranteed Investment Certificate HeloC Home equity line of Credit 74 Home Capital Group inC. AnnuAl RepoRt 2014 nHa national Housing Authority oCi other Comprehensive Income oSFi office of the Superintendent of Financial Institutions Canada teB taxable equivalent Basis Consolidated Financial Statements Con S oli DateD Fi na nC i al S tatem 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 Stat ementS 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. employee Benefits 16. Accumulated other Comprehensive Income 17. Income taxes 18. Commitments and Contingencies 19. Derivative Financial Instruments 20. Current and non-current Assets and liabilities 21. Fair Value of Financial Instruments 22. Related party transactions 23. Risk Management p. 76 p. 77 p. 78 p. 79 p. 80 p. 80 p. 81 p. 82 p. 82 p. 88 p. 89 p. 91 p. 95 p. 97 p. 97 p. 98 p. 98 p. 99 p. 99 p. 99 p. 100 p. 101 p. 103 p. 104 p. 105 p. 105 p. 108 p. 108 p. 111 p. 111 Home Capital Group inC. AnnuAl RepoRt 2014 75 management’s responsibility for Financial information the consolidated financial statements and Management’s Discussion and Analysis (MD&A) 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. the MD&A has been prepared according to the requirements of securities regulators. 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 Chief Financial officer, 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 monitors 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. As at December 31, 2014, the Company’s Chief executive officer and Chief Financial officer have determined that the Company’s internal control over financial reporting is effective. 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 and/or the Board of Directors, 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 and risk management as well as assessment of significant transactions and related party transactions through its Audit Committee. the Audit Committee is composed solely of independent Directors. the Audit Committee is responsible for selecting the shareholders’ auditors. Gerald m. Soloway Chief Executive Officer toronto, Canada February 11, 2015 robert morton, Cpa, Cma Chief Financial Officer 76 Home Capital Group inC. AnnuAl RepoRt 2014 independent auditors’ report to the Shareholders of Home Capital Group inc. We have audited the accompanying consolidated fi nancial statements of Home Capital Group Inc., which comprise the consolidated balance sheets as at December 31, 2014 and 2013, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash fl ows for the years ended December 31, 2014 and 2013, and a summary of signifi cant 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 fi nancial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated fi nancial 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 fi nancial 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 fi nancial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated fi nancial statements. the procedures selected depend on the auditors’ judgement, including the assessment of the risks of material misstatement of the consolidated fi nancial 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 fi nancial 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 fi nancial statements. We believe that the audit evidence we have obtained in our audits is suffi cient and appropriate to provide a basis for our audit opinion. opinion In our opinion, the consolidated fi nancial statements present fairly, in all material respects, the fi nancial position of Home Capital Group Inc. as at December 31, 2014 and 2013, and its fi nancial performance and its cash fl ows for the years ended December 31, 2014 and 2013 in accordance with International Financial Reporting Standards. Chartered professional Accountants licensed public Accountants toronto, Canada February 11, 2015 Home Capital Group inC. AnnuAl RepoRt 2014 77 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(A)) 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(B)) Mortgage-backed security liabilities Canada Mortgage Bond liabilities other Derivative liabilities (note 19) other liabilities (note 13) Deferred tax liabilities (note 17(C)) Shareholders’ equity Capital stock (note 14) Contributed surplus Retained earnings Accumulated other comprehensive loss (note 16) December 31 2014 $ 360,746 582,819 102,094 3,945,654 14,317,162 18,262,816 (34,100) 18,228,716 421,083 38,534 235,616 113,136 808,369 $ 20,082,744 $ 1,064,152 12,875,819 13,939,971 152,026 471,551 3,831,912 4,303,463 2,266 199,831 36,554 238,651 18,634,111 84,687 3,989 1,378,562 (18,605) 1,448,633 $ 20,082,744 As at December 31 2013 $ 733,172 424,272 137,975 5,210,021 12,671,905 17,881,926 (31,500) 17,850,426 648,283 29,886 162,679 89,157 930,005 $ 20,075,850 $ 429,269 12,336,685 12,765,954 153,474 660,964 5,112,100 5,773,064 3,809 167,427 34,425 205,661 18,898,153 70,233 5,984 1,119,959 (18,479) 1,177,697 $ 20,075,850 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 78 Home Capital Group inC. AnnuAl RepoRt 2014 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 and other 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)) prepayment income on portfolio sale (note 5(H)) net realized and unrealized gains on securities net realized and unrealized loss on derivatives (note 19) non-interest expenses Salaries and benefits premises other operating expenses income Before income taxes Income taxes (note 17(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 December 31 2014 For the year ended December 31 2013 $ $ $ $ $ 717,798 11,426 13,912 743,136 311,494 6,392 425,250 166,491 132,212 34,279 459,529 13,134 446,395 71,241 26,845 32,675 3,425 (827) 133,359 579,754 80,769 11,866 69,617 162,252 417,502 102,201 2,129 104,330 313,172 4.48 4.45 69,857 70,432 70,096 20.67 $ $ $ $ $ 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 3.70 3.66 69,340 70,046 69,488 16.95 During Q1 2014, the Company paid a stock dividend of one common share per each issued and outstanding common share. Accordingly, both basic and diluted net income per common share is reduced to half and the number of shares disclosed is doubled for all periods ending before Q1 2014 presented for comparative purposes. the accompanying notes are an integral part of these consolidated financial statements. Home Capital Group inC. AnnuAl RepoRt 2014 79 Consolidated Statements of Comprehensive income thousands of Canadian dollars net inCome otHer CompreHenSiVe loSS available for Sale Securities and retained interests net unrealized gains (losses) net gains reclassified to net income Income tax recovery Cash Flow Hedges (note 19) net unrealized (losses) gains net losses reclassified to net income Income tax expense total other comprehensive loss CompreHenSiVe inCome the accompanying notes are an integral part of these consolidated financial statements. December 31 2014 313,172 $ 2,854 (3,425) (571) (152) (419) (1,061) 1,461 400 107 293 (126) 313,046 $ For the year ended December 31 2013 256,542 $ (19,530) (2,584) (22,114) (5,859) (16,255) 702 1,362 2,064 543 1,521 (14,734) 241,808 $ Consolidated Statements of Changes in Shareholders’ equity thousands of Canadian dollars, except per share amounts Capital Stock Contributed Surplus retained earnings net unrealized (losses) Gains 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 Balance at December 31, 2013 Comprehensive income Stock options settled (notes 14(B), 15(C)) Amortization of fair value of employee stock options Repurchase of shares (note 14(C)) Dividends ($0.70 per share) Balance at December 31, 2014 Balance at December 31, 2012 Comprehensive income Stock options settled (notes14(B), 15(C)) Amortization of fair value of employee stock options Repurchase of shares (note 14(C)) Dividends ($0.54 per share) Balance at December 31, 2013 $ 70,233 $ 5,984 $ 1,119,959 $ (15,823) $ – – 313,172 (419) (2,656) $ (18,479) $ 1,177,697 313,046 (126) 293 14,488 (3,895) – – (34) – 1,900 – – – (1,356) (53,213) – – – – $ 84,687 $ 61,903 $ $ – 3,989 $ 1,378,562 $ (16,242) $ 432 $ 6,224 $ 903,831 $ – 256,542 (16,255) – – 10,593 – – – – – – 1,900 (1,390) (53,213) (2,363) $ (18,605) $ 1,448,633 (3,745) $ 968,213 (4,177) $ 241,808 1,521 (14,734) 8,400 (2,202) – 1,962 – – – – – – – – 6,198 1,962 (70) – 70,233 $ $ – – (2,232) (38,182) 5,984 $ 1,119,959 $ – – (15,823) $ – – (2,656) $ – – (2,302) (38,182) (18,479) $ 1,177,697 During Q1 2014, the Company paid a stock dividend of one common share per each issued and outstanding common share. Accordingly, dividends per share, presented for comparative purposes are reduced by half for all periods prior to the stock dividend. the accompanying notes are an integral part of these consolidated financial statements. 80 Home Capital Group inC. AnnuAl RepoRt 2014 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: Amortization of net premium on securities provision for credit losses prepayment income on portfolio sale Gain on sale of mortgages or residual interest net realized and unrealized gains on securities Amortization of capital and intangible assets Amortization of fair value of employee stock options Deferred income taxes Changes in operating assets and liabilities loans, net of securitization and sales Restricted assets Derivative assets and liabilities Accrued interest receivable Accrued interest payable Deposits Securitization liabilities taxes receivable or payable and other Cash flows (used in) provided by 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 proceeds from maturities purchases of capital assets Capitalized intangible development costs Cash flows used in investing activities net (decrease) increase 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 2014 For the year ended December 31 2013 $ 313,172 $ 256,542 1,001 13,134 (32,675) (23,712) (3,425) 10,387 1,900 2,129 (299,376) 227,200 (9,791) (1,951) 60 1,174,017 (1,469,601) (41,867) (139,398) (1,390) 10,593 (48,922) (39,719) (542,558) 206,020 178,772 (3,080) (32,463) (193,309) (372,426) 733,172 360,746 9,750 895,851 450,038 81,320 $ $ 2,562 15,868 – (11,010) (2,589) 11,368 1,962 (1,238) (863,438) 70,227 18,989 (1,388) 13,624 2,629,355 (1,562,831) (65,500) 512,503 (2,302) 6,198 (37,458) (33,562) (182,382) 38,400 112,094 (7,801) (14,926) (54,615) 424,326 308,846 733,172 9,022 861,424 438,885 108,243 $ $ Home Capital Group inC. AnnuAl RepoRt 2014 81 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 residential and non- residential mortgage lending, securitization of insured residential first mortgage products, consumer lending and credit card products. In addition, Home trust offers deposits via brokers and financial planners, and through its direct to consumer deposit brand, oaken Financial. 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, 2014 were authorized for issuance by the Board of Directors (the Board) of the Company on February 11, 2015. 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 $15.4 million or $0.22 per common share payable on March 1, 2015 to shareholders of record at the close of business on February 23, 2015. note 2 Summary oF SiGniFiC ant aCCoun tinG p ol i C i eS 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 2014 consolidated financial statements. the consolidated financial statements reflect the impact of the stock dividend paid on a one-for-one basis during the first quarter of 2014 on the Company’s issued and outstanding common shares. Accordingly, both basic and diluted earnings per share were restated to half and the number of shares was restated to double the amounts previously disclosed for the year ended December 31, 2013, that have been presented for comparative presentation purposes. 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. 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). In other cases, 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 remaining 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. the preparation of consolidated financial statements in accordance with GAAp 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. 82 Home Capital Group inC. AnnuAl RepoRt 2014 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, is 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 date. 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. loans Held for Securitization and Sale When identifiable, loans 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 securitized 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. Home Capital Group inC. AnnuAl RepoRt 2014 83 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) 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 mortgage, or retail 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. Material credit losses are generally 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 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, credit scores, current economic conditions, 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. 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. 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. 84 Home Capital Group inC. AnnuAl RepoRt 2014 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 retained 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 from the fair value changes in the hedged risk in the hedged item. Hedge ineffectiveness is recognized immediately in income. 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 or 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. Home Capital Group inC. AnnuAl RepoRt 2014 85 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) 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 purchased 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. intangible assets (internally developed software costs) the Company’s intangible assets comprise internally developed software costs. 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. In addition, the Company capitalizes borrowing costs directly attributable to the intangible assets flowing to the Company by applying a capitalization rate to the expenditures on the intangible assets. Following initial recognition, intangible assets are carried at cost less any accumulated amortization and any accumulated impairment losses. 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, with the exception of the core banking system, which has a useful life of 15 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. 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. 86 Home Capital Group inC. AnnuAl RepoRt 2014 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. 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 that increases or decreases 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. 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 21 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 21 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. Home Capital Group inC. AnnuAl RepoRt 2014 87 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) 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 15. 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 statement 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 15 for more information. 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 CHanGeS in aCCoun tinG poli C i eS the following accounting pronouncements issued by the IASB were not effective as at December 31, 2014 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), including classification and measurement, impairment and hedge accounting for annual periods beginning on or after January 1, 2018. Management is currently evaluating the potential impact that the adoption of IFRS 9 will have on the Company’s consolidated financial statements. 88 Home Capital Group inC. AnnuAl RepoRt 2014 iFrS 15 Revenue from Contracts with Customers the Company will be required to adopt IFRS 15, Revenue from Contracts with Customers (IFRS 15), which provides a single-principle- based framework that applies to contracts with customers, for annual periods beginning on or after January 1, 2017. Management is currently evaluating the potential impact that the adoption of IFRS 15 will have on the Company’s consolidated financial statements. amendments to iaS 1 Presentation of Financial Statements the Company will be required to adopt amendments to IAS 1, Presentation of Financial Statements, which includes amendments to further encourage companies to apply professional judgement in determining what information to disclose in their financial statements, for annual periods beginning on or after January 1, 2016. amendments to iFrS 7 Financial Instruments: Disclosures the Company will be required to adopt amendments to IFRS 7, Financial Instruments: Disclosures, requiring increased disclosure regarding continuing involvement accounting, for annual periods beginning on or after January 1, 2016. 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 2014 December 31 2013 $ $ 360,746 $ 360,746 $ 733,172 733,172 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, 2014, all ratio requirements have been met and no amounts have been drawn against the borrowing facility. the Company also has a committed insured mortgage purchase facility with a Canadian chartered bank in the amount of $300 million at December 31, 2014 (nil – December 31, 2013). this facility is used by the Company to fund insured mortgage loans until such time as they can be securitized. proceeds from securitized loans are used to pay down the facility. As at December 31, 2014, this facility was undrawn. (B) available for Sale Securities at Fair Value by type and remaining term to maturity and rate reset Date December 31 2014 December 31 2013 thousands of Canadian dollars Debt securities equity securities Mutual funds within 1 year $ 1 to 3 years 3 to 5 years over 5 years total Fair Value 15,011 $ 97,931 – 5,713 $ 108,147 – 314,026 $ 39,951 – $ 112,942 $ 113,860 $ 353,977 $ – $ 2,040 – 2,040 $ 334,750 $ 248,069 – 582,819 $ total Fair Value 149,559 273,058 1,655 424,272 Home Capital Group inC. AnnuAl RepoRt 2014 89 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (C) available for Sale Securities – net unrealized Gains and losses thousands of Canadian dollars, except % Debt securities equity securities thousands of Canadian dollars, except % Debt securities equity securities Mutual funds as at December 31, 2014 Cost 333,485 $ 272,380 605,865 $ $ $ Gross unrealized Gains 1,521 $ 565 2,086 $ Gross unrealized losses (256) $ (24,876) (25,132) $ total Fair Value 334,750 248,069 582,819 weighted- average yield 1.8% 3.8% Cost 149,501 $ 294,748 1,001 445,250 $ $ $ Gross unrealized Gains Gross unrealized losses 58 $ 25 654 737 $ – $ (21,715) – (21,715) $ As at December 31, 2013 total Fair Value 149,559 273,058 1,655 424,272 Weighted- average Yield 1.4% 4.7% – net unrealized gains and losses (excluding impairment losses which are transferred to net income) are included in accumulated other comprehensive income and presented in the table above. these unrealized gains and losses are not included in net income. please see note 16 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, 2014, the Company recognized $0.1 million (2013 – $0.2 million) of impairment losses on available for sale securities. 90 Home Capital Group inC. AnnuAl RepoRt 2014 note 5 loa n 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, 2014 $ 218,927 $ 182,797 $ 2,376,966 $ 127,999 $ 83,430 $ 2,990,119 133,838 352,765 661,661 7,972 9,956 5,829 826 72,615 255,412 445,390 36,869 480,693 2,857,659 10,737,812 147,697 45,263 16,505 2,204 1,001,141 302,699 182,576 79,128 207,127 392,998 22,645 10,422 1,477 – 686,244 $ 1,039,009 $ 546,231 801,643 $ 15,229,584 $ 12,371,925 427,542 634,669 $ 189,261 272,691 212,667 28,135 955,535 3,945,654 12,450,528 243,318 40,096 3,817 505 1,106,878 330,327 186,111 14,317,162 285,220 557,911 $1 8,262,816 100.0% 3.0% As at December 31, 2013 As a % of portfolio 5.7% 4.4% 83.4% 3.5% 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 $ 334,511 $ 256,770 $ 2,835,878 $ 192,751 $ 100,187 $ 3,720,097 201,181 535,692 536,212 8,897 7,753 7,230 899 191,910 448,680 367,211 16,192 706,883 3,542,761 9,391,757 135,133 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 a % of portfolio 6.1% 5.0% 81.4% 4.4% 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 2014 91 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 (included in credit card loans) 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. Cash 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 1 to 30 Days $ 19,082 $ – 220,062 910 9,040 3,487 119 252,700 $ as at December 31, 2014 31 to 60 Days 1,645 $ – 44,959 – 3,304 1,067 41 51,016 $ 61 to 90 Days over 90 Days 375 $ – 3,842 – – 502 46 4,765 $ 2,0871 $ – 9,2221 – – 24 – 11,333 $ total 23,189 – 278,085 910 12,344 5,080 206 319,814 As at December 31, 2013 1 to 30 Days $ 27,522 $ – 243,821 1,195 8,685 3,653 70 284,946 $ 31 to 60 Days 4,370 $ – 48,540 573 902 1,932 30 56,347 $ 61 to 90 Days 265 $ – 6,804 – – 963 31 8,063 $ over 90 Days 4,9821 $ 9,9191 6,1591 – – 23 – 21,083 $ total 37,139 9,919 305,324 1,768 9,587 6,571 131 370,439 $ $ 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 insured, material credit losses are generally not anticipated. as at December 31, 2014 thousands of Canadian dollars Single-family residential mortgages residential Commercial mortgages non-residential Commercial mortgages other Consumer retail loans Gross amount of impaired loans Individual allowances on principal net amount of impaired loans $ $ 52,551 $ (1,808) 50,743 $ 54 $ – 54 $ 2,516 $ (55) 2,461 $ Credit Card loans 1,938 $ (80) 1,858 $ 160 $ (160) – $ total 57,219 (2,103) 55,116 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 Included in the gross amount of impaired loans are foreclosed loans with an estimated realizable value of $1.8 million (2013 – $2.2 million). 92 Home Capital Group inC. AnnuAl RepoRt 2014 (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, 2014, the total appraised value of the collateral held for mortgages past due that are not impaired, as determined when the mortgages were originated, was $490.1 million (2013 – $539.7 million). For impaired mortgages, the total appraised value of collateral at December 31, 2014 was $81.2 million (2013 – $86.0 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 2014 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 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 201 $ 571 (752) 60 80 236 $ 196 (488) 216 160 1,638 10,754 (11,203) 914 2,103 1,201 $ 9,706 (9,645) 546 1,808 759 (199) 560 2,368 – $ – $ 24 (24) – – 25 (25) – – 257 (294) 92 55 44 13 57 112 – – – 80 18,032 2,600 20,632 23,000 $ 12,107 $ $ $ 327 – 327 327 $ (1) $ 9,300 – 9,300 9,412 $ 270 $ 3,541 – 3,541 3,621 $ 571 $ 12 (9) 3 163 840 (220) 620 2,723 300 – 300 463 $ 187 $ 31,500 2,600 34,100 36,823 13,134 111 $ 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 $ 13 (1) 12 248 300 – 300 548 $ 366 $ 932 (92) 840 2,478 30,000 1,500 31,500 33,978 15,868 thousands of Canadian dollars Single-family Residential Mortgages Residential Commercial Mortgages non-residential Commercial Mortgages Credit Card loans other Consumer Retail loans 2013 total there were no specific provisions, allowances or net write-offs on securitized residential mortgages. Home Capital Group inC. AnnuAl RepoRt 2014 93 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 2014 552,112 $ 26,746 14,355 64,852 28,529 31,204 717,798 105,393 54,634 6,464 166,491 884,289 $ 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 $ $ December 31 2014 December 31 2013 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 (H) Sale of loan portfolio $ 1,267,908 $ 927,303 $ 794,908 $ – $ 2,990,119 $ 3,720,097 239,487 76,979 277,731 361,338 955,535 1,489,924 8,947,815 164,842 2,738,127 67,846 713,716 9,728 50,870 902 12,450,528 243,318 10,847,367 196,880 623,515 452,428 30,667 268 1,106,878 994,210 330,327 13,151 11,587,045 – – 30,201 4,292,884 – – 68,576 1,895,326 – $ 11,587,045 $ 4,292,884 $ 1,895,326 $ – 74,183 487,561 – 293,485 330,327 339,963 186,111 17,881,926 18,262,816 (31,500) (34,100) 487,561 $ 18,228,716 $ 17,850,426 During the fourth quarter of 2014, the Company recognized $32.7 million of prepayment income in relation to the sale of $234.9 million of water heater loans and leases and other loans, as a result of the sale of a customer’s business. 94 Home Capital Group inC. AnnuAl RepoRt 2014 note 6 SeCuritiZ ation aCtiVity (a) assets pledged as Collateral As a requirement of the national Housing Authority Mortgage-Backed Securities (nHA MBS) and Canada Mortgage Bond (CMB) programs, the Company assigns to Canada Mortgage Housing Corporation (CMHC) all of its interest in securitized 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 MBS issued. the following table presents the activity associated with 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 Beginning balance on-balance sheet assets assigned as collateral for securitization1 Mortgages assigned in new securitizations Change in assets assigned as replacements of repaid amounts to Canada Housing trust net reduction of non-Home trust MBS and treasury bills less: Mortgages derecognized2 Maturity and amortization of securitization assets ending balance on-balance sheet assets assigned as collateral for securitization1 2014 2013 $ 5,740,171 $ 7,294,229 1,261,660 2,553,211 928,924 765,024 (57,884) (228,159) (1,136,505) (2,529,426) (2,053,177) (2,550,253) $ 4,247,644 $ 5,740,171 1 Included in the on-balance sheet assets assigned as collateral at December 31, 2014 is $302.0 million ($530.2 million – December 31, 2013) in non-Home trust MBS and treasury bills and $3.95 billion ($5.21 billion – December 31, 2013) of securitized mortgages. 2 Mortgages are derecognized upon the sale of residual interest in insured single-family residential mortgages and the securitization and sale of multi-unit residential mortgages. 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. Additionally, all off-balance sheet mortgage loans ($4.20 billion – December 31, 2014 and $1.92 billion – December 31, 2013) are assigned as collateral related to CMHC for sponsored securitization programs. please see note 7 for more information. (B) Securitization liabilities the following table presents the securitization liabilities, including liabilities added during the year, which are secured by insured mortgages and other restricted assets. this table includes only on-balance sheet originations and discharges. thousands of Canadian dollars Balance at the beginning of the year Addition to securitization liabilities as a result of on-balance sheet activity net reduction in securitization liabilities due to maturities, amortization and sales other1 Securitization liability proceeds received for mortgages assigned in new securitizations 1 other includes premiums, discounts, transaction costs and changes in the mark to market of hedged items. 2014 2013 $ 5,773,064 $ 7,335,895 504,931 (2,066,991) (771) $ 4,303,463 $ 5,773,064 $ 2,551,698 $ 1,242,991 144,354 (1,616,801) 2,846 the following table provides the remaining contractual term to maturity of mortgage-backed security and Canada Mortgage Bond liabilities. December 31 2014 December 31 2013 thousands of Canadian dollars, except % Mortgage-backed security liabilities Contractual yield Canada Mortgage Bond liabilities Contractual yield 1 to 3 years 3 to 5 years over 5 years within 1 year $ 138,232 $ 1.8% 22,763 $ 1.7% 310,556 $ 2.2% $ 1,834,460 $ 1,266,719 $ 236,114 $ 2.5% 1.9% 4.2% $ 1,972,692 $ 1,289,482 $ 546,670 $ – $ – 471,551 $ total Book Value total Book Value 660,964 2.1% 494,619 $ 3,831,912 $ 5,112,100 2.6% 494,619 $ 4,303,463 $ 5,773,064 3.8% 2.0% 2.5% Home Capital Group inC. AnnuAl RepoRt 2014 95 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) (C) Securitization income the following table presents the total securitization income for the period. thousands of Canadian dollars net gain on sale of mortgages or residual interest net change in unrealized gain or loss on hedging activities Servicing income total securitization income 2014 23,712 $ (177) 3,310 26,845 $ 2013 11,010 140 1,498 12,648 $ $ the hedging activities included in the previous table hedge interest rate risk on loans held for sale. the derivatives, which are typically bond forwards, are not designated in hedge accounting relationships. the gains or losses on the 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. During the year, the Company securitized and sold through the nHA MBS program certain insured multi-unit residential mortgages with no prepayment 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 also sold residual interests in certain pools of insured single-family mortgages securitized through the nHA MBS program. the sales resulted in the Company transferring substantially all of the risks and rewards of ownership associated with the underlying mortgages and the mortgages are derecognized. the gains on both of the above transaction types are included in non-interest income under securitization income in the consolidated statements of income. the following table provides additional quantitative information about these securitization and sales activities during the year. thousands of Canadian dollars Carrying value of underlying mortgages derecognized Gains on sale of mortgages or residual interest1 Retained interests recorded Servicing liability recorded 2014 Single-family residential mBS multi-unit residential mBS Single-family Residential MBS Multi-unit Residential MBS total mBS 2013 total MBS $ 1,745,454 $ 783,972 $ 2,529,426 $ 519,261 $ 617,244 $ 1,136,505 18,685 5,027 23,712 5,354 5,656 11,010 – – 32,090 6,781 32,090 6,781 – – 26,131 4,563 26,131 4,563 1 Gains on sale of mortgages are net of hedging impact. (D) purchased residual interests the Company purchased, from certain counterparties, residual interests of underlying insured fixed-rate residential mortgages that have been securitized. the purchase results in the Company acquiring only the residual interests without acquiring either underlying mortgages or the corresponding liabilities. During Q2 2014, the Company purchased residual interests of underlying insured fixed-rate residential mortgages. At December 31, 2014, the notional amount of these instruments was $602.6 million, with $14.1 million recorded in available for sale securities. no residual interests were purchased prior or subsequent to Q2 2014. Interest earned on these investments is recorded in other interest income on the consolidated statements of income. 96 Home Capital Group inC. AnnuAl RepoRt 2014 note 7 re S tri Cte D a SS et S 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 2014 December 31 2013 $ $ 106,624 $ 12,265 204 119,093 301,990 421,083 $ 91,900 21,482 4,751 118,133 530,150 648,283 Restricted cash – Canada Mortgage Bond program represents deposits held as collateral by CMHC in connection with the Company’s securitization activities. Restricted cash – interest rate swaps are deposits held by swap counterparties as collateral for the Company’s interest rate swap transactions. 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. these amounts are held as cash collateral against potential credit losses. 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 (A) for more information. December 31 2014 December 31 2013 thousands of Canadian dollars within 1 year 1 to 3 years 3 to 5 years over 5 years total Fair Value Restricted cash non-Home trust MBS and treasury bills assigned as replacement assets $ 119,093 $ 301,990 421,083 $ $ – $ – – $ – $ – – $ note 8 otHer a SSetS 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 total Fair Value 118,133 – $ 119,093 $ – – $ 301,990 421,083 $ 530,150 648,283 $ December 31 2014 65,132 $ 4,506 128,522 12,052 – 25,404 235,616 $ December 31 2013 62,961 7,168 54,556 10,875 9,519 17,600 162,679 $ Home Capital Group inC. AnnuAl RepoRt 2014 97 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 9 intan G iB le a SS et S Intangible assets comprise internally developed software costs which are principally related to the Company’s core banking system. the following table presents the net carrying amount of software costs for the core banking system and other software costs as at December 31, 2014 and 2013, along with the changes in net carrying amount for the years ended December 31, 2014 and 2013. thousands of Canadian dollars Core Banking System1 other Software Costs2 total Core Banking System1 other Software Costs2 2014 2013 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 $ 75,957 $ 19,703 95,660 13,797 $ 12,760 26,557 89,754 $ 32,463 122,217 67,672 $ 8,285 75,957 7,156 $ 6,641 13,797 74,828 14,926 89,754 14,084 8,369 22,453 73,207 $ 2,265 115 2,380 24,177 $ 16,349 8,484 24,833 97,384 $ 6,498 7,586 14,084 61,873 $ 1,987 278 2,265 11,532 $ 8,485 7,864 16,349 73,405 1 As at December 31, 2014, there was $20.3 million ($14.2 million – December 31, 2013) in work in progress related to the core banking system that was not being amortized. 2 As at December 31, 2014, there was $6.3 million ($3.5 million – December 31, 2013) in work in progress related to other software costs that was not being amortized. During the fourth quarter, the estimated useful lives of certain software development costs related to the Company’s core banking system were reviewed. this review by management included consideration of the Company’s experience in using the core banking system and its intended use for the future, which includes the continuing development of additional software projects that depend on the core banking system as a base platform. Based on the review, it was determined that the estimated useful life of the core banking system should be extended by 5 years from the original 10-year estimate to a revised estimate of 15 years. this change in useful life was accounted for as a change in accounting estimates and applied prospectively based on a straight-line amortization of the carrying value over the remaining revised useful life. the resulting impact on the fourth quarter and current year amortization expense was a decrease of $4.0 million from what the expense would have been in the absence of this change. the change in useful life is also expected to result in a decrease in annual amortization expense of $2.8 million per year over the remaining 12 years of the revised useful life. 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 2014 2,324 $ $ 13,428 15,752 $ $ December 31 2013 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 2014. 98 Home Capital Group inC. AnnuAl RepoRt 2014 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, 2018 and assuming a terminal growth rate of 3.0% (2013 – 3.0%) thereafter. A revenue growth rate of 6.4% (2013 – 4.9%) 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% (2013 – 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 19.3% or a decrease in annual revenue growth from 6.4% 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. note 11 DepoSitS By rem aininG C o ntr aC tua l ter m to m at ur ity payable December 31 2014 December 31 2013 thousands of Canadian dollars, except % Individuals Businesses Institutional deposits Average contractual yield note 12 Senior DeBt $ 3 to 5 years 1 to 3 years on Demand within 1 year total 782,560 $ 6,704,573 $ 3,553,500 $ 1,547,533 $ 12,588,166 $ 11,949,618 519,960 281,592 296,376 – $ 1,064,152 $ 6,877,452 $ 4,117,316 $ 1,881,051 $ 13,939,971 $ 12,765,954 2.1% 172,879 – 64,971 498,845 549,055 802,750 29,613 303,905 2.1% 2.7% 2.0% 2.2% 1.3% total 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 liaB ilitieS thousands of Canadian dollars Accrued interest payable on deposits Accrued interest payable on securitization liabilities Securitization servicing liability Income taxes payable other, including accounts payable and accrued liabilities $ December 31 2014 117,089 $ 10,046 11,216 11,317 50,163 199,831 $ December 31 2013 112,242 14,833 5,727 – 34,625 167,427 $ Home Capital Group inC. AnnuAl RepoRt 2014 99 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 14 Capital (a) authorized 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 number of Shares 69,488 $ 636 (28) 70,096 $ 2014 amount 70,233 14,488 (34) 84,687 number of Shares 69,260 $ 306 (78) 69,488 $ 2013 Amount 61,903 8,400 (70) 70,233 During Q1 2014, the Company paid a stock dividend of one common share per each outstanding common share. Comparative amounts have been restated to reflect the stock dividend. the Company has no preferred shares outstanding. (C) repurchase of Shares During the year, 28,000 (2013 – 78,200) common shares were purchased for $1.4 million (2013 – $2.3 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, 2014 was $34 thousand (2013 – $70 thousand). the balance of the purchase price of $1.4 million (2013 – $2.2 million) was charged to retained earnings. (D) earnings per Common Share (epS) Basic earnings per common share of $4.48 (2013 – $3.70) is determined as net income for the year divided by the average number of common shares outstanding of 69,857,391 (2013 – 69,339,868). Diluted earnings per common share of $4.45 (2013 – $3.66) is determined as net income for the year divided by the average number of common shares outstanding of 69,857,391 (2013 – 69,339,868) plus the stock options potentially exercisable, as determined under the treasury stock method, of 574,277 (2013 – 705,940) for a total of 70,431,668 (2013 – 70,045,808) diluted common shares. Diluted income per common share excludes contingently assumable average options outstanding of 599,791 with a weighted-average exercise price of $38.99 for December 31, 2014 and contingently assumable average options outstanding of 601,750 with a weighted- average exercise price of $31.04 for December 31, 2013, 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 Indicator Approach for operational risk. In addition, dividends paid by Home trust to Home Capital may be subject to restrictions by oSFI. 100 Home Capital Group inC. AnnuAl RepoRt 2014 the regulatory capital position of Home trust was as follows: Regulated capital to risk-weighted assets Common equity tier 1 ratio tier 1 capital ratio total regulatory capital ratio December 31 2014 all-in Basis December 31 2013 All-In Basis national Regulatory Minimum All-In Basis 18.30% 18.30% 20.94% 16.80% 16.80% 19.69% 7.00% 8.50% 10.50% 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. the ACM at December 31, 2014 was 12.47 (December 31, 2013 – 13.19). Subordinated debt advanced by Home Capital to Home trust is included in total Capital, as 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, as well as Home trust’s internal capital targets. no new capital was raised in 2014. note 15 emp loyee B eneFitS (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 $1.2 million for 2014 (2013 – $0.9 million). (B) employee retirement Savings plan During the year, Home trust contributed $1.1 million (2013 – $0.9 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: 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 2014 weighted- average exercise price 23.02 46.78 16.65 33.90 31.00 23.44 48.50 4.1 number of Shares 1,650 $ 263 (636) (42) 1,235 $ 634 $ $ 2013 Weighted- average exercise price 19.36 34.46 20.26 24.12 23.02 18.42 30.51 4.0 number of Shares 1,566 $ 432 (306) (42) 1,650 $ 1,048 $ $ the above table has been presented to reflect the stock dividend of one common share per each issued and outstanding common share paid by the Company during the first quarter of 2014. Accordingly, the number of shares has been doubled and weight-average exercise price is reduced to half. Home Capital Group inC. AnnuAl RepoRt 2014 101 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) 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. 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 in 2014 or 2013. As at December 31, 2014, the maximum number of options on common shares that may be issued was 9,170,396, representing approximately 13.2% 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. As at December 31, 2014, the exercise prices for stock options outstanding to acquire common shares ranged from $8.14 to $50.02. 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. Range of exercise prices less than $20.00 $20.01 – $25.00 $25.01 – $30.00 $30.01 – $35.00 $35.01 – $40.00 $40.01 – $45.01 over $45.01 Stock options outstanding weighted-average Contractual life remaining in years weighted- average exercise price as at December 31, 2014 Stock options exercisable number exercisable weighted- average exercise price 1.0 $ 3.0 5.0 5.6 5.9 6.2 5.0 4.1 $ 10.70 23.54 29.07 32.01 39.66 42.81 46.90 31.00 91,500 $ 441,100 44,500 9,250 48,000 – – 634,350 $ 10.70 23.58 28.95 32.01 39.66 – – 23.44 number outstanding 91,500 477,100 179,000 38,500 192,000 4,000 252,041 1,234,141 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 $6.65 (2013 – $11.03). 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 December 2014 november 2014 may 2014 February 2014 December 2013 november 2013 August 2013 February 2013 $ $ $ 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. 6.34 $ 8.36 $ 9.43 $ 9.51 $ 13.28 $ 13.28 $ 9.98 $ 8.85 44.66 $ 46.76 $ 50.11 $ 50.02 $ 46.04 $ 47.07 $ 42.50 $ 42.81 $ 39.65 $ 39.65 $ 39.75 $ 39.87 $ 31.30 $ 32.01 $ 28.54 29.43 23.2% 23.1% 26.0% 27.6% 34.5% 34.6% 34.6% 35.6% 3.8 0.8 6.8% 0.80% 1.25% 3.8 0.8 6.8% 0.72% 1.34% 4.8 0.7 6.8% 0.64% 1.57% 4.9 0.7 6.8% 0.56% 1.49% 7.0 4.0 6.8% 1.41% 2.19% 7.0 4.0 6.8% 1.41% 2.13% 7.0 4.0 6.8% 1.66% 2.18% 7.0 4.0 6.8% 1.82% 1.77% the above assumptions for expected volatility were determined on the basis of historical volatility. During Q2 2014, the Company amended its employee Stock option plan to allow options to be exercised, as they vest at a rate of 25% each year. previously, stock options could not be exercised until the end of the 4-year vesting period. 102 Home Capital Group inC. AnnuAl RepoRt 2014 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 (2014 – $1.9 million; 2013 – $2.0 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 (2014 – $10.6 million; 2013 – $6.2 million). (D) Deferred Share units (DSus) 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, 2014 was $2.81 million (2013 – $1.98 million). As of December 31, 2014, there were 58,603 DSus outstanding (2013 – 48,886). (e) restricted Share units (rSus) 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, 2014 was $714 thousand (2013 – $206 thousand). As of December 31, 2014, there were 64,424 RSus outstanding (2013 – 41,880 RSus outstanding). (F) performance Share units (pSus) 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, 2014 was $1.2 million and there were 84,298 pSus outstanding (2013 – $0.54 million and 34,318 pSus outstanding). (G) 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 16 aCCum ulateD otHer Co mp r eHen Si V e i nC o me thousands of Canadian dollars unrealized losses on Available for sale securities and retained interests Income tax recovery unrealized losses on Cash flow hedges Income tax recovery Accumulated other comprehensive loss 2014 1,900 $ 2,311 4,211 $ 2013 1,962 1,348 3,310 $ $ December 31 2014 December 31 2013 $ (22,101) $ (5,859) (16,242) (21,530) (5,707) (15,823) (3,212) (849) (2,363) (18,605) $ (3,612) (956) (2,656) (18,479) $ Home Capital Group inC. AnnuAl RepoRt 2014 103 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 17 in Come ta Xe S (a) reconciliation of income taxes 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% (2013 – 26.49%) due to various temporary and permanent differences. 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 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 other Scientific research and experimental development investment tax credits effective income tax rate (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 2014 2013 417,502 $ 337,432 89,377 110,587 $ $ $ (3,025) 568 97 (3,897) 104,330 $ (2,956) 568 91 (6,190) 80,890 $ 2014 26.49% (0.73)% 0.14% 0.02% (0.93)% 24.99% 2013 26.49% (0.90)% 0.17% 0.03% (1.83)% 23.96% December 31 2014 December 31 2013 $ $ 9,129 $ 3,914 2,121 4,712 25,795 344 46,015 7,649 5,949 4,008 5,258 19,443 344 42,651 8,169 1,292 9,461 36,554 $ 7,534 692 8,226 34,425 104 Home Capital Group inC. AnnuAl RepoRt 2014 note 18 Commitm ent S anD Conti nGen Ci e S (a) lease Commitments 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 2014 $ $ 14,212 $ 33,523 14,683 62,418 $ December 31 2013 8,806 27,116 21,770 57,692 lease payments recognized as an expense in the consolidated statements of income amounted to $19.3 million in 2014 (2013 – $16.5 million). (B) Credit Commitments outstanding amounts for future advances on mortgage loans amounted to $850.1 million as at December 31, 2014 (2013 – $754.6 million). these amounts include offers made but not yet accepted by the customers as of the reporting date. Also included within the outstanding amounts are unutilized non-residential commercial loan advances of $233.8 million at December 31, 2014 (2013 – $157.2 million). offers for loans remain open for various periods. the average rate on mortgage offers is 4.72% (2013 – 4.60%). the Company also has contractual amounts to extend credit to its clients for its credit card products. the contractual amounts 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, 2014, these contractual amounts in aggregate were $430.9 million (2013 – $373.7 million), of which $100.9 million (2013 – $80.8 million) had not been drawn by customers. outstanding amounts for future advances for the equityline Visa portfolio were $5.6 million at December 31, 2014 (2013 – $5.8 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 amounts. 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 2014. note 19 DeriVatiVe FinanCial inS tru men tS the Company utilizes interest rate swaps and bond forwards 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 and the ineffectiveness is measured. 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. Home Capital Group inC. AnnuAl RepoRt 2014 105 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) 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 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 is to use the bond forward 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 liability. 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 (losses) gains recorded in oCI Fair value losses recorded in non-interest income (ineffectiveness) Reclassification from oCI to net interest income and securitization gains Fair Value Hedging Relationships $ 2014 (1,061) $ – (1,461) 2013 702 13 (1,362) 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 2014 14,594 $ (9,171) 5,423 $ 2013 (16,494) 22,881 6,387 $ $ 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 losses of $2.0 million (2013 – net realized and unrealized gains of $0.2 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 $4.3 million was recorded in 2014 (2013 – $8.0 million). 106 Home Capital Group inC. AnnuAl RepoRt 2014 Swaps not designated as accounting hedges 1 to 5 years Bond forwards designated as accounting hedges1 1 to 5 years > 5 years Bond forwards not designated as accounting hedges1 1 to 5 years > 5 years total As at December 31, 2014 and 2013, the outstanding interest rate swap and bond forward contract positions were as follows: thousands of Canadian dollars as at December 31, 2014 term (years) Swaps designated as accounting hedges < 1 year 1 to 5 years > 5 years notional amount Current replacement Cost Credit equivalent amount risk- weighted Balance Derivative asset Derivative liability net Fair market Value $ 1,457,414 $ 1,945,800 59,000 3,462,214 7,623 $ 7,623 $ 25,754 5,151 38,528 35,433 6,036 49,092 1,525 $ 8,245 1,207 10,977 7,623 $ 25,754 5,151 38,528 (34) $ (36) – (70) 7,589 25,718 5,151 38,458 50,000 50,000 100,000 75,000 175,000 – – 6 – 6 250 250 506 1,125 1,631 50 50 101 225 326 – – 6 – 6 (509) (509) (509) (509) (391) (301) (692) (385) (301) (686) 6,600 83,500 90,100 $ 3,777,314 $ 1 – 1 38,535 $ 33 1,253 1,286 52,259 $ 49 15,255 15,304 26,657 $ – – – 38,534 $ (20) (975) (995) (2,266) $ (20) (975) (995) 36,268 thousands of Canadian dollars As at December 31, 2013 term (years) Swaps designated as accounting hedges < 1 year 1 to 5 years > 5 years notional Amount Current Replacement Cost Credit equivalent Amount Risk- weighted Balance Derivative Asset Derivative liability net Fair Market Value $ 586,000 $ 3,204 $ 3,204 $ 641 $ 3,204 $ (69) $ 1,590,214 59,000 2,235,214 22,105 3,186 28,495 30,056 4,071 37,331 6,011 814 7,466 22,105 3,186 28,495 (3,100) – (3,169) 3,135 19,005 3,186 25,326 Swaps not designated as accounting hedges 1 to 5 years 50,000 50,000 – – 250 250 50 50 – – (595) (595) (595) (595) Bond forwards not designated as accounting hedges1 1 to 5 years > 5 years total 43,700 172,500 216,200 $ 2,501,414 $ 212 1,179 1,391 29,886 $ 431 3,766 4,197 41,778 $ 236 2,602 2,838 10,354 $ 212 1,179 1,391 29,886 $ – (45) (45) (3,809) $ 212 1,134 1,346 26,077 1 the term of the bond forward contracts is based on the term of the underlying bonds. the notional amount is not recorded as an asset or liability as it represents the face amount of the contract to which the rate or price is applied in order to calculate the amount of cash exchanged. notional amounts do not represent the potential gain or loss associated with market risk and are not indicative of the credit risk associated with the derivatives. Home Capital Group inC. AnnuAl RepoRt 2014 107 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) note 20 Current anD non -Curren t aSSetS anD li a Bi li ti 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, 2014 and 2013. thousands of Canadian dollars 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 as at December 31, 2014 As at December 31, 2013 within 1 year after 1 year total Within 1 Year After 1 Year total $ – $ – $ 360,746 $ 112,942 102,094 1,696,838 10,483,974 (22,733) 421,083 7,623 164,879 – 733,172 424,272 137,975 5,210,021 12,671,905 (31,500) 648,283 29,886 162,679 89,157 $ 13,327,446 $ 6,755,298 $ 20,082,744 $ 12,564,806 $ 7,511,044 $ 20,075,850 360,746 $ 582,819 102,094 3,945,654 14,317,162 (34,100) 421,083 38,534 235,616 113,136 733,172 $ 201,416 137,975 1,741,367 9,005,240 (21,000) 643,563 3,204 119,869 – 469,877 – 2,248,816 3,833,188 (11,367) – 30,911 70,737 113,136 222,856 – 3,468,654 3,666,665 (10,500) 4,720 26,682 42,810 89,157 – $ 429,269 $ $ 1,064,152 $ 6,877,452 – 138,232 1,834,460 34 188,615 – 429,269 12,336,685 153,474 660,964 5,112,100 3,809 167,427 34,425 $ 10,102,945 $ 8,531,166 $ 18,634,111 $ 9,094,283 $ 9,803,870 $ 18,898,153 $ 3,224,501 $ (1,775,868) $ 1,448,633 $ 3,470,523 $ (2,292,826) $ 1,177,697 – $ 1,064,152 $ 12,875,819 152,026 471,551 3,831,912 2,266 199,831 36,554 5,998,367 152,026 333,319 1,997,452 2,232 11,216 36,554 7,141,008 – 85,087 1,277,150 69 161,700 – 5,195,677 153,474 575,877 3,834,950 3,740 5,727 34,425 note 21 Fair Value oF FinanCial inStrumen 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, to the greatest extent possible, 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. 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, certain corporate debt instruments, securitized and non-securitized mortgages and loans, securitization receivables and liabilities, other assets and liabilities, and deposits. 108 Home Capital Group inC. AnnuAl RepoRt 2014 the following table presents the fair value of financial instruments across the levels of the fair value hierarchy. thousands of Canadian dollars level 1 level 2 level 3 Fair Value Carrying Value as at December 31, 2014 $ 360,746 $ – $ Financial assets held for trading Cash and cash equivalents loans held for sale Derivative assets Restricted assets total financial assets held for trading Financial instruments available for sale Debt securities equity securities Restricted assets Retained interest owned total financial instruments available for sale loans and receivables Securitized mortgages non-securitized mortgages and loans Securitization receivables other total loans and receivables total Financial liabilities carried at amortized cost Deposits Senior debt Securitization liabilities other total financial liabilities carried at amortized cost Financial liabilities at fair value Derivative liabilities total – – 119,093 479,839 320,671 248,069 297,443 – 866,183 – – – – – $ 1,346,022 $ $ $ – $ – – – – – – $ 102,094 38,534 – 140,628 – – 4,547 – 4,547 – $ – – – – 360,746 $ 102,094 38,534 119,093 620,467 360,746 102,094 38,534 119,093 620,467 14,079 – – 58,685 72,764 334,750 248,069 301,990 58,685 943,494 334,750 248,069 301,990 58,685 943,494 – – – – – 3,945,654 14,283,062 69,837 69,638 18,368,191 145,175 $ 18,569,801 $ 20,060,998 $ 19,932,152 4,012,822 14,344,740 69,837 69,638 18,497,037 4,012,822 14,344,740 69,837 69,638 18,497,037 – $ 14,062,381 $ 14,062,381 $ 13,939,971 152,026 4,303,463 199,831 18,595,291 154,347 4,410,496 199,831 18,827,055 – 4,410,496 199,831 18,672,708 154,347 – – 154,347 2,266 2,266 156,613 $ 18,672,708 $ 18,829,321 $ 18,597,557 2,266 – Home Capital Group inC. AnnuAl RepoRt 2014 109 notes to the Consolidated Financial Statements (unless otherwise stated, all amounts are in Canadian dollars) thousands of Canadian dollars Financial assets held for trading Cash and cash equivalents loans held for sale Derivative assets Restricted assets total financial assets held for trading Financial instruments available for sale Debt securities equity securities Mutual funds Restricted assets Retained interest owned total financial instruments available for sale loans and receivables Securitized mortgages non-securitized mortgages and loans Securitization receivables other total loans and receivables total Financial liabilities carried at amortized cost Deposits Senior debt Securitization liabilities other total financial liabilities carried at amortized cost Financial liabilities at fair value Derivative liabilities total level 1 level 2 level 3 As at December 31, 2013 Fair Value Carrying Value $ 733,172 $ – $ – – 118,133 851,305 149,559 273,058 – 381,356 – 803,973 – – – – – $ 1,655,278 $ $ $ – $ – – – – – – $ 137,975 29,886 – 167,861 – – 1,655 148,794 – 150,449 – $ – – – – 733,172 $ 137,975 29,886 118,133 1,019,166 733,172 137,975 29,886 118,133 1,019,166 – – – – 31,935 31,935 149,559 273,058 1,655 530,150 31,935 986,357 149,559 273,058 1,655 530,150 31,935 986,357 – – – – – 5,210,021 12,640,405 22,621 79,648 17,952,695 318,310 $ 18,081,912 $ 20,055,500 $ 19,958,218 5,281,206 12,665,502 22,621 79,648 18,049,977 5,281,206 12,665,502 22,621 79,648 18,049,977 – $ 12,934,643 $ 12,934,643 $ 12,765,954 153,474 5,773,064 167,427 18,859,919 157,294 5,896,729 167,427 19,156,093 – 5,896,729 167,427 18,998,799 157,294 – – 157,294 3,809 3,809 161,103 $ 18,998,799 $ 19,159,902 $ 18,863,728 3,809 – the Company did not transfer any financial instrument from level 1 or level 2 to level 3 of the fair value hierarchy during the years ended December 31, 2014 and December 31, 2013. 110 Home Capital Group inC. AnnuAl RepoRt 2014 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. note 22 relateD party tranS aCti on S 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 2014 7,926 $ 7,784 300 16,010 $ $ $ 2013 7,626 1,719 241 9,586 the Company had no related party transactions, other than with key management personnel, as described above, for the years ended December 31, 2014 and 2013. note 23 riS k man 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, funding and liquidity, 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, procedures and limits 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 Management’s Discussion and Analysis included in this report. Significant exposures to credit and liquidity risks are described in notes 4, 5 and 19. Home Capital Group inC. AnnuAl RepoRt 2014 111 Corporate Directory Ho me Capital Group i n C. 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 Jacqueline Beaurivage 1, 2 Vice president, epMo & Strategy ontario teachers’ pension plan toronto, ontario william Falk 2, 3, 4 Managing partner pricewaterhouse Coopers Grand Valley, ontario Diana Graham 1, 2 Corporate Director toronto, ontario John m. e. marsh1, 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 then1, 2 Corporate Director 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 Chair emeritus: william a. Dimma Committees: audit Committee Robert A. Mitchell, CpA, CA Chair Bonita then Vice Chair risk and Capital Committee Bonita then Chair William Falk 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 morton, Cpa, Cma Chief Financial Officer and Executive Vice President pino Decina Executive Vice President, Residential Mortgage Lending John r. k. Harry Executive Vice President, Commercial Mortgage Lending marie Holland, Cpa, Ca Senior Vice President, Internal Audit Chris ahlvik, ll.B. Executive Vice President, Corporate Counsel and Corporate Secretary Greg parker Chief Risk Officer and Executive Vice President Fariba rawhani Executive Vice President, Chief Information Officer Dinah Henderson Executive Vice President, Operations John Hong Senior Vice President, Chief Compliance Officer and Chief Anti-Money Laundering Officer Stephen Copperthwaite, Cma, ormp Senior Vice President, Relationship Manager Carol Ferguson Senior Vice President, Human Resources annual and Special meeting notice the Annual and Special Meeting of Shareholders of Home Capital Group Inc. will be held at one King West, Grand Banking Hall, toronto, ontario, on Wednesday, May 13, 2015 at 11:00 a.m. local time. Shareholders and guests are invited to join Directors and Management for lunch and refreshments following the Annual and Special Meeting. All shareholders are encouraged to attend. 112 Home Capital Group inC. AnnuAl RepoRt 2014 Financial Highlights Summary of Data for 10 Year Review For the years ended December 31 (000s) 2014 – Adjusted 2014 2013 2012 2011 2010 IFRS 2010 CGAAP 2009 2008 2007 2006 2005 Total assets Total assets under administration Total loans Total loans under administration Securitized residential mortgages on-balance sheet Deposits Shareholders’ equity Revenue1 Net income1 Book value of common shares2 Earnings per share – basic1,2 Earnings per share – fully diluted1,2 $ $ $ $ $ $ $ $ $ $ $ $ 20,082,744 20,082,744 20,075,850 18,800,079 17,696,471 15,518,818 7,712,239 7,360,874 5,809,713 4,975,093 3,902,316 24,281,366 24,281,366 21,997,781 19,681,750 17,696,471 15,518,818 15,878,772 11,508,585 8,423,971 6,434,548 5,009,878 18,364,910 18,364,910 18,019,901 17,159,913 16,089,648 14,091,755 5,861,722 5,468,540 4,531,568 4,045,571 3,328,858 22,563,532 22,563,532 19,941,832 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 3,945,654 3,945,654 5,210,021 6,706,160 13,939,971 13,939,971 12,765,954 10,136,599 1,448,633 1,014,566 288,384 20.67 4.13 4.09 1,448,633 1,042,986 313,172 20.67 4.48 4.45 1,177,697 949,547 256,542 16.95 3.70 3.66 968,213 887,685 221,983 13.98 3.20 3.19 8,243,350 7,922,124 774,785 790,274 190,080 11.19 2.74 2.73 8,116,636 6,595,979 628,585 687,249 154,752 9.07 2.23 2.22 — — — — — — 6,522,850 6,409,822 5,102,781 4,413,984 3,443,640 2,901,515 742,280 533,937 180,944 10.71 2.61 2.60 590,288 489,179 144,493 8.50 2.10 2.08 432,753 454,695 108,687 6.28 1.57 1.57 348,040 368,881 90,241 5.04 1.31 1.29 276,866 282,549 67,815 4.05 0.99 0.97 218,885 234,704 60,861 3.22 0.90 0.86 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. 17 years Return on equity1 was 22.0% on an adjusted basis, exceeding 20% for the 17th successive year. $313.2 million Reported net income for 2014 was $313.2 million, an increase of 22.1% over 2013. $22.56 billion Total loans under administration grew by 13.1% over 2013 to reach $22.56 billion at the end of 2014. $1 billion Total Revenue exceeded $1 billion on an adjusted basis, reaching a signiﬁ cant milestone in 2014. Net Income1 ($ millions) 222 190 155 313 288 257 Diluted Earnings per Share1,2 ($) Return on Equity1 (percentage) 4.45 4.09 3.66 3.19 2.73 2.22 27.3 27.1 25.5 23.9 23.8 22.0 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 10 11 12 13 14 14 Adjusted 11.9% Home Capital recorded an 11.9% increase in adjusted net income over 2013, reaching $288.4 million for the year ended 2014. 350 280 210 140 11.1% Adjusted diluted earnings per share rose to $4.09 for the year ended December 31, 2014, an 11.1% increase over the year ended 2013. 5 4 3 2 22.0% Home Capital surpassed 20% return on equity for the 17th consecutive year, reaching 22.0% on an adjusted basis at December 31, 2014. 30 24 18 12 1 70 See deﬁ nition of Adjusted Net Income, Total Adjusted Revenue, Adjusted Earnings per Share and Adjusted Return on Equity in the Non-GAAP Measures and Glossary section of this report and the Reconciliation of Net Income to Adjusted Net Income in Table 3 of this report. 1 6 2 Share prices have been restated to reﬂ ect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted 0 10 IFRS 11 12 13 14 14 Adjusted HomeCap 2899 AnnualReport_Front-v2.indd 2 Inside Panel 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, 2004–December 31, 2014 Compounded Annual Growth Over 10 Years 13% HCG 13% S&P/TSX 8% 400 320 240 160 80 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 HCG Stock Price Performance $17.38 $17.03 $20.95 $9.90 $20.93 $25.90 $24.55 $29.54 $40.47 $47.99 Closing Price as of December 31 Share prices have been restated to reflect the stock dividend of one common share per each issued and outstanding share, paid on March 10, 2014. 400 320 240 160 80 0 “2005” “2006” “2007” “2008” “2009” “2010” “2011” “2012” “2013” 2014 Corporate Directory HOME TRUST COMPANY 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 Jacqueline Beaurivage William Falk Diana Graham John M. E. Marsh Robert A. Mitchell Martin Reid Gerald M. Soloway Bonita Then Ofﬁ cers: Gerald M. Soloway Chief Executive Ofﬁ cer Martin Reid President Brian R. Mosko Chief Operating Ofﬁ cer and Executive Vice President Robert Morton, CPA, CMA Chief Financial Ofﬁ cer and Executive Vice President Pino Decina Executive Vice President, Residential Mortgage Lending John R. K. Harry Executive Vice President, Commercial Mortgage Lending Chris Ahlvik, LL.B. Executive Vice President, Corporate Counsel and Corporate Secretary Greg Parker Chief Risk Ofﬁ cer and Executive Vice President Fariba Rawhani Executive Vice President, Chief Information Ofﬁ cer Dinah Henderson Executive Vice President, Operations 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 Halifax: 5251 Duke Street Duke Tower, Suite 1205 Halifax, Nova Scotia B3J 1P3 Tel: 902-422-4387 1-888-306-2421 Fax: 902-422-8891 1-888-306-2435 Montreal: 2020 Boul . Robert-Bourassa 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 Stephen Copperthwaite, CMA, ORMP Senior Vice President, Relationship Manager Carol Ferguson Senior Vice President, Human Resources 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: 507 – 10th Avenue SW Calgary, Alberta T2R 0A8 Tel: 403-244-2432 1-866-235-3081 Fax: 403-244-6542 1-866-544-3081 Vancouver: 200 Granville Street Suite 1288 Vancouver, British Columbia V6C 1S4 Tel: 604-484-4663 1-866-235-3080 Fax: 604-484-4664 1-866-564-3524 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 FSC LOGO TO GO HERE. Stock Listing: Toronto Stock Exchange Ticker Symbol: HCG Options Listing: Montreal Stock Exchange Ticker Symbol: HCG Capital Stock: As at December 31, 2014, there were 70,096,330 Common Shares outstanding Memberships: Canada Deposit Insurance Corporation Trust Companies Association of Canada For Shareholder Information, Please Contact: Chris Ahlvik Executive Vice President, Corporate Counsel and Corporate Secretary Home Capital Group Inc. 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 1-800-990-7881 Fax: 416-363-7611 1-888-470-2092 www.homecapital.com www.hometrust.ca HCG S&P/TSX 15-03-17 11:27 AM CANADA’S ONE-STOP MORTGAGE LENDER ANNUAL REPORT 2014 Business Profile Home Capital Group Inc. Suite 2300 145 King Street West Toronto, Ontario M5H 1J8 Tel: 416-360-4663 Toll Free: 1-800-990-7881 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 4 Another Great Year. CANADA’S ONE-STOP MORTGAGE LENDER HomeCap 2899 AnnualReport_Front-v2.indd 1 Front Panel 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 marketplace 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 beneﬁ t of 1% cash back on all purchases and 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’s direct-to-consumer brand, Oaken Financial, offers a competitive suite of deposit products and convenient online banking to customers as a secure alternative to manage their savings independently. With efﬁ cient, personal service and competitive rates, Home Trust and Oaken Financial offer 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 7 5 Consolidated Financial Statements 82 Notes to the Consolidated Financial Statements 112 Corporate Directory 15-03-17 11:27 AM

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