MCAN Mortgage Corporation
Annual Report 2016

Plain-text annual report

. S I L V E R EDITIO N. Celebrating 25Years N IVER S A R Y o . X S n T . A N 2016 ANNUAL REPORT A STRATEGIC INVESTOR IN CANADIAN MORTGAGES MCAN's VISION To be recognized as a knowledgeable institutional investor in the investment of residential mortgages and residential construction loans (cid:68)(cid:18)(cid:4)(cid:69)(cid:3)(cid:68)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:3)(cid:18)(cid:381)(cid:396)(cid:393)(cid:381)(cid:396)(cid:258)(cid:415)(cid:381)(cid:374)(cid:853)(cid:3)(cid:271)(cid:258)(cid:400)(cid:286)(cid:282)(cid:3)(cid:349)(cid:374)(cid:3)(cid:100)(cid:381)(cid:396)(cid:381)(cid:374)(cid:410)(cid:381)(cid:853)(cid:3)(cid:349)(cid:400)(cid:3) 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(cid:393)(cid:258)(cid:396)(cid:415)(cid:272)(cid:349)(cid:393)(cid:258)(cid:410)(cid:286)(cid:400)(cid:3)(cid:349)(cid:374)(cid:3)(cid:410)(cid:346)(cid:286)(cid:3)(cid:69)(cid:44)(cid:4)(cid:3)(cid:68)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:3)(cid:17)(cid:258)(cid:272)(cid:364)(cid:286)(cid:282)(cid:3) (cid:94)(cid:286)(cid:272)(cid:437)(cid:396)(cid:349)(cid:415)(cid:286)(cid:400)(cid:3)(cid:393)(cid:396)(cid:381)(cid:336)(cid:396)(cid:258)(cid:373)(cid:856)(cid:3)(cid:3)(cid:121)(cid:272)(cid:286)(cid:286)(cid:282)(cid:3)(cid:68)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:3)(cid:18)(cid:381)(cid:396)(cid:393)(cid:381)(cid:396)(cid:258)(cid:415)(cid:381)(cid:374)(cid:853)(cid:3) (cid:258)(cid:3)(cid:449)(cid:346)(cid:381)(cid:367)(cid:367)(cid:455)(cid:882)(cid:381)(cid:449)(cid:374)(cid:286)(cid:282)(cid:3)(cid:400)(cid:437)(cid:271)(cid:400)(cid:349)(cid:282)(cid:349)(cid:258)(cid:396)(cid:455)(cid:3)(cid:381)(cid:296)(cid:3)(cid:68)(cid:18)(cid:4)(cid:69)(cid:853)(cid:3)(cid:349)(cid:400)(cid:3)(cid:258)(cid:374)(cid:3) (cid:381)(cid:396)(cid:349)(cid:336)(cid:349)(cid:374)(cid:258)(cid:410)(cid:381)(cid:396)(cid:3)(cid:381)(cid:296)(cid:3)(cid:400)(cid:349)(cid:374)(cid:336)(cid:367)(cid:286)(cid:3)(cid:296)(cid:258)(cid:373)(cid:349)(cid:367)(cid:455)(cid:3)(cid:373)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:400)(cid:3)(cid:349)(cid:374)(cid:3)(cid:18)(cid:258)(cid:374)(cid:258)(cid:282)(cid:258)(cid:856) Investors We achieve superior and sustainable returns for our shareholders by employing expert balance sheet management and by leveraging our investment expertise. Term Deposits MCAN’s term deposits are eligible for CDIC insurance, have competitive rates and are distributed by a network of independent deposit brokers across Canada. Mortgages MCAN is a strategic investor in the Canadian real estate market. Our focus is residential mortgages and residential construction loans. 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION DESCRIPTION OF BUSINESS MCAN Mortgage Corporation (“MCAN”) is a public company listed on the Toronto Stock Exchange (“TSX”) under the symbol MKP and is a reporting issuer in all provinces and territories in Canada. MCAN is a Loan Company under the Trust and Loan Companies Act (Canada) (the “Trust Act”) and also qualifies as a mortgage investment corporation (“MIC”) under the Income Tax Act (Canada) (the “Tax Act”). Our objective is to generate a reliable stream of income by investing our funds in a portfolio of mortgages (including single family residential, residential construction, non-residential construction and commercial loans), as well as other types of loans and investments, real estate and securitization investments. We employ leverage by issuing term deposits eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance up to a maximum of five times capital (on a non-consolidated basis in the MIC entity) as limited by the provisions of the Tax Act applicable to a MIC. Our term deposits are sourced through a network of independent financial agents. As a MIC, we are entitled to deduct from income for tax purposes 50% of capital gains dividends and 100% of non-capital gains dividends that we pay to shareholders. Such dividends are received by our shareholders as capital gains dividends and interest income, respectively. MCAN’s wholly-owned subsidiary, Xceed Mortgage Corporation (“Xceed”), is an originator of residential first-charge mortgage products across Canada. As such, Xceed operates primarily in one industry segment through its sales team and mortgage brokers. TABLE OF CONTENTS PRESIDENT AND CEO’S MESSAGE TO SHAREHOLDERS .................................................................................................. 3 MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS ................................................................................... 5 CONSOLIDATED FINANCIAL STATEMENTS ................................................................................................................... 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .................................................................................................. 69 DIRECTORS AND EXECUTIVE OFFICERS ...................................................................................................................... 103 CORPORATE INFORMATION ..................................................................................................................................... 104 - 2 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION MESSAGE TO SHAREHOLDERS MCAN Mortgage Corporation (“MCAN”, the “Company” or “we”) reported record net income for the second year in a row in 2016. Net income increased by 22% to $40.2 million for the year ended December 31, 2016 from $32.9 million reported in the prior year ended December 31, 2015. We also experienced increases in earnings per share (from $1.51 to $1.75), return on average shareholders’ equity (from 13.45% to 14.74%) and taxable income per share (from $0.90 to $1.24). Current year improvements in financial performance and net income noted above were primarily attributable to an increase in equity income recorded from our equity investment in MCAP Commercial LP (“MCAP”) from $10.1 million to $13.5 million. Additionally, income from financial investments and other loans increased from $3.5 million to $6.5 million, driven by higher income from our investments in Crown Realty II Limited Partnership and the KingSett High Yield Fund. In the fourth quarter of 2016, the Board of Directors (the “Board”) increased the regular quarterly dividend to $0.30 per share, resulting in total 2016 dividends paid of $1.17 per share compared to $1.13 per share in 2015, an annual increase of 3.5%. Consistent with the prior quarter, the Board declared a regular dividend of $0.30 per share to be paid March 30, 2017 to shareholders of record as of March 15, 2017. Corporate Assets Corporate assets totalled $1.19 billion at December 31, 2016, up $33 million from December 31, 2015 but down $21 million from September 30, 2016. The corporate mortgage portfolio decreased by $61 million during Q4 2016 to $904 million from $965 million, which included decreases of $35 million in uninsured single family, $10 million in construction and $8 million in commercial mortgages. Our higher-yielding corporate non-mortgage investments, consisting of marketable securities, our equity investment in MCAP and financial investments, increased by $36 million during 2016. Total mortgage arrears were $27 million at December 31, 2016, significantly improved from $40 million at September 30, 2016 and $34 million at December 31, 2015. The impaired total mortgage ratio remained low at 0.14% at December 31, 2016, compared to 0.15% at September 30, 2016 and 0.11% at December 31, 2015. The impaired corporate mortgage ratio also remained low at 0.31%, compared to 0.32% at September 30, 2016 and 0.23% at December 31, 2015. Our arrears levels remain low by historical standards. We remain vigilant and use conservative underwriting standards and default management practices which we believe are appropriate in the context of the current market. Equity income from our investment in MCAP was $3.2 million in Q4 2016, up $1.1 million from Q4 2015. In fiscal 2016, MCAP contributed $13.5 million in income, which was $3.4 million higher than the $10.1 million earned in 2015. The increase was a result of higher securitized mortgage interest income from a larger average portfolio, and higher servicing and administration income due to an increase in assets under administration. MCAP’s origination volumes were $16 billion in 2016. MCAP had $60.6 billion of assets under administration as at November 30, 2016, which represents an increase of 14% from November 30, 2015. In mid-2016, MCAP filed a preliminary prospectus with respect to an initial public offering of common shares. Subsequently, MCAP withdrew the prospectus due to adverse market conditions. Despite this decision, MCAP posted strong financial results in 2016. MCAP continues to evaluate market conditions and the opportunity for the proposed initial public offering. Securitization Assets In 2016 we recommenced our participation in the CMB program by securitizing $100 million of insured single family mortgages and $86 million of insured multi family loans. We also continued our participation in the market MBS program by securitizing $42 million of insured single family mortgages. Business Activities In the second half of 2016, we maintained higher average construction and commercial portfolio balances. The higher outstanding balances helped to increase corporate net investment income, as these product lines generally have higher spreads than the single family mortgages. Our single family uninsured portfolio decreased by $111 million (31%) during 2016, primarily due to the fact that our focus was on the implementation of new systems and processes during the year. Earlier in the year we implemented a new origination system which was focused on two primary objectives: the transition from inefficient legacy systems that were over a decade old that slowed our origination processes, and the implementation of a new framework of underwriting and credit standards that were adopted in 2015. Additionally, we experienced longer mortgage approval and origination processing times during 2016 which were the result of our tighter credit approval standards and focus on mortgage quality. As a result of our enhanced underwriting processes, we also observed an increase in mortgage application declines due - 3 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION to an increased proportion of mortgages that did not meet our credit standards. These noted items contributed to lower origination volumes during 2016. During 2016, we observed heightened concerns regarding portions of the residential re-sale markets such as Vancouver and Toronto. We noted high levels of home price inflation and evidence of over-bid markets, where multiple offers contributed to home sale prices well above appraised values. As a result of this and the internal factors noted above, we believe that the measured decrease in our uninsured single family portfolio and related originations were a prudent step towards a more defensive position to limit our overall exposure. We offset the single family factors discussed above with growth in our construction portfolio during 2016. While the 2016 year- end balance was $32 million higher than 2015, we also carried a higher intra-year balance as a result of seasonal fundings. Construction growth involved lending to experienced developers who build and sell housing product in market segments where the cost to build has not followed the high rate of inflation experienced in the resale market. The cost basis that developers are currently building at exposes us to less risk than lending to borrowers for the purchase of single family homes in a market with significant price inflation. Our construction lending is based on specific conditions that must be met before we advance funds. Funds are also advanced on a staged basis to limit credit exposure during the different phases of construction. We did not experience any losses in our construction portfolio during 2016, nor did we have any construction loans in arrears at December 31, 2016. Our corporate asset growth was 3% in 2016 compared to our stated annual target of 10%. We continue to monitor Canadian housing market developments as they evolve to ensure that our corporate mortgage portfolio remains well positioned. Given the recent regulatory announcements and changes to mortgage insurance discussed in the Outlook section of the MD&A, we believe that our 2016 growth was moderate yet prudent. In 2017, we will continue to assess and monitor the impact of announced changes to the housing market and supply dynamics while adhering to our underwriting standards and risk appetite. Our market views are unchanged from the Q3 2016 Message to Shareholders, other than noting that we have also observed continued increasing volatility in the markets following the U.S. election which may impact future Canadian policy and real estate markets. As mortgage markets adjust, potentially with higher spreads, our origination and growth may continue to fluctuate as we focus on ensuring high credit level quality. Income tax asset capacity, which represents available room for additional corporate asset investment, was $209 million as at December 31, 2016. We believe that MCAN’s portfolio of assets continues to perform well and provide a solid risk adjusted return to our shareholders. In summary, we are pleased to have provided our shareholders a second consecutive year of strong earnings in 2016 while also ensuring that we remained cautious in our origination strategy. During 2017, our focus will remain on improving our origination platform capabilities, while we focus on the areas of the Canadian mortgage market that deliver positive risk adjusted returns for MCAN. William Jandrisits President and Chief Executive Officer - 4 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS This Management’s Discussion and Analysis of Operations (“MD&A”) should be read in conjunction with the consolidated balance sheets and accompanying notes as at December 31, 2016 and December 31, 2015 and the consolidated statements of income, changes in shareholders’ equity, comprehensive income and cash flows for the years then ended, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”) and presented in Canadian currency. This MD&A has been presented as at February 23, 2017. Additional information regarding MCAN Mortgage Corporation (“MCAN”, the “Company” or “we”), including copies of our continuous disclosure materials such as the Annual Information Form, are available on the System for Electronic Document Analysis and Retrieval (“SEDAR”) at www.sedar.com and our website at www.mcanmortgage.com. TABLE OF CONTENTS - MD&A A CAUTION ABOUT FORWARD-LOOKING INFORMATION AND STATEMENTS .................................................................................. 6 SELECTED FINANCIAL INFORMATION ............................................................................................................................................... 8 HIGHLIGHTS .................................................................................................................................................................................... 10 OUTLOOK ........................................................................................................................................................................................ 11 RESULTS OF OPERATIONS ............................................................................................................................................................... 13 FINANCIAL POSITION ...................................................................................................................................................................... 21 SELECTED QUARTERLY FINANCIAL DATA ........................................................................................................................................ 31 SUMMARY OF FOURTH QUARTER RESULTS .................................................................................................................................... 32 SECURITIZATION PROGRAMS.......................................................................................................................................................... 39 CAPITAL MANAGEMENT ................................................................................................................................................................. 41 LIQUIDITY MANAGEMENT .............................................................................................................................................................. 45 RISK GOVERNANCE AND MANAGEMENT........................................................................................................................................ 47 DESCRIPTION OF CAPITAL STRUCTURE ........................................................................................................................................... 55 OFF-BALANCE SHEET ARRANGEMENTS ......................................................................................................................................... 56 DIVIDEND POLICY AND RECORD ..................................................................................................................................................... 56 TRANSACTIONS WITH RELATED PARTIES ........................................................................................................................................ 57 FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS .................................................................................................................. 57 PEOPLE ............................................................................................................................................................................................ 57 REGULATORY COMPLIANCE ............................................................................................................................................................ 58 INTERNAL AUDIT ............................................................................................................................................................................. 58 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS .................................................................................................................. 58 STANDARDS ISSUED BUT NOT YET EFFECTIVE ................................................................................................................................ 60 DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING ........................................ 61 NON-IFRS MEASURES...................................................................................................................................................................... 62 - 5 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION A CAUTION ABOUT FORWARD-LOOKING INFORMATION AND STATEMENTS This MD&A contains “forward-looking statements” within the meaning of applicable Canadian securities laws. The words “may,” “believe,” “will,” “anticipate,” “expect,” “planned,” “estimate,” “project,” “future,” and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. Such statements reflect management’s current beliefs and are based on information currently available to management. The forward- looking statements in this MD&A include, among others, statements and assumptions with respect to: • the current business environment and outlook; • possible or assumed future results; • ability to create shareholder value; • business goals and strategy; • the stability of home prices; • effect of challenging conditions on us; • factors affecting our competitive position within the housing markets; • the price of oil and its impact on housing markets in Western Canada; • sufficiency of our access to capital resources; and • the timing of the effect of interest rate changes on our cash flows. The material factors or assumptions that were identified and applied by us in drawing conclusions or making forecasts or projections set out in the forward-looking statements include, but are not limited to: the effect of competition; factors and assumptions regarding interest rates; • the Company’s ability to successfully implement and realize on its business goals and strategy; • • housing sales and residential mortgage borrowing activities; • • government regulation of the Company’s business; • • • • • • acceptance of the Company’s products in the marketplace; • availability of key personnel; • • computer failure or security breaches; future capital and funding requirements; the value of mortgage originations; the expected margin between interest earned on mortgage portfolios and interest paid on deposits; the relative continued health of real estate markets; the Company’s operating cost structure; and the current tax regime. Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the anticipated future results expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from those set forth in the forward- looking statements include, but are not limited to: • global market activity; • worldwide demand for and related impact on oil and other commodity prices; • changes in government and economic policy; • changes in general economic, real estate and other conditions; • changes in interest rates; • changes in Canada Mortgage Bonds (“CMB”) and mortgage-backed securities (“MBS”) spreads and swap rates; • MBS and mortgage prepayment rates; • mortgage rate and availability changes; • adverse legislation or regulation; • availability of CMB and MBS issuer allocation; • technology changes; • confidence levels of consumers; • ability to raise capital and term deposits on favourable terms; • our debt and leverage; • competitive conditions in the homebuilding industry, including product and pricing pressures; • ability to retain our executive officers and other employees; • • relationships with our mortgage originators; • additional risks and uncertainties, many of which are beyond our control, referred to in this MD&A and our other public filings litigation risk; with the applicable Canadian regulatory authorities. - 6 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Subject to applicable securities law requirements, we undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in subsequent reports should be consulted. ACRONYMS ALCO Asset and Liability Committee HELOC Home Equity Line of Credit MD&A BCBS CAR CDIC Basel Committee on Banking Supervision Capital Adequacy Requirements Canada Deposit Insurance Corporation CET 1 Common Equity Tier 1 CHT Canada Housing Trust IAS IASB IFRIC IFRS LAR International Accounting Standard International Accounting Standards Board IFRS Interpretations Committee International Financial Reporting Standards Liquidity Adequacy Requirements Management’s Discussion & Analysis Mortgage Investment Corporation MIC NHA National Housing Act NSFR Net Stable Funding Ratio OSFI Office of the Superintendent of Financial Institutions RAF Risk Appetite Framework CMB Canada Mortgage Bonds LCR Liquidity Coverage Ratio RCB Risk Committee of the Board CMHC Canada Mortgage and Housing Corporation LP ARA Limited Partner’s At-Risk Amount RMBS DRIP Dividend Reinvestment Plan LTV Loan to Value (ratio) SEDAR Residential Mortgage Backed Securities System for Electronic Document Analysis and Retrieval EIM Effective Interest Rate Method MBS Mortgage Backed Securities TSX Toronto Stock Exchange - 7 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SELECTED FINANCIAL INFORMATION Table 1: Income Statement Highlights (in thousands except for per share amounts and %) 2016 2015 2014 Change from 2015 (%) ($) Income Statement Highlights Net investment income - corporate assets Net investment income - securitization assets Other income Operating expenses Net income before income taxes Provision for (recovery of) income taxes Net income Basic and diluted earnings per share Dividends per share Taxable income per share 1 Return on average shareholders' equity 1 Yields Average mortgage portfolio yield - corporate 2 Term deposit average interest rate 2 Spread of mortgages over term deposits Average mortgage portfolio yield - securitized 2 Financial liabilities from securitization - average interest rate 2 Spread of mortgages over liabilities $ 51,701 $ 42,741 $ 39,151 (94) 39,057 782 13,383 26,456 1,010 $ 40,182 $ 32,857 $ 25,446 4,467 47,208 68 14,508 32,768 (89) 5,778 57,479 - 17,963 39,516 (666) $ $ $ 1.75 $ 1.17 $ 1.51 $ 1.13 $ 1.23 1.12 1.24 $ 0.90 $ 14.74% 13.45% 0.86 11.50% 5.15% 2.23% 2.92% 5.35% 2.34% 3.01% 5.62% 2.46% 3.16% 2.73% 2.71% 2.90% 2.02% 0.71% 2.07% 0.64% 2.37% 0.53% $ $ $ $ $ 8,960 1,311 10,271 21.0% 29.3% 21.8% (68) (100.0%) 23.8% 20.6% 648.3% 22.3% 3,455 6,748 (577) 7,325 0.24 0.04 0.34 15.9% 3.5% 37.8% 1.29% (0.20%) (0.11%) (0.09%) 0.02% (0.05%) 0.07% 1 Refer to the “Non-IFRS Measures” section of this MD&A for a definition of these measures. 2 Refer to “Average Interest Rate” in the “Non-IFRS Measures” section of this MD&A for a definition of this measure. - 8 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 2: Balance Sheet Highlights (in thousands except for per share amounts and %) As at December 31 Balance Sheet Highlights Assets Corporate Securitization Total assets Mortgages - corporate Mortgages - securitized Liabilities Corporate Securitization Total liabilities Shareholders' equity Capital Ratios 1 Income Tax Assets to Capital Ratio Common Equity Tier 1 Capital Ratio (transitional) Common Equity Tier 1 Capital Ratio (all-in) Tier 1 Capital Ratio (transitional) Tier 1 Capital Ratio (all-in) Total Capital Ratio (transitional) Total Capital Ratio (all-in) Leverage ratio 2 Assets to Capital Multiple 2 Credit Quality Impaired mortgage ratio (total) 1 Impaired mortgage ratio (corporate) 1 Mortgage Arrears Corporate Securitized Total Common Share Information (end of period) Number of common shares outstanding Book value per common share 1 Common share price - close Market capitalization 1 2016 2015 2014 Change from 2015 ($) (%) $ $ $ $ $ $ $ $ $ $ $ $ 1,188,480 $ 1,092,375 2,280,855 $ 1,155,046 $ 1,091,912 2,246,958 $ 1,045,352 $ 760,366 1,805,718 $ 33,434 463 33,897 904,112 $ 1,071,849 $ 944,109 $ 1,075,947 $ 895,467 $ 741,184 $ (39,997) (4,098) 927,293 $ 1,071,786 1,999,079 $ 917,852 $ 1,070,304 1,988,156 $ 834,310 $ 746,105 1,580,415 $ 9,441 1,482 10,923 281,776 $ 258,802 $ 225,303 $ 22,974 4.87 5.11 5.05 22.98% 22.55% 22.98% 22.55% 22.98% 22.55% 10.46% n/a 0.14% 0.31% 23.58% 23.02% 23.58% 23.02% 23.58% 23.02% 9.96% n/a 0.11% 0.23% 23.37% 22.62% 23.37% 22.62% 23.37% 22.62% n/a 8.14 0.50% 0.92% 13,041 $ 13,609 26,650 $ 19,889 $ 14,361 34,250 $ 29,859 $ 8,546 38,405 $ (6,848) (752) (7,600) 23,075 12.21 $ 14.32 $ 330,434 $ 22,782 11.36 $ 12.14 $ 276,573 $ 20,808 10.83 $ 14.40 $ 299,635 $ 0.85 2.18 53,861 2.9% 0.0% 1.5% (4.2%) (0.4%) 1.0% 0.1% 0.5% 8.9% (4.7%) (0.60%) (0.47%) (0.60%) (0.47%) (0.60%) (0.47%) 0.50% n/a 0.03% 0.08% (34.4%) (5.2%) (22.2%) 1.3% 7.5% 18.0% 19.5% 1 Refer to the “Non-IFRS Measures” section of this MD&A for a definition of these measures. 2 Mortgages securitized through the market MBS program and CMB program for which derecognition has not been achieved are included in regulatory assets in the leverage ratio and assets to capital multiple. The leverage ratio replaced the assets to capital multiple effective January 1, 2015 such that the leverage ratio is n/a for 2014 and the assets to capital multiple is n/a for 2015 and 2016. For further information, refer to the “Capital Management” section of this MD&A. - 9 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION HIGHLIGHTS Income Statement (cid:120) We earned record net income of $40.2 million in 2016, an increase of $7.3 million (22%) from $32.9 million in 2015. (cid:120) (cid:120) (cid:120) Our equity investment in MCAP Commercial LP (“MCAP”) continued to provide strong equity income of $13.5 million Earnings per share increased by $0.24 (16%) to $1.75 in 2016 from $1.51 in 2015. Return on average shareholders’ equity1 increased to 14.74% in 2016 from 13.45% in 2015. (cid:120) in 2016, an increase of 34% from $10.1 million in 2015. Increase of 29% in securitization income from our continued participation in the market MBS program and re-entry into the CMB program in 2016. Corporate Activity (cid:120) (cid:120) (cid:120) (cid:120) Corporate assets, which totalled $1.19 billion at December 31, 2016, increased by $33 million from December 31, 2015. The corporate mortgage portfolio decreased by $40 million during 2016 to $904 million from $944 million, which included increases of $32 million in construction, $28 million in commercial and $25 million in insured single family, and decreases of $111 million in uninsured single family and $13 million in completed inventory loans. Increase of $36 million during 2016 in our higher-yielding corporate non-mortgage investments, consisting of marketable securities, our equity investment in MCAP and financial investments. Increases in the fair value of marketable securities and financial investments led to a $5.8 million increase in accumulated other comprehensive income during 2016, up from a $2.9 million increase in 2015. Consistent with the prior quarter dividend increase, the Board of Directors (the “Board”) declared a 2017 first quarter dividend of $0.30 per share to be paid on March 30, 2017 to shareholders of record as of March 15, 2017. Securitization Activity (cid:120) We recommenced our participation in the CMB program in 2016 by securitizing $100 million of insured single family mortgages and $86 million of insured multi family loans. We recognized upfront gains of $394,000 on securitization of the multi family loans, while the single family mortgages remained on our balance sheet after securitization. (cid:120) We securitized $42 million of new MBS to third parties through the market MBS program. Credit Quality (cid:120) (cid:120) (cid:120) The impaired total mortgage ratio1 increased to 0.14% at December 31, 2016 from 0.11% at December 31, 2015. The impaired corporate mortgage ratio1 increased to 0.31% at December 31, 2016 from 0.23% at December 31, 2015. Total mortgage arrears1 were $27 million at December 31, 2016, down $7 million (22%) from $34 million at December 31, 2015. (cid:120) Net write-offs were 2.4 basis points of the average corporate portfolio in 2016, improved from 4.2 basis points in 2015. (cid:120) The average loan to value ratio (“LTV”) of our uninsured single family portfolio was 56.5% at December 31, 2016, improved from 63.4% at December 31, 2015. Capital (cid:120) Our Common Equity Tier 1, Tier 1 and Total Capital to risk-weighted assets ratios1 were 22.98% on the transitional basis and 22.55% on the “all-in” basis at December 31, 2016 compared to 23.58% and 23.02%, respectively, at December 31, 2015. (cid:120) Our leverage ratio1 was 10.46% at December 31, 2016 compared to 9.96% at December 31, 2015. (cid:120) Income tax asset capacity1 was $209 million at December 31, 2016 compared to $141 million at December 31, 2015. 1 Considered to be a “Non-IFRS Measure”. For further details, refer to the “Non-IFRS Measures” section of this MD&A. - 10 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION OUTLOOK Market conditions The Bank of Canada has forecasted 2017 Canadian GDP growth of 2.1%, a slight increase over the 1.9% rate for Q4 2016. With the relatively low levels of expected economic growth, the probability of increased interest rates is again low for 2017. However, one of the effects of the recent U.S. election has been an increase in U.S. bond yields, which has also impacted the interest rate market in Canada. We expect housing markets to continue to benefit from historically low interest rates, but we also expect a slowdown in housing as a result of the impact of regulatory changes announced last quarter to mortgage underwriting and insurance. Canadian residential real estate markets continue to have mixed performances as regional economies adjust with local economic conditions. Western Canada continues to experience the negative impact of weak oil prices on employment, while other regional economies benefit from the lower Canadian dollar and employment strength in the manufacturing sector. The Canadian dollar has strengthened marginally since the U.S. election, but has continued to trade at a discount to the U.S. dollar due to weak world- wide commodity prices, a stronger U.S. economy, higher U.S. interest rates and the potential for further U.S. rate increases. We expect financial markets to experience increased volatility following the U.S. election result, with increased uncertainty around U.S. policy, particularly trade. Fluctuations in stock markets upon reaction to announced changes will impact expectations for global growth and volatility in international currencies as they impact corporate earnings and valuations. In Canada, the impact of a weak oil sector and soft commodity prices continues to affect a significant portion of the stock market. Concerns over low or regionally negative economic growth and increases in unemployment rates are expected to have a spillover effect on consumer confidence. Ontario and British Columbia have continued to exhibit strong fundamentals and growth, with GDP growth driven by exports and immigration. In Alberta, housing markets have continued to slow as a result of lower oil prices and weakening employment. We continue to focus our origination in Ontario and British Columbia and monitor our exposure to Alberta. We are selective in our origination of new residential construction projects. Real estate conditions Canadian housing market conditions continue to be mixed. The Toronto housing market continues to experience significant price inflation with forecasts for continued strength in 2017. Price inflation in Toronto continues to be well in excess of levels supported by employment and income growth. Vancouver has recently experienced a slowing of sales and price inflation. This has arisen after recent changes in mortgage underwriting rules and the 15% tax on non-resident real estate purchases enacted in mid-2016. This tax was intended to help restore housing affordability for residents in the Metro Vancouver Area by raising non-residents’ cost of purchasing and, on the margin, discouraging foreign speculation. The greatest impact of this foreign buyer tax has been on homes selling above $5 million. While some of the price inflation in both Toronto and Vancouver is driven by low mortgage rates and lot supply shortages, we believe that price inflation at these high levels increases the risk of a price correction. We are operating with tightened underwriting policies for uninsured mortgages, specifically for self-employed applicants. In late 2016, the Department of Finance announced new mortgage regulations. The most significant regulations expected to impact the market are as follows: (cid:120) (cid:120) (cid:120) Expanding the stress tests to all insured mortgages, to be qualified using the Bank of Canada’s posted rate (currently at 4.64%). All portfolio-insured mortgages will be required to conform to the same lending guidelines as insured mortgages. Principal residence capital gains will be limited to Canadian residents. We expect the impact of these new regulations to be as follows: (cid:120) No change to overall market CMB issuance levels. (cid:120) Expected decrease to MBS issuance levels and tighter MBS spreads in the market as less mortgages are eligible for portfolio insurance. Redirection of uninsurable mortgages to balance sheet investors such as MCAN, chartered bank covered bonds, asset- backed commercial paper and potentially the private residential mortgage-backed securities (“RMBS”) market. Higher market uninsured mortgage rates as lenders price in higher capital requirements and increased funding costs. Stable short-term market insured mortgage rates due to increased competition amongst lenders. (cid:120) (cid:120) (cid:120) - 11 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION The Department of Finance also launched a consultation in late 2016 on lender risk sharing for government backed insured mortgages. We expect the impact of potential risk sharing to be as follows: (cid:120) (cid:120) Increased lender costs; the Department of Finance expects an increase of 20-30 basis points in lender costs over a five- year period. To date, we have noted market increases in excess of this amount. Increased risk-weighting and capital requirements for these assets due to higher risk of loss, which may require increased collective and individual mortgage allowances. We have observed the early impacts of the changes noted above on housing markets, specifically the slowing of first time buyers in the market. However, Q4 2016 market activity is not a good indicator of market momentum, given the relatively small portion of annual sales that it represents. We are continuing to evaluate the impact of these regulatory changes to the market and MCAN. We believe that the effect of these changes will likely require a minimum of 6-12 months to begin providing clarity on the direction of the mortgage market in Canada. Effective January 1, 2017, the Office of the Superintendent of Financial Institutions Canada (“OSFI”) introduced new minimum capital adequacy requirements for mortgage insurers. These changes are expected to increase premiums on mortgage portfolio insurance paid by lenders which may impact rates charged to borrowers. Impact on MCAN We will continue to monitor housing market developments as they evolve and will continue to ensure that our mortgage portfolio remains well positioned. MCAN has a stated annual corporate asset growth target of 10%. In 2016, we experienced below-target growth of 3%. In 2017, we expect to continue to make adjustments to the composition of our balance sheet so as to evaluate the risks and rewards of each of our product lines. We believe that MCAN is well positioned to adapt to changes in mortgage and housing markets given that we, as a regulated financial institution, have access to both the insured securitization market as well as the term deposit funding market. - 12 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION RESULTS OF OPERATIONS Table 3: Net Income - For the Years Ended December 31 (in thousands except for per share amounts and %) 2016 2015 Change from 2015 (%) ($) Net Investment Income - Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Fees Marketable securities Financial investments and other loans Interest on cash and cash equivalents Whole loan gain on sale income Realized loss on derivatives Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses Other Income - Corporate Assets Gain on dilution of investment in MCAP Commercial LP Net Investment Income - Securitization Assets Mortgage interest Other securitization income Interest on financial liabilities from securitization Mortgage expenses Fair value adjustment - derivative financial instruments Operating Expenses Salaries and benefits General and administrative Net Income Before Income Taxes Provision for (recovery of) income taxes Net Income Basic and diluted earnings per share Dividends per share $ 50,670 13,509 2,547 3,622 6,487 604 324 - 77,763 22,035 3,993 244 (210) 26,062 $ 50,997 10,096 3,231 2,076 3,506 730 626 (2,914) 68,348 20,671 3,823 838 275 25,607 $ (327) 3,413 (684) 1,546 2,981 (126) (302) 2,914 9,415 1,364 170 (594) (485) 455 (1%) 34% (21%) 74% 85% (17%) (48%) (100%) 14% 7% 4% (71%) (176%) 2% 51,701 42,741 8,960 21% - - 68 68 (68) (68) (100%) (100%) 28,298 461 28,759 21,176 1,805 - 22,981 25,564 198 25,762 19,763 1,461 71 21,295 2,734 263 2,997 1,413 344 (71) 1,686 11% 133% 12% 7% 24% (100%) 8% 5,778 4,467 1,311 29% 9,406 8,557 17,963 39,516 (666) 40,182 8,515 5,993 14,508 32,768 (89) $ 32,857 1.75 1.17 $ $ 1.51 1.13 $ $ $ $ $ $ 891 2,564 3,455 6,748 (577) 7,325 0.24 0.04 10% 43% 24% 21% 648% 22% 16% 4% - 13 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Net Income The $7.3 million increase in net income from 2015 was primarily due to increases in equity income from MCAP, income from financial investments and other loans and securitization income. Additionally, we incurred a significant hedge loss in 2015 that did not recur in 2016. These items were offset by higher operating expenses in 2016. Net Investment Income - Corporate Assets Mortgage interest income Table 4: Interest Income and Average Rate by Mortgage Portfolio (Corporate) For the Years Ended December 31 2016 2015 Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income (in thousands except %) Single family - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non residential Commercial loans - Uninsured Mortgages - corporate portfolio Term deposits Spread of mortgages over term deposits Mortgages - securitized portfolio Financial liabilities from securitization Spread of mortgages over liabilities $ $ $ 318,503 $ 110,694 19,099 14,611 3,562 1,038 4.59% $ 3.40% 5.44% 318,892 $ 143,685 14,534 407,246 6,957 22,286 390 5.47% 5.61% 336,762 1,186 124,625 987,124 $ 940,926 8,783 50,670 22,035 1,035,457 $ 1,046,154 28,298 21,176 7.05% 5.15% $ 2.23% 2.92% 2.73% $ 2.02% 0.71% 94,567 909,626 $ 844,309 950,480 $ 962,263 25,564 19,763 15,171 5,154 799 20,262 65 9,546 50,997 20,671 4.74% 3.58% 5.48% 5.57% 5.52% 9.28% 5.35% 2.34% 3.01% 2.71% 2.07% 0.64% 1 Average interest rate is equal to income/expense divided by the average balance on an annualized basis. The average interest rate as presented may not necessarily be equal to “Income/Expense” divided by “Average Balance”, as non-recurring items such as discount income on impaired loans, deferred interest and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Excluding discount income on impaired loans and deferred interest, non-recurring items were immaterial for the years ended December 31, 2016 and December 31, 2015. Average interest rate is considered to be a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. We experienced a significant increase in our construction portfolio balance during 2016 amidst lower single family origination volumes. The construction growth was a result of lending to experienced builders in market segments where the cost to build has not followed real estate appreciation. Lending in this segment is based on specific conditions required prior to funding, which act as a risk mitigant given other concerns in the real estate market. The average portfolio balance experienced a seasonal increase in the middle of the year, but levelled off later in the year. The decrease in the average yield was a result of lower funding rates for new loans in the residential construction portfolio in 2016. The higher income from the construction portfolio provided a balance against the decrease in uninsured single family income, as that portfolio declined significantly during 2016. New uninsured single family originations were low in 2016 due to reduced spreads from a competitive market, the tightening of our underwriting standards (specifically for self-employed borrowers) and increased processing times as we worked on a transition of our systems and processes. As a result of these factors, we experienced an increase in mortgage applications in 2016 that did not meet our underwriting standards or had unsupported or difficult to substantiate income verification. We took a more defensive approach to origination in 2016 given the accelerated valuations in this market segment. We believe that this conservative approach to uninsured single family mortgage origination was an appropriate course of action given the risk environment in 2016. The average uninsured single family portfolio balance was comparable to 2015, however the portfolio balance trended downwards throughout 2016 given the lower origination volumes and tightened underwriting standards noted above. Market rates for the funding of new single family mortgages decreased for most of 2016, which led to the decreases in the portfolio average yield for both uninsured single family and insured single family. - 14 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In general, the majority of our insured single family originations from the Xceed platform are destined for securitization such that the majority of the portfolio is held on a short-term basis. Given our lower securitization volumes in 2016 compared to 2015, the average insured single family portfolio balance decreased in 2016. The 2016 growth in the commercial portfolio was primarily in commercial term mortgages. In 2016, we targeted growth in this higher-yielding portfolio and were able to identify investment opportunities. The decrease in the yield from 2015 was due to a lower average rate on the high ratio component of the portfolio, which consists of loans such as second mortgages on residential construction projects. The yield on this component of the commercial portfolio can be volatile. In 2015, we earned discount income of $1.5 million on the payout of previously impaired construction loans and $529,000 of deferred interest on a commercial loan, both of which are excluded from the average yield as they were non-recurring items. Average mortgage portfolio yield is considered to be a non-IFRS measure. For a definition of this measure, refer to the “Non-IFRS Measures” section of this MD&A. Equity income from MCAP The increase in equity income from MCAP in 2016 was a result of higher securitized mortgage interest income from a larger average portfolio, and higher servicing and administration income due to an increase in assets under administration. Other net investment income The decrease in fees in 2016 is primarily due to a non-recurring $742,000 deferred profit participation fee received on a commercial loan in 2015. The increase in marketable securities income in 2016 is a result of a significantly higher average portfolio balance. Income from financial investments and other loans includes $4.1 million of income recognized from our investment in the Crown Realty II Limited Partnership (“Crown LP”), compared to $2.5 million in 2015. The receipt of partnership distributions from Crown LP generates a transfer from accumulated other comprehensive income to net income. We also recognized $2.1 million of income from our investment in the KingSett High Yield Fund, up from $0.9 million in 2015 as a result of a higher average investment balance. The realized loss on derivatives incurred in 2015 was related to the hedging of mortgage funding commitments at that time. In late 2015, we closed out these hedges and adjusted the structure of our term deposit portfolio to provide a closer term match such that we did not have any gains or losses from derivatives in 2016. The change in the average term deposit balance is generally similar to that of the average corporate mortgage portfolio in that we use term deposits to fund our corporate assets. Similar to single family mortgages, market rates for new term deposits, all of which are fixed-rate, decreased from 2015. Mortgage expenses, consisting primarily of mortgage servicing fees, were comparable to 2015. Although we had a larger average mortgage portfolio, the average servicing rate decreased slightly from 2015. Details of the provision for (recovery of) credit losses are discussed in the “Credit Quality” sub-section below. For further information on corporate and securitization net investment income, refer to the “Net Interest Income” sub-section below. Net Investment Income - Securitization Assets Net investment income from securitization assets relates to our participation in the market MBS program and CMB program, which involve the securitization of insured mortgages through the Canada Mortgage and Housing Corporation (“CMHC”) National Housing Act (“NHA”) MBS program. For further details on these programs, refer to the “Securitization Programs” section of this MD&A. In 2016, our total securitization volumes were $228 million (2015 - $589 million), consisting of $42 million of insured single family mortgages (2015 - $589 million) through the market MBS program and $100 million of insured single family mortgages (2015 - $nil) and $86 million of insured multi family loans (2015 - $nil) through the CMB program. Securitization volumes in 2016 were lower than the past two years due to the reduced origination volumes noted above. - 15 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Market MBS Program Although our 2016 market MBS program securitization volumes were lower than 2015, the average portfolio balance increased over 2015 as new securitizations were adequate to offset mortgage repayments. Additionally, the average yield increased slightly due to the fact that the 2016 average portfolio contained a higher proportion of mortgages originated through our internal Xceed platform than 2015. Our internally originated mortgages are significantly more profitable than externally purchased mortgages, which contributed to the increase in spread income. CMB Program Spread income from insured single family mortgages securitized through the CMB program was minimal in 2016 given the small average portfolio size. These mortgages remained on our consolidated balance sheet since we retained significant continuing involvement with the mortgages. Although our average portfolio balance was low in 2016 given our recent re-entry into the program and low origination volumes, the net spread of 1.08% earned on the CMB program mortgages is significantly higher than the market MBS spread given the much lower CMB program funding cost. On securitization, the multi family loans were derecognized from our balance sheet as we transferred control of the assets at that time. Accordingly, we recognized upfront gains of $394,000 on the securitization of these mortgages, which are included in other securitization income. - 16 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Net Interest Income Presented in the following tables is an analysis of average rates and net interest income. Net interest income is the difference between interest earned on certain assets and the interest paid on liabilities to fund those assets. For further details, refer to the “Non-IFRS Measures” section of this MD&A. Average Balance 1 2016 Income / Expense Average Rate3 Average Balance 1 2015 Income / Expense Average Rate3 Table 5: Net Interest Income For the Years Ended December 31 (in thousands except %) Assets Cash and cash equivalents Marketable securities Mortgages - corporate Financial investments Other loans Corporate interest earning assets Cash held in trust Mortgages - securitized Financial investments Securitization interest earning assets Total interest earning assets Non interest earning assets Total assets $ 77,790 $ 50,078 987,124 19,117 3,878 1,137,987 15,158 1,035,457 - 1,050,615 2,188,602 85,404 $ 2,274,006 $ $ Liabilities and shareholders' equity Term deposits Loans payable Corporate liabilities Securitization liabilities Total interest bearing liabilities Non interest bearing liabilities Shareholders' equity Total liabilities and shareholders' equity $ 2,274,006 $ 940,926 $ 6,749 947,675 1,046,154 1,993,829 7,541 272,636 604 3,622 50,670 2,135 204 57,235 40 28,298 - 28,338 85,573 4,148 89,721 22,035 244 22,279 21,176 43,455 - - 43,455 0.78% 7.23% 5.15% 11.17% 5.26% 5.03% 0.26% 2.73% - 2.70% 3.91% - 3.95% 2.23% 3.32% 2.24% 2.02% 2.13% - - 1.91% $ 86,138 $ 30,250 909,626 7,851 1,774 1,035,639 17,511 950,480 95 968,086 2,003,725 75,161 $ 2,078,886 $ $ 844,309 $ 21,595 865,904 962,263 1,828,167 6,480 244,239 $ 2,078,886 $ 730 2,076 50,997 913 84 54,800 76 25,564 1 25,641 80,441 2,509 82,950 20,671 838 21,509 19,763 41,272 - - 41,272 0.85% 6.86% 5.35% 11.63% 4.74% 5.29% 0.87% 2.71% 2.11% 2.68% 4.01% - 3.99% 2.34% 3.12% 2.37% 2.07% 2.23% - - 1.99% Net Interest Income 2 $ 46,266 $ 41,678 1 The average balances (excluding cash and cash equivalents, mortgages and term deposits) are calculated with reference to opening and closing monthly balances and as such may not be as precise as if daily balances were used. The average cash and cash equivalents, mortgage and term deposit balances are calculated using daily balances. 2 Net interest income is equal to net investment income less equity income from MCAP, fees, whole loan gain on sale income, realized gain (loss) on derivatives, other securitization income, mortgage expenses, provision for credit losses and fair value adjustment - derivative financial instruments. Net interest income is a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. 3 Average rate is equal to income/expense divided by the average balance on an annualized basis. The average rate as presented may not necessarily be equal to “Income/Expense” divided by “Average Balance”, as non-recurring items consisting of one-time gains/losses, asset write- downs and fees not associated with the asset/liability yield are excluded from the calculation of the average rate. Excluding discount income on impaired loans and deferred interest, non-recurring items were immaterial for the years ended December 31, 2016 and December 31, 2015. Average rate is considered to be a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. - 17 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Credit Quality Table 6: Provisions for Credit Losses and Write-offs (in thousands except basis points) For the Years Ended December 31 2016 2015 Change from 2015 (%) ($) Individual provision (recovery) Single family uninsured Residential construction Collective provision (recovery) Single family uninsured Single family uninsured - completed inventory Construction Commercial Corporate mortgages - total Other provisions (recoveries) Total provision for (recovery of) credit losses Corporate mortgage portfolio data: Provision for (recovery of) credit losses Net write offs Net write offs (basis points) $ $ $ $ $ $ 287 - 287 (459) (56) 200 257 (58) (439) (497) $ 78 $ (55) 23 363 42 (99) 341 647 (395) 252 $ 209 55 264 (822) (98) 299 (84) (705) (44) (749) 268% (100%) 1148% (226%) (233%) (302%) (25%) (109%) 11% (297%) (210) $ 275 $ (540) (196%) $ $ 229 239 2.4 670 $ 385 $ 4.2 (441) (146) (1.8) (66%) (38%) (43%) Individual mortgage allowances are recorded to reduce a mortgage to its estimated realizable value. Collective mortgage allowances represent losses that we believe have been incurred in the mortgage portfolio but have not yet been specifically identified. The collective provisions (recoveries) recorded during both periods are consistent with the growth (reduction) in the size of the respective mortgage portfolios. During 2016, we had recoveries of $387,000 as a result of mortgage settlements or litigations, included in other provisions (recoveries). These recoveries related to Xceed-originated insured single family mortgages that had previously been written off prior to the acquisition of Xceed in 2013. Operating Expenses Table 7: Operating Expenses (in thousands) For the Years Ended December 31 2016 2015 Change from 2015 (%) ($) Salaries and benefits General and administrative $ $ 9,406 8,557 17,963 $ $ 8,515 5,993 14,508 $ $ 891 2,564 3,455 10% 43% 24% The increase in salaries and benefits in 2016 is partly due to an increase in the average number of employees from 2015. We have continued to grow the size of our staff in operations, risk management and credit to maintain a sound corporate governance environment and risk management framework. Additionally, certain long-term compensation expenses were higher in 2016 as a result of a more pronounced increase in the share price in 2016. The increase in general and administrative expense in 2016 consists primarily of expenditures relating to the development of new systems and processes related to single family mortgage operations; during 2016 we undertook multiple projects to improve governance and mitigate risk as part of this overall development process. This increase was also due to internal audit, risk and related expenses related to the Company’s procedures and controls. - 18 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Provision for Income Taxes Table 8: Income Taxes (in thousands) For the Years Ended December 31 2016 2015 Change from 2015 (%) ($) Current tax provision Deferred tax provision (recovery) $ $ (100) $ (566) (666) $ - $ (89) (89) $ (100) (477) (577) $ $ - 536% 648% The deferred tax recoveries in both years were due to tax losses recognized at the subsidiary level. As at December 31, 2016, we had $11 million of losses available for carry-forward in the MCAN mortgage investment corporation (“MIC”) parent company on a non-consolidated basis (December 31, 2015 - $12 million), the benefit of which is not reflected in deferred taxes. The March 31, 2016 dividend created a timing difference in the loss carry forward balance in that it was deducted from 2016 taxable income instead of 2015. This deduction will increase the loss carry forward by $6.6 million when we finalize our 2016 corporate tax position. For further information, refer to Note 4 to the consolidated financial statements. Taxable Income The table below provides a reconciliation between net income for accounting purposes and taxable income. The adjustments below represent the difference between the individual components of net income for accounting and tax purposes. Taxable income is presented on a non-consolidated basis and does not incorporate taxable income from Xceed and other subsidiaries as it does not directly impact MCAN’s non-consolidated taxable income. The key differences between taxable income and pre-tax net income for accounting purposes include differences between equity income from MCAP and Xceed for accounting and tax purposes and the treatment of securitization program origination costs, securitization gains or losses, capital gains income, collective provisions for credit losses and the amortization of upfront securitization program costs for tax purposes. As a MIC, we typically pay out all of our taxable income to shareholders through dividends. In addition, our MIC status allows us to deduct dividends paid within 90 days of year end from taxable income. Dividends that are deducted in the calculation of taxable income are not included in the table below. We originate and purchase insured mortgages that are securitized through the market MBS program and CMB program and sold to third parties or retained on our balance sheet (for further details on these programs, refer to the “Securitization Programs” section of this MD&A). The purchase of mortgages involves the payment of an up-front origination fee that is deductible for income tax purposes in the period that the mortgages are securitized, while for accounting purposes this fee is capitalized and amortized over the term of the associated mortgages. In 2016, we incurred $3.8 million of origination costs on securitized mortgages, including market MBS held by MCAN (2015 - $13.8 million). As at December 31, 2016, the unamortized origination fee balance was $15.6 million (2015 - $17.1 million), which represents costs that are still to be expensed for non-consolidated accounting purposes but will be added back in the calculation of taxable income in future periods. Taxable income is considered to be a non-IFRS measure. For further details, refer to the “Non-IFRS Measures” section of this MD&A. - 19 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 9: Taxable Income Reconciliation 1 (in thousands) For the Periods Ended December 31 Net income for accounting purposes Adjustments: Equity income from MCAP Equity income from subsidiaries 2 Provision for (recovery of) credit losses 2 Amortization of upfront securitization program costs 3 Securitization program mortgage origination costs 3 CMB program multi family gain on sale adjustment 4 Other securitization program cash outflows Gain on sale of interest-only strips Capital gains Other items Taxable Income Q4 2016 Q4 2015 YTD 2016 YTD 2015 $ 9,000 $ 9,450 $ 40,182 $ 32,857 (1,104) 622 (255) 1,614 (1,171) (300) (321) - - (403) 7,682 $ (3,610) (2,522) 527 1,776 (1,235) - (209) 3,073 (57) (373) 6,820 (9,674) (601) (56) 6,300 (3,799) (1,830) (452) - (163) (1,460) 28,447 $ (5,919) (440) 557 6,003 (13,810) - (1,639) 3,073 (57) (1,045) 19,580 $ $ 1 Taxable income is presented above on a non-consolidated basis for the MIC entity. The current year amounts presented above represent estimates as they are not finalized until the completion of our corporate tax filings. 2 Not deductible/recognizable in the calculation of taxable income. Individual mortgage allowances are 90% deductible for tax purposes. 3 Deductible in full for tax purposes as mortgages securitized; capitalized and amortized for accounting purposes, however amortization is added back in calculation of taxable income. 4 This adjustment reverses the recognition of the non-cash component of the upfront accounting gain and accounts for spread income collected for tax purposes. Summary of Three Year Results of Operations 2014 represented the first full year of the integration of Xceed into MCAN operations. We re-launched the Xceed single family brand with mortgage brokers and originated over $200 million of new mortgages. Additionally, our securitization volumes through the market MBS program grew significantly to $561 million as the program provided incremental income to MCAN. Earnings per share were $1.23. In 2015, we earned then-record net income of $32.9 million while earnings per share increased to $1.51. The Xceed origination platform increased significantly with $518 million in new mortgages originated. Our market MBS program securitization volumes were $589 million as the securitized mortgage portfolio continued to provide a reliable source of incremental income. Equity income from our investment in MCAP also increased by 63% to over $10 million. Corporate asset growth exceeded our 10% annual target as we finished the year with a $1.16 billion portfolio. In 2016, we again posted record net income of $40.2 million with earnings per share of $1.75. Although we had lower single family originations and a reduction in the size of those portfolios, we experienced growth in certain higher-yielding asset classes such as construction and commercial mortgages, marketable securities and financial investments, and earned strong returns in these investments. Additionally, we had a record performance from our equity investment in MCAP, providing $13.5 million of income which represented a 34% increase over 2015. We also re-commenced our participation in the CMB program, and increased our net investment income from securitization assets. Cash Flows Operating activities provided cash flows of $52 million in 2016 and $22 million in 2015, primarily due to lower net corporate mortgage fundings in 2016. Investing activities provided cash flows of $6 million in 2016 and $4 million in 2015. In 2016, we had higher distributions from the equity investment in MCAP. Financing activities used cash flows of $23 million in 2016 and $1 million in 2015. In 2015, we had a substantially higher inflow from the issuance of common shares due to a rights issue. - 20 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION FINANCIAL POSITION Table 10: Assets (in thousands) As at Corporate Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Equity investment in MCAP Commercial LP Foreclosed real estate Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets Mortgages - Corporate & Securitized Table 11: Mortgage Summary (in thousands) As at Corporate portfolio: Single family mortgages - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non-residential Commercial loans - Uninsured Securitized portfolio: Single family insured - Market MBS program Single family insured - CMB program December 31 December 31 2015 2016 Change from 2015 (%) ($) $ $ 111,732 55,126 904,112 57,264 3,584 50,805 529 1,782 3,546 1,188,480 $ 75,762 40,735 944,109 41,793 4,176 44,191 529 1,125 2,626 1,155,046 15,724 1,071,849 4,802 1,092,375 2,280,855 13,112 1,075,947 2,853 1,091,912 $ 2,246,958 $ $ 35,970 14,391 (39,997) 15,471 (592) 6,614 - 657 920 33,434 2,612 (4,098) 1,949 463 33,897 47% 35% (4%) 37% (14%) 15% - 58% 35% 3% 20% - 68% - 2% December 31 2016 December 31 2015 Change from 2015 (%) ($) $ 248,065 $ 108,334 18,162 359,465 $ 83,619 31,280 379,212 7,851 142,488 904,112 349,808 5,595 114,342 944,109 (111,400) 24,715 (13,118) - 29,404 2,256 - 28,146 (39,997) 971,548 100,301 1,071,849 1,975,961 $ 1,075,947 - 1,075,947 2,020,056 $ (104,399) 100,301 (4,098) (44,095) $ (31%) 30% (42%) 8% 40% 25% (4%) (10%) - - (2%) - 21 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Corporate and Securitized Mortgage Portfolio Analysis Figure 1: Total Corporate and Securitized Mortgage Portfolio (in thousands) The corporate mortgage portfolio decreased in the first half of 2015 as we took a measured approach to new construction fundings and reduced our Alberta exposure. After completing this rebalancing, we experienced significant growth in late 2015 and the first half of 2016 before experiencing seasonal repayments in the second half of 2016. This intra-year increase caused the average 2016 construction portfolio balance to be significantly higher than 2015. The uninsured single family mortgage portfolio declined throughout 2016 as a result of low origination volumes, which drove the overall decline in the corporate portfolio. The securitized mortgage portfolio increased significantly throughout 2015 as a result of high securitization volumes, but decreased in Q4 2015 as a result of the sale of the interest-only strips associated with certain mortgages and a resulting derecognition from our balance sheet. Our 2016 securitization volumes were low such that new issuances and repayments of the existing portfolio offset each other. Figure 2: Corporate Mortgage Portfolio Composition by Product Type (in thousands) - 22 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Figure 3: Mortgage Portfolio Geographic Distribution as at December 31, 2016 (December 31, 2015) Corporate Mortgages 2016 Summary After $75 million of growth in the first two quarters of 2016, our corporate portfolio decreased by $115 million in the second half of the year for a net decrease of $40 million in 2016. The construction portfolio was very strong in the first half of 2016 as a result of seasonal portfolio growth. This portfolio reduced to a more typical balance in the second half of the year as a result of seasonal repayments. Single family mortgage origination volumes were lower in 2016 as a result of a tightening of our underwriting standards and increased processing times as we worked on a transition of systems and processes. Additionally, we took a more defensive approach to origination in 2016 given the accelerated valuations in this market segment. The uninsured portfolio decreased consistently throughout 2016, reducing by $111 million in the year. Despite the low origination volumes, the insured portfolio balance was relatively consistent in 2016 since the majority of originations are destined for securitization and therefore are held on a short-term basis. Single family mortgages We invest in insured and uninsured single family mortgages in Canada, primarily originated through Xceed for our own corporate portfolio and for securitization activities. Uninsured mortgages may not exceed 80% of the value of the real estate securing such loans at the time of funding. For the purposes of this ratio, value is the appraised value of the property as determined by a qualified appraiser at the time of funding. Residential mortgages insured by CMHC or other private insurers may exceed this ratio. As we securitize mortgages that do not achieve derecognition, the assets are effectively transferred from corporate mortgages to securitized mortgages on the balance sheet. The change contributes to changes in asset levels when corporate mortgages are securitized in the following quarter. For further information on MCAN-issued market MBS retained for liquidity purposes and included in corporate insured single family mortgages, refer to the “Securitization Programs” section of this MD&A. Completed inventory loans Completed inventory loans are credit facilities extended to developers to provide interim mortgage financing on residential units (condominium or freehold) where all construction has been completed and therefore no further construction risk exists. Satisfactory confirmation that all units are substantially complete is required prior to funding all completed inventory loans. Final occupancy permits, condominium corporation registration and/or written confirmation by the cost consultant as to the completion of the units are examples of verification measures. - 23 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Construction loans Residential construction loans are made to homebuilders to finance residential construction projects. These loans generally have a floating interest rate and terms of one to two years. Non-residential construction loans provide construction financing for retail shopping developments, office buildings and industrial developments. Commercial loans Commercial loans include commercial term mortgages (e.g. loans secured by apartment buildings) and high ratio mortgage loans (e.g. second mortgages on residential construction projects). As at December 31, 2016, 50% of our commercial loan portfolio consisted of multi-family residential loans (December 31, 2015 - 46%). Other items While MCAN has exposure to real estate in the Fort McMurray area, we have no existing commercial lending or construction projects in the region. In regards to our single family mortgage exposure, we had $1.1 million and $8.9 million of outstanding corporate and securitized single family mortgages, respectively, and $7.4 million of off-balance sheet mortgages as at December 31, 2016. All of the aforementioned mortgages have mortgage insurance except for $117,000 of the corporate portfolio, for which no damage or loss was incurred. We are continuing to work with our borrowers and business partners to resolve any insurance claims. The fire in the Fort McMurray region has not had a material impact on net income to date and is not expected to have a future material impact on net income. The Canadian mortgage industry has experienced an increase in the risk relating to the falsification of supporting documents provided to lenders in the mortgage underwriting process and we have observed this activity in our own underwriting processes. In response, we have added enhanced procedures to our underwriting process. We do not expect a material impact to our financial position or performance arising out of any such activity within the market or our own operations. We continue to monitor our Alberta-based corporate mortgage portfolio. We are very diligent and selective in our mortgage funding opportunities and work with seasoned borrowers. Mortgage renewal rights Through Xceed, we retain the renewal rights to internally originated single family mortgages that are held as corporate or securitized mortgages or have been sold to third parties and derecognized from the balance sheet. At renewal, we may be able to renew these mortgages by offering clients attractive renewal options, thereby contributing to future revenues. As at December 31, 2016, we had the renewal rights to $1.1 billion of single family mortgages (December 31, 2015 - $1.3 billion billion). The majority of these renewal rights relate to mortgages held on the consolidated balance sheet as corporate or securitized mortgages. The remaining balance of $130 million relates to off-balance sheet mortgages sold to third parties on a whole loan basis (December 31, 2015 - $219 million). - 24 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 12: Arrears and Impaired Mortgages (in thousands except %) As at Corporate impaired mortgages Single family - uninsured Single family - insured Securitized impaired mortgages Total impaired mortgages Impaired mortgage ratio (total) 1 Impaired mortgage ratio (corporate) 1 Total corporate mortgage arrears 1 Single family - uninsured Single family - insured Commercial Total securitized mortgage arrears 1 Total mortgage arrears 1 Collective allowance Individual allowance Total allowance December 31 2016 September 30 2016 December 31 2015 $ $ $ $ $ $ 2,759 1,118 3,877 587 4,464 0.14% 0.31% 8,878 4,163 - 13,041 13,609 26,650 4,859 390 5,249 $ $ $ $ $ $ 3,091 1,892 4,983 - 4,983 0.15% 0.32% 15,208 6,002 3,000 24,210 15,887 40,097 5,115 377 5,492 $ $ $ $ $ $ 2,196 531 2,727 - 2,727 0.11% 0.23% 14,826 5,063 - 19,889 14,361 34,250 4,920 339 5,259 1 Refer to the "Non-IFRS Measures" section of this MD&A for a definition of this measure. Economic volatility and continued weakness in commodity prices continue to affect housing markets in impacted provinces such as Alberta and Saskatchewan where job losses have impacted industry mortgage arrears. We continue to be diligent in monitoring the local housing markets in which we lend and will closely monitor our mortgage portfolio for early indicators of potential performance concerns. Figure 4: Impaired Corporate Mortgage Ratio - 25 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 13: Mortgage Originations (in thousands) For the Periods Ended December 31 Single family - insured Single family - uninsured Single family - uninsured completed inventory Residential construction (new loan fundings) Non-residential construction (advances) Commercial Q4 2016 Q4 2015 Annual 2016 Annual 2015 $ $ 43,895 6,998 - 21,951 - 15,725 88,569 $ 51,099 $ 144,241 23,993 53,181 17,214 - 78,662 89,689 638 5,215 79,294 10,754 $ 209,938 $ 344,042 $ 356,594 167,453 4,603 173,117 5,215 58,674 $ 765,656 Uninsured single family originations were significantly lower in 2016 as a result of reduced spreads from a competitive market, the tightening of our underwriting standards (specifically for self-employed borrowers) and increased processing times as we transition our processes and legacy systems. Throughout 2016, we had an increase in mortgage applications that did not meet our underwriting standards and we therefore experienced a notable increase in the proportion of declined mortgage applications. The Toronto and Vancouver markets have experienced significant price inflation recently which is well in excess of supporting employment and income growth. Accordingly, we tightened our underwriting standards to mitigate these and other risks. Insured single family originations also decreased in 2016, primarily due to increased processing times noted above. Residential and non-residential construction volumes represent first advances on newly originated loans, i.e. they exclude additional fundings on existing loans in the portfolio. Although originations decreased from 2015, we still experienced growth in the portfolio during 2016 as a result of further draws on existing loans. An increased focus on higher yielding commercial loans in 2016 led to higher origination volumes and an increase in the portfolio from December 31, 2015. Table 14: Average Mortgage Loan to Value (LTV) Ratios As at Corporate portfolio: Single family mortgages - Uninsured - Uninsured completed inventory - Insured Construction loans - Residential - Non-residential Commercial loans - Uninsured Securitized portfolio: Single family insured - Market MBS Program Single family insured - CMB Program December 31 2016 September 30 2016 December 31 2015 72.2% 63.8% 77.9% 58.8% 58.4% 67.3% 66.2% 86.2% 83.1% 85.9% 76.8% 72.5% 51.0% 81.1% 60.2% 58.7% 58.1% 65.7% 86.0% 83.7% 85.9% 76.2% 72.7% 63.3% 79.3% 66.1% 59.4% 68.7% 63.5% 85.9% - 85.9% 75.4% - 26 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Additional Information on Residential Mortgages and Home Equity Lines of Credit (“HELOCs”) In accordance with OSFI Guideline B-20, Residential Mortgage Underwriting Practices and Procedures, additional information is provided on the composition of MCAN’s single family mortgage portfolio by insurance status and province, as well as amortization periods and LTV by province. LTV is calculated as the ratio of the outstanding loan balance on an amortized cost basis to the value of the underlying collateral at the time of origination. Insured mortgages include mortgages insured by CMHC or other approved insurers at origination and mortgages that are portfolio insured after origination. The HELOC balances displayed below relate to insured single family mortgages that have been acquired by MCAN. We do not originate HELOCs. Table 15: Single Family Mortgages by Province as at December 31, 2016 (in thousands except %) Insured % Uninsured % HELOCs % Corporate Securitized Insured % Total % Ontario Alberta British Columbia Quebec Atlantic Provinces Other Total $ 68,374 63.2% $ 173,246 65.1% $ 160 63.2% $ 47,312 17.8% 9.4% 24,947 2.5% 6,777 3.0% 8,103 2.2% 5,842 613,036 57.1% 231,027 21.6% 107,980 10.1% 4.0% 3.9% 3.3% $ 108,081 100.0% $ 266,227 100.0% $ 253 100.0% $ 1,071,849 100.0% 20,311 18.8% 2.7% 5.1% 8.0% 2.2% 51 20.2% 42 16.6% - - - 2,953 5,495 8,616 2,332 42,715 41,407 35,684 - - - Table 16: Single Family Mortgages by Province as at December 31, 2015 (in thousands except %) Insured % Uninsured % HELOCs % Corporate Securitized Insured % Ontario Alberta British Columbia Quebec Atlantic Provinces Other Total $ 42,449 50.9% $ 264,490 67.7% $ 122 52.2% $ 589,912 54.8% 239,192 22.2% 121,811 11.3% 4.1% 4.1% 3.5% $ 83,385 100.0% $ 390,745 100.0% $ 234 100.0% $ 1,075,947 100.0% 54,815 14.0% 41,809 10.7% 2.2% 2.9% 2.5% 19,433 23.3% 4.4% 3,646 6,887 8.3% 8,848 10.6% 2.5% 2,122 53 22.6% 59 25.2% - - - 8,688 11,303 9,640 43,960 43,712 37,360 - - - $ 854,816 59.1% 298,701 20.7% 9.4% 135,922 3.8% 54,987 4.0% 58,126 3.0% 43,858 $ 1,446,410 100.0% Total % $ 896,973 57.9% 313,493 20.2% 167,325 10.8% 3.8% 4.1% 3.2% $ 1,550,311 100.0% 59,535 63,863 49,122 Table 17: Single Family Mortgages by Amortization Period as at December 31, 2016 (in thousands except %) Up to 20 Years >20 to 25 Years >25 to 30 Years >30 to 35 Years >35 to 40 Years Total Corporate Securitized Total $ $ $ 67,175 $ 17.9% 88,400 $ 23.6% 211,956 $ 56.6% 6,924 $ 1.9% 106 $ 0.0% 374,561 100.0% 164,923 $ 15.4% 568,428 $ 53.0% 247,246 $ 23.1% 90,905 $ 8.5% 347 $ 1,071,849 100.0% 0.0% 232,098 $ 16.1% 656,828 $ 45.4% 459,202 $ 31.7% 97,829 $ 6.8% 453 $ 1,446,410 100.0% 0.0% - 27 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 18: Single Family Mortgages by Amortization Period as at December 31, 2015 (in thousands except %) Up to 20 Years >20 to 25 Years >25 to 30 Years >30 to 35 Years >35 to 40 Years Total Corporate Securitized Total $ $ $ 76,636 $ 16.2% 79,032 $ 16.7% 301,874 $ 63.6% 16,434 $ 3.5% 388 $ 0.0% 474,364 100.0% 119,194 $ 11.1% 575,192 $ 53.5% 277,016 $ 25.7% 103,802 $ 9.6% 743 $ 1,075,947 100.0% 0.1% 195,830 $ 12.6% 654,224 $ 42.2% 578,890 $ 37.3% 120,236 $ 7.8% 1,131 $ 1,550,311 100.0% 0.1% Table 19: Average Loan to Value (LTV) Ratio for Uninsured Single Family Mortgage Originations (in thousands except %) For the Periods Ended December 31 Q4 Average LTV 2016 YTD Average LTV 2016 Q4 Average LTV 2015 YTD Average LTV 2015 Ontario Alberta British Columbia Atlantic Provinces Other $ $ 6,064 - 750 - 184 6,998 74.4% - 57.7% - 80.0% 72.8% $ 30,627 5,525 4,502 - 553 $ 41,207 74.0% 69.3% 67.3% - 72.8% 72.7% $ 40,084 6,401 4,733 - 1,963 $ 53,181 73.8% 73.2% 73.0% - 76.4% 73.7% $ 127,446 26,023 13,149 1,336 4,102 $ 172,056 73.8% 74.3% 72.7% 62.7% 73.7% 73.7% Based on past experience and relative to the specifics of the then prevailing economic conditions, we would expect to observe an increase in overall mortgage default and arrears rates in the event of an economic downturn as realization periods on collateral become longer and borrowers adjust to the new economic conditions and changing real estate values. This would also result in a corresponding increase in our allowance for credit losses. An economic downturn, for example, could include changes to employment and unemployment rates, income levels and consumer spending which would have the above noted impact on our single family mortgage portfolio. MCAN utilizes a number of risk assessment and mitigation strategies to lessen the potential impact for loss on single family mortgages. In addition, MCAN’s corporate uninsured single family mortgage portfolio is also secured with an average LTV at origination of 71.6% as at December 31, 2016 (December 31, 2015 - 73.4%). Based on an industry index that incorporates current real estate values, the ratios would be 56.5% and 63.4%, respectively. Other Corporate Assets Cash and cash equivalents Cash and cash equivalents, which include cash balances with banks and overnight term deposits, increased by $36 million in 2016. The December 31, 2016 balance was higher than usual as a result of certain early loan payouts. Cash and cash equivalents provide liquidity to meet maturing term deposit and new mortgage funding commitments and are considered to be Tier 1 liquid assets. For further information, refer to the “Liquidity Management” section of this MD&A. Marketable securities Marketable securities, consisting of corporate bonds and real estate investment trusts (“REITs”), increased by $14 million in 2016, which included a $3.6 million net increase in the unrealized gain on the portfolio that was reflected in accumulated other comprehensive income. The unrealized gain on the portfolio was volatile throughout 2016, primarily due to the impact of interest rate movements on REIT valuations. Marketable securities provide additional liquidity at yields in excess of cash and cash equivalents and are considered to be Tier 2 liquid assets. For further details, refer to the “Liquidity Management” section of this MD&A. - 28 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Financial investments Corporate financial investments include a $33 million investment in Crown LP, in which we have a 14.1% equity interest (December 31, 2015 - $31 million). Crown LP invests primarily in commercial office buildings and classifies them into its core fund, which represents buildings expected to provide stable cash flows over a longer time horizon, and its opportunity fund, which represents buildings with medium term capital appreciation. Its fair value is driven primarily by independent appraisals of the buildings. As property acquisitions are made by Crown LP, we advance our proportionate share to finance the acquisitions. During 2016, we recorded a $7.2 million gross increase in the unrealized gain on the investment (2015 - $8.5 million), which is recognized in the consolidated statements of comprehensive income net of deferred taxes. Additionally, we recognized $4.1 million of income from the Crown LP investment in 2016 (2015 - $2.5 million). The receipt of partnership distributions from Crown LP generates a transfer from accumulated other comprehensive income to net income, where it is reflected in income from financial investments and other loans. We hold a $24 million investment in the KingSett High Yield Fund, in which we have a 9% equity interest (December 31, 2015 - $11 million). The fund invests in mortgages secured by real estate with a focus on mezzanine, subordinate and bridge mortgages and is carried at fair value. As mortgage advances are made by the fund, we advance our proportionate share. The fund pays a base distribution of 9% per annum, and distributes any additional income earned on a quarterly basis. Our 2016 return was 11.2%. Our total funding commitment is $63 million, which consists of $42 million of capital advances for the fund and $21 million that supports credit facilities. Equity investment in MCAP We hold a 14.74% equity interest in MCAP, which represents 4.3 million units held by MCAN of the 29.2 million total outstanding MCAP partnership units. The investment had a net book value of $51 million as at December 31, 2016 (December 31, 2015 - $44 million). The Limited Partner’s At-Risk Amount (“LP ARA”), which represents the cost base of the equity investment in MCAP for income tax purposes, was $39 million as at December 31, 2016 (December 31, 2015 - $42 million). For further information on the LP ARA, refer to the “Non-IFRS Measures” section of this MD&A. Our investment in MCAP creates a deduction from Total Capital under Basel III (refer to the “Capital Management” section of this MD&A), which is measured on an accounting basis and is phased in by 20% on an annual basis to 2018 such that the deduction was 60% in 2016. We have managed our investment in MCAP in line with our Risk Appetite Framework (“RAF”) and regulatory requirements in order to minimize this deduction from Total Capital under Basel III while optimizing the economic benefits of the investment. MCAP is an originator and servicer of mortgages for third party investors in Canada and securitizes mortgages on its own behalf. MCAP’s origination volumes were $15.9 billion in 2016. MCAP had $60.6 billion of assets under administration as at November 30, 2016. We currently use the equity basis of accounting for our investment in MCAP as per International Accounting Standard (“IAS”) 28, Investments in Associates and Joint Ventures, as we have significant influence in MCAP through our entitlement to a position on MCAP’s Board of Directors. If we experience further dilution we may no longer qualify for the equity basis of accounting. In that case, we would not recognize our pro-rata share of MCAP’s net income as equity income, but would instead recognize distributions received from MCAP as income and would carry the investment as available for sale with changes in fair value recognized through accumulated other comprehensive income. In mid-2016, MCAP filed a preliminary prospectus with respect to an initial public offering of common shares. Subsequently, MCAP withdrew the prospectus due to adverse market conditions. Since the events did not lead to a change in accounting, we continue to use the equity basis of accounting for our investment in MCAP. Foreclosed real estate Foreclosed real estate consists of a real estate investment which was previously an impaired construction loan. This investment is carried at the lower of the carrying amount and fair value less estimated costs to sell. Securitization Assets Securitization assets consist primarily of single family insured mortgages securitized through the market MBS program and CMB program. During 2016 we recognized $42 million of new securitized mortgages on our balance sheet from our participation in the market MBS program and $100 million from the CMB program. For further information, refer to the “Securitization Programs” section of this MD&A. - 29 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 20: Liabilities and Shareholders' Equity (in thousands) As at Corporate Liabilities Term deposits Current tax liabilities Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders’ Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income December 31 2016 September 30 2016 December 31 2015 Change from 2015 (%) ($) $ $ 911,866 - 3,050 12,377 927,293 $ 948,946 - 2,363 5,428 956,737 903,041 $ 100 2,299 12,412 917,852 8,825 (100) 751 (35) 9,441 1% (100%) 33% - 1% 1,071,786 1,071,786 1,999,079 1,058,402 1,058,402 2,015,139 1,070,304 1,070,304 1,988,156 210,239 510 55,923 15,104 281,776 $ 2,280,855 210,239 510 53,846 11,271 275,866 $ 2,291,005 206,382 510 42,617 9,293 258,802 2,246,958 $ $ 1,482 1,482 10,923 3,857 - 13,306 5,811 22,974 33,897 - - 1% 2% - 31% 63% 9% 2% We issue term deposits that are eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance to fund our corporate operations. The role of term deposits in managing liquidity risk is discussed in the “Liquidity and Funding Risk” sub- section of the “Risk Governance and Management” section of this MD&A. Financial liabilities from securitization relate to our participation in the market MBS program and CMB program, representing MBS that we have sold to third parties but have not been derecognized from our balance sheet. Activity in 2016 consists of the creation of $42 million of new liabilities from our participation in the market MBS program and $100 million from the CMB program less $141 million of net repayments. For further information on the market MBS program and CMB program, refer to the “Securitization Programs” section of this MD&A. Share capital activity for 2016 reflects new common shares issued through the Dividend Reinvestment Plan (“DRIP”) and the Executive Share Purchase Plan. For further information, refer to Note 21 to the consolidated financial statements. Retained earnings activity for 2016 consists of net income of $40.2 million less dividends of $26.9 million. Accumulated other comprehensive income represents unrealized gains or losses on available for sale marketable securities and financial investments. During 2016, we recorded a $3.6 million net increase in the unrealized gain on the marketable securities portfolio. In addition, we recorded a $2.2 million net increase in the unrealized gain on available for sale financial investments, which included a $7.0 million gross increase in the unrealized gain less a $4.1 million transfer to net income net of deferred taxes. - 30 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SELECTED QUARTERLY FINANCIAL DATA Table 21: Selected Quarterly Financial Data (in thousands except for per share amounts and %) Net investment income - corporate assets Other income - corporate assets Net investment income - securitization assets Operating expenses Net income before income taxes Provision for (recovery of) income taxes Net income Q4/16 Q3/16 Q2/16 Q1/16 Q4/15 Q3/15 Q2/15 Q1/15 $ 11,684 $ 12,396 $ 16,996 - - - $ 10,625 - $ 12,602 $ - 8,996 $ 13,745 68 - 1,519 13,203 4,471 8,732 1,594 13,990 4,323 9,667 1,421 18,417 4,650 13,767 1,244 11,869 4,519 7,350 1,469 14,071 4,224 9,847 1,246 10,242 3,577 6,665 1,058 14,871 3,136 11,735 (268) 9,000 $ (108) 131 9,775 $ 13,636 $ (421) 7,771 $ 397 9,450 $ (528) (183) 7,193 $ 11,918 $ 7,398 - 694 8,092 3,571 4,521 225 4,296 Average mortgage portfolio yield - corporate 1 Average term deposit interest rate 1 Basic and diluted earnings per share $ Return on average shareholders' equity 1 4.99% 2.20% 5.14% 2.22% 5.21% 2.22% 5.27% 2.25% 5.31% 2.27% 5.25% 2.32% 5.34% 2.38% 5.48% 2.40% 0.39 $ 0.43 $ 0.59 $ 0.34 $ 0.42 $ 0.32 $ 0.56 0.21 12.94% 14.08% 20.10% 11.80% 14.66% 11.36% 20.16% 7.49% Dividends per share Regular Total $ $ 0.30 $ 0.30 $ 0.29 $ 0.29 $ 0.29 0.29 $ $ 0.29 0.29 $ $ 0.29 $ 0.29 $ 0.28 $ 0.28 $ 0.28 0.28 0.28 0.28 1 Refer to the “Non-IFRS Measures” section of this MD&A for a definition of these measures. Net investment income from corporate assets has been consistent since Q1 2015 with the exception of significant increases in Q4 2015 and Q2 2016 from income recognized upon the receipt of distributions from Crown LP. Q2 2015 and Q2 2016 also had substantial equity income from MCAP. Additionally, Q1 2015 was negatively impacted by significant realized and unrealized losses on derivatives. We have experienced a steady decrease in our corporate mortgage portfolio and term deposit yields due to decreases in market rates for new fundings. Realized and unrealized losses on derivatives were volatile in 2015. Net investment income from securitization assets has increased steadily from growth in the market MBS program and our re-entry into the CMB program. For an analysis of the increase in operating expenses in recent quarters, refer to the “Operating Expenses” sub-section of the “Results of Operations” section of this MD&A. Table 22: Ten Year Financial Summary (in thousands except per share amounts) December 31 2016 (IFRS) 2015 (IFRS) 2014 (IFRS) 2013 (IFRS) 2012 (IFRS) 2011 (IFRS) 2010 (IFRS) 2009 (CGAAP) 2008 (CGAAP) 2007 (CGAAP) $ Net Income Earnings Dividends Per Share Per Share 40,182 $ 32,857 25,446 30,805 16,494 24,262 31,667 24,742 30,348 14,843 1.75 $ 1.51 1.23 1.57 0.94 1.50 2.20 1.73 2.14 1.12 1.17 $ 1.13 1.12 1.15 1.42 1.81 1.19 1.44 0.96 1.00 Assets1 1,188,480 $ 1,155,046 1,044,579 1,027,176 950,686 753,799 538,118 506,683 570,154 557,425 Shareholders’ Market Equity Capitalization 330,434 281,776 $ 276,573 258,802 299,635 225,303 265,993 214,900 262,393 177,781 225,951 158,465 200,249 125,079 194,766 122,879 129,438 116,609 140,416 103,007 1 2010-2016 consist of corporate assets only as reported under IFRS. 2007-2009 consist of total assets as reported under Canadian Generally Accepted Accounting Principles (“CGAAP”). - 31 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SUMMARY OF FOURTH QUARTER RESULTS Table 23: Quarterly Net Income (in thousands) For the Quarters Ended Net Investment Income - Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Fees Marketable securities Financial investments and other loans Interest on cash and cash equivalents Whole loan gain on sale income Realized gain on derivatives Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses Net Investment Income - Securitization Assets Mortgage interest Other securitization income Interest on financial liabilities from securitization Mortgage expenses Operating Expenses Salaries and benefits General and administrative Net Income Before Income Taxes Provision for (recovery of) income taxes Net Income Basic and diluted earnings per share Dividends per share December 31 2016 September 30 2016 December 31 2015 $ $ $ $ $ 11,728 3,209 638 889 933 206 - - 17,603 5,492 1,013 - (586) 5,919 $ 12,987 3,276 683 1,205 614 145 - - 18,910 5,685 1,009 64 (244) 6,514 12,610 2,070 937 802 2,920 149 113 2 19,603 5,189 1,124 163 525 7,001 11,684 12,396 12,602 7,122 112 7,234 5,250 465 5,715 1,519 2,129 2,342 4,471 8,732 (268) 9,000 0.39 0.30 $ $ $ 7,187 219 7,406 5,356 456 5,812 1,594 2,191 2,132 4,323 9,667 (108) 9,775 0.43 0.29 $ $ $ 7,556 50 7,606 5,684 453 6,137 1,469 2,586 1,638 4,224 9,847 397 9,450 0.42 0.29 - 32 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Q4 2016 vs. Q4 2015 Net Investment Income - Corporate Assets Table 24: Interest Income and Average Rate by Mortgage Portfolio (Corporate) For the Quarters Ended December 31 2016 2015 (in thousands except %) Single family - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non residential Commercial loans - Uninsured Mortgages - corporate portfolio Term deposits Spread of mortgages over term deposits Mortgages - securitized portfolio Financial liabilities from securitization Spread of mortgages over liabilities Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income $ 271,126 $ 125,902 17,888 387,536 7,852 3,104 755 244 5,152 108 143,843 $ 954,147 $ 934,475 2,365 11,728 5,492 $ 1,032,208 $ 1,046,078 7,122 5,250 4.56% $ 3.12% 5.42% 354,792 $ 102,650 19,822 5.29% 5.45% 348,882 4,705 4,026 938 229 4,883 65 6.55% 4.99% $ 2.20% 2.79% 101,567 932,418 $ 864,518 2,469 12,610 5,189 2.74% $ 1,126,839 $ 2.01% 0.73% 1,135,196 7,556 5,684 4.53% 3.65% 4.59% 5.59% 5.52% 8.88% 5.31% 2.27% 3.04% 2.66% 2.01% 0.65% 1 Average interest rate is equal to income/expense divided by the average balance on an annualized basis. The average interest rate as presented may not necessarily be equal to “Income/Expense” divided by “Average Balance”, as non-recurring items such as discount income on impaired loans, deferred interest and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Excluding discount income on impaired loans and deferred interest, non-recurring items were immaterial for the quarters ended December 31, 2016 and December 31, 2015. Average interest rate is considered to be a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. Changes in the average portfolio balance from Q4 2015 are generally consistent with the fiscal 2016 discussion in the “Net Investment Income - Corporate Assets” sub-section of the “Results of Operations” section of this MD&A. The uninsured single family portfolio declined throughout 2016 as a result of low origination volumes for new mortgages in the year. Despite a general trend downwards in funding rates for new mortgages, the average portfolio yield increased over Q4 2015 as a result of higher penalty income. The increase in the average construction portfolio balance from Q4 2015 was primarily due to strong funding volumes in the first half of 2016 that helped to maintain a high balance throughout the year amidst seasonal repayments. We targeted growth in our commercial portfolio during 2016 and experienced a significant increase in the average portfolio balance over Q4 2015. Market rates for new mortgage and term deposit fundings have generally decreased since 2015. Average mortgage portfolio yield is considered to be a non-IFRS measure. For a definition of this measure, refer to the “Non-IFRS Measures” section of this MD&A. The increase in equity income from MCAP in Q4 2016 was a result of higher securitized mortgage interest income from a larger average portfolio, and higher servicing and administration income due to an increase in assets under administration. The decrease in income from financial investments and other loans in Q4 2016 is primarily due to the recognition of $2.5 million of income from our investment in Crown LP in Q4 2015 upon the receipt of partnership distributions. Net Investment Income - Securitization Assets Despite a lower average portfolio balance, spread income from securitization assets was unchanged from Q4 2015. The slight increase in net investment income from securitization assets was due to a $78,000 upfront gain earned on the securitization of insured multi family loans through the CMB program. - 33 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In Q4 2016, our total securitization volumes were $74 million (Q4 2015 - $239 million), consisting of $8 million of insured single family mortgages (Q4 2015 - $239 million) through the market MBS program and $51 million of insured single family mortgages (Q4 2015 - $nil) and $15 million of insured multi family loans (Q4 2015 - $nil) through the CMB program. For further information on corporate and securitization net investment income, refer to the “Net Interest Income” sub-section below. Net Interest Income Presented in the following tables is an analysis of average rates and net interest income. Net interest income is the difference between interest earned on certain assets and the interest paid on liabilities to fund those assets. For further details, refer to the “Non-IFRS Measures” section of this MD&A. Table 25: Net Interest Income For the Quarters Ended December 31 2016 2015 Average Balance 1 Income / Average Rate 3 Expense Average Balance 1 Income / Average Rate 3 Expense (in thousands except %) Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Corporate interest earning assets Short term investments Mortgages Financial investments Securitized interest earning assets Total interest earning assets Non interest earning assets Total assets $ 98,044 $ 51,682 954,147 21,195 3,662 1,128,730 18,405 1,032,208 - 1,050,613 2,179,343 88,514 $ 2,267,857 $ $ 934,475 $ Liabilities and shareholders' equity Term deposits Loans payable Corporate liabilities Securitization liabilities Total interest bearing liabilities Non interest bearing liabilities Shareholders' equity Total liabilities and shareholders' equity $ 2,267,857 $ - 934,475 1,046,078 1,980,553 9,044 278,260 208 889 11,728 494 48 13,367 11 7,122 - 7,133 20,500 391 20,891 5,492 - 5,492 5,250 10,742 - - 10,742 0.84% 6.84% 4.99% 9.27% 5.21% 4.71% 0.24% 2.74% - 2.70% 3.74% - 3.66% 2.20% - 2.20% 2.01% 2.11% - - 1.88% $ 74,384 $ 38,829 932,418 9,149 2,027 1,056,807 11,775 1,126,839 - 1,138,614 2,195,421 83,036 $ 2,278,457 $ $ 864,518 $ 14,234 878,752 1,135,196 2,013,948 6,728 257,781 $ 2,278,457 $ 149 802 12,610 382 29 13,972 8 7,556 - 7,564 21,536 2,509 24,045 5,189 163 5,352 5,684 11,036 - - 11,036 0.79% 8.19% 5.31% 16.57% 5.68% 5.25% 0.27% 2.66% - 2.64% 3.89% - 4.19% 2.27% 3.06% 2.29% 2.01% 2.15% - - 1.92% Net Interest Income 2 $ 10,149 $ 13,009 1 The average balances (excluding cash and cash equivalents, mortgages and term deposits) are calculated with reference to opening and closing monthly balances and as such may not be as precise as if daily balances were used. The average cash and cash equivalents, mortgage and term deposit balances are calculated using daily balances. 2 Net interest income is equal to net investment income less equity income from MCAP, fees, whole loan gain on sale income, realized gain (loss) on derivatives, other securitization income, mortgage expenses and provision for credit losses. Net interest income is a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. 3 Average rate is equal to income/expense divided by the average balance on an annualized basis. The average rate as presented may not necessarily be equal to “Income/Expense” divided by “Average Balance”, as non-recurring items consisting of one-time gains/losses, asset write-downs and fees not associated with the asset/liability yield are excluded from the calculation of the average rate. Excluding discount income on impaired loans and deferred interest, non-recurring items were immaterial for the quarters ended December 31, 2016 and December 31, 2015. Average rate is considered to be a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. - 34 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Credit Quality Table 26: Provisions for Credit Losses and Write-offs (in thousands except basis points) For the Quarters Ended Individual provision (recovery) Single family uninsured Collective provision (recovery) Single family uninsured Single family uninsured - completed inventory Construction Commercial Corporate mortgages - total Other provisions (recoveries) Total provision for (recovery of) credit losses Corporate mortgage portfolio data: Provision for (recovery of) credit losses Net write offs Annualized net write offs (basis points) December 31 September 30 December 31 2015 2016 2016 $ 50 $ 51 $ (148) (1) (67) (37) (253) (383) (636) $ (167) 8 (218) 105 (272) (23) (295) $ (586) $ (244) $ (203) $ $ 39 1.6 (221) $ - $ - $ $ $ $ 6 133 96 291 38 558 (39) 519 525 564 45 1.9 The change in the corporate mortgage collective provision from Q4 2015 to Q4 2016 was largely driven by portfolio activity. Corporate mortgages that attract a collective allowance increased by $96 million in Q4 2015, compared to a $53 million decrease in Q4 2016. For a discussion of other provisions (recoveries), refer to the “Credit Quality” sub-section of the “Results of Operations” section of this MD&A. Table 27: Operating Expenses (in thousands) For the Quarters Ended Salaries and benefits General and administrative December 31 2016 September 30 2016 December 31 2015 $ $ 2,129 $ 2,342 4,471 $ 2,191 2,132 4,323 $ $ 2,586 1,638 4,224 Salaries and benefits were higher in Q4 2015 as a result of a higher variable compensation expense. For a discussion of general and administrative expenses, refer to the “Operating Expenses” sub-section of the “Results of Operations” section of this MD&A. Table 28: Income Taxes (in thousands) For the Quarters Ended Deferred tax provision December 31 2016 September 30 2016 December 31 2015 $ $ (268) (268) $ $ (108) (108) $ $ 397 397 The deferred tax provision (recovery) is driven by taxable income (losses) recognized in subsidiaries. - 35 - 3,621 954 374 5,729 104 2,205 12,987 5,685 7,187 5,356 4.72% 3.23% 6.75% 5.42% 5.57% 6.57% 5.14% 2.22% 2.92% 2.77% 2.05% 0.72% 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Q4 2016 vs. Q3 2016 Net Investment Income - Corporate Assets Table 29: Interest Income and Average Rate by Mortgage Portfolio (Corporate) For the Quarters Ended December 31, 2016 September 30, 2016 Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income (in thousands except %) Single family - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non residential Commercial loans - Uninsured Mortgages - corporate portfolio Term deposits Spread of mortgages over term deposits $ 271,126 $ 125,902 17,888 387,536 7,852 3,104 755 244 5,152 108 143,843 $ 954,147 $ 934,475 2,365 11,728 5,492 4.56% $ 3.12% 5.42% 306,022 $ 117,815 22,098 5.29% 5.45% 421,242 7,408 133,784 6.55% 4.99% $ 1,008,369 $ 2.20% 2.79% 962,150 Mortgages - securitized portfolio Financial liabilities from securitization Spread of mortgages over liabilities $ 1,032,208 $ 1,046,078 7,122 5,250 2.74% $ 1,032,280 $ 2.01% 0.73% 1,045,122 1 Average interest rate is equal to income/expense divided by the average balance on an annualized basis. The average interest rate as presented may not necessarily be equal to “Income/Expense” divided by “Average Balance”, as non-recurring items such as discount income on impaired loans, deferred interest and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Excluding discount income on impaired loans and deferred interest, non-recurring items were immaterial for the quarters ended December 31, 2016 and September 30, 2016. Average interest rate is considered to be a non-IFRS measure. Refer to the “Non-IFRS Measures” section of this MD&A for a definition of this measure. Lower corporate mortgage interest was the main factor behind the small decrease in net income from Q3 2016 to Q4 2016. The decline in the average corporate portfolio balance in Q4 2016 was a result of continued low uninsured single family originations and seasonal repayments in the construction portfolio. All other key components of net income were comparable to Q3 2016. - 36 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Financial Position Table 30: Quarterly Balance Sheet (in thousands) As at Assets Corporate Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Equity investment in MCAP Commercial LP Foreclosed real estate Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets Liabilities and Shareholders' Equity Liabilities Corporate Liabilities Term deposits Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders' Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income December 31 September 30 Change from Prior Quarter (%) 2016 2016 ($) $ $ $ $ 111,732 55,126 904,112 57,264 3,584 50,805 529 1,782 3,546 1,188,480 $ 80,204 52,901 964,901 49,716 3,729 49,073 529 1,501 7,017 1,209,571 15,724 1,071,849 4,802 1,092,375 2,280,855 17,669 1,059,512 4,253 1,081,434 $ 2,291,005 $ 911,866 3,050 12,377 927,293 948,946 2,363 5,428 956,737 $ $ $ 31,528 2,225 (60,789) 7,548 (145) 1,732 - 281 (3,471) (21,091) (1,945) 12,337 549 10,941 (10,150) 39% 4% (6%) 15% (4%) 4% - 19% (49%) (2%) (11%) 1% 13% 1% - (37,080) 687 6,949 (29,444) (4%) 29% 128% (3%) 1,071,786 1,071,786 1,058,402 1,058,402 13,384 13,384 210,239 510 55,923 15,104 281,776 2,280,855 210,239 510 53,846 11,271 275,866 $ 2,291,005 $ - - 2,077 3,833 5,910 (10,150) 1% 1% - - 4% 34% 2% - - 37 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 31: Quarterly Mortgage Summary (in thousands) As at Corporate portfolio: Single family mortgages - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non-residential Commercial loans - Uninsured Securitized portfolio: Single family insured - Market MBS program Single family insured - CMB program December 31 2016 September 30 Change from Prior Quarter (%) 2016 ($) $ 248,065 $ 108,334 18,162 283,016 $ 115,840 18,515 (34,951) (7,506) (353) 379,212 7,851 142,488 904,112 389,679 7,516 150,335 964,901 (10,467) 335 (7,847) (60,789) 971,548 100,301 1,071,849 1,975,961 $ 1,009,426 50,086 1,059,512 2,024,413 $ (37,878) 50,215 12,337 (48,452) $ (12%) (6%) (2%) (3%) 4% (5%) (6%) (4%) 100% 1% (2%) The primary change in the corporate balance sheet during Q4 2016 was the decline in the corporate mortgage portfolio noted above. Our cash balances increased significantly during Q4 2016 due to certain early loan payouts. The increase in financial investments was driven by an increase in the fair value of the Crown LP investment, recorded to accumulated other comprehensive income. Securitization assets increased modestly as a result of new CMB program and market MBS program securitization issuances. - 38 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SECURITIZATION PROGRAMS We are an NHA MBS issuer, which involves the securitization of insured mortgages to create MBS. We issue MBS through our internal market MBS program and the Canada Housing Trust (“CHT”) CMB program. In both programs, we leverage our regulatory asset capacity by originating or purchasing insured single family mortgages for securitization and sale to third parties, thus providing us with a reliable source of incremental income. Pursuant to the NHA MBS program, investors of MBS receive monthly cash flows consisting of interest and scheduled and unscheduled principal payments. CMHC makes principal and interest payments in the event of any MBS default by the issuer, thus fulfilling the Timely Payment obligation to investors. In instances where we have sold MBS, where applicable, these sales are executed for the purposes of transferring various economic exposures that result in accounting outcomes noted for each program below. Each of the programs noted below provide for many responsibilities that are linked to the issuer of these MBS instruments. We do not transfer program oversight or these specific responsibilities when selling MBS to other parties. Market MBS Program As part of the market MBS program, we may sell MBS to third parties and may also sell the interest-only strips to third parties. The MBS portion of the mortgage represents the core securitized mortgage principal and the right to receive coupon interest at a specified rate. The interest-only strips represent the right to receive excess cash flows after satisfying the MBS coupon interest payment and any other expenses such as mortgage servicing. As part of this program, we originate and purchase insured single family mortgages to sell as MBS. During 2016, we pooled and sold $42 million of MBS to third parties (2015 - $589 million). The majority of our previous mortgage sales have not achieved derecognition as we retained significant continuing involvement with the assets such that the associated mortgages remained on the balance sheet while a corresponding liability was incurred. The mortgage interest income and interest on the financial liability from securitization associated with these mortgages are recognized on the accrual basis over the term of the mortgages. During 2015, we sold the interest-only strips associated with $147 million of mortgages securitized through the market MBS program to third parties. Subsequent to sale, we derecognized the securitized mortgages and associated financial liabilities from securitization from the consolidated balance sheet as a result of the transfer of substantially all risks and rewards of ownership to the purchaser of the interest-only strip. We did not sell any interest-only strips in 2016. We may issue market MBS through the NHA MBS program and retain the underlying MBS security instead of selling it to a third party. As at December 31, 2016, we held $37 million of retained MBS on our balance sheet (December 31, 2015 - $21 million), which is included in the insured single family classification within corporate mortgages. CMB Program We recommenced our participation in the CMB program in 2016 by securitizing both insured single family and insured multi family loans (e.g. loans secured by apartment buildings) through the CMB program. The CMB program involves the sale of MBS to CHT who in turn issues a non-amortizing bullet bond to external investors. The CMB program generally includes the reinvestment of mortgage principal repayments by the issuer into certain permitted assets, however we have transferred the benefits and obligations associated with the principal reinvestment function to a third party such that we only earn spread income on the amortizing mortgage balance. The third party is responsible for sourcing assets in which to reinvest and any associated obligations. This transfer has no net ongoing financial impact on MCAN. We securitized $100 million of insured single family mortgages during 2016 (2015 - $nil). Similar to the market MBS program transaction, we did not derecognize the mortgages from the consolidated balance sheet as we retained significant continuing involvement with the assets such that the associated mortgages remained on the consolidated balance sheet while a corresponding liability was incurred. The mortgage interest income and interest on the financial liability from securitization associated with these mortgages is recognized on the accrual basis over the term of the mortgages. We securitized $86 million of insured multi family loans during 2016 (2015 - $nil). We derecognized the mortgages from the consolidated balance sheet as control over the assets was transferred on securitization. In achieving derecognition, we recognized upfront gains of $394,000, which are included in other securitization income. Additionally, we recognized receivables in the amount of estimated discounted spread income to be earned over the term of the securitized mortgages. Other Accounting Considerations The primary risks associated with the market MBS program and CMB program are prepayment, liquidity and funding risk, including the obligation to fund 100% of any cash shortfall related to the Timely Payment (discussed below in the “Timely - 39 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Payment” sub-section). Prepayment risk includes the acceleration of the amortization of mortgage premiums as a result of early payouts. Any mortgages securitized through the market MBS program or CMB program for which derecognition is not achieved remain on the consolidated balance sheet as securitized assets and are also included in total exposures in the calculation of the leverage ratio. A corresponding liability is also recognized on the balance sheet for mortgage securitizations that fail derecognition. However, for income tax purposes, all mortgages securitized by MCAN are considered to be true mortgage sales and therefore are not included in income tax assets. For further details on total exposures, regulatory capital and income tax assets and capital, refer to the “Capital Management” and “Non-IFRS Measures” sections of this MD&A. MCAN has capitalized certain mortgage acquisition costs. These costs are amortized using the effective interest rate method (“EIM”), which incorporates mortgage prepayment assumptions. Timely Payment Consistent with all issuers of MBS, we are required to remit scheduled mortgage principal and interest payments to CMHC, even if these mortgage payments have not been collected from mortgagors, to ensure that the Timely Payment of principal and interest to MBS investors is effected. Similarly, at the maturity of the MBS pools that have been issued by MCAN, any outstanding principal must be paid to CMHC. We maintain the Timely Payment obligation in our role as MBS issuer until the maturity of the security. If we fail to make a scheduled principal and interest payment to CMHC, CMHC may enforce the assignment of the mortgages included in all MBS pools in addition to other assets backing the MBS issued. If mortgage payments have not been collected from mortgagors or mortgagors are unable to renew their mortgages at their scheduled maturities, we will be required to use our own financial resources to fund our pro-rata share of these obligations until mortgage arrears are collected or proceeds are received from the mortgage insurers following the sale of the mortgaged properties. As part of our participation in the market MBS program and CMB program, we are required to fund 100% of any cash shortfall unless we have sold the interest-only strip, in which case the purchaser of the interest-only strip is obligated to fund 100% of any cash shortfall. If the interest-only strip purchaser is not able to provide funds to cover any cash shortfalls, we will be required to use our own financial resources to fund our 100% share of this obligation until mortgage arrears are collected or proceeds are received from the mortgage insurers following the sale of the mortgaged properties. In the case of mortgage defaults, we are required to make scheduled principal and interest payments to investors as part of the Timely Payment and then place the mortgage/property through the insurance claims process to recover any losses. These defaults may result in cash flow timing mismatches that may marginally increase funding and liquidity risks. - 40 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CAPITAL MANAGEMENT Our primary capital management objectives are to maintain sufficient capital for regulatory purposes and to earn acceptable and sustainable risk-weighted returns for our shareholders. Through our risk management and corporate governance framework, we assess current and projected economic, housing market, interest rate and credit conditions to determine appropriate levels of capital. We typically pay out all taxable income by way of dividends. Capital growth is achieved through retained earnings, public share offerings, rights offerings and the DRIP. Our capital management is driven by the guidelines set out by the Income Tax Act (Canada) (the “Tax Act”) and OSFI. Income Tax Capital As a MIC under the Tax Act, we are limited to an income tax liabilities to capital ratio of 5:1 (or an income tax assets to capital ratio of 6:1), based on our non-consolidated balance sheet in the MIC entity measured at its tax value. Securitization assets and liabilities (less accrued interest) are both excluded from the calculation of the income tax assets to capital ratio. We manage our income tax assets to a level of 5.75 times income tax capital on a non-consolidated tax basis to provide a prudent cushion between the maximum permitted assets and total actual assets. Income tax asset capacity represents additional asset growth available to yield a 5.75 income tax assets to income tax capital ratio. Table 32: Income Tax Capital 1 (in thousands except ratios) As at Income tax assets 1 Consolidated assets Adjust for assets in subsidiaries Non-consolidated assets in MIC entity Add: mortgage allowances Less: securitization assets 2 Less: equity investments in MCAP and subsidiaries Other adjustments Income tax liabilities 1 Consolidated liabilities Adjust for liabilities in subsidiaries Non-consolidated liabilities in MIC entity Less: securitization liabilities 2 Income tax capital 1 Income tax asset capacity 1 Income tax capital ratios 1 Income tax assets to capital ratio Income tax liabilities to capital ratio December 31 2016 September 30 2016 December 31 2015 $ $ $ $ $ $ 2,280,855 $ 6,918 2,287,773 4,897 (1,089,358) (37,049) (5,605) 1,160,658 $ 2,291,005 $ 7,363 2,298,368 5,152 (1,075,746) (32,292) (5,483) 1,189,999 $ 2,246,958 5,535 2,252,493 4,953 (1,091,099) (31,088) 122 1,135,381 1,999,079 $ (6,500) 1,992,579 (1,070,117) 2,015,139 $ (5,860) 2,009,279 (1,056,713) 922,462 $ 952,566 $ 1,988,156 (6,213) 1,981,943 (1,068,541) 913,402 238,196 $ 237,433 $ 221,979 208,970 $ 175,243 $ 140,998 4.87 3.87 5.01 4.01 5.11 4.11 1 Refer to the “Non-IFRS Measures” section of this MD&A for a definition of these measures. 2 The majority of securitization assets and liabilities per balance sheet are excluded from income tax assets, liabilities and capital to the extent that they are held in the MIC entity. - 41 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Regulatory Capital As a Loan Company under the Trust and Loan Companies Act (the “Trust Act”), OSFI oversees the adequacy of our capital. For this purpose, OSFI has imposed minimum capital-to-regulatory (or risk-weighted) assets ratios and a minimum leverage ratio which is calculated on a different basis from the income tax assets to capital ratio discussed in the “Income Tax Capital” sub- section. Since the financial crisis, OSFI and the Basel Committee on Banking Supervision (“BCBS”) have taken measures to promote a more resilient banking sector and strengthen global capital standards. Changes from Basel III that impact MCAN through the Capital Adequacy Requirements (“CAR”) Guideline, Leverage Ratio and other items are listed below. We expect to be able to meet OSFI’s requirements and expectations without materially adversely affecting the Company’s business plan. (cid:120) OSFI requires all federally regulated financial institutions to meet the minimum Common Equity Tier 1 (“CET 1”), Total Tier 1 and Total Capital requirements set out therein. The minimum capital ratios are 4.5% for CET 1, 6% for Total Tier 1 and 8% for Total Capital (with the phase-in of certain regulatory adjustments and phase-out of non-qualifying capital instruments by 2022). (cid:120) (cid:120) (cid:120) The regulatory adjustments to be phased into the calculation of the capital ratios of a federally regulated financial institution include the deduction of certain significant investments in the capital of banking, financial and insurance entities above 10% of the institution’s CET 1 Capital (after certain prescribed regulatory adjustments), which incorporates an adjustment for the equity investment in MCAP into CET 1 capital. For 2016, the “transitional” basis phases the adjustment in by a factor of 60%, while the “all-in” basis incorporates the entire adjustment. The adjustment factor will increase by 20% annually over the phase-in period until it is fully deductible by 2018. In 2016, OSFI implemented the requirement for all federally regulated financial institutions to maintain a capital conservation buffer. The buffer will be phased in over time and will reach its final level of 2.5% in 2019. In addition to the minimum capital requirements and capital conservation buffer to be maintained by all federally regulated institutions, OSFI expects all such institutions to attain target capital ratios equal to or greater than the 2019 minimum capital ratios and the 2019 capital conservation buffer well in advance of the phase-in period. Accordingly, OSFI expects all federally regulated institutions to have a CET 1 ratio of 7% and a Total Tier 1 ratio of 8.5% and a Total Capital ratio of 10.5% (in each case, calculated on an “all in” basis giving effect to all regulatory adjustments that will be required by 2019 and including the 2019 capital conservation buffer). Failure to achieve such targets will serve as triggers for supervisory intervention. OSFI began the phase-in of the Credit Valuation Adjustment (“CVA”) risk capital charge in 2014. The CVA risk capital charge applicable to CET 1 Capital is 64% in 2016. This will increase annually until it reaches 100% by 2019. The implementation of the CVA risk capital charge has had an insignificant impact on MCAN. Our internal target minimum CET 1, Tier 1 and Total Capital ratios are 20%. We maintain prudent capital planning practices to ensure that we are adequately capitalized and continue to satisfy minimum standards and internal targets. OSFI and the BCBS are finalizing consultations for an update to the regulatory capital framework for loans secured by residential real estate properties. The potential impact to MCAN will largely be in changes to the risk weighting of mortgages as calculated in the standardized approach and a new capital charge for insured mortgages. In late 2016, OSFI enacted revisions to the CAR Guideline effective January 1, 2017. The key revisions that impact MCAN are as follows: (cid:120) (cid:120) An explicit requirement that institutions have appropriate policies and procedures in place to originate, underwrite and administer insured single family mortgages so as to receive a 0% risk-weighting for these assets; otherwise they would attract a 35% or 75% risk weighting similar to uninsured single family mortgages. A revision to the risk-weighting of equity investments in funds. MCAN would likely use the “look through” approach that incorporates the risk-weighting of assets held inside the fund and the leverage used by the fund. This revision will impact the risk-weighting of the financial investments in Crown LP and the KingSett High Yield Fund. - 42 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 33: Regulatory Capital (in thousands except %) As at Regulatory Ratios (OSFI) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Deduction for equity investment in MCAP (Transitional adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (Transitional) 2 Deduction for equity investment in MCAP (All-in adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (All-in) 2 Total Exposures/Regulatory Assets 2 Consolidated assets Less: deductions from all-in Tier 1 Capital 1 Other adjustments 3 Total On-Balance Sheet Exposures Mortgage and investment funding commitments Less: conversion to credit equivalent amount (50%) Letters of credit Less: conversion to credit equivalent amount (50%) Total Off-Balance Sheet Items December 31 September 30 December 31 2016 2016 2015 $ $ $ $ $ $ $ $ 210,239 510 55,923 15,104 (13,576) 268,200 (9,051) 259,149 2,280,855 (22,627) 1,489 2,259,717 402,861 (201,431) 30,537 (15,269) 216,698 210,239 510 53,846 11,271 (12,892) 262,974 (8,595) 254,379 $ $ $ 206,382 510 42,617 9,293 (7,324) 251,478 (10,986) 240,492 2,291,005 (21,487) 1,920 2,271,438 $ 2,246,958 (18,310) 2,229 2,230,877 393,698 (196,849) 31,306 (15,653) 212,502 333,667 (166,834) 35,863 (17,932) 184,764 Total Exposures/Regulatory Assets $ 2,476,415 $ 2,483,940 $ 2,415,641 Leverage ratio 2 Risk weighted assets (transitional) 2 Risk weighted assets (all-in) 2 10.46% 10.24% 9.96% $ $ 1,167,226 1,149,124 $ $ 1,183,427 1,166,237 $ 1,066,558 $ 1,044,586 Regulatory Capital Ratios 2 Common Equity Tier 1 capital to risk-weighted assets ratio (transitional) Tier 1 capital to risk-weighted assets ratio (transitional) Total capital to risk-weighted assets ratio (transitional) Common Equity Tier 1 capital to risk-weighted assets ratio (all-in) Tier 1 capital to risk-weighted assets ratio (all-in) Total capital to risk-weighted assets ratio (all-in) 22.98% 22.98% 22.98% 22.55% 22.55% 22.55% 22.22% 22.22% 22.22% 21.81% 21.81% 21.81% 23.58% 23.58% 23.58% 23.02% 23.02% 23.02% 1 The deduction for the equity investment in MCAP on an all-in basis is equal to the equity investment balance less 10% of the Company’s shareholders’ equity. In 2016, the deduction on the transitional basis is equal to 60% of the all-in adjustment (2015 - 40%). The adjustment factor will increase by 20% annually over the phase-in period until it is fully deductible by 2018. 2 Refer to the “Non-IFRS Measures” section of this MD&A for a definition of these measures. 3 Certain items, such as negative cash balances, are excluded from total exposures but included in consolidated assets. - 43 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 34: Regulatory Risk-Weighted Assets (in thousands except %) As at December 31 2016 Per Balance Average Risk Weighted Assets Rate Sheet 2015 Per Balance Average Risk Weighted Assets Rate Sheet On-Balance Sheet Assets Cash and cash equivalents Cash held in trust Marketable securities Mortgages - corporate Mortgages - securitized Financial investments Other loans Equity investment in MCAP (all-in) 1 Foreclosed real estate Deferred tax asset Other assets $ 111,732 15,724 55,126 904,112 1,071,849 57,264 3,584 50,805 529 1,782 8,348 20% $ 20% 100% 71% 3% 100% 100% 55% 100% 100% 100% Off-Balance Sheet Items Letters of credit Commitments Charge for operational risk 30,537 402,861 50% 46% $ 75,762 13,112 40,735 944,109 1,075,947 41,793 4,176 44,191 529 1,125 5,479 21% $ 20% 100% 67% 3% 100% 100% 59% 100% 100% 100% 35,863 333,667 50% 44% 22,644 3,145 55,126 637,871 37,432 57,264 3,584 28,177 529 1,782 8,348 855,902 15,269 184,378 199,647 93,575 15,598 2,622 40,735 629,171 27,288 41,793 4,176 25,879 529 1,125 5,479 794,395 17,932 148,109 166,041 84,150 Risk-Weighted Assets (all-in) 1,149,124 1,044,586 Equity investment in MCAP (transitional adjustment) 1 Risk-Weighted Assets (transitional) 18,102 $ 1,167,226 21,972 $ 1,066,558 1 In calculating risk-weighted assets on the "all-in" basis, the capital deduction related to the investment in MCAP is risk weighted at 0%, while the component not deducted from capital is risk weighted at 100%. In calculating risk-weighted assets on the transitional basis, the difference between the all-in deduction and the transitional deduction is risk weighted at 200%. Other Capital Management Activity In conjunction with the annual strategic planning and budgeting process, we complete an Internal Capital Adequacy Assessment Process (“ICAAP”) in order to ensure that we have the capital adequacy to support our business plan and risk appetite. The ICAAP assesses the capital necessary to support the various inherent risks that we face, including credit, liquidity, interest rate, market, geographic concentration and reputational risks. Our business plan is also stress-tested under various adverse scenarios in order to determine the impact on our results from operations and financial condition. The ICAAP is reviewed by both management and the Board and is submitted to OSFI annually. In addition, the Company performs stress testing on our internal forecasts for capital adequacy on a quarterly basis, and the results of such testing are reported to the Board. - 44 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION LIQUIDITY MANAGEMENT Our liquidity management process includes a Liquidity Risk Management Framework that incorporates multi scenario stress testing. Results of the stress testing are reported to management on a monthly basis and to the Risk Committee of the Board (“RCB”) on a quarterly basis. For further information on how we manage liquidity risk, refer to the “Liquidity and Funding Risk” sub-section of the “Risk Governance & Management” section of this MD&A. For information on our credit facilities refer to Note 31 to the consolidated financial statements. OSFI’s Liquidity Adequacy Requirements (“LAR”) guideline establishes three minimum standards based on the Basel III framework with national supervisory discretion applied to certain treatments: the Liquidity Coverage Ratio (“LCR”) and Net Cumulative Cash Flow (“NCCF”) metric, which both became effective January 1, 2015, and the Net Stable Funding Ratio (“NSFR”), which is effective January 1, 2018. As at December 31, 2016, we were in compliance with the LCR and NCCF and we believe that we will be able to comply with the NSFR requirements once enacted. These requirements are supplemented by additional supervisory monitoring metrics including the liquidity monitoring tools and the intraday liquidity monitoring tools as considered in the Basel III framework. The following table shows the composition of our internal liquidity ratios. These internal ratios include assumptions relating to the value of liquid assets such as the ability to sell these assets in a stressed market scenario. We manage our liquid assets to a minimum of 100% of term deposit liabilities maturing within 100 days. As at December 31, 2016, we were in compliance with our internal liquidity ratios. Table 35: Liquidity Ratios (in thousands except %) As at Tier 1 liquid assets 1 Cash and cash equivalents Tier 2 liquid assets 1 Marketable securities Less: marketable securities adjustment 2 Market MBS retained by MCAN 3 Tier 3 liquid assets 1 Single family insured mortgages 4 Less: single family insured mortgages adjustment 4 December 31 2016 September 30 2016 December 31 2015 $ 111,732 $ 80,204 $ 75,762 55,126 (13,007) 36,606 78,725 69,899 (24,293) 45,606 52,901 (12,636) 37,616 77,881 76,338 (29,820) 46,518 40,735 (10,104) 21,250 51,881 60,399 (18,503) 41,896 Total liquid assets 1 100 day term deposit maturities $ $ 236,063 $ 204,603 130,357 $ 141,194 $ $ 169,539 92,622 Liquidity ratios 1 Tier 1 & 2 liquid assets to 100 day term deposit maturities Total liquid assets to 100 day term deposit maturities 146% 181% 112% 145% 138% 183% 1 Refer to the "Non-IFRS Measures" section of this MD&A for a definition of these measures. 2 Adjusted to reflect estimated impact to fair market value in a stressed scenario. Corporate bonds are reduced as follows: BBB- or higher (30%); below BBB- (45%). REITs are reduced as follows: constituent in TSX/S&P Composite Index (20%); not a constituent in TSX/S&P Composite Index (40%). 3 Included in corporate mortgages - insured single family. For further information, refer to the "Securitization Programs" section of this MD&A. 4 Single family insured mortgages exclude mortgages pledged as collateral and second mortgages not insured by CMHC. The adjustment reflects lower liquidity than Tier 1 and Tier 2 liquidity, as follows: CMHC insured (25%), CMHC insured second mortgages (50%), privately insured (50%). - 45 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Our sources and uses of liquidity are outlined in the table below. We manage our net liquidity surplus/deficit by raising term deposits as mentioned above. Table 36: Liquidity Analysis (in thousands) Sources of liquidity Cash and cash equivalents Marketable securities Mortgages - corporate Financial investments Other loans Uses of liquidity Term deposits Other liabilities Within 3 Months To 1 Year 3 Months 1 to 3 Years 3 to 5 Years Over 5 December 31 December 31 2015 2016 Years $ 111,732 $ 53,953 118,906 - 1,535 286,126 513 420,209 - - 420,722 - $ - $ 629 314,006 - - 314,635 - $ - 38,464 - 2,049 40,513 - $ 31 12,527 57,264 - 69,822 111,732 $ 55,126 904,112 57,264 3,584 1,131,818 75,762 40,735 944,109 41,793 4,176 1,106,575 119,472 12,377 131,849 327,739 - 327,739 336,926 - 336,926 127,729 - 127,729 - - - 911,866 12,377 924,243 903,041 12,412 915,453 Net liquidity surplus (deficit) $ 154,277 $ 92,983 $ (22,291) $ (87,216) $ 69,822 $ 207,575 $ 191,122 Off-Balance Sheet Unfunded mortgage commitments $ 324,680 $ 39,481 $ Commitment - KingSett High Yield Fund - - $ 324,680 $ 39,481 $ - $ - - $ - $ - $ 364,161 $ 308,242 38,700 - - $ 38,700 $ 38,700 402,861 $ 25,425 333,667 Note: The above table excludes securitized assets and liabilities and pledged assets as their use is restricted to securitization program operations. - 46 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION RISK GOVERNANCE AND MANAGEMENT We are exposed to a number of risks, including credit risk, liquidity and funding risk, operational risk, strategic and business risk, reputational risk, interest rate risk, market risk and cyber risk, that can adversely affect our ability to achieve our business objectives or execute our business strategies, and which may result in a loss of earnings, capital and/or damage to our reputation. We mitigate these risks through prudent credit limits, established lending policies and procedures, effective monitoring and reporting, investment diversification and by the diligent management of assets and liabilities. We operate in changing regulatory and economic environments. As a result, we believe that our management team and the Board are particularly diligent in their consideration of all identified and emerging risks. Our goal is not to eliminate risk, as this would result in significantly reduced earnings, but rather to be proactive in our assessment and management of risk, as a means to gain a strategic advantage and ultimately enhance shareholder value. The risks that have been identified may not be the only risks that we face. Other risks of which we are not aware of or which we currently deem to be immaterial may surface and have a material adverse impact on our business, results from operations and financial condition. The shaded areas of this MD&A represent a discussion of risk factors and risk management policies and procedures relating to credit, liquidity, interest rate and market risks as required under IFRS 7, Financial Instruments: Disclosures. The relevant MD&A sections are identified by shading within boxes and the content forms an integral part of the consolidated financial statements. Risk Governance The RCB is responsible for overseeing risk management across the Company. It looks to ensure the relevance of the Company’s Risk Appetite Framework (“RAF”) and its alignment with the Company’s strategy. It has the responsibility to ensure that the risk management function is independent from the business activity it oversees, and is supported by an Enterprise Risk Management framework (“ERMF”) consisting of policies, procedures and controls. The goal of the ERMF is to manage risks within the Company’s risk framework and appetite. The Chief Executive Officer (“CEO”) and the executive management team are responsible for developing the strategy and a comprehensive set of enterprise wide policies, including the RAF and ERMF for approval by the Board. They are responsible for fostering a strong risk culture through the “tone at the top” and applying the approved strategy and RAF to the business operations of the Company to help maximize, within the Company’s risk appetite, the benefit to shareholders and other stakeholders from a portfolio of risks that the Company is willing to accept. MCAN’s Executive Committee recommends a risk appetite that aligns with the Mission Statement, Operating Philosophies and Goals and Objectives of the Company and the Operating Committee provides governance over the operations of MCAN to ensure that the strategy and tactics used by MCAN in its funding and investing activities are effective in meeting the Company’s stated objectives. The Company’s operating model is predicated on the three-lines-of-defense approach to the management of risk. The operating areas headed by the CEO are the first line of defense in the Company’s management of risk. They “own” the risk in their areas of responsibility and are responsible for ensuring the Company pursues only suitable business opportunities that are within the Company’s risk appetite. The second line of defense establishes the enterprise level risk management framework and policies, and provides risk guidance and oversight of the effectiveness of first line risk management practices. These activities are provided by: (cid:120) (cid:120) The Chief Risk Officer (“CRO”), who is responsible for providing independent review and oversight of enterprise-wide risks and for the fostering of a strong risk culture throughout the organization. The CRO has responsibility for maintaining and managing the RAF and in that regard for confirming and reporting on the significant business risks as identified by and assessed by the first line of defense of the Company. The Chief Financial Officer (“CFO”), who is responsible for the accuracy and integrity of the Company’s accounting and financial reporting systems, financial statements, and planning and budgeting systems and documents. The CFO ensures legal and regulatory compliance for all financial matters within the Company. The CFO is responsible for the Company’s financial and capital plans which are presented to the Executive Committee and the Board for annual approval. Progress against these plans is regularly reported to the Board and regulators. The Finance department, led by the CFO, also updates the plan with periodic forecasts, advises the Board of anticipated outcomes, and recommends revisions to capital plans and structures as appropriate. (cid:120) The Chief Compliance Officer (“CCO”), who is responsible for measuring, and reporting on, compliance with the Company’s policies and processes that have been designed to manage and mitigate regulatory compliance risk. The - 47 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CCO is mandated to promote a sound compliance culture, report to the Board on compliance with legislative requirements and make recommendations related to compliance activities. (cid:120) The Chief Anti-Money Laundering Officer (“CAMLO”), who is responsible for the Company’s adherence to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) with regard to its deposit taking and lending activities. The third line of defense is provided by MCAN’s internal audit group which monitors, and reports on, the effectiveness of controls, risk management, and governance practices within the Company. Risk Appetite MCAN’s RAF sets out the approach to risk management used by the Company in pursuing its strategic and business objectives. Key principles that guide MCAN’s approach to risk appetite are as follows: (cid:120) MCAN’s strategy, including business objectives, business plans and stakeholder expectations should be reflected in the risk appetite. (cid:120) (cid:120) (cid:120) (cid:120) The approach should engage both top down senior management and Board leadership and bottom up involvement of employees at all levels. Risk appetite considerations should be embedded in both strategic and day-to-day decisions and supported by a reinforced risk culture aligning decision making and risk. The approach to risk appetite should reflect good industry practices and relevant regulatory guidance. The approach should be forward looking and enable adaptation to changing business and market conditions; it should also give consideration to the skills, resources and technology required to manage and monitor identified risk exposures and the potential impacts of stressed conditions. The RAF purposes and objectives are as follows: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Define maximum levels of risk that are within MCAN’s risk capacity including regulatory constraints in order to achieve its strategic objectives within appropriate and approved target returns. Give consideration to all material risks reflecting all key aspects of the business. Contain both qualitative and quantitative elements to define acceptable risk levels within MCAN’s risk capacity. Set out limits and targets to enable the Board and senior management to assess MCAN’s performance and current risk levels relative to risk appetite. Consider MCAN’s current capital position and ability to handle the range of results that may occur under normal operating conditions and under a range of stress scenarios. - 48 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION The Board has oversight responsibility for risk governance within MCAN. It provides this oversight and carries out its risk management mandate primarily through the RCB, the Audit Committee of the Board (the “Audit Committee”), the Conduct Review, Corporate Governance and Human Resources Committee of the Board (the “CR, CG & HR Committee”) and the Enterprise Risk Management Ad Hoc Committee (the “ERM Ad Hoc Committee”). There is a further committee structure at the management level as illustrated in the following diagram: - 49 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Credit Risk Credit risk is the risk of financial loss resulting from the failure of a counterparty, for any reason, to fully honour its financial or contractual obligations to the Company, primarily arising from our mortgage and lending activities. Fluctuations in real estate values may increase the risk of default and may also reduce the net realizable value of the collateral property to the Company. These risks may result in defaults and credit losses, which may result in a loss of earnings. Credit losses occur when a counter party fails to meet its obligations to the Company and the value realized on the sale of the underlying security deteriorates below the carrying amount of the exposure. Credit Risk Management Credit and commitment exposure is closely monitored through a reporting process that includes a formal monthly review involving ALCO and a formal quarterly review involving the RCB. A CRO Report, which identifies, assesses, ranks and provides trending analysis on all material risks to the Company, is provided to the RCB on a quarterly basis. Monitoring also takes place through our Capital Commitments Committee and Single Family Credit Committee, which are both comprised of certain members of management. Our exposure to credit risk is managed through prudent risk management policies and procedures that emphasize the quality and diversification of our investments. Credit limits, based on our risk appetite, which is approved by the Board at least annually, have been established for concentration by asset class, geographic region, dollar amount and borrower. These policies are amended on an ongoing basis to reflect changes in market conditions and our risk appetite. All members of management are subject to limits on their ability to commit the Company to credit risk. We identify potential risks in our mortgage portfolio by way of regular review of market metrics, which are a key component of quarterly market reports provided to the RCB. We also undertake site visits of active mortgage properties. Existing risks in our mortgage portfolio are identified by arrears reporting, portfolio diversification analysis, annual reviews of large loans and risk rating trends of the entire mortgage portfolio. The aforementioned reporting and analysis provides adequate monitoring of and control over our exposure to credit risk. In the current economic environment, we have increased our monitoring of real estate market values for single family mortgages, with independent assessments of value obtained as individual mortgages exceed 90 days in arrears. We assign a credit score and risk rating for all mortgages at the time of underwriting based on the quality of the borrower and the underlying real estate. Risk ratings are reviewed annually for large exposures, and whenever there is an amendment or a material adverse change such as a default or impairment. We have established a methodology for determining the adequacy of our collective allowances. The adequacy of collective allowances is assessed periodically, taking into consideration economic factors such as Gross Domestic Product, employment, housing market conditions as well as the current position in the economic cycle. We record an individual allowance to the extent that the estimated realizable value of a mortgage has decreased below its net book value. Individual allowances include all of the accumulated provisions for credit losses on a particular mortgage. Our maximum credit exposure on our individual financial assets is equal to the carrying value of the respective assets, except for our corporate mortgage portfolio, whose maximum credit exposure also includes outstanding commitments for future mortgage fundings. Liquidity and Funding Risk Liquidity and funding risk is the risk that cash inflows, supplemented by assets readily convertible to cash, will be insufficient to honour all cash outflow commitments (both on and off-balance sheet) as they come due. The failure of borrowers to make regular mortgage payments increases the uncertainties associated with liquidity management, notwithstanding that we may eventually collect the amounts outstanding, which may result in a loss of earnings or capital, or have an otherwise adverse effect on our financial condition and results of operations. For information on the contractual maturities of certain obligations of the Company, refer to notes 17, 20 and 30 to the consolidated financial statements. Liquidity and Funding Risk Management We closely monitor our liquidity position to ensure that we have sufficient cash to meet liability obligations as they become due. The RCB is responsible for the approval of liquidity policies. The Asset and Liability Committee (“ALCO”), which is comprised of management, is responsible for liquidity management. We have an internal target of a standard level of liquid investments (cash - 50 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION and cash equivalents, marketable securities, MCAN-issued market MBS retained on our balance sheet, 75% of CMHC-insured single family mortgages, 50% of CMHC-insured single family second mortgages and 50% of privately insured mortgages) of at least 100% of term deposits maturing within 100 days. As at December 31, 2016 and December 31, 2015, we met this internal target. In addition, all single family mortgages are readily marketable within a time frame of one to three months, providing us with added flexibility to meet unexpected liquidity needs. We have access to capital through our ability to issue term deposits eligible for CDIC deposit insurance. These term deposits also provide us with the ability to fund asset growth as needed. We also maintain an overdraft facility to fund asset growth or meet our short-term obligations as required. The overdraft facility is a component of a larger credit facility that also has a portion which guarantees letters of credit used to support the obligations of borrowers to municipalities in conjunction with construction loans. The total facility is $75 million, with sub-limits of $50 million for overdrafts and $50 million for letters of credit. As at December 31, 2015 we also maintained a $50 million credit warehouse facility for which insured single family mortgages acted as collateral. In early 2016, the credit warehouse facility counterparty ceased its operations, and as a result thereof, the credit warehouse was terminated. Subsequent to year end, we entered into an agreement with a Canadian Schedule I Chartered bank that enables the Company to execute repurchase agreements for liquidity purposes. This facility provides a new source of liquidity and allows the Company to encumber certain eligible securities for financing purposes. As part of the agreement, we may sell assets to the counterparty at a specified price with an agreement to repurchase at a specified future date. The interest rate on the borrowings is driven by market spot rates at the time of borrowing. We believe that our liquidity position and our access to capital markets in the form of term deposits and the banking facility support our ability to meet current and future commitments as they come due. Management has developed a Liquidity Risk Management Framework that is reviewed and approved annually by the Board. This framework details the daily, monthly and quarterly analysis that is performed by management. Management monitors changes in cash and cash requirements on a daily basis and formally reports to ALCO on a monthly basis. Management also completes monthly and quarterly stress testing which is reviewed by ALCO and the RCB. Management monitors trends in deposit concentration with significant term deposit brokers on a monthly basis. We have established and maintain liquidity policies and procedures which meet the standards set under the Trust Act and regulations or guidelines issued by OSFI. For a discussion regarding liquidity risk relating to the maturity of securitization program liabilities, refer to the “Timely Payment” sub-section of the “Securitization Programs” section of this MD&A. Operational Risk Operational risk is the potential for loss resulting from people, inadequate or failed internal processes, systems, or from external events. The risk of loss from people includes internal or external fraud, non-adherence to internal procedures/values/objectives or unethical behaviour. The largest components of this risk for MCAN have been separately identified as outsourcing risk and cyber risk. The remaining risks arise from the small size and entrepreneurial nature of MCAN, and the legacy systems used within it. The exposure to financial misreporting, inaccurate financial models, fraud, breaches in privacy, information security, attraction and retention of employees, and business continuity and recovery are included within operational risk. Operational Risk Management We manage operational risk through various committees and processes. Our management team reviews operational measures on a recurring basis as part of the Operating Committee, Compliance Audit and ERM Ad Hoc Committee, and ALCO. We also provide monthly updates to the Board on operations and other key factors and issues that arise. We also maintain appropriate insurance coverage through a financial institution bond policy, which is reviewed at least annually by the Board for changes to coverage and our operations. Outsourcing Risk Within operational risk, outsourcing risk is the risk incurred when we contract out a business function to a service provider instead of performing the function ourselves, and the service provider performs at a lower standard than we would have under similar circumstances. We outsource the majority of our mortgage and loan origination, servicing and collections to MCAP and other third parties. - 51 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Outsourcing Risk Management MCAN’s Outsourcing Policy, which is approved annually by the Board, incorporates the relevant requirements of OSFI Guideline B-10, Outsourcing of Business Activities, Functions and Processes. We review our outsourced arrangements on an annual basis to determine if the arrangement is material. If the arrangement is material it is subjected to a risk management program, which includes detailed monitoring activities. Risk of Accuracy and Completeness of Borrower Information Within operational risk, in the single family mortgage underwriting process, we rely on information provided by potential borrowers and other third parties, including mortgage brokers. We may also rely on the representations of potential borrowers and third parties as to the accuracy and completeness of that information. Our financial position and performance may be negatively impacted if this information is intentionally misleading or does not fairly represent the financial condition of the potential borrower and is not detected by our internal controls. Management of Risk of Accuracy and Completeness of Borrower Information We frequently review and/or update our underwriting policies, procedures and control processes to strengthen our ability to detect and to better manage this risk. These updates include improvements to underwriting staff training, independent income verification procedures, internal audit, risk and other quality control and quality assurance processes. Strategic and Business Risk Strategic and business risk is the risk of loss due to fluctuations 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 Management Strategic and business risk is managed by the CEO and senior management. The Board approves the Company’s strategies at least annually and reviews results against those strategies at least quarterly. Reputational Risk Reputational risk is the negative consequence of the occurrence of other risks and can occur from an activity undertaken by the Company, its affiliated companies, or its representatives. The loss of reputation can greatly affect shareholder value through reduced public confidence, a loss of business, legal action, or increased regulatory oversight. Reputation refers to the perception of the enterprise by various stakeholders. Typically, key stakeholder groups include investors, customers, employees, suppliers and regulators. Perceptions may be impacted by various events including financial performance, specific adverse occurrences from events such as cyber security issues, unfavourable media coverage, and changes or actions of the corporation’s leadership. Failure to effectively manage reputation risk can result in reduced market capitalization, loss of client loyalty, and the inability to achieve our strategic objectives. Reputational Risk Management We believe that the most effective way for the Company to safeguard its public reputation is through the successful management of the underlying risks in the business. Interest Rate Risk Interest rate risk is the potential impact of changes in interest rates on our earnings and capital. Interest rate risk arises when our assets and liabilities, both on and off-balance sheet, have mismatched repricing dates. Changes in interest rates where we have mismatched repricing dates may have an adverse effect on our financial condition and results of operations. In addition, interest rate risk may arise when changes in the underlying interest rates on assets do not match changes in the interest rates on liabilities. This potential mismatch may have an adverse effect on our financial condition and results of operations. Our exposure to interest rate risk is discussed further in Note 32 to the consolidated financial statements. Interest Rate Risk Management We evaluate our exposure to a variety of changes in interest rates across the term spectrum of our assets and liabilities, including both parallel and non-parallel changes in interest rates. By managing and matching the terms of corporate assets and term - 52 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION deposits so that they offset each other, we seek to reduce the risks associated with interest rate changes, and in conjunction with liquidity management policies and procedures, we also manage cash flow mismatches. ALCO reviews our interest rate exposure on a monthly basis using interest rate spread and gap analysis as well as interest rate sensitivity analysis based on various scenarios. This information is also formally reviewed by the RCB each quarter. We are exposed to interest rate risk on insured single family mortgages between the time that a mortgage rate is committed to borrowers and the time that the mortgage is funded, or in the case of mortgages securitized through the market MBS or CMB programs, the time that the mortgage is securitized. To manage this risk, we may enter into interest rate swaps or we may match them with long-term fixed-rate term deposits. Ultimately, risk management is monitored and controlled at the highest level of the Company. ALCO reviews and manages these risks on a monthly basis. The Board also reviews and approves all risk management policies and procedures at least annually. Management reports to the Board on the status of risk management at least quarterly. Market Risk Market risk is the exposure to adverse changes in the value of financial assets. Our market risk factors include price risk on marketable securities, interest rates, real estate values and commodity prices, among others. Any changes in these market risk factors may negatively affect the value of our financial assets, which may have an adverse effect on our financial condition and results of operations. We do not undertake trading activities as part of our regular operations, and therefore are not exposed to risks associated with activities such as market making, arbitrage or proprietary trading. Market Risk Management Our marketable securities portfolio is susceptible to market price risk arising from uncertainties about future values of the securities. We manage the equity price risk through diversification and limits on both individual and total securities. Reports on the portfolio are submitted to senior management on a regular basis and to the Board on a quarterly basis. Cyber Risk We collect and store confidential and personal information to the extent needed for operational purposes. Unauthorized access to the Company’s computer systems could result in the theft or publication of confidential information or the deletion or modification of records or could otherwise cause interruptions in the Company’s operations. In addition, despite the Company’s implementation of security measures, its systems are vulnerable to damages from computer viruses, natural disasters, unauthorized access, cyber-attack and other similar disruptions. Any such system failure, accident or security breach could disrupt the Company’s delivery of services and make the Company’s applications unavailable or cause similar disruptions to the Company’s operations. If a person penetrates the Company’s network security or otherwise misappropriates sensitive data, we could be subject to liability or our business could be interrupted, and any of these developments could have a material adverse effect on the Company’s business, results of operations and financial condition. Cyber Risk Management We manage cyber risk through oversight by management, including an IT Management Committee, as well as the use of external third party advisors and service providers to provide technical expertise. We undertook a cyber security assessment during 2016 that is intended to be updated on an annual basis. We employ the use of external security experts to assist and monitor our information technology infrastructure for cybersecurity risks. We have also undertaken external vulnerability tests performed by an independent external party. Additionally, we maintain an incident response plan and have designated officers responsible for the oversight over the cybersecurity risks. We also maintain cyber security insurance coverage for both direct and third party coverage in the event of a cyber security incident that would result in a loss. Other Risk Factors General Litigation In the ordinary course of business, MCAN and its service providers (including MCAP), their subsidiaries and related parties may be party to legal proceedings that may result in unplanned payments to third parties. To the best of our knowledge, we do not expect the outcome of any existing proceedings to have a material adverse effect on the consolidated financial position or results of operations of the Company. - 53 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Reliance on Key Personnel Our future performance is dependent on the abilities, experience and efforts of our management team and other key personnel. There is no assurance that we will be able to continue to attract and retain key personnel, although it remains a key objective of the Company. Should any key personnel be unwilling or unable to continue their employment with MCAN, there may be an adverse effect on our financial condition and results of operations. Economic Conditions Factors that could impact general business conditions include changes in short-term and long-term interest rates, commodity prices, inflation, consumer, business and government spending, real estate prices and adverse economic events. Regulatory Risk Changes in laws and regulations, including interpretation or implementation, may affect the Company by limiting the products or services that we can provide and increasing the ability of competitors to compete with our products and services. Also, any failure by the Company to comply with applicable laws and regulations may result in sanctions and financial penalties which may adversely impact our earnings and damage our reputation. Increasing regulations and expectations as a result of the recent financial crisis, both globally and domestically, have increased the cost and resources necessary to meet regulatory expectations for the Company. Qualification as a Mortgage Investment Corporation If for any reason we do not maintain our qualification as a MIC under the Tax Act, taxable dividends and capital gains dividends paid by MCAN on our common shares will cease to be fully or partly deductible in computing income for tax purposes and such dividends will no longer be deemed by the rules in the Tax Act that apply to MICs to have been received by shareholders as interest or a capital gain, as the case may be. As a consequence, the rules in the Tax Act regarding the taxation of public corporations and their shareholders should apply, with the result that the combined rate of corporate and shareholder tax could be significantly greater. Mortgage Renewal Risk We retain renewal rights on mortgages that we originate that are either sold to third parties or retained on the consolidated balance sheet. If mortgagors are unable to renew their mortgages at their scheduled maturities, we may be required to use our own financial resources to fund these obligations until mortgage arrears are collected or proceeds are received from mortgage insurers following the sale of mortgaged properties. Mortgage Prepayment Risk In acquiring certain mortgages from third parties, we pay a premium to the mortgage par value based on the expected term of the mortgage. To the extent that mortgages repay prior to maturity, we may be required to accelerate the amortization of the premium and sustain a financial loss. Competition Risk Our operations and income are a function of the interest rate environment, the availability of mortgage products at reasonable yields and the availability of term deposits at reasonable cost. The availability of mortgage products for the Company and the yields thereon are dependent on market competition. In the event that we are unable to compete successfully against our current or future competitors or raise term deposits to fund our lending activities, there may be an adverse effect on our financial condition and results of operations. Monetary Policy Our earnings are affected by the monetary policies of the Bank of Canada. Changes in the supply and demand of money and the general level of interest rates could affect our earnings. Changes in the level of interest rates affect the interest spread between our mortgages, loans and investments, securitization investments and term deposits, and as a result may impact our net investment income. Changes to monetary policy and in financial markets in general are beyond our control and are difficult to predict or anticipate. - 54 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Environmental Risk We recognize that environmental hazards are a potential liability. This risk exposure can result from non-compliance with environmental laws, either as principal or lender, which may negatively affect our financial condition and results of operations. We aim to mitigate this risk by complying with all environmental laws and by applying a rigorous environmental policy and procedures to our commercial and development lending activities. Changes in Laws and Regulations Changes to current laws, regulations, regulatory policies or guidelines (including changes in their interpretation, implementation or enforcement), the introduction of new laws, regulations, regulatory policies or guidelines or the exercise of discretionary oversight by regulatory or other competent authorities including OSFI, may adversely affect us, including by limiting the products or services that we provide, restricting the scope of our operations or business lines, increasing the ability of competitors to compete with our products and services or requiring us to cease carrying on business. In addition, delays in the receipt of any regulatory approvals and authorizations that may be necessary to the operation of our business may adversely affect our operations and financial condition. Our failure to comply with applicable laws and regulations may result in sanctions and financial penalties that could adversely impact our earnings and damage our reputation. Changes in Accounting Standards and Accounting Policies We may be subject to changes in the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes may materially impact how we record and report our financial condition and results of operations and, in certain circumstances, we may be required to retroactively apply a new or revised standard that results in our restating prior period financial statements. Please refer to the “Standards Issued But Not Yet Effective” section of this MD&A for further details. Leverage Leverage increases our potential exposure to all risk factors described above. No Assurance of Achieving Investment Objectives or Payment of Dividends As a result of the risks discussed above, there is no assurance that we will be able to achieve our investment objectives or be able to pay dividends at targeted or historic levels. The funds available for the payment of dividends to our shareholders will vary according to, among other things, the principal and interest payments received in respect of the Company’s investments. There can be no assurance that the Company will generate any returns or be able to pay dividends to our shareholders in the future. DESCRIPTION OF CAPITAL STRUCTURE Our authorized share capital consists of an unlimited number of common shares with no par value. At December 31, 2016, there were 23,075,227 common shares outstanding (December 31, 2015 - 22,782,433). As at February 23, 2017, there were 23,147,410 common shares outstanding. During 2016, we issued 280,376 new common shares under the DRIP (2015 - 568,588), which provides MCAN with a reliable source of new capital and existing shareholders an opportunity to acquire additional shares at a discount to market value. Under the DRIP, dividends paid to shareholders are automatically reinvested in common shares issued out of treasury at the weighted average trading price for the five days preceding such issue less a discount of 2%. Additionally, in 2016 we issued 12,418 common shares through the Executive Share Purchase Plan (2015 - nil). In 2015, we closed a rights offering to common shareholders that raised $15.1 million of new share capital through the issuance of 1,406,084 common shares, creating $87 million of additional income tax asset capacity. For additional information related to share capital, refer to Note 21 to the consolidated financial statements. - 55 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION OFF-BALANCE SHEET ARRANGEMENTS We have contractual obligations relating to an operating lease, in addition to outstanding commitments for future fundings of corporate mortgages and our investment in the KingSett High Yield Fund. We outsource the majority of our mortgage servicing and continue to pay servicing expenses as long as the mortgages remain on our balance sheet. Table 37: Contractual Obligations (in thousands) Mortgage funding commitments Commitment - KingSett High Yield Fund Operating lease Less than one year One to Three to three years five years Over five December 31 2016 years December 31 2015 $ 364,161 $ - $ - $ - $ 364,161 $ 308,242 - 575 $ 364,736 $ - 1,158 1,158 $ - 1,194 1,194 $ 38,700 1,642 40,342 $ 38,700 4,569 407,430 $ 25,425 5,145 338,812 We retain mortgage servicing obligations relating to securitized mortgages where balance sheet derecognition has been achieved. For further information, refer to Note 6 to the consolidated financial statements. We provide letters of credit, which are not reflected on the consolidated balance sheet, for the purpose of supporting developer obligations to municipalities in conjunction with residential construction loans. For further information, refer to Note 31 to the consolidated financial statements. As at December 31, 2016, of our total single family mortgage renewal rights of $1.1 billion (December 31, 2015 - $1.3 billion), $130 million related to off-balance sheet mortgages sold to third parties on a whole loan basis (December 31, 2015 - $219 million). DIVIDEND POLICY AND RECORD Our dividend policy is to pay out substantially all of our taxable income to our shareholders. As a MIC under the Tax Act, we can deduct dividends paid to shareholders during the year and within 90 days thereafter from income for tax purposes. These dividends are taxable in the shareholders’ hands as interest income. In addition, as a MIC, we can pay certain capital gains dividends which are taxed as capital gains in the shareholders’ hands. We intend to continue to declare dividends on a quarterly basis. Dividends per share paid over the past three years are indicated in the table below. All dividends during this period have been regular dividends, i.e. none have been capital gains dividends. Table 38: Dividends Fiscal Period First Quarter Second Quarter Third Quarter Fourth Quarter 2016 2015 2014 $ $ 0.29 0.29 0.29 0.30 1.17 $ $ 0.28 0.28 0.28 0.29 1.13 $ $ 0.28 0.28 0.28 0.28 1.12 Consistent with the prior quarter dividend increase, the Board declared a first quarter dividend of $0.30 per share to be paid March 30, 2017 to shareholders of record as of March 15, 2017. - 56 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Figure 5: Dividend History Historically, extra dividends have been paid with the regular first quarter dividend. TRANSACTIONS WITH RELATED PARTIES Related party transactions for the years ended December 31, 2016 and December 31, 2015 are discussed in Note 29 to the consolidated financial statements. FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS The majority of our consolidated balance sheet consists of financial instruments, and the majority of net income is derived from the related income, expenses, gains and losses. Financial instruments include cash and cash equivalents, cash held in trust, marketable securities, mortgages, financial investments, other loans, financial liabilities from securitization, term deposits and loans payable, which are discussed throughout this MD&A. The use of financial instruments exposes us to interest rate, credit, liquidity and market risk. A discussion of these risks and how these risks are managed is found in the “Risk Governance and Management” section of this MD&A. Information on the financial statement classification and amounts of income, expenses, gains and losses associated with the instruments are located in the “Results from Operations” and “Financial Position” sections of this MD&A. Information on the determination of the fair value of financial instruments is located in the “Critical Accounting Estimates and Judgments” section of this MD&A. PEOPLE As at December 31, 2016, we had 61 employees. - 57 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION REGULATORY COMPLIANCE Our CCO ensures that management understands the impact of all relevant legislation affecting the business, assesses compliance with current and pending legislation and works with management to address any gaps in policies and procedures. We use a Regulatory Compliance Management System that ensures all managers assess their compliance with relevant legislation on a quarterly basis. Senior management liaises with regulators to keep them apprised of company progress and changes to our business. Our CCO reports quarterly to the CR, CG & HR Committee. INTERNAL AUDIT The Internal Audit function, consisting of the Chief Audit Officer, has unrestricted access to our operations, records, property and personnel, including senior management, the Chair of the Audit Committee and the other members of the Board. Internal Audit formulates an annual risk-based plan for approval by the Audit Committee and then undertakes internal audit reviews throughout the year with regular and direct reporting to both senior management and the Audit Committee. CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS The preparation of the Company’s financial statements requires management to make judgments and estimations and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities, at the end of the reporting period. Estimates are considered carefully and reviewed at an appropriate level within MCAN. We believe that our estimates of the value of our assets and liabilities are appropriate. However, uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of the asset or liability affected in future periods. Critical Accounting Estimates Fair value of financial instruments Where the fair values of financial assets and financial liabilities recorded in the consolidated financial statements cannot be derived from active markets, they are determined using a variety of valuation techniques that include the use of mathematical models. The inputs to these models are derived from observable market data where possible, but where observable market data are not available, estimates are required to establish fair values. These estimates include considerations of liquidity and model inputs such as discount rates, prepayment rates and default rate assumptions for certain investments. Allowances for credit losses The allowance for credit losses reduces the carrying value of mortgage assets to provide for an estimate of the principal amounts that borrowers may not repay in the future. In assessing the estimated realizable value of assets, we must rely on estimates and exercise judgment regarding matters for which the ultimate outcome is unknown. A number of factors can affect the amount that we ultimately collect, including the quality of our own underwriting process and credit criteria, the diversification of the portfolio, the underlying security relating to the loans and the overall economic environment. Individual allowances include all of the accumulated provisions for losses on particular assets required to reduce the related assets to estimated realizable value. The collective allowance represents losses that we believe have been incurred but not yet specifically identified. The collective allowance is established by considering historical loss trends during economic cycles, the risk profile of our current portfolio, estimated losses for the current phase of the economic cycle and historic industry experience. Allowance rates depend on asset class, as different classes have varying underlying risks. Future changes in circumstances could materially affect our future provisions for credit losses from those provisions determined in the current year, and there could be a need to increase or decrease the allowance for credit losses. We review our individually significant mortgage balances at each consolidated financial statement date to assess whether an impairment loss should be recorded. In particular, estimates by management are required in the calculation of the amount and timing of future cash flows when determining the impairment loss. In estimating these cash flows, the Company makes assumptions about the borrower’s financial situation and the net realizable value of collateral. These estimates are based on assumptions about a number of factors and actual results may differ, resulting in future changes to the allowance. Mortgages that have been assessed individually and found not to be impaired and all individually insignificant mortgages are then assessed collectively, in groups of mortgages with similar risk characteristics, to determine whether a provision should be made due to incurred loss events for which there is objective evidence but whose effects are not yet evident. The collective assessment takes account of data from the mortgage portfolio (such as credit quality, levels of arrears, credit utilization, loan to value ratios, etc.), concentrations of risks and economic data (including levels of unemployment, real estate prices indices and the performance of different individual groups). There have been no recent changes to the methodology, nor are any expected in the foreseeable future. No trends, events or uncertainties exist that may affect the methodology and assumptions used. - 58 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION We complete a review of all provisioning policies at least annually. We continue to monitor asset performance and current economic conditions, focusing on any regionally specific issues to assess the adequacy of the current provisioning policies. Provisioning rates are reviewed on a quarterly basis. In addition to considering current economic conditions, we assessed the probability of default, expected loss as a result of default and the mortgage exposure at the time of default when establishing our collective allowance. We continue to review our underwriting and credit requirements on a regular basis, and we have taken measures as warranted by changes in the market and economic conditions. Our current provisioning rates consider the impact of a decline in real estate values and anticipated default/loss percentages that are sufficient to offset current and historical loss experiences. Mortgage prepayment rates In calculating the rate at which borrowers prepay their mortgages, the Company makes estimates based on its historical experience. These assumptions impact the timing of revenue recognition and the amortization of mortgage premiums using the EIM. Taxes Uncertainties exist with respect to the interpretation of complex tax regulations, changes in tax laws and the amount and timing of future taxable income in the subsidiaries of the Company. Differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate future adjustments to tax income and expense already recorded in the subsidiaries of the Company. The Company establishes provisions, based on reasonable estimates, for possible consequences of audits by relevant tax authorities. The amount of such provisions is based on various factors, such as experience of previous tax audits and interpretations of tax regulations by the responsible tax authority. As the Company assesses the probability of litigation and subsequent cash outflow with respect to taxes as remote, no contingent liability has been recognized. Deferred tax assets are recognized for all unused tax losses to the extent that it is probable that taxable income will be available against which the losses can be used in the subsidiaries of the Company. Significant management judgment is required to determine the amount of deferred tax assets that can be recognized in the subsidiaries of the Company, based upon the likely timing and the level of future taxable income together with future tax planning strategies. Impairment of financial assets As applicable, the Company reviews financial assets at each consolidated financial statement date to assess whether an impairment loss should be recorded. In particular, estimates by management are required in the calculation of the amount and timing of future cash flows when determining the impairment loss. These estimates are based on assumptions about a number of factors and actual results may differ, resulting in future changes to the fair value of the asset. Critical Accounting Judgments Going concern The Company’s management has made an assessment of the Company’s ability to continue as a going concern and is satisfied that the Company has the resources to continue in business for the foreseeable future. Furthermore, management is not aware of any material uncertainties that may cast significant doubt upon the Company’s ability to continue as a going concern. Therefore, the consolidated financial statements continue to be prepared on the going concern basis. Significant influence In determining whether it has significant influence over an entity, the Company makes certain judgments based on the applicable accounting standards. These judgments form the basis for the Company’s policies in accounting for its equity investments. Taxes As a MIC under the Tax Act, the Company is able to deduct from income for tax purposes dividends paid within 90 days of year- end. The Company intends to maintain its status as a MIC and intends to pay sufficient dividends in current and future years to ensure that it is not subject to income taxes in the MIC entity on a non-consolidated basis. Accordingly, the Company does not record a provision for current and deferred taxes within the MIC entity; however provisions are recorded as applicable in all subsidiaries of MCAN. - 59 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION STANDARDS ISSUED BUT NOT YET EFFECTIVE Standards issued but not yet effective up to the date of issuance of the consolidated financial statements are listed below. This listing is of standards and interpretations issued, which we reasonably expect to be applicable at a future date. We intend to adopt these standards when they become effective. IFRS 9, Financial Instruments In July 2014, the International Accounting Standards Board (“IASB”) issued a final revised IFRS 9 standard, which addresses impairment, classification and measurement, and hedge accounting. IFRS 9 is effective for annual periods beginning on or after January 1, 2018. Project Plan/Implementation We have established an IFRS 9 Committee which includes representatives of finance, risk and other executives. The Committee is responsible for the overall implementation of IFRS 9, ensuring proper integration throughout the Company and providing review and approval of key decisions. We continue to analyze the impact of the IFRS 9 changes on our consolidated financial statements and will continue to provide details as the project progresses. Impairment IFRS 9 introduces a new expected credit loss (“ECL”) impairment model for all financial assets, with the most significant impact on the Company’s mortgage portfolio. The new ECL model will result in a collective allowance being recorded on financial assets regardless of whether there has been an actual loss event. The expected credit loss model requires the recognition of 12-month expected credit losses at origination and the recognition of expected lifetime losses on financial assets that have experienced a significant increase in credit risk since origination. IFRS 9 requires consideration of past events, current market conditions and reasonable supportable information about future economic conditions in determining whether there has been a significant increase in credit risk, and in calculating the amount of expected losses. We are in the process of developing our IFRS 9 models and we have not yet quantified the impact on our collective allowance. Classification and Measurement IFRS 9 requires that debt instruments are classified based on the business model for managing the assets and the contractual cash flow characteristics of the asset. The business model test determines classification based on the business purpose for holding the asset. Our debt instruments that have contractual cash flows representing only payments of principal and interest will be eligible for classification as fair value reported through other comprehensive income (“FVOCI”) or amortized cost. Our equity instruments would generally be measured at FVOCI with unrealized gains and losses recognized in other comprehensive income. We are currently analyzing our business models and contractual cash flow characteristics. Hedge Accounting IFRS 9 has new hedge accounting principles that are aimed to align hedge accounting more closely with risk management. We currently do not have any hedging relationships eligible for hedge accounting under IFRS 9 and therefore we do not expect any impact from the introduction of IFRS 9 hedge accounting rules. IFRS 15, Revenue from Contracts with Customers IFRS 15 provides a single principle-based framework that applies to contracts with customers. IFRS 15 is effective for annual periods beginning on or after January 1, 2018. We are in the process of assessing the impact of IFRS 15 on our consolidated financial statements. IFRS 16, Leases IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e., the customer (‘lessee’) and the supplier (‘lessor’). IFRS 16 is effective for annual periods beginning on or after January 1, 2019. All leases result in a company (the lessee) obtaining the right to use an asset at the start of the lease and, if lease payments are made over time, also obtaining financing. Accordingly, IFRS 16 eliminates the classification of leases as either operating leases or finance leases as is required by IAS 17, Leases and, instead, introduces a single lessee accounting model. Applying that model, a lessee is required to recognize: (a) assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value; and (b) depreciation of lease assets separately from interest on lease liabilities in the income statement. We have not yet determined the impact of IFRS 16 on our consolidated financial statements. - 60 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION IFRS 2, Share-based Payment Transactions In June 2016, the IASB issued amendments to IFRS 2, which clarify how to classify and measure certain types of share-based payment transactions. These amendments are effective for annual periods beginning on or after January 1, 2018 and can be applied prospectively. We have not yet determined the impact of IFRS 2 on our consolidated financial statements. DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING Disclosure Controls and Procedures (“DC&P”) A disclosure committee (the “Disclosure Committee”), comprised of members of our senior management is responsible for establishing and maintaining adequate disclosure controls and procedures. As of December 31, 2016, we have evaluated the effectiveness of the design and operation of our DC&P in accordance with requirements of National Instrument 52-109 of the Canadian Securities Commission – Certification of Disclosure in Issuers’ Annual and Interim Filings (“NI 52-109”). Our CEO and CFO supervised and participated in this evaluation. Based on the evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit is recorded, processed, summarized and reported within the time periods specified in securities legislation and is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosure. Internal Controls over Financial Reporting (“ICFR”) The Disclosure Committee is responsible for establishing and maintaining adequate ICFR. Under the supervision and with the participation of the Disclosure Committee, including our CEO and CFO, we evaluated the effectiveness of our ICFR based upon the framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, a recognized control model, and the requirements of NI 52-109. Based on the evaluation, our CEO and CFO concluded that our ICFR were effective as of December 31, 2016. Ernst & Young LLP, our Independent Registered Chartered Accountants, have audited our consolidated financial statements for the year ended December 31, 2016. Changes in ICFR There were no changes in our ICFR that occurred during the period beginning on January 1 and ending on December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our ICFR. Inherent Limitations of Controls and Procedures All internal control systems, no matter how well designed, have inherent limitations. As a result, even systems determined to be effective may not prevent or detect misstatements on a timely basis, as systems can provide only reasonable assurance that the objectives of the control system are met. In addition, projections of any evaluation of the effectiveness of ICFR to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may change. - 61 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION NON IFRS MEASURES We prepare our consolidated financial statements in accordance with IFRS. We use a number of financial measures to assess our performance. Some of these measures are not calculated in accordance with IFRS, are not defined by IFRS, and do not have standardized meanings that would ensure consistency and comparability between companies using these measures. The non- IFRS measures used in this MD&A are defined as follows: Return on Average Shareholders’ Equity Return on average shareholders’ equity is a profitability measure that presents the annualized net income available to shareholders’ equity as a percentage of the capital deployed to earn the income. We calculate return on average shareholders’ equity as a monthly average using all components of shareholders’ equity. Taxable Income Measures Taxable Income Measures include taxable income and taxable income per share. Taxable income represents MCAN’s net income on a non-consolidated basis calculated under the provisions of the Tax Act applicable to a MIC. Taxable income is calculated as an estimate until we complete our annual tax returns subsequent to year end, at which point it is finalized. Average Interest Rate The average interest rate is a profitability measure that presents the average annualized yield of an asset or liability. Average mortgage portfolio yield (corporate or securitized), term deposit average interest rate, financial liabilities from securitization average interest rate, spread of mortgages over term deposits and spread of securitized assets over liabilities are examples of average interest rates. The average asset/liability balance that is incorporated into the average interest rate calculation is calculated on either a daily or monthly basis depending on the nature of the asset/liability. Please refer to the applicable tables containing average balances for further details. Net Interest Income Net interest income is a profitability measure that reflects net income earned only from interest-bearing assets and liabilities. Impaired Mortgage Ratios The impaired mortgage ratios represent the ratio of impaired uninsured mortgages to both corporate and total (corporate and securitized) mortgage principal. Mortgage Arrears Mortgage arrears measures include total corporate mortgage arrears, total securitized mortgage arrears and total mortgage arrears. These measures represent the amount of mortgages from the corporate portfolio, securitized portfolio and the sum of the two, respectively, that are at least one day past due. Common Equity Tier 1, Tier 1 and Total Capital, Total Exposures, Regulatory Assets, Leverage Ratio, Assets to Capital Multiple and Risk Weighted Assets These measures provided in this MD&A are in accordance with guidelines issued by OSFI and are located on Table 33 of this MD&A and Note 33 to the consolidated financial statements. Tier 1, Tier 2, Tier 3 and Total Liquid Assets and Liquidity Ratios Tier 1, Tier 2, Tier 3 and Total Liquid Assets are internal metrics that quantify the balance sheet assets (or components of assets) that comprise various liquidity levels. Liquidity ratios represent the ratio of select tiers of liquid assets to term deposits maturing within 100 days. Income Tax Capital Measures Income tax assets, income tax liabilities and income tax capital represent assets, liabilities and capital as calculated on a non- consolidated basis using the provisions of the Tax Act applicable to a MIC. The calculation of the income tax assets to capital ratio and income tax liabilities to capital ratio are based on these amounts. Income tax asset capacity represents additional income tax asset growth available to yield a 5.75 income tax assets to capital ratio, which is our target ratio. Market Capitalization Market capitalization is calculated as the number of common shares outstanding multiplied by the closing common share price as of that date. Book Value per Common Share Book value per common share is calculated as total shareholders’ equity divided by the number of common shares outstanding. Limited Partner’s At-Risk Amount The value of our equity investment in MCAP for income tax purposes is referred to as the Limited Partner’s At-Risk Amount (“LP ARA”), which represents the cost base of the limited partner’s investment in the partnership. The LP ARA is increased (decreased) by the partner’s share of partnership income (loss) on a tax basis, increased by the amount of capital contributions into the partnership and reduced by distributions received from the partnership. - 62 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION STATEMENT OF MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL INFORMATION The accompanying consolidated financial statements of MCAN Mortgage Corporation (“MCAN” or the “Company”) are the responsibility of management and have been approved by the Board of Directors. Management is responsible for the information and representations contained in these consolidated financial statements, the Management’s Discussion and Analysis of Operations and all other sections of the annual report. The consolidated financial statements have been prepared by management in accordance with International Financial Reporting Standards (“IFRS”), including the accounting requirements of our regulator, the Office of the Superintendent of Financial Institutions Canada. The Company’s accounting system and related internal controls are designed, and supporting procedures maintained to provide reasonable assurance that the Company’s financial records are complete and accurate and that assets are safeguarded against loss from unauthorized use or disposition. The Office of the Superintendent of Financial Institutions Canada makes such examination and enquiry into the affairs of MCAN as deemed necessary to be satisfied that the provisions of the Trust and Loan Companies Act are being duly observed for the benefit of depositors and that the Company is in sound financial condition. The Board of Directors is responsible for ensuring that management fulfils its responsibility for financial reporting and is ultimately responsible for reviewing and approving the consolidated financial statements. These responsibilities are carried out primarily through an Audit Committee of unrelated directors appointed by the Board of Directors. The Chief Financial Officer reviews internal controls, control systems and compliance matters and reports thereon to the Audit Committee. The Audit Committee meets periodically with management and the external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues. The Audit Committee reviews the consolidated financial statements and recommends them to the Board of Directors for approval. The Audit Committee also recommends to the Board of Directors and Shareholders the appointment of external auditors and approval of their fees. The consolidated financial statements have been audited by the Company’s external auditors, Ernst & Young LLP, in accordance with Canadian generally accepted auditing standards. Ernst & Young LLP has full and free access to the Audit Committee. William Jandrisits President and Chief Executive Officer Jeff Bouganim Senior Vice President and Chief Financial Officer Toronto, Canada, February 23, 2017 - 63 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Independent auditors’ report To the Shareholders of MCAN Mortgage Corporation We have audited the accompanying consolidated financial statements of MCAN Mortgage Corporation, which comprise the consolidated balance sheets as at December 31, 2016 and 2015, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management's responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors' responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of MCAN Mortgage Corporation as at December 31, 2016 and 2015, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Toronto, Canada February 24, 2017 - 64 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands of Canadian dollars) As at December 31 Assets Corporate Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Equity investment in MCAP Commercial LP Foreclosed real estate Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets Liabilities and Shareholders' Equity Liabilities Corporate Liabilities Term deposits Current taxes payable Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders' Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Note 2016 2015 7 8 9 10 11 12 13 18 14 15 16 14 17 18 18 19 20 21 21 23 $ $ $ $ 111,732 55,126 904,112 57,264 3,584 50,805 529 1,782 3,546 1,188,480 15,724 1,071,849 4,802 1,092,375 2,280,855 911,866 - 3,050 12,377 927,293 1,071,786 1,071,786 1,999,079 210,239 510 55,923 15,104 281,776 2,280,855 $ $ $ $ 75,762 40,735 944,109 41,793 4,176 44,191 529 1,125 2,626 1,155,046 13,112 1,075,947 2,853 1,091,912 2,246,958 903,041 100 2,299 12,412 917,852 1,070,304 1,070,304 1,988,156 206,382 510 42,617 9,293 258,802 2,246,958 The accompanying notes and shaded areas of the "Risk Governance and Management" section of Management's Discussion and Analysis of Operations are an integral part of these consolidated financial statements. On behalf of the Board: William Jandrisits Karen Weaver President and Chief Executive Officer Director, Chair of the Audit Committee - 65 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands of Canadian dollars except for per share amounts) Years Ended December 31 Note 2016 2015 Net Investment Income - Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Fees Marketable securities Financial investments and other loans Interest on cash and cash equivalents Whole loan gain on sale income Realized loss on derivatives Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses Other Income - Corporate Assets Gain on dilution of investment in MCAP Commercial LP Net Investment Income - Securitization Assets Mortgage interest Other securitization income Interest on financial liabilities from securitization Mortgage expenses Fair value adjustment - derivative financial instruments Operating Expenses Salaries and benefits General and administrative Net Income Before Income Taxes Provision for (recovery of) income taxes Current Deferred Net Income Basic and diluted earnings per share Dividends per share Weighted average number of basic and diluted shares (000's) 12 24 10 27 28 25 26 12 6 25 18 18 $ $ $ $ 50,670 13,509 2,547 3,622 6,487 604 324 - 77,763 22,035 3,993 244 (210) 26,062 51,701 - - 28,298 461 28,759 21,176 1,805 - 22,981 5,778 9,406 8,557 17,963 39,516 (100) (566) (666) 40,182 1.75 1.17 22,968 $ $ $ $ 50,997 10,096 3,231 2,076 3,506 730 626 (2,914) 68,348 20,671 3,823 838 275 25,607 42,741 68 68 25,564 198 25,762 19,763 1,461 71 21,295 4,467 8,515 5,993 14,508 32,768 - (89) (89) 32,857 1.51 1.13 21,830 The accompanying notes and shaded areas of the "Risk Governance and Management" section of Management's Discussion and Analysis of Operations are an integral part of these consolidated financial statements. - 66 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands of Canadian dollars) Years Ended December 31 Net income Other comprehensive income Change in unrealized gain on available for sale marketable securities Transfer of gains on sale of marketable securities to net income Change in unrealized gain on available for sale financial investments Transfer of income distribution from available for sale financial investments to net income Transfer of unrealized gains on available for sale financial investments to net income Less: deferred taxes 2016 2015 $ 40,182 $ 32,857 3,981 (361) 6,999 (3,181) (967) (660) 5,811 (2,132) (114) 8,466 (2,509) - (791) 2,920 Comprehensive income $ 45,993 $ 35,777 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of Canadian dollars) Years Ended December 31 Share capital Balance, beginning of period Common shares issued Balance, end of period Contributed surplus Balance, beginning of period Changes to contributed surplus Balance, end of period Retained earnings Balance, beginning of period Net income Dividends declared Balance, end of period Accumulated other comprehensive income Balance, beginning of period Other comprehensive income Balance, end of period Note 2016 2015 21 $ 206,382 3,857 210,239 $ 183,939 22,443 206,382 510 - 510 42,617 40,182 (26,876) 55,923 9,293 5,811 15,104 510 - 510 34,481 32,857 (24,721) 42,617 6,373 2,920 9,293 Total shareholders' equity $ 281,776 $ 258,802 The accompanying notes and shaded areas of the "Risk Governance and Management" section of Management's Discussion and Analysis of Operations are an integral part of these consolidated financial statements. - 67 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of Canadian dollars) Years Ended December 31 2016 2015 Cash provided by (used for): Operating Activities Net income Adjustments to determine cash flows relating to operating activities: Current taxes Deferred taxes Equity income from MCAP Commercial LP Provision for (recovery of) credit losses Amortization of securitized mortgage and liability transaction costs Amortization of other assets Amortization of mortgage discounts Gain on dilution of MCAP Commercial LP Fair value adjustment - derivative financial instruments Changes in operating assets and liabilities: Mortgages Term deposits Financial liabilities from securitization Marketable securities Cash held in trust Financial investments Other loans Other assets Other liabilities Cash flows from operating activities Investing Activities Distributions from MCAP Commercial LP Decrease in foreclosed real estate Acquisition of capital and intangible assets Cash flows from investing activities Financing Activities Issue of common shares Dividends paid Cash flows for financing activities Increase in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period Supplementary Information Interest received Interest paid Distributions received from investments $ 40,182 $ 32,857 (100) (566) (13,509) (210) 5,550 353 (95) - - 39,614 8,825 517 (10,770) (2,612) (12,620) 592 (2,651) (150) 52,350 6,895 - (572) 6,323 3,857 (26,560) (22,703) 35,970 75,762 111,732 75,969 40,098 9,451 $ $ - (89) (10,096) 275 5,403 349 (246) (68) 71 (535,388) 81,299 470,562 (18,081) 3,651 (6,461) (2,068) (274) 286 21,982 4,765 157 (735) 4,187 22,443 (23,940) (1,497) 24,672 51,090 75,762 2015 74,507 36,911 5,200 $ $ The accompanying notes and shaded areas of the "Risk Governance and Management" section of Management's Discussion and Analysis of Operations are an integral part of these consolidated financial statements. - 68 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note Page 1. Corporate Information .......................................................................................................................................... 70 2. Basis of Preparation .............................................................................................................................................. 70 3. Basis of Consolidation ........................................................................................................................................... 71 4. Summary of Significant Accounting Policies ......................................................................................................... 71 5. Significant Accounting Judgments and Estimates ................................................................................................. 80 6. Securitization Activities ......................................................................................................................................... 82 7. Cash and Cash Equivalents .................................................................................................................................... 83 8. Marketable Securities ........................................................................................................................................... 84 9. Mortgages - Corporate .......................................................................................................................................... 84 10. Financial Investments ........................................................................................................................................... 86 11. Other Loans........................................................................................................................................................... 87 12. Equity Investment in MCAP Commercial LP ......................................................................................................... 87 13. Foreclosed Real Estate .......................................................................................................................................... 88 14. Other Assets .......................................................................................................................................................... 88 15. Cash Held in Trust ................................................................................................................................................. 89 16. Mortgages - Securitized ........................................................................................................................................ 89 17. Term Deposits ....................................................................................................................................................... 90 18. Income Taxes ........................................................................................................................................................ 91 19. Other Liabilities ..................................................................................................................................................... 91 20. Financial Liabilities from Securitization ................................................................................................................ 92 21. Share Capital and Contributed Surplus ................................................................................................................. 92 22. Dividends .............................................................................................................................................................. 92 23. Accumulated Other Comprehensive Income ........................................................................................................ 93 24. Fees ....................................................................................................................................................................... 93 25. Mortgage Expenses............................................................................................................................................... 93 26. Provision for Credit Losses .................................................................................................................................... 93 27. Whole Loan Gain on Sale Income ......................................................................................................................... 93 28. Realized Loss on Derivatives ................................................................................................................................. 93 29. Related Party Disclosures ..................................................................................................................................... 94 30. Commitments and Contingencies ......................................................................................................................... 96 31. Credit Facilities...................................................................................................................................................... 96 32. Interest Rate Sensitivity ........................................................................................................................................ 96 33. Capital Management ............................................................................................................................................ 98 34. Financial Instruments ......................................................................................................................................... 100 35. Comparative Amounts ........................................................................................................................................ 102 - 69 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 1. Corporate Information MCAN Mortgage Corporation (the “Company” or “MCAN”) is a Loan Company under the Trust and Loan Companies Act (Canada) (the “Trust Act”) and a Mortgage Investment Corporation (“MIC”) under the Income Tax Act (Canada) (the “Tax Act”). As a Loan Company under the Trust Act, the Company is subject to the guidelines and regulations set by the Office of the Superintendent of Financial Institutions Canada (“OSFI”). MCAN’s primary objective is to generate a reliable stream of income by investing its corporate funds in a portfolio of mortgages (including single family residential, residential construction, non-residential construction and commercial loans), as well as other types of financial investments, loans and real estate investments. MCAN employs leverage by issuing term deposits eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance up to a maximum of five times capital (on a non-consolidated income tax basis in the MIC entity) as limited by the provisions of the Tax Act applicable to a MIC. The term deposits are sourced through a network of independent financial agents. As a MIC, MCAN is entitled to deduct from income for tax purposes 50% of capital gains dividends and 100% of other dividends paid. Such dividends are received by shareholders as capital gains dividends and interest income, respectively. MCAN’s primary wholly owned subsidiary, Xceed Mortgage Corporation (“Xceed”), is an originator of residential first-charge mortgage products across Canada. As such, Xceed operates primarily in one industry segment through its sales team and mortgage brokers. Xceed is incorporated in the province of Ontario. MCAN is also a National Housing Act (“NHA”) mortgage-backed securities (“MBS”) issuer. For further details, refer to Note 6. MCAN is incorporated in Canada. MCAN and Xceed’s head office is located at 200 King Street West, Suite 600, Toronto, Ontario, Canada. MCAN is listed on the Toronto Stock Exchange under the symbol MKP. The consolidated financial statements were approved in accordance with a resolution of the Board of Directors (the “Board”) on February 24, 2017. 2. Basis of Preparation The consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”), effective for the Company as at December 31, 2016, as issued by the International Accounting Standards Board (“IASB”), including the accounting guidance of OSFI. The consolidated financial statements have been prepared on a historical cost basis, except for cash and cash equivalents, marketable securities, foreclosed real estate and certain financial investments designated as available for sale, which have been measured at fair value. The consolidated financial statements are presented in Canadian dollars. The disclosures that accompany the consolidated financial statements include the significant accounting policies applied (Note 4) and the significant judgments (Note 5(a)) and estimates (Note 5(b)) applicable to the preparation of the consolidated financial statements. The Company separates its assets into its corporate and securitization portfolios for reporting purposes. Corporate assets represent the Company’s core strategic investments, and are funded by term deposits and share capital. Securitization assets consist primarily of mortgages that have been securitized through the NHA MBS program and subsequently sold to third parties. These assets are funded by the cash received from the sale of the associated securities, which is then classified as a financial liability from securitization. - 70 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 3. Basis of Consolidation The consolidated financial statements include the balances of MCAN and its subsidiaries as at December 31, 2016. Subsidiaries are fully consolidated from the date on which the Company obtains control, and continue to be consolidated until the date that such control ceases. Per IFRS 10, Consolidated Financial Statements, an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The financial statements of the subsidiaries are prepared for the same reporting period as the Company, using consistent accounting policies. All intercompany balances due to/from subsidiaries, income and expenses and unrealized gains and losses resulting from intercompany transactions and dividends are eliminated in full. 4. Summary of Significant Accounting Policies The following are the significant accounting policies applied by the Company in the preparation of its consolidated financial statements. Certain policies adopted in or relevant to fiscal 2016 and 2015 are also discussed below. (1) Financial instruments - initial recognition and subsequent measurement (i) Date of recognition All financial assets and liabilities are initially recognized on the trade date, which is the date that the Company becomes a party to the contractual provisions of the instrument. (ii) Measurement of financial instruments All financial instruments are measured initially at their fair value plus, in the case of financial instruments not subsequently recorded at fair value through the consolidated statements of income, directly attributable transaction costs. Subsequent measurement and accounting treatment depends principally on the classification of financial instruments at initial recognition. The classification of an instrument in the measurement categories specified in IFRS depends on a number of factors, including the purpose and management’s intention for which the financial instruments were acquired and their contractual characteristics. The Company classifies its financial instruments in the measurement categories noted below: a. Financial assets or financial liabilities held for trading Financial assets or financial liabilities held for trading are recorded at fair value. Changes in fair value are recognized in the consolidated statements of income. Interest income or expense is recorded in the consolidated statements of income on the accrual basis. A financial asset or financial liability is classified as held for trading if: (a) it is acquired or incurred principally for the purpose of selling or repurchasing in the near term; (b) on initial recognition it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking; or (c) it is a derivative (except for a derivative that is a financial guarantee contract or a designated and effective hedging instrument). Derivatives are recorded at fair value and carried as assets when their fair value is positive and as liabilities when their fair value is negative. Changes in the fair value of derivatives are included in the consolidated statements of income. - 71 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) b. Available for sale financial investments Available for sale investments include marketable securities, an equity investment in commercial real estate and an equity investment in a mortgage fund. Equity investments classified as available for sale are those that are neither classified as held for trading nor designated at fair value through the consolidated statements of income. Certain marketable securities are intended to be held for an indefinite period of time but may be sold in response to needs for liquidity or in response to changes in the market conditions. c. Loans and receivables The loans and receivables category includes mortgages, other loans, non-derivative financial assets and certain financial investments with fixed or determinable payments that are not quoted in an active market, other than: (cid:120) (cid:120) (cid:120) Those that the Company intends to sell immediately or in the near term and those that the Company upon initial recognition designates at fair value; Those that the Company, upon initial recognition, designates as available for sale; or Those for which the Company may not recover substantially all of its initial investment, other than because of credit deterioration. After initial measurement, financial assets classified as loans and receivables are subsequently measured at amortized cost using the effective interest rate method (“EIM”), less any allowance for impairment. Amortized cost is calculated by taking into account any discount or premium on acquisition and fees and costs that are an integral part of the EIM. The amortization is included in mortgage interest income or interest on financial investments and other loans in the consolidated statements of income. The losses arising from impairment are recognized in the consolidated statements of income. d. Financial liabilities After initial recognition, interest bearing financial liabilities are subsequently measured at amortized cost using the EIM. Amortized cost is calculated by taking into account any discount or premium on acquisition and fees or costs using the EIM. The amortization is included in the related line in the consolidated statements of income. Unamortized premiums and discounts are recognized in the consolidated statements of income upon extinguishment of the liability. (iii) Transaction costs Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. Transaction costs are capitalized and amortized over the expected life of the instrument using the EIM, except for transaction costs which are related to financial assets or financial liabilities classified as held for trading or designated at fair value, which are expensed. - 72 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (2) Derecognition of financial assets and financial liabilities (i) Financial assets A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognized when: (cid:120) (cid:120) The rights to receive cash flows from the asset have expired; or The Company has transferred its rights to receive cash flows from the asset or has assumed an obligation to pay the received cash flows in full without material delay to a third party under a qualifying “pass-through” arrangement; and either: (cid:120) (cid:120) the Company has transferred substantially all the risks and rewards of ownership of the financial asset, or the Company has neither transferred nor retained substantially all the risks and rewards of ownership of the financial asset, but has transferred control of the financial asset. When substantially all the risks and rewards of ownership of the financial asset have been transferred, the Company will derecognize the financial asset and recognize separately as assets or liabilities any rights and obligations created or retained in the transfer. When substantially all the risks and rewards of ownership of the financial asset have been retained, the Company continues to recognize the financial asset and also recognizes a financial liability for the consideration received. Certain transaction costs incurred are also capitalized and amortized using the EIM. When the Company has neither transferred nor retained substantially all the risks and rewards of ownership of the financial asset nor transferred control of the financial asset, the financial asset is recognized to the extent of the Company’s continuing involvement in the financial asset. In that case, the Company also recognizes an associated liability. The transferred asset and the associated liability are measured on a basis that reflects the rights and obligations that the Company has retained. (ii) Financial liabilities A financial liability is derecognized when the obligation under the liability is discharged or cancelled or expires. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability and the difference in the respective carrying amounts is recognized in the consolidated statements of income. (3) Determination of fair value Per IFRS 13, Fair Value Measurement, 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. Financial assets and liabilities are classified into three levels, as follows: quoted prices in an active market (Level 1), fair value based on observable inputs other than quoted prices (Level 2) and fair value based on inputs that are not based on observable data (Level 3). For all other financial instruments not traded in an active market, the fair value is determined by using appropriate valuation techniques. Valuation techniques include the discounted cash flow method, comparison to similar instruments for which market observable prices may exist and other relevant valuation models. Certain financial instruments are recorded at fair value using valuation techniques in which current market transactions or observable market data are not available. Where available, their fair value is determined using a valuation model that has been tested against prices or inputs to actual market transactions and using the Company’s best estimate of the most appropriate model assumptions. The fair value of certain real estate assets is determined using independent appraisals. Models and valuations are adjusted to reflect counterparty credit and liquidity spread and limitations in the models. - 73 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (4) Foreclosed assets held for sale Foreclosed assets are repossessed non-financial assets where the Company gains title, ownership or possession of individual properties, such as real estate properties, which are managed for sale in an orderly manner with the proceeds, used to reduce or repay any outstanding debt. The Company holds foreclosed properties for sale rather than for its business use. Held-for-sale foreclosed assets are initially carried at fair value less costs to sell. In subsequent measurements, the asset is carried at the lower of its carrying amount and fair value less the estimated cost to sell at the date of foreclosure. Any difference between the carrying value of the asset before foreclosure and the initially estimated realizable amount of the asset is recorded in the provision for credit losses line in the consolidated statements of income. The Company predominantly relies on third-party appraisals to determine the carrying value of foreclosed assets. (5) Impairment of financial assets The Company assesses at each consolidated financial statement date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is deemed to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (an incurred “loss event”) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or the group of financial assets that can be reliably estimated. Impaired mortgages include uninsured mortgages that are more than 90 days in arrears or are less than 90 days in arrears but for which management does not have reasonable assurance that the full amount of principal and interest will be collected in a timely manner. An insured mortgage is considered to be impaired when the mortgage is 365 days past due, whether or not collection is in doubt. Evidence of impairment may include indications that the borrower or a group of borrowers is experiencing significant financial difficulty, the probability that they will enter bankruptcy or other financial reorganization, default or delinquency in interest or principal payments and where observable data indicates that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults. (i) Financial assets carried at amortized cost For financial assets carried at amortized cost, the Company first assesses individually whether objective evidence of impairment exists for financial assets that are significant, or collectively for financial assets that are not individually significant. If the Company determines that no objective evidence of impairment exists for an individually assessed financial asset, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is, or continues to be, recognized are not included in a collective assessment of impairment. If there is objective evidence that an impairment loss has occurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future expected credit losses that have not yet been incurred). The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognized in the consolidated statements of income. Interest income continues to be accrued using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. The interest income is recorded as part of the related interest income component. Mortgages, together with the associated allowance, are written off when there is no realistic prospect of future recovery and all collateral has been realized. If, in a subsequent period, the amount of the estimated impairment loss increases or decreases because of an event occurring after the impairment was recognized, the previously recognized impairment loss is increased or reduced by adjusting the allowance account. If a write-off is later recovered, the recovery is credited to the provision for credit losses. - 74 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) The present value of the estimated future cash flows is discounted at the financial asset’s original effective interest rate (“EIR”). If a mortgage has a variable interest rate, the discount rate for measuring any impairment loss is the current EIR. The calculation of the present value of estimated future cash flows reflects the projected cash flows less costs to sell. For the purpose of a collective evaluation of impairment, financial assets are grouped on the basis of the Company’s internal system that considers credit risk characteristics such as asset type, industry, geographical location, collateral type, risk rating, past-due status and other relevant factors. Risk ratings are mapped to rating agency assessments of corporate bonds. Corporate bond historical default rates are used for an actual historical period similar to the environment at the time of measurement, using factors such as housing starts, unemployment rate, and GDP growth. Future cash flows on a group of financial assets that are collectively evaluated for impairment are estimated on the basis of historical loss experience for assets with credit risk characteristics similar to those in the group. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. Estimates of changes in future cash flows reflect, and are directionally consistent with, changes in related observable data from year to year (such as changes in unemployment rates, property prices, payment status or other factors that are indicative of incurred losses in the group and their magnitude). The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. (ii) Available for sale financial investments For available for sale financial investments, the Company assesses at the consolidated financial statement date whether there is objective evidence that an investment or a group of investments is impaired. In the case of equity investments classified as available for sale, one of the indications of impairment would include a significant or prolonged decline in the fair value of the investment below its cost. “Significant” is evaluated against the original cost of the investment and “prolonged” against the period in which the fair value has been below its original cost. Where there is evidence of impairment, the cumulative loss - measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that investment previously recognized in the consolidated statements of income - is removed from other comprehensive income and recognized in the consolidated statements of income. Impairment losses on equity investments are not reversed through the consolidated statements of income; increases in their fair value after impairment are recognized directly in other comprehensive income. In the case of debt instruments classified as available for sale, impairment is assessed based on the same criteria as financial assets carried at amortized cost. However, the amount recorded for impairment is the cumulative loss measured as the difference between the amortized cost and the current fair value, less any impairment loss on that investment previously recognized in the consolidated statements of income. Future interest income continues to be accrued based on the reduced carrying amount of the asset, using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. The interest income is recorded to the related interest income component. If, in a subsequent year, the fair value of a debt instrument increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in the consolidated statements of income, the impairment loss is reversed through the consolidated statements of income. (6) Offsetting financial instruments Financial assets and financial liabilities where the Company is considered the principal to the underlying transactions are offset and the net amount reported in the consolidated financial statements if, and only if, the Company currently has an enforceable legal right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. As at December 31, 2016, the Company did not have any outstanding transactions that are subject to netting contracts with third parties. - 75 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (7) Taxes (i) Current tax Current tax assets and liabilities are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted at the consolidated financial statement date. As a MIC under the Tax Act, the Company is able to deduct from income for tax purposes dividends paid within 90 days of year-end. The Company intends to maintain its status as a MIC and intends to pay sufficient dividends in current and future years to ensure that it is not subject to income taxes in the MIC entity on a non-consolidated basis. Accordingly, the Company does not record a provision for current taxes within the MIC entity, however provisions are recorded as applicable in all subsidiaries of MCAN. Current tax relating to items recognized directly to shareholders’ equity is recognized in equity and not in the consolidated statements of income. Management periodically evaluates positions taken in the Company’s tax returns with respect to situations in which applicable tax regulations are subject to interpretation, and establishes provisions where appropriate. (ii) Deferred tax Deferred tax is provided on temporary differences at the consolidated financial statement date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax liabilities are recognized for all taxable temporary differences, except: (cid:120) In respect of taxable temporary differences associated with investments in subsidiaries or associates and interests in joint ventures where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred tax assets are recognized for all deductible temporary differences, carry forward of unused tax credits and unused tax losses, to the extent that it is probable that taxable income will be available against which the deductible temporary differences, and the carry forward of unused tax credits and unused tax losses can be used, except in the following instances: (cid:120) Where the deferred tax asset relating to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting income nor taxable income; and (cid:120) In respect of deductible temporary differences associated with investments in subsidiaries or associates and interests in joint ventures, deferred tax assets are recognized only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable income will be available against which the temporary differences can be utilized. The carrying amount of deferred tax assets is reviewed at each consolidated financial statement date and reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the deferred tax asset to be utilized. Unrecognized deferred tax assets are reassessed at each consolidated financial statement date and are recognized to the extent that it has become probable that future taxable income will allow the deferred tax asset to be recovered. Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the consolidated financial statement date. Deferred tax relating to items recognized directly in shareholders’ equity is recognized in shareholders’ equity and not in the consolidated statements of income. Deferred tax assets and deferred tax liabilities are offset if a legally enforceable right exists to set off current tax assets against current tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority. - 76 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) As a MIC under the Tax Act, the Company is able to deduct from income for tax purposes dividends paid within 90 days of year-end. The Company intends to maintain its status as a MIC and intends to pay sufficient dividends in current and future years to ensure that it is not subject to income taxes in the MIC entity on a non-consolidated basis. Accordingly, the Company does not record a provision for deferred taxes within the MIC entity, however provisions are recorded as applicable in all subsidiaries of MCAN. (8) Dividends on common shares Dividends on common shares are deducted from shareholders’ equity in the quarter that they are approved. Dividends that are approved after the consolidated financial statement date are not recognized as a liability in the consolidated financial statements but are disclosed as an event after the consolidated financial statement date. (9) Investment in associate The Company’s investment in its associate, MCAP Commercial LP (“MCAP”), is accounted for using the equity method. An associate is an entity in which the Company has significant influence. Under the equity method, the investment in the associate is carried on the consolidated balance sheets at cost plus post acquisition changes in the Company’s share of net assets of the associate. The consolidated statements of income reflect the Company’s proportionate share of the results of operations of the associate. Where there has been a change recognized directly in the equity of the associate, the Company recognizes its share of any changes and discloses this change, when applicable, in the consolidated statements of changes in shareholders’ equity. Unrealized gains and losses resulting from transactions between the Company and the associate are eliminated to the extent of the interest in the associate. The most recent available financial statements of the associate are used by the investor in applying the equity method. When the financial statements of an associate used in applying the equity method are prepared as of a different date from that of the investor, adjustments shall be made for the effects of significant transactions or events that occur between that date and the date of the investor’s financial statements. Where necessary, adjustments are made to harmonize the accounting policies of the associate with those of the Company. After application of the equity method, the Company determines whether it is necessary to recognize an additional impairment loss on the Company’s investment in its associate. The Company determines at each consolidated financial statement date whether there is any objective evidence that the investment in the associate is impaired. If this is the case, the Company then calculates the amount of impairment as the difference between the recoverable amount of the associate and its carrying value and recognizes the amount in the consolidated statements of income, thus reducing the carrying value by the amount of impairment. (10) Revenue recognition Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Company and that the revenue can be reliably measured, regardless of when the payment is being made. Revenue is measured at the fair value of the consideration received or receivable, taking into account contractually defined terms of payment and excluding taxes and duty. The Company assesses its revenue arrangements against specific criteria in order to determine if it is acting as principal or agent. The Company has concluded that it is acting as a principal in all of its revenue arrangements. Interest income or expense For all financial investments measured at amortized cost and interest bearing financial assets classified as available for sale, interest income or expense is recorded using the EIM, which reflects the rate that exactly discounts the estimated future cash payments or receipts through the expected life of the financial instrument or a shorter period, where appropriate, to the net carrying amount of the financial asset or liability. The calculation takes into account the contractual interest rate, along with any fees or incremental costs that are directly attributable to the instrument and all other premiums or discounts. Interest income or expense is included in the appropriate component of the consolidated statements of income. - 77 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (11) Cash and cash equivalents Cash and cash equivalents (including cash held in trust) on the consolidated balance sheets comprise cash held at banks and short-term deposits with original maturity dates of less than 90 days. (12) Share-based payment transactions The cost of cash-settled transactions is measured initially at fair value at the grant date, further details of which are discussed in Note 29. The obligations are adjusted for fluctuations in the market price of the Company’s common shares. Changes in the obligations are recorded as salaries and benefits in the consolidated statements of income with a corresponding change to other liabilities. The liability is re-measured at fair value at each consolidated financial statement date up to and including the settlement date. (13) Capital assets and intangible assets Capital assets and intangible assets are recorded at cost less accumulated amortization. Amortization is recorded at the following rates: Capital assets Furniture and fixtures Computer hardware Leasehold improvements Intangible assets Computer software Five years straight line Three to five years straight line Lease term and one renewal straight line One year to five years straight line The amortization expense is included in the general and administrative operating expense category in the consolidated statements of income. The amortization period and the amortization method for capital assets and intangible assets are reviewed at least at the end of each reporting period. Research and development costs Research costs are expensed as incurred. Development expenditures on an individual project are recognized as an intangible asset when the Company can demonstrate: (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) The technical feasibility of completing the intangible asset so that the asset will be available for use or sale Its intention to complete and its ability and intention to use or sell the asset How the asset will generate future economic benefits The availability of resources to complete the asset The ability to measure reliably the expenditure during development (14) Share capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new ordinary shares are shown in equity as a deduction, net of tax, from the proceeds. Where the Company purchases the Company’s equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs is deducted from equity attributable to the Company’s equity holders until the share are either cancelled or re-issued. Where such ordinary shares are subsequently reissued, any consideration received, net of any directly attributable incremental transactions costs, is included in equity. - 78 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (15) Contingent liabilities Provisions for legal claims are recognized when the group (a) has a present legal or constructive obligation as a result of past events; (b) it is probable that an outflow of resources will be required to settle the obligation; and (c) the amount has been reliably estimated. Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the obligation. The increase in the provision due to passage of time is included in interest expense. (16) Standards issued but not effective Standards issued but not yet effective up to the date of issuance of the Company’s consolidated financial statements are listed below. This listing is of standards and interpretations issued that the Company reasonably expects to be applicable at a future date. The Company intends to adopt those standards when they become effective. IFRS 9, Financial Instruments In July 2014, the IASB issued a final revised IFRS 9 standard, which addresses impairment, classification and measurement, and hedge accounting. IFRS 9 is effective for annual periods beginning on or after January 1, 2018. Project Plan/Implementation The Company has established an IFRS 9 Committee which includes representatives of finance, risk and other executives. The Committee is responsible for the overall implementation of IFRS 9, ensuring proper integration throughout the Company and providing review and approval of key decisions. The Company continues to analyze the impact of the IFRS 9 changes on its consolidated financial statements and will continue to provide details as the project progresses. Impairment IFRS 9 introduces a new expected credit loss (“ECL”) impairment model for all financial assets, with the most significant impact on the Company’s mortgage portfolio. The new ECL model will result in a collective allowance being recorded on financial assets regardless of whether there has been an actual loss event. The expected credit loss model requires the recognition of 12-month expected credit losses at origination and the recognition of expected lifetime losses on financial assets that have experienced a significant increase in credit risk since origination. IFRS 9 requires consideration of past events, current market conditions and reasonable supportable information about future economic conditions in determining whether there has been a significant increase in credit risk, and in calculating the amount of expected losses. The Company is in the process of developing its IFRS 9 models and it has not yet quantified the impact on the collective allowance. Classification and Measurement IFRS 9 requires that debt instruments are classified based on the business model for managing the assets and the contractual cash flow characteristics of the asset. The business model test determines classification based on the business purpose for holding the asset. The Company’s debt instruments that have contractual cash flows representing only payments of principal and interest will be eligible for classification as fair value reported through other comprehensive income (“FVOCI”) or amortized cost. The Company’s equity instruments would generally be measured at FVOCI with unrealized gains and losses recognized in other comprehensive income. The Company is currently analyzing its business models and contractual cash flow characteristics. Hedge Accounting IFRS 9 has new hedge accounting principles that are aimed to align hedge accounting more closely with risk management. The Company currently does not have any hedging relationships eligible for hedge accounting under IFRS 9 and therefore does not expect any impact from the introduction of IFRS 9 hedge accounting rules. IFRS 15, Revenue from Contracts with Customers IFRS 15 provides a single principle-based framework that applies to contracts with customers. IFRS 15 is effective for annual periods beginning on or after January 1, 2018. The Company is in the process of assessing the impact of IFRS 15 on its consolidated financial statements. - 79 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) IFRS 16, Leases IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e., the customer (‘lessee’) and the supplier (‘lessor’). IFRS 16 is effective for annual periods beginning on or after January 1, 2019. All leases result in a company (the lessee) obtaining the right to use an asset at the start of the lease and, if lease payments are made over time, also obtaining financing. Accordingly, IFRS 16 eliminates the classification of leases as either operating leases or finance leases as is required by IAS 17, Leases and, instead, introduces a single lessee accounting model. Applying that model, a lessee is required to recognize: (a) assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value; and (b) depreciation of lease assets separately from interest on lease liabilities in the income statement. The Company has not yet determined the impact of IFRS 16 on its consolidated financial statements. IFRS 2, Share-based Payment Transactions In June 2016, the IASB issued amendments to IFRS 2, which clarify how to classify and measure certain types of share-based payment transactions. These amendments are effective for annual periods beginning on or after January 1, 2018 and can be applied prospectively. The Company has not yet determined the impact of IFRS 2 on its consolidated financial statements. 5. Significant Accounting Judgments and Estimates The preparation of the Company’s consolidated financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities, at the end of the reporting period. However, uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of the asset or liability affected in future periods. (a) Significant Accounting Judgments Going concern The Company’s management has made an assessment of the Company’s ability to continue as a going concern and is satisfied that the Company has the resources to continue in business for the foreseeable future. Furthermore, management is not aware of any material uncertainties that may cast significant doubt upon the Company’s ability to continue as a going concern. Therefore, the consolidated financial statements continue to be prepared on the going concern basis. Significant influence In determining whether it has significant influence over an entity, the Company makes certain judgments based on the applicable accounting standards. These judgments form the basis for the Company’s policies in accounting for its equity investments. Taxes As a MIC under the Tax Act, the Company is able to deduct from income for tax purposes dividends paid within 90 days of year-end. The Company intends to maintain its status as a MIC and intends to pay sufficient dividends in current and future years to ensure that it is not subject to income taxes in the MIC entity on a non-consolidated basis. Accordingly, the Company does not record a provision for current and deferred taxes within the MIC entity, however provisions are recorded as applicable in all subsidiaries of MCAN. - 80 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 5. Significant Accounting Judgments and Estimates (continued) (b) Significant Accounting Estimates Fair value of financial instruments Where the fair values of financial assets and financial liabilities recorded in the consolidated financial statements cannot be derived from active markets, they are determined using a variety of valuation techniques that include the use of mathematical models. The inputs to these models are derived from observable market data where possible, but where observable market data are not available, estimates are required to establish fair values. These estimates include considerations of liquidity and model inputs such as discount rates, prepayment rates and default rate assumptions for certain investments. Impairment losses on mortgages The Company reviews its individually significant mortgage balances at each consolidated financial statement date to assess whether an impairment loss should be recorded. In particular, estimates by management are required in the calculation of the amount and timing of future cash flows when determining the impairment loss. In estimating these cash flows, the Company makes assumptions about the borrower’s financial situation and the net realizable value of collateral. These estimates are based on assumptions about a number of factors, and actual results may differ, resulting in future changes to the allowance. Mortgages that have been assessed individually and found not to be impaired and all individually insignificant mortgages are then assessed collectively, in groups of mortgages with similar risk characteristics, to determine whether a provision should be made due to incurred loss events for which there is objective evidence but whose effects are not yet evident. The collective assessment takes account of data from the mortgage portfolio (such as credit quality, levels of arrears, credit utilization, loan to value ratios, etc.), concentrations of risks and economic data (including levels of unemployment, real estate price indices and the performance of different individual groups). Mortgage prepayment rates In calculating the rate at which borrowers prepay their mortgages, the Company makes estimates based on its historical experience. These assumptions impact the timing of revenue recognition and the amortization of mortgage premiums using the EIM. Taxes Deferred tax assets are recognized for all unused tax losses to the extent that it is probable that taxable income will be available against which the losses can be used in the subsidiaries of the Company. Significant management judgment is required to determine the amount of deferred tax assets that can be recognized in the subsidiaries of the Company, based upon the likely timing and the level of future taxable income together with future tax planning strategies. Impairment of financial assets As applicable, the Company reviews financial assets at each consolidated financial statement date to assess whether an impairment loss should be recorded. In particular, estimates by management are required in the calculation of the amount and timing of future cash flows when determining the impairment loss. These estimates are based on assumptions about a number of factors and actual results may differ, resulting in future changes to the fair value of the asset. - 81 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 6. Securitization Activities The Company is an NHA MBS issuer, which involves the securitization of insured mortgages to create MBS. The Company issues MBS through its internal market MBS program and the Canada Housing Trust (“CHT”) Canada Mortgage Bonds (“CMB”) program. In both programs, the Company originates or purchases mortgages for securitization. Pursuant to the NHA MBS program, investors of MBS receive monthly cash flows consisting of interest and scheduled and unscheduled principal payments. Canada Mortgage and Housing Corporation (“CMHC”) makes principal and interest payments in the event of any MBS default by the issuer, thus fulfilling the timely payment obligation to investors. To date, the Company has sold MBS as part of the market MBS program and the CMB program, which are discussed below. Market MBS Program MCAN originates and purchases insured single family mortgages to sell as MBS as part of the market MBS program. The Company may sell MBS to third parties and may also sell the net economics and cash flows from the underlying mortgages (“interest-only strips”) to third parties. The MBS portion of the mortgage represents the core securitized mortgage principal and the right to receive coupon interest at a specified rate. The interest-only strips represent the right to receive excess cash flows after satisfying the MBS coupon interest payment and any other expenses such as mortgage servicing. During 2016, MCAN pooled and sold $41,728 of MBS to third parties (2015 - $589,148). When the MBS is sold to third parties and the interest-only strip is retained by MCAN, the securitized mortgages remain on MCAN’s consolidated balance sheet while a corresponding financial liability from securitization is incurred (Notes 16 and 20), due to the fact that MCAN retains significant continuing involvement with the assets. During 2015, MCAN sold the interest-only strips associated with $147,219 of mortgages securitized through the market MBS program to third parties. Subsequent to sale, MCAN derecognized the securitized mortgages and associated financial liabilities from securitization from its consolidated balance sheet as a result of the transfer of substantially all risks and rewards of ownership to the purchaser of the interest-only strip. As part of the transaction, MCAN recognized a loan receivable from the third party purchaser (Note 11) and recognized a gain on sale net of unamortized transaction costs, which is included in other securitization income. The Company did not sell any interest-only strips in 2016. CMB Program The Company recommenced its participation in the CMB program in 2016 by securitizing both insured single family and insured multi family loans (e.g. loans secured by apartment buildings). The CMB program involves the sale of MBS to CHT who in turn issues a non-amortizing bullet bond to external investors. The CMB program generally includes the reinvestment of mortgage principal repayments by the issuer into certain permitted assets, however the Company has transferred the benefits and obligations associated with the principal reinvestment function to a third party such that it only earns spread income on the amortizing mortgage balance. During 2016, the Company securitized $100,377 of insured single family mortgages (2015 - $nil). Similar to the market MBS program transaction, the Company did not derecognize the mortgages from its consolidated balance sheet as it retained significant continuing involvement with the assets such that the associated mortgages remained on the consolidated balance sheet while a corresponding liability was incurred. The mortgage interest income and interest on the financial liability from securitization associated with these mortgages are recognized on the accrual basis over the term of the mortgages. During 2016, the Company securitized $85,526 of insured multi family loans (2015 - $nil). The Company derecognized the mortgages from its consolidated balance sheet as control over the assets was transferred on securitization. In achieving derecognition, the Company recognized upfront gains of $394 (2015 - $nil), which is included in other securitization income, and recognized receivables in the amount of the estimated discounted spread income to be earned over the term of the securitized mortgages. Other Accounting Considerations The primary risks associated with the market MBS program and CMB program are prepayment, liquidity and funding risk, including the obligation to fund 100% of any cash shortfall related to the Timely Payment (discussed below). Any mortgages securitized through the market MBS program or CMB program for which derecognition is not achieved remain on MCAN’s consolidated balance sheet as securitized assets and are also included in total exposures in the calculation of the leverage ratio (Note 33). For income tax purposes, mortgage securitizations by MCAN are considered to be true mortgage sales and therefore are not included in income tax assets (Note 33). - 82 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 6. Securitization Activities (Continued) MCAN has capitalized certain mortgage acquisition costs. These costs are amortized using the EIM, which incorporates mortgage prepayment assumptions. Timely Payment Consistent with all issuers of MBS, the Company is required to remit scheduled mortgage principal and interest payments to CMHC, even if these mortgage payments have not been collected from mortgagors. Similarly, at the maturity of the MBS pools that have been issued by MCAN, any outstanding principal must be paid to CMHC. If the Company fails to make a scheduled principal and interest payment to CMHC, CMHC may enforce the assignment of the mortgages included in all MBS pools in addition to other assets backing the MBS issued. As part of its participation in the market MBS program and CMB program, the Company is required to fund 100% of any cash shortfall unless it has sold the interest-only strip, in which case the purchaser of the interest-only strip is obligated to fund 100% of any cash shortfall. In the case of mortgage defaults, MCAN is required to make scheduled principal and interest payments to investors as part of the Timely Payment and then place the mortgage/property through the insurance claims process to recover any losses. These defaults may result in cash flow timing mismatches that may marginally increase funding and liquidity risks. Transferred financial assets that are not derecognized in their entirety Since MCAN neither transferred nor retained risks and rewards of ownership on sale and retained significant continuing involvement through the provision of the Timely Payment obligation, the majority of the market MBS program and single family CMB program sale transactions have resulted in MCAN continuing to recognize the securitized mortgages and financial liabilities from securitization on its consolidated balance sheet. The securitized mortgage balance as at December 31, 2016 was $1,071,849 (December 31, 2015 - $1,075,947) (Note 16). The financial liabilities from securitization balance as at December 31, 2016 was $1,071,786 (December 31, 2015 - $1,070,304) (Note 20). Transferred financial assets that are derecognized in their entirety but where the Company has a continuing involvement MCAN sells MBS and the associated interest only strips to third parties and derecognizes the mortgages from its consolidated balance sheet as a result of the transfer of control of the asset or substantially all risks and rewards on sale. The Company’s continuing involvement is the ongoing obligation in its role as MBS issuer to service the mortgages and MBS until maturity. The total outstanding derecognized MBS balance related to the market MBS program and CMB program as at December 31, 2016 was not reflected as an asset or liability on MCAN’s consolidated balance sheet. The MBS mature as follows: 2016 2017 2020 2021 2026 Total December 31, 2016 December 31, 2015 $ $ - 29,272 $ $ 122,016 157,741 $ $ 132,075 147,219 $ $ 75,142 - $ $ 9,911 - $ $ 339,144 334,232 7. Cash and Cash Equivalents Cash and cash equivalents include balances with banks and certain short-term investments with original maturity dates of less than 90 days. Refer to Note 31 for an analysis of the Company’s available credit facilities. - 83 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Marketable Securities As at December 31 Real estate investment trusts Corporate bonds 2016 53,953 1,173 55,126 $ $ 2015 37,958 2,777 40,735 $ $ Marketable securities are designated as available for sale. Corporate bonds mature between 2017 and 2022 while real estate investment trusts have no specific maturity date. Fair values are based on bid prices quoted in active markets (real estate investment trusts) and observable inputs other than quoted prices (corporate bonds), and changes in fair value are recognized in the consolidated statements of comprehensive income. 9. Mortgages - Corporate (a) Summary As at December 31, 2016 Corporate portfolio: Single family mortgages - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non-residential Commercial loans - Uninsured As at December 31, 2015 Corporate portfolio: Single family mortgages - Uninsured - Insured - Uninsured - completed inventory Construction loans - Residential - Non-residential Commercial loans - Uninsured Gross Principal Collective Allowance Individual Total Net Principal $ $ 249,296 108,334 18,240 381,904 7,902 $ 1,061 - 78 2,472 51 170 - - 220 - $ 1,231 - 78 $ 248,065 108,334 18,162 2,692 51 379,212 7,851 143,685 $ 909,361 $ 1,197 4,859 $ - 390 $ 1,197 5,249 142,488 $ 904,112 Gross Principal Collective Allowance Individual Total Net Principal $ $ 361,107 83,619 31,415 352,314 5,632 $ 1,523 - 135 2,286 37 $ 119 - - 220 - 1,642 - 135 2,506 37 $ 359,465 83,619 31,280 349,808 5,595 115,281 $ 949,368 $ 939 4,920 $ - 339 $ 939 5,259 114,342 $ 944,109 Gross principal as presented in the tables above includes unamortized capitalized transaction costs and accrued interest. MCAN’s corporate mortgage portfolio includes insured and uninsured single family mortgages. The Company does not invest in the United States mortgage market. Uninsured mortgages may not exceed 80% of the value of the real estate securing such loans at the time of funding. Residential mortgages insured by CMHC or other private insurers may exceed this ratio. Uninsured completed inventory loans are credit facilities extended to developers to provide interim mortgage financing on residential units (condominium or freehold) where all construction has been completed and therefore no further construction risk exists. Residential construction loans are made to homebuilders to finance residential construction projects. These loans generally have a floating interest rate and terms of one to two years. - 84 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 9. Mortgages - Corporate (continued) Commercial loans include commercial term mortgages (e.g. loans secured by apartment buildings) and high ratio mortgage loans (e.g. second mortgages on residential construction projects). The weighted average yield of the Company’s corporate mortgage portfolio is as follows: As at December 31 Single family - uninsured Single family - uninsured completed inventory Single family - insured Construction - residential Construction - non residential Commercial Total 2016 4.57% 5.23% 3.14% 5.16% 5.41% 6.35% 4.90% 2015 4.42% 5.10% 3.52% 5.52% 5.59% 7.22% 5.12% Outstanding commitments for future fundings of mortgages intended for the Company’s corporate portfolio are as follows: As at December 31 Single family - insured Single family - uninsured Single family - uninsured completed inventory Construction - residential Construction - non-residential Commercial Total 2016 2015 $ $ 32,139 3,026 1,229 311,653 203 15,911 364,161 $ $ 30,691 10,396 789 259,684 1,593 5,089 308,242 The fair value of the corporate mortgage portfolio as at December 31, 2016 was $913,016 (December 31, 2015 - $958,772). Fair values are calculated on a discounted cash flow basis using the prevailing market rates for similar mortgages. For information regarding the maturity dates of the Company’s mortgages, refer to Note 32. As at December 31, 2016, single family insured mortgages included $36,606 of mortgages that had been securitized through the market MBS program, however the underlying MBS security has been retained by the Company for liquidity purposes (December 31, 2015 - $21,250). (b) Geographic Analysis As at December 31, 2016 Single Family Construction Commercial Total Ontario Alberta British Columbia Quebec Atlantic Provinces Other $ $ 241,780 67,674 27,942 12,272 16,719 8,174 374,561 $ $ 164,649 90,583 108,746 - - 23,085 387,063 $ $ 73,064 22,587 35,899 - - 10,938 142,488 $ $ 479,493 180,844 172,587 12,272 16,719 42,197 904,112 As at December 31, 2015 Single Family Construction Commercial Total Ontario Alberta British Columbia Quebec Atlantic Provinces Other $ $ 307,061 74,301 45,514 15,575 20,151 11,762 474,364 $ $ 154,006 76,743 104,855 - - 19,799 355,403 $ $ 72,275 17,991 12,430 - 11,500 146 114,342 $ $ 533,342 169,035 162,799 15,575 31,651 31,707 944,109 53.0% 20.0% 19.1% 1.4% 1.8% 4.7% 100.0% 56.5% 17.9% 17.2% 1.6% 3.4% 3.4% 100.0% - 85 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 9. Mortgages - Corporate (continued) (c) Mortgage Allowances Details of the allowances for mortgage credit losses for the current and prior years are as follows: Collective Individual 2016 Total Collective Individual Balance, beginning of year Provisions Reversals of provisions Write-offs, net Balance, end of year $ $ 4,920 $ (58) - (3) 4,859 $ 339 $ 364 (77) (236) 390 $ 5,259 $ 306 (77) (239) 5,249 $ 4,332 $ 647 - (59) 4,920 $ 642 $ 721 (698) (326) 339 $ 2015 Total 4,974 1,368 (698) (385) 5,259 (d) Arrears and Impaired Mortgages Mortgages past due but not impaired are as follows: As at December 31, 2016 Single family - uninsured Single family - insured As at December 31, 2015 Single family - uninsured Single family - insured 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days $ $ 3,992 2,081 6,073 1 to 30 days $ $ 8,132 2,269 10,401 $ $ $ $ 1,083 76 1,159 31 to 60 days 3,374 273 3,647 $ $ $ $ 1,044 - 1,044 $ $ - 888 888 61 to 90 days Over 90 days 1,124 - 1,124 $ $ - 1,990 1,990 Total 6,119 3,045 9,164 Total 12,630 4,532 17,162 $ $ $ $ Impaired mortgages (net of individual allowances) are as follows: As at SF Insured SF Uninsured Total SF Insured SF Uninsured Total December 31, 2016 December 31, 2015 Ontario Alberta Quebec Atlantic Provinces Other $ $ 129 623 366 - - 1,118 $ $ 1,079 1,228 333 119 - 2,759 $ $ 1,208 $ 1,851 699 119 - 3,877 $ 98 - 364 69 - 531 $ $ 873 322 614 143 244 2,196 $ $ 971 322 978 212 244 2,727 10. Financial Investments As at December 31 Investment - Crown Realty II Limited Partnership Investment - KingSett High Yield Fund 2016 2015 $ $ 33,207 24,057 57,264 $ $ 31,102 10,691 41,793 The Company holds an investment in Crown Realty II Limited Partnership (“Crown LP”), in which it has a 14.1% equity interest. Crown LP invests primarily in commercial office buildings and classifies them into its core fund, which represents buildings expected to provide stable cash flows over a longer time horizon, and its opportunity fund, which represents buildings with medium-term capital appreciation. Its fair value is driven primarily by independent appraisals of the buildings. As property acquisitions are made by Crown LP, the Company advances its proportionate share to finance the acquisitions. - 86 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 10. Financial Investments (continued) During 2016, the Company recorded a $7,242 gross increase in the unrealized gain on the investment (2015 - $8,466), which is recognized in the consolidated statements of comprehensive income net of deferred taxes. Additionally, the Company recognized $4,148 of income from the Crown LP investment in 2016 (2015 - $2,509). The receipt of partnership distributions from Crown LP generates a transfer from accumulated other comprehensive income to net income, where it is reflected in income on financial investments and other loans. The Company holds an investment in the KingSett High Yield Fund, in which it has a 9% equity interest. The fund invests in mortgages secured by real estate with a focus on mezzanine, subordinate and bridge mortgages. As mortgage advances are made by the fund, the Company advances its proportionate share. The fund pays a base distribution of 9% per annum, and distributes any additional income earned on a quarterly basis. The Company’s total funding commitment is $63,000, which consists of $42,000 of capital advances for the fund and $21,000 that supports credit facilities. As at December 31, 2016, the Company’s unfunded commitment was $38,700 (December 31, 2015 - $25,425). Both investments noted above are designated as available for sale, with changes in fair value recognized in the consolidated statements of comprehensive income. 11. Other Loans As at December 31 Loans receivable - Executive Share Purchase Plan Loans receivable - other All other loans are classified as loans and receivables. 12. Equity Investment in MCAP Commercial LP Note 29 6 $ $ 2016 1,535 2,049 3,584 2015 1,559 2,617 4,176 $ $ As at December 31, 2016, the Company held a 14.74% equity interest in MCAP Commercial LP (“MCAP”) (December 31, 2015 - 14.70%), consisting of 15.0% of voting class A units (December 31, 2015 - 15.0%), 0% of non-voting class B units (December 31, 2015 - 0%) and 17.0% of non-voting class C units (December 31, 2015 - 17.0%). The equity interest represents 4.3 million units held by MCAN of the 29.2 million total outstanding MCAP partnership units. MCAN holds a 15.0% voting interest in MCAP through its class A units (December 31, 2015 - 15.0%). Since MCAP’s fiscal year end is November 30th, MCAN records equity income from MCAP on a one-month lag. To the extent that MCAP has a material transaction during the one-month lag, MCAN is required to reflect the transaction in the month in which it occurred instead of the subsequent month. MCAP’s head office is located at 200 King Street West, Suite 400, Toronto, Ontario, Canada. Although MCAN’s voting interest in MCAP was less than 20% as at December 31, 2016, MCAN uses the equity basis of accounting for the investment as it has significant influence in MCAP per IAS 28, Investments in Associates and Joint Ventures, as a result of its entitlement to a position on MCAP’s Board of Directors. - 87 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 12. Equity Investment in MCAP Commercial LP (continued) Years Ended December 31 Balance, beginning of year Equity income Dilution gain Distributions received Balance, end of year Selected MCAP financial information is as follows: As at November 30 MCAP's balance sheet: Assets Liabilities Equity Years Ended November 30 MCAP revenue and net income: Revenue Net income 13. Foreclosed Real Estate 2016 44,191 13,509 - (6,895) 50,805 $ $ 2015 38,792 10,096 68 (4,765) 44,191 $ $ 2016 2015 $ 28,436,501 28,060,296 376,205 $ 21,081,191 20,748,503 332,688 2016 2015 $ $ 516,896 91,678 $ $ 470,053 68,660 The Company holds a real estate investment which is a previously impaired residential construction loan that was foreclosed upon. The investment is carried at the lower of its carrying amount and fair value less estimated costs to sell. 14. Other Assets As at December 31 Corporate assets: Intangible assets, net Capital assets, net Prepaid expenses Related party receivable - MCAP Receivables Other 2016 2015 $ $ 1,020 811 778 876 61 - 3,546 $ $ 668 945 569 21 219 204 2,626 Other securitization assets, totalling $4,802 as at December 31, 2016 (December 31, 2015 - $2,853), consist of interest-only strips from CMB program multi-family securitizations (Note 6) and prepaid expenses. Other assets are carried at cost. - 88 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 14. Other Assets (continued) The capital assets and intangible assets continuity is as follows: Furniture & Fixtures Computer Hardware Leasehold Capital Assets Total Improvements Intangible Assets $ 793 $ 23 816 - 816 792 3 795 5 800 1,554 $ 147 1,701 15 1,716 1,291 98 1,389 93 1,482 1,574 $ 263 1,837 - 1,837 3,921 $ 433 4,354 15 4,369 1,171 54 1,225 51 1,276 3,254 155 3,409 149 3,558 $ 21 16 $ 312 234 $ 612 561 $ 945 811 $ 4,386 304 4,690 556 5,246 3,831 191 4,022 204 4,226 668 1,020 Cost At January 1, 2015 Additions At December 31, 2015 Additions At December 31, 2016 Amortization At January 1, 2015 Amortization for the year At December 31, 2015 Amortization for the year At December 31, 2016 Net Book Value At December 31, 2015 At December 31, 2016 15. Cash Held in Trust Cash held in trust represents securitized mortgage principal collections from borrowers payable to MBS holders. It includes balances with banks and certain short-term investments with original maturity dates of less than 90 days. 16. Mortgages - Securitized MCAN’s securitized mortgage portfolio consists of insured mortgages securitized through the market MBS program and CMB program. These mortgages are held as collateral against the related securitization liabilities (Notes 6 and 20). (a) Summary As at December 31 Single family insured - Market MBS program Single family insured - CMB program 2016 2015 $ 971,548 100,301 $ 1,071,849 $ 1,075,947 - $ 1,075,947 Certain capitalized transaction costs are included in mortgages and are amortized using the EIM. As at December 31, 2016, the unamortized capitalized cost balance was $10,110 (December 31, 2015 - $13,563). The amortization of these transaction costs incorporates a 12% annual mortgage prepayment rate. All mortgages in the securitized portfolio are insured, therefore they do not have a collective allowance. The fair value of the securitized mortgage portfolio as at December 31, 2016 was $1,106,997 (December 31, 2015 - $1,107,168). The weighted average yield of the Company's securitized mortgage portfolio is as follows: As at December 31 Single family - Market MBS program Single family - CMB program Total 2016 2.50% 2.21% 2.47% 2015 2.48% - 2.48% - 89 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 16. Mortgages - Securitized (continued) (b) Geographic Analysis As at Ontario Alberta British Columbia Quebec Atlantic Provinces Other December 31, 2016 December 31, 2015 $ $ 613,036 231,027 107,980 42,715 41,407 35,684 1,071,849 57.2% 21.6% 10.1% 4.0% 3.9% 3.2% 100.0% $ 589,912 239,192 121,811 43,960 43,712 37,360 $ 1,075,947 54.8% 22.2% 11.3% 4.1% 4.1% 3.5% 100.0% Mortgages past due but not impaired are as follows: As at December 31, 2016 Single family - Market MBS Program Single family - CMB Program 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days Total $ $ 6,922 336 7,258 $ $ 2,948 649 3,597 $ $ 769 - 769 $ $ 1,398 - 1,398 $ $ 12,037 985 13,022 As at December 31, 2015 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days Total Single family - Market MBS program $ 10,651 $ 1,849 $ 1,356 $ 505 $ 14,361 Impaired mortgages are as follows: As at Quebec 17. Term Deposits December 31, 2016 December 31, 2015 CMB Market MBS Total CMB Market MBS Total $ $ - - $ $ 587 587 $ $ 587 587 $ - - $ - - $ - - Term deposits are issued to various individuals and institutions with original maturities ranging from 30 days to five years. The weighted average term deposit interest rate as at December 31, 2016 was 2.21% (December 31, 2015 - 2.26%). The Company’s term deposits are eligible for CDIC deposit insurance. Term deposits mature as follows: Within 3 Months 3 Months to 1 Year One to three years Three to five years Total December 31, 2016 December 31, 2015 $ $ 119,472 86,895 $ $ 327,739 489,020 $ $ 336,926 289,175 $ $ 127,729 37,951 $ $ 911,866 903,041 Term deposits are classified as other financial liabilities and are recorded at amortized cost. The estimated fair value of term deposits as at December 31, 2016 was $913,071 (December 31, 2015 - $905,167), and is determined by discounting the contractual cash flows using market interest rates currently offered for deposits of similar remaining maturities. - 90 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 18. Income Taxes The composition of the provision for (recovery) of income taxes is as follows: Years Ended December 31 Income before income taxes Statutory rate of tax Tax provision (recovery) before the following: Income subject to tax in subsidiaries Years Ended December 31 Current tax Current tax provision Deferred tax provision (recovery) Financial investment Relating to loss carry forward benefit Other The composition of the deferred tax asset and liability is as follows: As at December 31 Deferred tax asset Loss carry forward benefit Other Deferred tax liability Financial investments 2016 2015 $ $ 39,516 0% - (666) (666) $ $ 32,768 0% - (89) (89) 2016 2015 $ (100) $ - 91 (568) (89) (666) $ 330 (328) (91) (89) 2016 2015 1,478 304 1,782 3,050 3,050 $ $ $ $ 910 215 1,125 2,299 2,299 $ $ $ $ $ Deferred taxes recorded in accumulated other comprehensive income relating to financial investments were $660 in 2016 (2015 - $791). The Company has loss carry forward amounts in the non-consolidated MIC entity of $11,052 (December 31, 2015 - $11,710), the benefit of which has not been recorded to deferred taxes. Tax activity for 2016 has not been reflected in the table below as the Company’s 2016 tax position has not yet been finalized. Tax loss carry forwards expire after 20 years, as follows: 2033 2034 19. Other Liabilities As at December 31 Accounts payable and accrued charges Dividends payable $ $ 5,517 5,535 11,052 2016 $ $ 5,454 6,923 12,377 $ $ 2015 5,805 6,607 12,412 - 91 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 20. Financial Liabilities from Securitization Financial liabilities from securitization consist of liabilities relating to the Company’s participation in the market MBS program and the CMB program. As at December 31 Financial liabilities - Market MBS program Financial liabilities - CMB program Note 2016 2015 6 6 $ $ 972,263 99,523 1,071,786 $ 1,070,304 - $ 1,070,304 The weighted average interest rate on financial liabilities from securitization is as follows: As at December 31 Financial liabilities - Market MBS program Financial liabilities - CMB program 2016 1.84% 1.42% 1.80% 2015 1.87% - 1.87% Financial liabilities from securitization mature as follows: December 31, 2016 December 31, 2015 $ $ 120,825 $ 137,731 $ 468,304 $ 504,041 $ 383,134 $ 428,532 $ 99,523 $ - $ 1,071,786 1,070,304 2018 2019 2020 2021 Total 21. Share Capital and Contributed Surplus The authorized share capital of the Company consists of unlimited common shares with no par value. Number of Shares 2016 Number of Shares 2015 Balance, beginning of year Issued Dividend reinvestment plan Executive Share Purchase Plan Rights offering Balance, end of year 22,782,433 $ 206,382 20,807,761 $ 183,939 280,376 12,418 - 23,075,227 $ 3,680 177 - 210,239 568,588 - 1,406,084 22,782,433 $ 7,332 - 15,111 206,382 During 2016, the Company issued 280,376 (2015 - 568,588) shares under the dividend reinvestment plan (“DRIP”) out of treasury at the weighted average trading price for the five days preceding such issue less a discount of 2%. The DRIP participation rate for the 2016 fourth quarter dividend was 15% (2015 fourth quarter - 14%). During 2015, the Company completed a rights offering to its common shareholders. The rights offering raised net proceeds of $15,111 with 1,406,084 new common shares issued. For details on the Executive Share Purchase Plan, refer to Note 29. The Company had no potentially dilutive instruments as at December 31, 2016 or December 31, 2015. Contributed surplus of $510 represents the discount on the repurchase of warrants in 2004. 22. Dividends Subsequent to the end of the year and before the date that these consolidated financial statements were authorized for issuance, the Board declared a quarterly dividend of $0.30 per share payable on March 30, 2017 to shareholders of record as of March 15, 2017. - 92 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 23. Accumulated Other Comprehensive Income Accumulated other comprehensive income consists of unrealized gains and losses on available for sale marketable securities and financial investments. As at December 31 2016 2015 To be reclassified to the income statement in subsequent periods: Unrealized gain (loss) on available for sale marketable securities $ 1,049 $ (2,571) Unrealized gain on available for sale financial investments Less: deferred taxes 16,526 (2,471) 14,055 13,675 (1,811) 11,864 $ 15,104 $ 9,293 24. Fees Fees include extension, renewal and letter of credit fees earned on the Company’s corporate mortgage portfolio. 25. Mortgage Expenses Corporate Assets Years Ended December 31 Mortgage servicing expense Letter of credit expense Other mortgage expenses 2016 3,109 605 279 3,993 $ $ 2015 3,016 623 184 3,823 $ $ Letter of credit expense relates to outstanding letters of credit in the Company’s credit facility, discussed in Note 31. Securitization Assets Mortgage expenses associated with securitization assets consist primarily of mortgage servicing expenses. 26. Provision for Credit Losses Years Ended December 31 Note 2016 2015 Mortgages - collective provisions (recoveries), net Mortgages - individual provisions (reversals), net Other provisions (recoveries), net 9 9 $ $ (58) 287 (439) (210) $ $ 647 23 (395) 275 27. Whole Loan Gain on Sale Income The Company regularly sells mortgages to third party mortgage aggregators on a whole-loan basis with mortgage premiums received at the time of sale. The Company maintains renewal rights on these sales. During 2016, the Company sold $13,343 of insured mortgages (2015 - $26,215) and recorded a gain on sale of $324 (2015 - $626). 28. Realized Loss on Derivatives During 2015, the Company incurred net realized losses of $2,914 on interest rate swaps used to hedge interest rate risk on mortgage funding commitments. The Company did not apply hedge accounting. The hedge positions were closed before the end of 2015 such that there was no impact to the consolidated statement of income in 2016. - 93 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 29. Related Party Disclosures The consolidated financial statements include the financial statements of the Company and its equity-accounted associate, MCAP. The Company holds a 14.74% equity interest in MCAP (December 31, 2015 - 14.70%), a non-public entity. MCAP’s principal activities include the origination and servicing of mortgages. The Company holds one of six seats on MCAP’s Board of Directors. Transactions between the Company and its subsidiaries meet the definition of related party transactions. If these transactions are eliminated on consolidation, they are not disclosed as related party transactions. In 2016, the Company purchased certain corporate services from MCAP in the amount of $144 (2015 - $231) and purchased certain mortgage origination and administration services from MCAP in the amount of $3,904 (2015 - $3,765). The Company received $3,823 of mortgage fees from MCAP in 2016 (2015 - $4,851). Related party balances with MCAP are reflected in other assets and other liabilities on the consolidated balance sheet where applicable. In 2015, the Company paid $5,346 in mortgage premiums to MCAP as part of the acquisition of mortgages securitized through the market MBS program. The Company holds construction loans totalling $638 as at December 31, 2016 for which the borrower is a close family member of a member of the Board (December 31, 2015 - $3,971). In 2016, the Company earned interest income of $110 (2015 - $222) on these loans. The outstanding commitment for future fundings of these loans as at December 31, 2016 was $1,998 (December 31, 2015 - $1,100). The loans were contracted at market terms. All related party transactions noted above were in the normal course of business. Key management personnel of the Company consists of individuals that have authority and responsibility for planning, directing and controlling the activities of the Company, directly or indirectly. Key management personnel includes the members of the Board. The compensation of key management personnel is as follows: Years Ended December 31 Short term employee benefits (salaries, benefits and director fees) Share-based payments (DSU, RSU, PSU) Executive Share Purchase Plan 2016 3,337 424 3,761 $ $ 2015 2,630 60 2,690 $ $ The Company has an Executive Share Purchase Plan (the “Share Purchase Plan”) whereby the Board can approve loans to senior management for the purpose of purchasing the Company’s common shares. The maximum amount of loans approved under the Share Purchase Plan is limited to 10% of the issued and outstanding common shares. Dividend distributions on the common shares are used to reduce the principal balance of the loans as follows: 50% of regular distributions; 75% of capital gain distributions. Common shares are issued out of treasury for the Share Purchase Plan at the weighted average trading price for the 20 days preceding such issue. In 2016, the Company advanced $177 of new loans under the Share Purchase Plan (2015 - $185). As at December 31, 2016, $1,535 of loans were outstanding (December 31, 2015 - $1,559). The loans under the Share Purchase Plan bear interest at prime plus 1% (3.7%) as at December 31, 2016 (December 31, 2015 - prime plus 1% (3.7%) and have a five-year term. The shares are pledged as security for the loans and had a fair value of $2,753 as at December 31, 2016 (December 31, 2015 - $2,469). In 2016, MCAN recognized $56 of interest income (2015 - $58) on the Share Purchase Plan loans. - 94 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 29. Related Party Disclosures (continued) Deferred Share Units Plan The Company has a Deferred Share Units Plan (the “DSU Plan”) whereby the Board granted units under the DSU Plan to the President and Chief Executive Officer (the “DSU Participant”). Each unit is equivalent in value to one common share of the Company. Following his retirement/termination date, the DSU Participant is entitled to receive cash for each unit. The individual unit value is based on the average market value of the Company’s common shares for the five days preceding the retirement/termination date. The DSU Participant was initially granted 30,000 units under the DSU Plan and is entitled to receive dividend distributions in the form of additional units. All dividends paid after July 6, 2014 vest immediately such that as at December 31, 2016, all 53,234 units issued had vested (December 31, 2015 - 48,890). The Company recognizes compensation expenses associated with the DSU Plan over the vesting period. The compensation expense recognized related to the DSU Plan for 2016 was $184 (2015 - recovery of $61). As at December 31, 2016, the accrued DSU Plan liability was $766 (December 31, 2015 - $581). Restricted Share Units Plan The Company has a Restricted Share Units Plan (the “RSU Plan”) whereby the Board granted units under the RSU Plan to certain members of senior management of the Company (the “RSU Participants”). Each unit is equivalent in value to one common share of the Company. The RSU Participants are entitled to receive cash for each unit three years subsequent to the awarding of the units subject to continued employment with the Company. The individual unit values are based on the value of the Company’s common shares at the time of payment. In addition, the RSU Participants are entitled to receive dividend distributions in the form of additional units. All RSU units vest after three years. During 2016, the RSU Participants were granted 3,808 units under the RSU Plan (2015 - 35,120). Additionally, 9,452 units vested during 2016 (2015 - nil). At the time of vesting, the Company paid the RSU Participants $133 (2015 - $nil). As at December 31, 2016, 46,785 units were outstanding (December 31, 2015 - 65,802), of which no units had vested (December 31, 2015 - nil). The Company recognizes compensation recoveries or expenses associated with the RSU Plan over the vesting period. The compensation expense (recovery) recognized related to the RSU Plan for 2016 was $231 (2015 - $152). As at December 31, 2016, the accrued RSU Plan liability was $326 (December 31, 2015 - $229). Performance Share Units Plan In 2016, the Company established a Performance Share Units Plan (the “PSU Plan”) whereby the Board granted units under the PSU Plan to certain members of senior management of the Company (the “PSU Participants”). Each unit is equivalent in value to one common share of the Company and vests three years subsequent to the awarding of the units subject to continued employment with the Company. The individual unit values are based on the value of the Company’s common shares at the time of payment. In addition, the PSU Participants are entitled to receive dividend distributions in the form of additional units. At the time of vesting, a “Performance Factor” of 0-150% is applied to the number of units awarded which is based on earnings per share and other adjustments in the fiscal year two years subsequent to the grant date. The units granted under the PSU Plan may be either PSU units or Performance Deferred Share Units (“PDSU” units). Holders of PSU units are paid in cash at the time of vesting. Holders of PDSU units are paid in cash at their retirement/termination date, provided that the units have vested. Additionally, the PDSU units earn dividends subsequent to vesting until the retirement/termination date. In 2016, the PSU Participants were granted 26,796 units under the PSU Plan (2015 - n/a). As at December 31, 2016, 27,328 units were outstanding (December 31, 2015 - n/a). As at December 31, 2016, no units had vested (December 31, 2015 - n/a). The Company recognizes compensation recoveries or expenses associated with the PSU Plan over the vesting period. The compensation expense (recovery) recognized related to the PSU Plan for 2016 was $56 (2015 - n/a). As at December 31, 2016, the accrued PSU Plan liability was $56 (December 31, 2015 - n/a). - 95 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 30. Commitments and Contingencies The Company’s mortgage funding commitments relate primarily to its corporate residential construction loan portfolio. The commitment as noted below represents the undrawn portion of the authorized loan facility for construction and commercial loans. For single family mortgages, the commitment represents irrevocable offers to clients that the Company is contractually obligated to fund. For further details on the commitment associated with the KingSett High Yield Fund investment, refer to Note 10. The Company also has contractual obligations associated with its premises lease. One to Less than one year three years Three to Over five December 31 December 31 2015 2016 years five years Mortgage funding commitments Commitment - KingSett High Yield Fund Operating lease $ 364,161 $ - 575 $ 364,736 $ - $ - 1,158 1,158 $ - $ - 1,194 1,194 $ - $ 38,700 1,642 40,342 $ 364,161 $ 38,700 4,569 407,430 $ 308,242 25,425 5,145 338,812 The Company incurred $548 of operating lease expenses during 2016 (2015 - $492), included in general and administrative expenses. The Company outsources the majority of its mortgage servicing and continues to pay servicing expenses as long as the mortgages remain on its consolidated balance sheet. In the ordinary course of business, MCAN and its service providers (including MCAP), their subsidiaries and related parties may from time to time be party to legal proceedings which may result in unplanned payments to third parties. To the best of its knowledge, the Company’s management does not expect the outcome of any existing proceedings to have a material effect on the consolidated financial position or results of operations of the Company. 31. Credit Facilities The Company has a $75,000 line of credit facility from a Canadian Schedule I Chartered bank bearing interest at prime plus 0.75% (3.45%) as at December 31, 2016 (December 31, 2015 - prime plus 0.75% (3.45%)). The facility has a sub limit of $50,000 for issued letters of credit and $50,000 for overdrafts, and is due and payable upon demand. As at December 31, 2016, the outstanding overdraft balance was $nil (December 31, 2015 - $nil). The letters of credit have a term of up to one year from the date of issuance, plus a renewal clause providing for an automatic one-year extension at the maturity date subject to the bank’s option to cancel by written notice at least 30 days prior to the letters of credit expiry date. The letters of credit are for the purpose of supporting developer obligations to municipalities in conjunction with residential construction loans. As at December 31, 2016, there were letters of credit in the amount of $30,537 issued (December 31, 2015 - $35,863) and additional letters of credit in the amount of $26,138 committed but not issued (December 31, 2015 - $22,936). Subsequent to year end, the Company entered into an agreement with a Canadian Schedule I Chartered bank that enables the Company to execute repurchase agreements for liquidity purposes. This facility allows the Company to encumber certain eligible securities for financing purposes. As part of the agreement, the Company may sell assets to the counterparty at a specified price with an agreement to repurchase at a specified future date. The interest rate on the borrowings is driven by market spot rates at the time of borrowing. 32. Interest Rate Sensitivity Interest rate risk, or sensitivity, is the potential impact of changes in interest rates on financial assets and liabilities. Interest rate risk arises when principal and interest cash flows have mismatched repricing and maturity dates. An interest rate gap is a common measure of interest rate sensitivity. A positive gap occurs when more assets than liabilities reprice/mature within a particular time period. A negative gap occurs when there is an excess of liabilities over assets repricing/maturing. The former provides a positive earnings impact in the event of an increase in interest rates during the time period. Conversely, negative gaps are positively positioned for decreases in interest rates during that particular time period. The determination of the interest rate sensitivity or gap position is based upon the earlier of the repricing or maturity date of each asset and liability, and includes numerous assumptions. - 96 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 32. Interest Rate Sensitivity (continued) The interest rate sensitivity analysis is based on the Company’s consolidated balance sheets as at December 31, 2016 and December 31, 2015 and does not incorporate mortgage and loan prepayments. The Company currently cannot reasonably estimate the impact of prepayments on its interest rate sensitivity analysis. The analysis is subject to significant change in subsequent periods based on changes in customer preferences and in the application of asset/liability management policies. Floating rate assets and liabilities are immediately sensitive to a change in interest rates while other assets are sensitive to changing interest rates periodically, either as they mature or as contractual repricing events occur. Non-interest rate sensitive assets and liabilities are not directly affected by changes in interest rates. The Company manages interest rate risk by matching the terms of corporate assets and term deposits. To the extent that the two components offset each other, the risks associated with interest rate changes are reduced. The Asset and Liability Management Committee (“ALCO”) reviews the Company's interest rate exposure on a monthly basis using interest rate spread and gap analysis as well as interest rate sensitivity analysis based on various scenarios. This information is also formally reviewed by the Risk Committee of the Board each quarter. The following tables present the assets and liabilities of the Company by interest rate sensitivity. Yield spread represents the difference between the weighted average interest rate of the assets and liabilities in a certain category. As at December 31, 2016 Floating Rate Within 3 Months 3 Months to 1 Year 1 to 3 Years 3 to 5 years Over 5 years Non Interest Sensitive Total Assets Corporate Securitization Liabilities Corporate Securitization Shareholders' Equity $ 492,842 $ - 492,842 88,766 $ 240,380 $ 146,335 $ 15,724 104,490 609,883 756,218 - 240,380 39,973 $ 36,362 $ 461,967 501,940 - 36,362 143,822 $ 1,188,480 1,092,375 2,280,855 4,801 148,623 - - - - 119,472 - 119,472 327,739 - 327,739 336,926 589,129 926,055 127,729 482,657 610,386 - - - - - - - - 15,427 - 15,427 927,293 1,071,786 1,999,079 281,776 281,776 GAP $ 492,842 $ (14,982) $ (87,359) $ (169,837) $ (108,446) $ 36,362 $ (148,580) $ - YIELD SPREAD 4.05% 2.45% 2.62% 1.26% 1.00% 6.71% As at December 31, 2015 Floating Rate Within 3 Months 3 Months to 1 Year 1 to 3 Years 3 to 5 Years Over 5 Years Non Interest Sensitive Total Assets Corporate Securitization Liabilities Corporate Securitization Shareholders' Equity $ 341,705 $ 66,107 $ 325,826 $ 252,821 $ 32,992 $ 18,063 $ 117,532 $ 1,155,046 1,091,912 2,246,958 - 341,705 896,370 929,362 179,577 432,398 - 325,826 2,853 120,385 - 18,063 13,112 79,219 - - - - 86,895 - 86,895 489,020 - 489,020 289,175 137,731 426,906 37,951 932,573 970,524 - - - - - - - - 14,811 - 14,811 917,852 1,070,304 1,988,156 258,802 258,802 GAP $ 341,705 $ (7,676) $ (163,194) $ 5,492 $ (41,162) $ 18,063 $ (153,228) - YIELD SPREAD 4.08% 2.42% 2.98% 1.95% 1.02% 6.47% - 97 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 32. Interest Rate Sensitivity (continued) Certain residential construction loans and single family uninsured completed inventory loans are subject to the greater of a minimum interest rate (ranging between 3.75% and 9%) or a prime based interest rate. To the extent that the minimum rate exceeds the prime based rate as at December 31, 2016, these mortgages have been reflected in the table above as fixed rate mortgages, as follows: within 3 months - $41,304 (December 31, 2015 - $33,005), 3 months to 1 year - $60,947 (December 31, 2015 - $75,877) and 1 to 5 years - $28,973 (December 31, 2015 - $85,065). An immediate and sustained 1% increase to market interest rates as at December 31, 2016 would have an estimated positive effect of $1,478 (December 31, 2015 - $1,508) to net income over the following twelve month period. An immediate and sustained 1% decrease to market interest rates as at December 31, 2016 would have an estimated adverse effect of $1,835 (December 31, 2015 - $720) to net income over the following twelve month period. An immediate and sustained 1% increase (decrease) to market interest rates as at December 31, 2016 would have an estimated adverse (positive) effect of $9 (December 31, 2015 - $27) on accumulated other comprehensive income. When calculating the effect of an immediate and sustained 1% change in market interest rates on net investment income, the Company determines which assets and liabilities reprice over the following twelve months and applies a 1% change to their respective yields at the time of repricing to determine the change in net investment income for the duration of the twelve month period. 33. Capital Management The Company's primary capital management objectives are to maintain sufficient capital for regulatory purposes and to earn acceptable and sustainable risk-weighted returns for shareholders. Through its risk management and corporate governance framework, the Company assesses current and projected economic, housing market, interest rate and credit conditions to determine appropriate levels of capital. The Company typically pays out all of its taxable income by way of dividends. Capital growth is achieved through retained earnings, public share offerings, rights offerings and the DRIP. The Company's capital management is driven by the guidelines set out by the Tax Act and OSFI. Regulatory Capital As a Loan Company under the Trust Act, OSFI oversees the adequacy of the Company’s capital. For this purpose, OSFI has imposed minimum capital to risk-weighted asset ratios and a minimum leverage ratio which is calculated on a different basis from the aforementioned MIC leverage ratio. In order to promote a more resilient banking sector and strengthen global capital standards, the Basel Committee on Banking Supervision (“BCBS”) has issued a revised capital framework, referred to as Basel III. Further details on Basel III are available in the Capital Management section of the Management’s Discussion and Analysis (“MD&A”) or on the Company’s website at www.mcanmortgage.com. - 98 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 33. Capital Management (continued) As at December 31 Regulatory Ratios (OSFI) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Deduction for equity investment in MCAP (Transitional adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (Transitional) Deduction for equity investment in MCAP (All-in adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (All-in) Total Exposures/Regulatory Assets Consolidated assets Less: deductions from all-in Tier 1 Capital 1 Other adjustments 2 Total On-Balance Sheet Exposures Mortgage and investment funding commitments Less: conversion to credit equivalent amount (50%) Letters of credit Less: conversion to credit equivalent amount (50%) Off-Balance Sheet Items $ $ $ 2016 2015 210,239 510 55,923 15,104 (13,576) 268,200 (9,051) 259,149 $ $ 206,382 510 42,617 9,293 (7,324) 251,478 (10,986) 240,492 2,280,855 (22,627) 1,489 2,259,717 $ 2,246,958 (18,310) 2,229 2,230,877 402,861 (201,431) 30,537 (15,269) 216,698 333,667 (166,834) 35,863 (17,932) 184,764 Total Exposures/Regulatory Assets $ 2,476,415 $ 2,415,641 Leverage ratio 10.46% 9.96% 1 The deduction for the equity investment in MCAP on an all-in basis is equal to the equity investment balance less 10% of the Company’s shareholders’ equity. In 2016, the deduction on the transitional basis is equal to 60% of the all-in adjustment (2015 - 40%). The adjustment factor will increase by 20% annually over the phase-in period until it is fully deductible by 2018. 2 Certain items, such as negative cash balances, are excluded from total exposures but included in consolidated assets. As at December 31, 2016 and December 31, 2015, the Company was in compliance with the capital guidelines issued by OSFI under Basel III. Income Tax Capital As a MIC under the Tax Act, the Company is limited to an income tax liabilities to capital ratio of 5:1 (or an income tax assets to capital ratio of 6:1), based on the non-consolidated balance sheet in the MIC entity measured at its tax value. For further information on the Company’s income tax capital management, refer to the “Income Tax Capital” sub-section of the Capital Management section of the MD&A. - 99 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 34. Financial Instruments The majority of the Company’s consolidated balance sheet consists of financial instruments, and the majority of net income is derived from the related income, expenses, gains and losses. Financial instruments include cash and cash equivalents, cash held in trust, marketable securities, mortgages, financial investments, other loans, financial liabilities from securitization, term deposits and loans payable. All financial instruments that are carried at fair value on the consolidated balance sheets (marketable securities and certain financial investments) or for which fair value is disclosed are estimated using valuation techniques based on observable market data such as market interest rates currently charged for similar financial investments to expected maturity dates. The following table summarizes financial assets reported at fair value and financial assets and liabilities for which fair values are disclosed. As at December 31, 2016 Level 1 Level 2 Level 3 Total Carrying Value Assets measured at fair value Cash and cash equivalents Marketable securities Financial investments - Crown Realty II Limited Partnership 1 Financial investments - KingSett High Yield Fund 2 Securitization program cash held in trust Assets for which fair values are disclosed Mortgages - corporate 3 Other loans 4 Mortgages - securitized 3 Liabilities measured at fair value Other liabilities - corporate 5 Liabilities for which fair values are disclosed Term deposits 6 Financial liabilities from securitization 7 $ $ $ $ $ $ 111,732 53,953 $ $ - 1,173 - - $ 111,732 55,126 $ 111,732 55,126 - - 15,724 $ 181,409 - - - 1,173 $ 33,207 24,057 - 57,264 33,207 24,057 15,724 $ 239,846 33,207 24,057 15,724 $ 239,846 - - - - $ 913,016 3,584 1,106,997 $ 2,023,597 $ 913,016 3,584 1,106,997 $ 2,023,597 $ 904,112 3,584 1,071,849 $ 1,979,545 $ $ $ - - - - - $ - $ 12,377 $ 12,377 $ 12,377 - - - $ $ - - - $ 913,071 1,086,583 $ 1,999,654 $ 913,071 1,086,583 $ 1,999,654 $ 911,866 1,071,786 $ 1,983,652 1 Fair value of investment is based on the underlying real estate properties determined by the discount cash flow method and direct capitalization method. The significant unobservable inputs are the capitalization rate and discount rate. 2 Fair value is based on the redemption value of the fund less a credit allowance based on the nature of the underlying mortgages. 3 Corporate and securitized fixed rate mortgages are calculated based on discounting the expected future cash flows of the mortgages, adjusting for credit risk and prepayment assumptions at current market rates for offered mortgages based on term, contractual maturities and product type. For variable rate mortgages, fair value is assumed to equal their carrying amount since there are no fixed spreads. The Company classifies its mortgages as Level 3 given the fact that although many of the inputs to the valuation models used are observable, the mortgages are not specifically quoted in an open market. 4 Fair value is assumed to be the carrying value as underlying mortgages and loans are variable rate. 5 The carrying value of the asset/liability approximates fair value. 6 As term deposits are non-transferable by the deposit holders, there is no observable market. As such, the fair value of the deposits is determined by discounting expected future cash flows of the deposits at current offered rates for deposits with similar terms. 7 Fair value of financial liabilities from securitization is determined using current market rates for CMB and MBS. - 100 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 34. Financial Instruments (continued) As at December 31, 2015 Level 1 Level 2 Level 3 Total Carrying Value Assets measured at fair value Cash and cash equivalents Marketable securities Financial investments - Crown Realty II Limited Partnership 1 Financial investments - KingSett High Yield Fund 2 Securitization program cash held in trust Assets for which fair values are disclosed Mortgages - corporate 3 Other loans 4 Mortgages - securitized 3 Liabilities measured at fair value Other liabilities - corporate 5 Liabilities for which fair values are disclosed Term deposits 6 Financial liabilities from securitization 7 $ $ $ $ $ $ $ 75,762 37,958 - $ $ - - $ 75,762 40,735 75,762 40,735 - - 13,112 $ 126,832 31,102 10,691 - 41,793 31,102 10,691 13,112 $ 171,402 31,102 10,691 13,112 $ 171,402 $ 2,777 - - - 2,777 $ $ $ - - - - - - - - $ 958,772 4,176 1,107,168 $ 2,070,116 $ 958,772 4,176 1,107,168 $ 2,070,116 $ 944,109 4,176 1,075,947 $ 2,024,232 - $ - $ 12,412 $ 12,412 $ 12,412 - - - $ $ - - - $ 905,167 1,103,339 $ 2,008,506 $ 905,167 1,103,339 $ 2,008,506 $ 903,041 1,070,304 $ 1,973,345 1 Fair value of investment is based on the underlying real estate properties determined by the discount cash flow method and direct capitalization method. The significant unobservable inputs are the capitalization rate and discount rate. 2 Fair value is based on the redemption value of the fund less a credit allowance based on the nature of the underlying mortgages. 3 Corporate and securitized fixed rate mortgages are calculated based on discounting the expected future cash flows of the mortgages, adjusting for credit risk and prepayment assumptions at current market rates for offered mortgages based on term, contractual maturities and product type. For variable rate mortgages, fair value is assumed to equal their carrying amount since there are no fixed spreads. The Company classifies its mortgages as Level 3 given the fact that although many of the inputs to the valuation models used are observable, the mortgages are not specifically quoted in an open market. 4 Fair value is assumed to be the carrying value as underlying mortgages and loans are variable rate. 5 The carrying value of the asset/liability approximates fair value. 6 As term deposits are non-transferable by the deposit holders, there is no observable market. As such, the fair value of the deposits is determined by discounting expected future cash flows of the deposits at current offered rates for deposits with similar terms. 7 Fair value of financial liabilities from securitization is determined using current market rates for CMB and MBS. The following table shows the continuity of Level 3 financial assets recorded at fair value: Balance, December 31, 2015 Advances Repayments Changes in fair value, recognized in other comprehensive income Balance, December 31, 2016 $ $ 41,793 13,611 (2,975) 4,835 57,264 An increase of 0.25% to capitalization rates as at December 31, 2016 would result in a decrease to the fair value of the investment in Crown LP by $1,144 (December 31, 2015 - $1,099). A decrease of 0.25% to capitalization rates as at December 31, 2016 would result in an increase to the fair value of the investment in Crown LP by $1,123 (December 31, 2015 - $1,085). There were no transfers between levels during the years ended December 31, 2016 or December 31, 2015. - 101 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 34. Financial Instruments (continued) Risk Management The types of risks to which the Company is exposed include but are not limited to interest rate, credit, liquidity and market risk. The Company’s enterprise risk management framework includes policies, guidelines and procedures, with oversight by senior management and the Board. These policies are developed and implemented by management and reviewed and approved annually by the Board. The nature of these risks and how they are managed is provided in the Risk Governance and Management section of the MD&A. Certain disclosures required under IFRS 7, Financial Instruments: Disclosures, related to the management of credit, interest rate, liquidity and market risks inherent with financial instruments are included in the MD&A. The relevant MD&A sections are identified by shading within boxes and the content forms an integral part of these consolidated financial statements. 35. Comparative Amounts Certain comparative amounts have been reclassified to conform to the presentation adopted in the current year. There was no impact to the financial position or net income as a result of these reclassifications. - 102 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION DIRECTORS Scott Coates Managing Director, Mortgage Investments, KingSett Capital Member of Audit Committee Member of Risk Committee Director since May 2014 EXECUTIVE OFFICERS William Jandrisits President and Chief Executive Officer Jeffrey Bouganim Senior Vice President and Chief Financial Officer Leonard Zaidener Vice President, Investments Robert Horton Vice President and Chief Risk Officer Carl Brown Vice President, Operations Business Continuity/Disaster Recovery Coordinator Jeffrey Lum Vice President, Treasury and Securitization Martin Beaudry Vice President, Single Family Mortgage Operations Sylvia Pinto Vice President, Chief Compliance Officer & Corporate Secretary Dipti Patel Vice President and Chief Audit Officer Brydon Cruise Chair, Brookfield Financial Chair of Risk Committee Director since May 2010 Verna Cuthbert Counsel, Fasken Martineau DuMoulin LLP Member of Conduct Review, Corporate Governance and Human Resources Committee Member of Risk Committee Director since September 2013 Susan Doré Corporate Director Member of Audit Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Director since May 2010 William Jandrisits President and Chief Executive Officer, MCAN Mortgage Corporation Member of Enterprise Risk Management Ad Hoc Committee Director since August 2010 Brian A. Johnson Partner, Crown Capital Partners and Crown Realty Partners Member of Risk Committee Member of Enterprise Risk Management Ad Hoc Committee Chair of Conduct Review, Corporate Governance and Human Resources Committee Director since January 2001 Ian Sutherland Chair, MCAN Mortgage Corporation Member of Enterprise Risk Management Ad Hoc Committee Director since January 1991 Karen Weaver Executive Vice President and Chief Financial Officer, DH Corporation Chair of Audit Committee Director since November 2011 W. Terrence Wright Counsel, Pitblado LLP Member of Audit Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Chair of Enterprise Risk Management Ad Hoc Committee Director since September 2013 - 103 - 2016 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CORPORATE INFORMATION Head Office 200 King Street West, Suite 600 Toronto, Ontario M5H 3T4 Tel: 416-572-4880 Tel: 1-855-213-6226 (toll free) Fax: 416-598-4142 mcanexecutive@mcanmortgage.com Term Deposits Tel: 1-800-387-9096 (toll free) Fax: 1-877-821-0710 termdeposits@mcanmortgage.com Stock Listing Toronto Stock Exchange Symbol: MKP Corporate Counsel Goodmans LLP Toronto, Ontario Auditors Ernst & Young LLP Toronto, Ontario Bank Bank of Montreal First Canadian Place Toronto, Ontario Registrar and Transfer Agent Computershare Investor Services Inc. 100 University Avenue, 9th Floor Toronto, Ontario M5J 2Y1 Tel: 1-800-564-6253 Websites www.mcanmortgage.com www.xceedmortgage.com Dividend Reinvestment Plan (DRIP) For further information regarding MCAN’s Dividend Reinvestment Plan, please visit: www.mcanmortgage.com/investor-relations/investor- materials. An Enrolment Form may be obtained at any time upon written request addressed to the Plan Agent, Computershare. Registered Participants may also obtain Enrolment Forms online at www- us.computershare.com/investor/. Shareholders For dividend information, change in share registration or address, lost certificates, estate transfers, or to advise of duplicate mailings, please call MCAN Mortgage Corporation’s Transfer Agent and Registrar, Computershare (see left for contact). Report Copies This MCAN Mortgage Corporation 2016 Annual Report is available for viewing/printing on our website at www.mcanmortgage.com, and also on SEDAR at www.sedar.com. To request a printed copy, please contact Ms. Sylvia Pinto, Corporate Secretary, or e-mail spinto@mcanmortgage.com. General Information For general enquiries about MCAN Mortgage Corporation, please write to Ms. Sylvia Pinto, Corporate Secretary (head office details at left) or e-mail mcanexecutive@mcanmortgage.com Annual and Special Meeting of Shareholders Tuesday, May 9, 2017 4:30pm (local time) St. Andrew’s Club & Conference Centre 150 King Street West, 27th Floor Toronto, Ontario All shareholders and prospective investors are invited to attend. - 104 - (cid:68)(cid:18)(cid:4)(cid:69)(cid:3)(cid:68)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:3)(cid:18)(cid:381)(cid:396)(cid:393)(cid:381)(cid:396)(cid:258)(cid:415)(cid:381)(cid:374) 200 King Street West, Suite 600 Toronto, ON M5H 3T4 Toll Free Phone: 1-855-213-6226 Toronto Phone: Fax: (cid:28)(cid:373)(cid:258)(cid:349)(cid:367)(cid:855)(cid:3)(cid:3) (cid:3) 416-572-4880 416-598-4142 (cid:373)(cid:272)(cid:258)(cid:374)(cid:286)(cid:454)(cid:286)(cid:272)(cid:437)(cid:415)(cid:448)(cid:286)(cid:923)(cid:373)(cid:272)(cid:258)(cid:374)(cid:373)(cid:381)(cid:396)(cid:410)(cid:336)(cid:258)(cid:336)(cid:286)(cid:856)(cid:272)(cid:381)(cid:373) www.mcanmortgage.com 

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