2017 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 diversified 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 taxed in the hands of our shareholders as capital gains dividends and interest income, respectively, to the extent that they are held in a non‐registered plan. MCAN’s wholly‐owned subsidiary, XMC Mortgage Corporation (“XMC”) (formerly Xceed Mortgage Corporation), is an originator of residential first‐charge mortgage products across Canada. As such, XMC operates primarily in one industry segment through its sales team and mortgage brokers. We renamed the subsidiary to XMC as of September 1, 2017. TABLE OF CONTENTS PRESIDENT AND CEO’S MESSAGE TO SHAREHOLDERS .................................................................................................. 3 MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS ................................................................................... 5 CONSOLIDATED FINANCIAL STATEMENTS ................................................................................................................... 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .................................................................................................. 68 DIRECTORS AND EXECUTIVE OFFICERS ...................................................................................................................... 103 CORPORATE INFORMATION ..................................................................................................................................... 104 ‐ 2 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION MESSAGE TO SHAREHOLDERS MCAN Mortgage Corporation (“MCAN”, the “Company” or “we”) reported net income for fiscal 2017 of $39.9 million, down slightly from record net income of $40.2 million earned in 2016. Earnings per share totalled $1.72 in 2017 compared to $1.75 per share in 2016. Return on average shareholders’ equity was 13.75% compared to 14.74% in the prior year. We ended 2017 with a strong fourth quarter, reporting quarterly net income of $10.8 million ($0.47 per share), up from $9.0 million ($0.39 per share) in the fourth quarter of 2016. During 2017, markets experienced significant volatility in the pricing and availability of both deposits and mortgages driven primarily by liquidity issues in the market. This volatility stabilized in the third quarter and markets normalized during the fourth quarter. We did not experience any issues raising deposits through the market disruption, and we increased our deposit balances to carry extra liquidity as a precaution. We temporarily curtailed construction and mortgage commitments in the second quarter, and then resumed in the third quarter once we observed signs of a more stable market. The result is that we held additional liquidity throughout most of 2017 and ended the year with higher liquid assets. We believe that this positions MCAN well to be able to take advantage of potential market opportunities to either originate or acquire mortgages. On October 13, 2017, the Board of Directors (the “Board”) declared an increase to the quarterly dividend from $0.32 per share to $0.37 per share effective with the fourth quarter dividend paid on January 2, 2018. Consistent with the prior quarter, the Board declared a $0.37 per share dividend on February 23, 2018 to be paid on March 29, 2018. Corporate Assets Corporate assets totalled $1.18 billion at December 31, 2017, a decrease of $6 million from December 31, 2016. The corporate mortgage portfolio decreased by $41 million during 2017 to $863 million from $904 million, which included decreases of $50 million in uninsured single family and $28 million in insured single family, partially offset by an increase of $33 million in uninsured completed inventory. The decrease in the uninsured single family portfolio is a result of low origination volumes by our historical standards. Mortgage arrears totalled $18 million at December 31, 2017, an improvement of $9 million (33%) from $27 million at December 31, 2016. The December 31, 2017 balance consists entirely of single family mortgages, $5.9 million of which were uninsured. The impaired total mortgage ratio decreased to 0.09% as at December 31, 2017 from 0.14% at December 31, 2016, while the impaired corporate mortgage ratio decreased to 0.20% from 0.31% during the same period. We remain vigilant and continue to use underwriting and credit standards and default management practices which we believe are conservative and appropriate in the context of the current market. Equity income from our investment in MCAP Commercial LP (“MCAP”) increased to $14.4 million in 2017 from $13.5 million in 2016. MCAP earned higher net interest income on securitized mortgages from a larger average portfolio and higher servicing revenue as a result of an increase in assets under administration in 2017. These increases were offset by lower net fair value adjustments to financial instruments in 2017. MCAP’s 2017 origination volumes were $14.5 billion (2016 ‐ $15.9 billion). MCAP had $65.9 billion of assets under administration as at November 30, 2017 (November 30, 2016 ‐ $60.6 billion). Income from financial investments and other loans, relating primarily to our investments in the Crown Realty II Limited Partnership (“Crown LP”) and the KingSett High Yield Fund, increased by 39% to $9.0 million in 2017 from $6.5 million in 2016 primarily due to an increase in the financial investments balance. Securitization Assets In 2017, we securitized $110 million of insured single family mortgages through both the market mortgage‐backed securities (“MBS”) program and Canada Mortgage Bonds (“CMB”) program (2016 ‐ $228 million). Recent changes to mortgage regulations have reduced volumes in the market and have led to tightened securitization spreads. These changes have led to a reduction in mortgage origination and securitization volumes during 2017, and a reduction in the associated securitization economics. We have reduced our securitization volumes to a level where we are primarily securitizing mortgages that we have renewed. We will continue to securitize mortgages to the extent that it is profitable. Business Activities Our corporate mortgage portfolio decreased by $41 million (5%) during 2017, and similarly the average portfolio balance decreased by $88 million (9%) from 2016. Our single family uninsured portfolio decreased by $50 million during the year while ‐ 3 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION the insured portfolio decreased by $28 million, continuing the declining trend from 2016 as we maintained our conservative underwriting and credit standards and experienced maturities in the portfolio. During 2017, the Bank of Canada announced two 0.25% increases in the overnight rate. The Bank of Canada also announced a third 0.25% rate increase in January 2018. These rate increases are expected to continue to have a positive impact on mortgage interest income relating to the floating rate component of our corporate mortgage portfolio. The 2017 rate increases contributed approximately 0.19% and 0.12%, respectively, to the average interest rate for the construction and total corporate portfolios in 2017, as approximately 96% and 61% of those respective portfolios are floating rate and repriced following the rate increases. The term deposit portfolio is entirely fixed‐rate, therefore these rate increases will be reflected in future yields. An unprecedented number of rule changes affecting residential mortgage lending have been announced in the past year by the federal and provincial governments. These are expected to impact real estate affordability, mortgage affordability and demand for housing, as already observed in the fourth quarter of 2017 and early 2018. OSFI implemented significant changes to Guideline B‐20, Residential Mortgage Underwriting Practices and Procedures as of January 1, 2018. Since 2016, we have implemented more conservative underwriting and credit standards relative to the market, and have continued to enhance the systems and processes associated with our single family mortgage operations. We believe that our existing underwriting standards are consistent with the new B‐20 guidelines. The new B‐20 guidelines require a 200 basis point stress test on the borrower qualifying rate, which will further enhance the credit quality of newly originated mortgages. We expect that this stress test may have some impact on the proportion of mortgages that we approve. Given our available asset capacity, the market repositioning and rule changes, we feel that we are well positioned to capitalize on this asset class by way of internal originations or from mortgage acquisitions in the upcoming year. To start 2018, we have observed increased market volatility and we believe that this volatility will continue during the year. We also believe that Canadian real estate lending markets may experience additional headwinds as the combination of new lending rules and lower housing affordability take effect. Additionally, we have observed declines in both home sales and the pricing of properties in the Greater Toronto Area (“GTA”), which represents one of the key markets that we lend in. As a result of our curtailed single family origination activity in 2017 and our increased available liquidity at the end of 2017, we believe that we are well positioned to manage risk and capitalize on potential opportunities in the near future. As a lender across Canada we are also able to diversify and adjust our lending to markets outside the GTA as needed. As mortgage markets adjust to new regulations and housing markets adjust to new pricing levels, we have actively commenced sourcing new opportunities for origination and portfolio acquisitions. In late 2017, we commenced new acquisition programs for single family mortgages from MCAP and another third party originator, and we will continue examining additional opportunities into 2018. Our corporate assets decreased by 1% in 2017, compared to our stated annual growth target of 10%. We have maintained our stated annual growth target for corporate assets of 10% per annum. We believe that this target provides our shareholders with a measure of the long term expected pace of annual growth for the Company. As market conditions change, we may choose to deviate from this target to exercise prudent risk management, such as avoiding mortgage markets where home prices have shown excessive inflation levels, or to capitalize on opportunities that fit within our overall risk appetite and strategic objectives. We believe that we ended 2017 in a sound liquidity position with available income tax asset capacity of $287 million, and that we are well positioned to adapt to future uncertainty during the upcoming year. William Jandrisits President and Chief Executive Officer ‐ 4 ‐ 2017 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, 2017 and December 31, 2016 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, 2018. 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 ........................................................................................................................................ 32 SUMMARY OF FOURTH QUARTER RESULTS .................................................................................................................................... 33 SECURITIZATION PROGRAMS ......................................................................................................................................................... 39 CAPITAL MANAGEMENT ................................................................................................................................................................. 41 LIQUIDITY MANAGEMENT .............................................................................................................................................................. 44 RISK GOVERNANCE AND MANAGEMENT ....................................................................................................................................... 46 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 ........................................ 60 NON‐IFRS MEASURES ...................................................................................................................................................................... 61 ‐ 5 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION A CAUTION ABOUT FORWARD‐LOOKING INFORMATION AND STATEMENTS This MD&A contains forward‐looking information within the meaning of applicable Canadian securities laws. All information contained in this MD&A, other than statements of current and historical fact, is forward‐looking information. All of the forward‐ looking information in this MD&A is qualified by this cautionary note. Often, but not always, forward‐looking information can be identified by the use of words such as “may,” “believe,” “will,” “anticipate,” “expect,” “planned,” “estimate,” “project,” “future,” and variations of these or similar words or other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters. Forward‐looking information in this MD&A includes, among others, statements and assumptions with respect to: the potential impact of changes to regulations; • the current business environment and outlook; • possible or assumed future results; • our ability to create shareholder value; • our business goals and strategy; • • the stability of home prices; • the 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. Forward‐looking information is not, and cannot be, a guarantee of future results or events. Forward‐looking information reflects management’s current beliefs and is based on information currently available to management. Forward‐looking information is based on, among other things, opinions, assumptions, estimates and analyses that, while considered reasonable by us at the date the forward‐looking information is provided, inherently are subject to significant risks, uncertainties, contingencies and other factors that may cause actual results and events to be materially different from those expressed or implied by the forward‐looking information. The material factors or assumptions that we identified and were applied by us in drawing conclusions or making forecasts or projections set out in the forward‐looking information include, but are not limited to: the effect of competition; factors and assumptions regarding interest rates; • our ability to successfully implement and realize on our business goals and strategy; • • housing sales and residential mortgage borrowing activities; • • government regulation of our business; computer failure or security breaches; • the availability of funding and capital to meet our 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; • acceptance of our products in the marketplace; • availability of key personnel; • our operating cost structure; and • the current tax regime. Reliance should not be placed on forward‐looking information because it involves known and unknown risks, uncertainties and other factors, which may cause actual results to differ materially from anticipated future results expressed or implied by such forward‐looking information. Factors that could cause actual results to differ materially from those set forth in the forward‐ looking information 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; ‐ 6 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION • technology changes; • confidence levels of consumers; • our 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; • our ability to retain our executive officers and other employees; • • our 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. Subject to applicable securities law requirements, we undertake no obligation to publicly update or revise any forward‐looking information after the date of this MD&A whether as a result of new information, future events or otherwise or to explain any material difference between subsequent actual events and any forward‐looking information. 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 MBS Mortgage Backed Securities 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 ICB IFRIC IFRS CMB Canada Mortgage Bonds LAR International Accounting Standard International Accounting Standards Board Investment Committee of the Board IFRS Interpretations Committee International Financial Reporting Standards Liquidity Adequacy Requirements MD&A MIC Management’s Discussion & Analysis Mortgage Investment Corporation NHA National Housing Act NSFR Net Stable Funding Ratio OSFI Office of the Superintendent of Financial Institutions RAF Risk Appetite Framework CMHC Canada Mortgage and Housing Corporation LCR Liquidity Coverage Ratio RMBS DRIP Dividend Reinvestment Plan LP ARA Limited Partner’s At‐Risk Amount SEDAR Residential Mortgage Backed Securities System for Electronic Document Analysis and Retrieval ECL Expected Credit Losses LTV Loan to Value (ratio) TSX Toronto Stock Exchange EIM Effective Interest Rate Method ‐ 7 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SELECTED FINANCIAL INFORMATION Table 1: Income Statement Highlights (in thousands except for per share amounts and %) 2017 2016 2015 Change from 2016 (%) ($) $ $ $ $ $ $ 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 Next quarter's dividend per share Return on average shareholders' equity 1 Taxable income per share 1,3 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 52,413 $ 5,613 58,026 876 19,218 39,684 (244) 39,928 $ 1.72 $ 1.31 $ 0.37 57,479 5,778 51,701 $ 42,741 4,467 47,208 68 14,508 32,768 (89) 40,182 $ 32,857 ‐ 17,963 39,516 (666) 1.75 $ 1.17 $ 1.51 1.13 13.75% 14.74% 13.45% $ $ $ $ 712 (165) 547 876 1,255 168 422 (254) (0.03) 0.14 1.4% (2.9%) 1.0% ‐ 7.0% 0.4% (63.4%) (0.6%) (1.7%) 12.0% (0.99%) 1.51 $ 1.24 $ 0.90 $ 0.27 21.8% 5.31% 2.24% 3.07% 2.61% 1.87% 0.74% 5.15% 2.23% 2.92% 5.35% 2.34% 3.01% 2.73% 2.71% 2.02% 0.71% 2.07% 0.64% 0.16% 0.01% 0.15% (0.12%) (0.15%) 0.03% 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. 3 For further information refer to the “Taxable Income” section of this MD&A. ‐ 8 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 2: Balance Sheet Highlights (in thousands except for per share amounts and %) As at December 31, 2017 2017 2016 2015 Change from 2016 (%) ($) 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 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 $ $ $ $ $ $ $ $ $ $ $ $ 1,182,371 $ 1,034,404 2,216,775 $ 1,188,480 $ 1,092,375 2,280,855 $ 1,155,046 $ 1,091,912 2,246,958 $ (6,109) (57,971) (64,080) 863,384 $ 1,016,724 $ 904,112 $ 1,071,849 $ 944,109 $ 1,075,947 $ (40,728) (55,125) 904,099 $ 1,015,699 1,919,798 $ 927,293 $ 1,071,786 1,999,079 $ 917,852 $ 1,070,304 1,988,156 $ (23,194) (56,087) (79,281) 296,977 $ 281,776 $ 258,802 $ 15,201 4.60 4.87 5.11 21.53% 21.26% 21.53% 21.26% 21.53% 21.26% 22.98% 22.55% 22.98% 22.55% 22.98% 22.55% 23.58% 23.02% 23.58% 23.02% 23.58% 23.02% 11.31% 10.46% 9.96% 0.09% 0.20% 0.14% 0.31% 0.11% 0.23% 8,766 $ 8,803 17,569 $ 13,041 $ 13,609 26,650 $ 19,889 $ 14,361 34,250 $ (4,275) (4,806) (9,081) 23,378 12.70 $ 17.84 $ 417,064 $ 23,075 12.21 $ 14.32 $ 330,434 $ 22,782 11.36 $ 12.14 $ 276,573 $ 0.49 3.52 86,630 (1%) (5%) (3%) (5%) (5%) (3%) (5%) (4%) 5% (6%) (1.45%) (1.29%) (1.45%) (1.29%) (1.45%) (1.29%) 0.85% (0.05%) (0.11%) (33%) (35%) (34%) 1% 4% 25% 26% 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. For further information, refer to the “Capital Management” section of this MD&A. ‐ 9 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION HIGHLIGHTS Income Statement Fiscal 2017 We earned net income of $39.9 million, down slightly from record net income of $40.2 million earned in 2016. Our equity investment in MCAP Commercial LP (“MCAP”) continued to provide solid equity income of $14.4 million, up Earnings per share totalled $1.72 per share in 2017 compared to $1.75 per share in 2016. Return on average shareholders’ equity1 was 13.75% in 2017 compared to 14.74% in 2016. from $13.5 million in 2016. Income from financial investments and other loans, consisting primarily of our investments in the Crown Realty II Limited Partnership (“Crown LP”) and the KingSett High Yield Fund, increased by 39% to $9.0 million in 2017 from $6.5 million in 2016. We had decreases in corporate mortgage interest income ($2.9 million) and fees ($1.3 million) from 2016, in addition to higher operating expenses ($1.3 million). Q4 2017 Net income was $10.8 million in Q4 2017, an increase of 20% from $9.0 million in Q4 2016. The increase was driven by higher equity income from MCAP and income from financial investments and other loans, partially offset by higher operating expenses. Earnings per share increased by $0.08 (21%) to $0.47 in Q4 2017 from $0.39 in Q4 2016. Return on average shareholders’ equity increased to 14.63% in Q4 2017 from 12.94% in Q4 2016. Corporate Activity Corporate assets, which totalled $1.18 billion at December 31, 2017, decreased by $6 million from December 31, 2016. The corporate mortgage portfolio decreased by $41 million during 2017 to $863 million from $904 million, which included decreases of $50 million in uninsured single family, $28 million in insured single family, partially offset by an increase in $33 million in uninsured completed inventory. Our higher yielding corporate non‐mortgage investments portfolio, consisting of marketable securities, our equity investment in MCAP and financial investments, increased by $27 million (16%) from December 31, 2016. Dividend Consistent with the fourth quarter dividend, the Board of Directors (the “Board”) declared a first quarter dividend of $0.37 per share to be paid on March 29, 2018 to shareholders of record as of March 15, 2018. Credit Quality The impaired total mortgage ratio1 decreased to 0.09% at December 31, 2017 from 0.14% at December 31, 2016. The impaired corporate mortgage ratio1 decreased to 0.20% at December 31, 2017 from 0.31% at December 31, 2016. Total mortgage arrears1 were $18 million at December 31, 2017, a decrease of $9 million (33%) from $27 million at December 31, 2016. The December 31, 2017 balance consists entirely of single family mortgages, $5.9 million of which were uninsured. Net write‐offs were 5.7 basis points of the average corporate portfolio in 2017 compared to 2.4 basis points in 2016. The average loan to value ratio (“LTV”) of our uninsured single family portfolio based on an industry index of current real estate values was 52.6% at December 31, 2017 compared to 56.5% at December 31, 2016. Capital Our Common Equity Tier 1, Tier 1 and Total Capital to risk‐weighted assets ratios1 were 21.53% on the transitional basis and 21.26% on the “all‐in” basis at December 31, 2017 compared to 22.98% and 22.55%, respectively, at December 31, 2016. Our leverage ratio1 was 11.31% at December 31, 2017 compared to 10.46% at December 31, 2016. Income tax asset capacity1 was $287 million at December 31, 2017 compared to $209 million at December 31, 2016. This balance represents the additional amount of corporate assets in which we could invest within the rules of the Income Tax Act (Canada) (the “Tax Act”) that govern leverage for mortgage investment corporations. 1 Considered to be a “Non‐IFRS Measure”. For further details, refer to the “Non‐IFRS Measures” section of this MD&A. ‐ 10 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION OUTLOOK Market Conditions Housing markets are expected to face headwinds as a result of recent regulations enacted by the Federal and Ontario governments to cool down real estate markets and mortgage lending in Canada. Additionally, consumers are also facing a rising interest rate environment. After two interest rate hikes in 2017 and one in January 2018, the Bank of Canada will continue to monitor economic conditions before considering future interest rate increases. Recent reporting of job losses may add to the concerns over economic growth. Canadian residential real estate markets continue to have a mixed performance as regional markets adjust to local economic conditions. The Prairie Provinces have demonstrated some stabilization following the strengthening of oil prices. Other regional economies previously benefited from the lower Canadian dollar, which helped to strengthen employment in the manufacturing sector. These regional economies are now facing a relatively strong Canadian dollar, with forecasts for strong Canadian GDP supporting higher interest rates. Ontario and British Columbia have continued to exhibit strong fundamentals, with GDP growth driven by exports and immigration. We continue to focus our origination in Ontario and British Columbia and selectively lend in Alberta. Announced increases in immigration levels by the Federal government are expected to positively impact housing markets, particularly those that are supply‐constrained such as Toronto and Vancouver. Real Estate Conditions We expect Canadian housing market conditions to be volatile in 2018. Markets are adjusting to an unprecedented level of regulatory and policy changes affecting mortgage insurance rules, foreign buyer taxes, underwriting requirements for regulated lenders and rising interest rates. It will take another 6 months to see the full impact of these changes on housing sale volumes and prices. We expect home sale levels to slow considerably in Ontario, as buyers react to the uncertainty caused by the multiple rule changes, with significant increases in the number of days listings are on the market and marked decreases in sales volumes. We expect to see some level of weakness in resale markets as markets adjust to fewer buyers and more available listings. Actual sales activity in the Greater Toronto Area (“GTA”) was down 22.5% in January 2018 compared to January 2017. In line with reduced sales, the average price in January 2018 was 4.1% less than the average price in January 2017. The GTA saw existing home sales decrease by over 29% in the second half of 2017 (compared to 2016) following the Government of Ontario’s announced reforms to rental and housing markets. We expect the negative impact of the announced changes to impact the market for the first half of 2018, similar to what occurred in the Greater Vancouver Area (“GVA”) market. Notwithstanding the slowdown in the resale market, the GTA set a record in new condominium apartment sales in 2017, while having a record low in available inventory at year end. With regards to the GVA, demand is currently outpacing supply. There continues to be a lack of inventory in the market, which has and will continue to push prices upward. We expect the volumes and pricing on new home sales in the GVA to be steady due to a low supply of housing lots against demand. We believe that there is an increased risk of a price correction in the GTA residential housing market through 2018, as prices adjust from historical highs. We will continue to operate with more conservative underwriting and credit policies relative to the market for uninsured mortgages through this market transition. Regulatory Changes Revised Guideline B‐20, Residential Mortgage Underwriting Practices and Procedures came into effect on January 1, 2018. We believe that our existing underwriting standards are consistent with the new B‐20 guidelines. The new B‐20 guidelines require a 200 basis point stress test on the borrower qualifying rate, which will further enhance the credit quality of newly originated mortgages. We expect that this stress test may have some impact on the proportion of mortgages that we approve. This increase in the qualifying rate on uninsured mortgages will have the largest impact on market origination activity. The prime insured mortgage market is expected to decrease again this year, as a result of the cumulative effect of new mortgage insurance rules and the increased cost of portfolio insurance. We have been impacted by these rules, as insured mortgage rates have been under pressure due to increased competition amongst lenders despite the recent Bank of Canada interest rate increases. ‐ 11 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Impact on MCAN We will continue to monitor housing markets as they react to an unprecedented level of regulatory changes. We will continue to ensure that our mortgage portfolio remains well positioned. Our corporate assets decreased by 1% in 2017, compared to our stated annual growth target of 10%. As market conditions change, we may choose to deviate from this target to exercise prudent risk management, such as avoiding mortgage markets where home prices have shown excessive inflation levels, or to capitalize on opportunities that fit within our overall risk appetite and strategic objectives. We continue to maintain annual 10% corporate asset growth as our ongoing target as a measure of our expected annualized growth objective into 2018 and beyond. Real estate markets will react to the conditions described above, with the GTA market showing the greatest volatility in the first half of 2018. We believe that the market will recover to more normal volumes in the second half of the year. We expect to continue to make adjustments to the composition of our balance sheet as we evaluate the risks and rewards of each of our product lines in the geographic markets we lend to. We expect our equity investments in MCAP, Crown LP and the KingSett High Yield Fund to positively contribute to our earnings in 2018. KingSett’s announcement during Q2 2017 regarding its agreement to acquire over $1 billion in commercial mortgages from Home Capital has advanced the investment level and is expected to continue to have a positive impact on future income from our investment in the KingSett High Yield Fund. Subsequent to year end, we funded an additional $2.7 million of our capital commitment relating to our investment in the High Yield Fund. We continue to evaluate the impact of regulatory changes on the market and MCAN. We believe that it will require another 6 months to see the impact of these changes on construction, home sales, and mortgage volumes. We have significant available asset capacity, and with the market repositioning and changing rules, we feel that we are well positioned to capitalize on the single family uninsured asset class by way of internal originations or from mortgage acquisitions in the upcoming year. In late 2017 we commenced new acquisition programs for single family mortgages from MCAP and another third party originator and we will continue examining additional opportunities into 2018. IFRS 9 IFRS 9, Financial Instruments, became effective as of January 1, 2018. IFRS 9 requires the Company to begin including forward‐ looking economic information in its calculation of expected credit losses (“ECL”), which may add volatility to ECL balances. As part of the calculation of ECLs under IFRS 9 we expect to reflect negative trends in our economic outlook of the real estate market for 2018 and 2019. For further information on IFRS 9, please refer to Note 4 to the consolidated financial statements. ‐ 12 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION RESULTS OF OPERATIONS Table 3: Net Income ‐ For the Years Ended December 31 (in thousands except for per share amounts and %) 2017 2016 Change from 2016 (%) ($) Net Investment Income ‐ Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Financial investments and other loans Marketable securities Fees Interest on cash and cash equivalents Whole loan gain on sale income Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses Other Income ‐ Corporate Assets Gain on sale of investment in MCAP Commercial LP 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 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 $ 47,765 14,427 9,018 3,722 1,239 883 ‐ 77,054 20,837 3,877 38 (111) 24,641 $ 50,670 13,509 6,487 3,622 2,547 604 324 77,763 22,035 3,993 244 (210) 26,062 $ (2,905) 918 2,531 100 (1,308) 279 (324) (709) (1,198) (116) (206) 99 (1,421) 52,413 51,701 712 785 91 876 27,028 221 27,249 19,533 2,103 21,636 ‐ ‐ ‐ 28,298 461 28,759 21,176 1,805 22,981 785 91 876 (1,270) (240) (1,510) (1,643) 298 (1,345) 5,613 5,778 (165) 10,555 8,663 19,218 39,684 (244) 39,928 1.72 1.31 9,406 8,557 17,963 39,516 (666) 40,182 1.75 1.17 $ $ $ $ $ $ $ $ $ 1,149 106 1,255 168 422 (254) (0.03) 0.14 (6%) 7% 39% 3% (51%) 46% (100%) (1%) (5%) (3%) (84%) (47%) (5%) 1% ‐ ‐ ‐ (4%) (52%) (5%) (8%) 17% (6%) (3%) 12% 1% 7% 0% (63%) (1%) (2%) 12% ‐ 13 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Net Investment Income ‐ Corporate Assets Mortgage interest income Table 4: Interest Income and Average Rate by Mortgage Portfolio For the Years Ended December 31 2017 2016 (in thousands except %) Single family ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non residential Commercial loans ‐ Multi family residential ‐ Other commercial 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 $ $ $ 220,160 $ 88,473 44,610 391,310 7,308 45,549 101,609 899,019 $ 870,393 10,185 2,934 2,570 21,837 394 2,119 7,726 47,765 20,837 1,034,699 $ 1,046,976 27,028 19,533 4.63% $ 3.32% 5.76% 318,503 $ 110,694 19,099 5.58% 5.40% 407,246 6,957 4.65% 7.61% 5.31% $ 2.24% 3.07% 41,761 82,864 987,124 $ 940,926 2.61% $ 1,035,457 $ 1.87% 0.74% 1,046,154 14,611 3,562 1,038 22,286 390 1,917 6,866 50,670 22,035 28,298 21,176 4.59% 3.40% 5.44% 5.47% 5.61% 4.60% 8.30% 5.15% 2.23% 2.92% 2.73% 2.02% 0.71% 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, deferred interest and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Excluding discount income, non‐ recurring items were immaterial for the years ended December 31, 2017 and December 31, 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. In 2017, our construction, commercial and completed inventory portfolios were comparable to 2016 on a combined basis. In these portfolios, we continue to target experienced builders in construction market segments where the cost to build has not increased in line with the cumulative real estate appreciation experienced in the housing resale market in recent years. Construction lending is based on specific conditions required prior to funding, which act as a risk mitigant given concerns about inflated valuations in certain real estate markets. During 2017, we transferred certain existing construction projects to the completed inventory portfolio upon the substantial completion of units which led to an increase in the average completed inventory portfolio. On a combined basis, the two portfolios increased modestly from 2016. We have also targeted growth in our commercial loan portfolio, as it provides a different risk profile from single family while providing appropriate risk‐adjusted returns. The other commercial category includes higher‐yielding loans such as second mortgages on construction projects and term mortgages secured by retail or industrial buildings. The Bank of Canada announced two 0.25% increases in the overnight rate during 2017 which had and are expected to continue to have a positive impact on mortgage interest income related to the floating rate component of our corporate mortgage portfolio. These rate increases contributed approximately 0.19% and 0.12%, respectively, to the average interest rate for the construction and total corporate portfolios in 2017, as approximately 96% and 61% of those respective portfolios are floating rate and repriced following the rate increases. Our uninsured single family portfolio declined for a second consecutive year in 2017. Given the significant increase in home prices in the single family market segment in recent years, especially in the GTA, we continue to take a conservative approach to our underwriting and credit standards. We believe that this conservative approach to uninsured single family mortgage origination has been an appropriate course of action in the current risk environment. We continue to monitor the market for appropriate risk‐adjusted returns in this segment of the market. In late 2017, we commenced new acquisition programs for uninsured single family mortgages from MCAP and another third party origination source by acquiring $4.6 million of mortgages. We have targeted additional sources for uninsured single family mortgage origination given the attractive risk‐adjusted returns and our excess balance sheet capacity. Our single family origination volumes, while still low by historical standards, increased to $45 million in 2017 from $25 million in 2016. ‐ 14 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In late 2017, OSFI announced the finalization of significant changes to Guideline B‐20, Residential Mortgage Underwriting Practices and Procedures, effective January 1, 2018. We believe that our existing underwriting standards are consistent with the new B‐20 guidelines. The new B‐20 guidelines require a 200 basis point stress test on the borrower qualifying rate, which will further enhance the credit quality of newly originated mortgages. We expect that this stress test may have some impact on the proportion of mortgages that we approve. Our available asset capacity, market repositioning and these rule changes position us well to capitalize on this asset class by way of internal originations or through mortgage acquisitions. Multiple changes to mortgage regulations enacted within the last two years have led to a reduction in market insured single family mortgage origination and securitization volumes during 2017 and have led to tightened securitization spreads. These changes contributed to low mortgage origination and securitization volumes during 2017, and a reduction in the associated securitization economics. 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 Equity income from MCAP increased from 2016, although both years were strong by historical standards. MCAP earned higher net interest income on securitized mortgages from a larger average portfolio and higher servicing revenue as a result of an increase in assets under administration in 2017. These increases were offset by lower net fair value adjustments to financial instruments in 2017. We recognize equity income from MCAP on a one‐month lag such that our 2017 equity income from MCAP is based on MCAP’s net income for the year ended November 30, 2017. For further information on our equity investment in MCAP, refer to the “Equity investment in MCAP” sub‐section of the “Financial Position” section of this MD&A. Other net investment income Income from financial investments and other loans includes $5.3 million of income recognized from Crown LP (2016 ‐ $4.1 million). The recognition of income upon the receipt of partnership distributions from Crown LP is offset by a corresponding reduction to accumulated other comprehensive income. While distributions from Crown LP do not occur on a regular basis and therefore income from this investment can be volatile, this investment has performed well during 2016 and 2017. Income from financial investments and other loans also includes $3.5 million of income from our investment in the KingSett High Yield Fund (2016 ‐ $2.1 million). For further information on both of these investments, refer to the “Other Corporate Assets” sub‐section of the “Financial Position” section of this MD&A. 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. We issue term deposits that are eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance. We do not accept deposits that can be cashed prior to maturity or paid on demand except in the event of the death of a depositor. For further details, refer to the “Liquidity Management” section of this MD&A. Mortgage expenses consist primarily of mortgage servicing fees paid to external mortgage servicers. 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. Other Income ‐ Corporate Assets During 2017, we sold 100,000 partnership units in MCAP at a price of $19.47 per unit (compared to a net book value of $11.62 per unit), recognizing a gain on sale of $0.8 million. MCAP also issued additional class B units to other partners of MCAP during 2017 which diluted our equity interest. Since the new units were issued at a price in excess of our carrying value per unit, we recorded a dilution gain of $0.1 million. 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”) NHA MBS program. For further details on these programs, refer to the “Securitization Programs” section of this MD&A. ‐ 15 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In 2017, our total securitization volumes were $110 million (2016 ‐ $228 million), consisting of $63 million of insured single family mortgages securitized through the CMB program (2016 ‐ $100 million) and $47 million securitized through the market MBS program (2016 ‐ $42 million). Additionally, in 2016 we securitized $86 million of insured multi family mortgages; these mortgages were derecognized from the balance sheet and we recorded an upfront gain from securitization of $0.4 million, which is recorded in other securitization income. Market MBS Program The average outstanding market MBS program mortgage balance decreased to $909 million in 2017 from $1.0 billion in Q4 2016, while the net spread increased to 0.76% from 0.70% as a result of higher penalty income. As noted earlier, new securitization volumes have been low since 2016 as a result of our decision to reduce securitization activities due to tightened spreads from a more competitive market for insured single family mortgages. CMB Program The average outstanding CMB program mortgage balance increased to $125 million in 2017 from $22 million in Q4 2016, while the net spread decreased to 0.64% from 1.08%. Normally, the CMB program spread is higher than the market MBS program spread due to a lower funding cost. However, the tightening of spreads in CMB issuances from 2017 has made the CMB program net spread lower than that from the market MBS program. 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 2017 Income / Expense Average Rate3 Average Balance 1 2016 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 Securitization interest earning assets Total interest earning assets Non interest earning assets Total assets $ 86,758 $ 58,633 899,019 27,992 3,286 1,075,688 17,083 1,034,699 1,051,782 2,127,470 90,222 $ 2,217,692 $ $ 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 $ 2,217,692 $ 870,393 $ 1,096 871,489 1,046,976 1,918,465 8,926 290,301 883 3,722 47,765 3,540 168 56,078 121 27,028 27,149 83,227 5,310 88,537 20,837 38 20,875 19,533 40,408 ‐ ‐ 40,408 1.02% 6.32% 5.31% 12.65% 5.11% 5.21% 0.71% 2.61% 2.58% 3.91% ‐ 3.99% 2.24% 3.47% 2.24% 1.87% 2.06% ‐ ‐ 1.82% $ 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 $ $ 940,926 $ 6,749 947,675 1,046,154 1,993,829 7,541 272,636 $ 2,274,006 $ 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% 6.51% 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% Net Interest Income 2 $ 48,129 $ 46,266 ‐ 16 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 such as discount income, 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, non‐recurring items were immaterial for the years ended December 31, 2017 and December 31, 2016. 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. Credit Quality Table 6: Provisions for Credit Losses and Write‐offs (in thousands except basis points) For the Years Ended December 31 2017 2016 Change from 2016 (%) ($) 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 Net write offs (basis points) $ 176 $ 287 $ (111) (39%) (207) 142 44 (86) (107) (180) (287) $ (459) (56) 200 257 (58) (439) (497) $ 252 198 (156) (343) (49) 259 210 (55%) (354%) (78%) (133%) 84% (59%) (42%) (111) $ (210) $ 99 (47%) $ $ 69 508 5.7 $ $ 229 239 2.4 (160) 269 3.2 (70%) 113% 133% $ $ $ $ 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. For details of collective mortgage allowances, refer to Note 8 to the consolidated financial statements. The adoption of IFRS 9 as of January 1, 2018 will require MCAN to use forward‐looking economic information in its calculation of ECLs. This change will impact the calculation of collective and individual allowances on MCAN’s corporate mortgage portfolio. For further information on IFRS 9, refer to Note 4 to the consolidated financial statements. Other recoveries consist primarily of recoveries from mortgage settlements or litigations relating to XMC‐originated insured single family mortgages that had previously been written off. Write‐offs in 2017 include $220,000 relating to capitalized legal fees on a construction loan for which an individual allowance had already been recorded, while the balance of 2017 and the fiscal 2016 balance consist of uninsured single family mortgages for which an individual allowance had already been recorded. Accordingly, these write‐offs had no impact on net income. ‐ 17 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Operating Expenses Table 7: Operating Expenses (in thousands) For the Years Ended December 31 2017 2016 Change from 2016 (%) ($) Salaries and benefits General and administrative $ $ 10,555 $ 8,663 19,218 $ 9,406 8,557 17,963 $ $ 1,149 106 1,255 12% 1% 7% The increase in salaries and benefits is a result of an increase in the number of employees from 2016 and an increase in the expense associated with certain long term compensation programs as a result of a more pronounced increase in the share price in 2017. General and administrative includes expenditures relating to the continued development of our systems and processes, including corporate governance and our risk management framework. Provision for Income Taxes Table 8: Income Taxes (in thousands) For the Years Ended December 31 2017 2016 Change from 2016 (%) ($) Current tax provision Deferred tax provision (recovery) $ $ ‐ $ (244) (244) $ (100) (566) (666) $ $ 100 $ 322 422 $ (100%) (57%) (63%) Deferred tax provisions (recoveries) are generally due to taxable income (losses) recognized at the subsidiary level. As at December 31, 2017, 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, 2016 ‐ $11 million), the benefit of which is not reflected in deferred taxes. Tax activity for 2017 has not been reflected in this balance as our 2017 tax position has not been finalized. 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 XMC and other subsidiaries as it does not directly impact MCAN’s non‐consolidated taxable income. Taxable income is considered to be a non‐IFRS measure. For further details, refer to the “Non‐IFRS Measures” section of this MD&A. ‐ 18 ‐ 2017 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: Deduct: Equity income from MCAP ‐ accounting purposes Add: MCAP taxable income 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 Return of capital on marketable securities 5 Gain on dilution of investment in MCAP 2 Gain on partial sale of MCAP 6 Reorganization of investment in XMC 7 Other items Taxable Income Q4 2017 Q4 2016 YTD 2017 YTD 2016 $ 10,807 $ 9,000 $ 39,928 $ 40,182 (5,457) 1,016 819 8 1,701 (444) 74 (484) (253) ‐ ‐ ‐ 205 7,992 $ (3,209) 2,572 622 (255) 1,614 (1,171) (300) (321) (415) ‐ ‐ ‐ 12 8,149 (14,428) 8,729 (1,134) (147) 6,759 (1,966) 292 (1,479) (1,158) (91) (248) ‐ 179 35,236 $ (13,510) 4,303 (451) (56) 6,300 (3,799) (1,830) (452) (1,054) ‐ ‐ 4,017 (34) 33,616 $ $ 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. 5 Represents a separate deduction for tax purposes only. 6 For tax purposes, the accounting gain is excluded and only 50% of the taxable gain is included. 7 In 2017, we officially finalized the transfer value for tax purposes relating to the 2016 reorganization of the holding structure of our subsidiary investment in XMC. This transaction created a $4.6 million taxable capital gain in the MIC entity on a non‐consolidated basis. The amount presented in the table above represents the difference between this taxable capital gain and the accounting gain recorded in the MIC entity on a non‐consolidated basis. On finalization of the sale price for tax purposes, 2016 taxable income was retroactively restated from $28.4 million to $33.6 million. The increase in taxable income in 2017 is primarily due to higher taxable income from MCAP, lower deductions for upfront securitization program origination costs and higher CMB program multi family cash flow income, partially offset by the taxable gain recorded on the reorganization of XMC discussed below. The increase in income from MCAP from 2016 was more significant for tax purposes than for accounting purposes, as net fair value gains (which are excluded from taxable income) were lower in 2017. During 2017, we finalized our 2016 corporate tax position. Fiscal 2016 taxable income was revised to $33.6 million from the estimate of $28.4 million disclosed in our 2016 Annual Report. The change was primarily due to the above‐noted taxable capital gain created on the reorganization of the holding structure of our subsidiary investment in XMC which represented $0.22 per share of taxable income. The key differences between taxable income and pre‐tax net income for accounting purposes include differences between equity income from MCAP and XMC for accounting and tax purposes and the treatment of securitization program origination costs, securitization gains and losses, capital gains income, collective provisions for credit losses and the amortization of upfront securitization program costs for tax purposes. 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 2017, we incurred $2.0 million of origination costs on securitized mortgages, including market MBS held by MCAN (2016 ‐ $3.8 million). As at December 31, 2017, the unamortized origination fee balance was $11.9 million (December 31, 2016 ‐ $15.6 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. ‐ 19 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In recent quarters, taxable income has exceeded dividends paid as a result of the relatively low volume of deductions of payments of upfront origination fees. If our securitization volumes remain low, we would expect this excess of taxable income over dividends to continue. This recent trend in taxable income contributed to the 16% per share increase in the regular quarterly dividend as of the fourth quarter of 2017 from $0.32 per share to $0.37 per share. 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 above. Summary of Three Year Results of Operations In 2015, we earned then‐record net income of $32.9 million while earnings per share were $1.51. The XMC 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. In 2017, we recorded solid net income of $39.9 million, just below 2016’s record amount. Performance from our equity investment in MCAP, Crown LP and the KingSett High Yield Fund was strong once again with increases in both portfolio balances and income earned from those investments. We experienced modest growth in our construction, commercial and completed inventory mortgage portfolios on a combined basis while again reducing the size of the uninsured single family portfolio. Additionally, we continued to securitize new insured single family mortgages through the market MBS program and CMB program. Cash Flows Operating activities provided cash flows of $24 million in 2017 and provided $52 million in 2016. In 2017, we had higher net outflows related to term deposits and financial liabilities from securitization, partially offset by higher mortgage inflows. Investing activities provided cash flows of $7 million in 2017 and provided $6 million in 2016. In 2017, we received proceeds from a partial sale of our equity investment in MCAP of $1.9 million, offset by lower distributions from MCAP. Financing activities used cash flows of $24 million in 2017 and used $23 million in 2016. In 2017, there was an increase in outflows from dividends paid. ‐ 20 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION FINANCIAL POSITION Table 10: Assets (in thousands except %) As at Corporate Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Equity investment in MCAP Commercial LP Foreclosed real estate Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets Mortgages ‐ Corporate & Securitized Table 11: Mortgage Summary (in thousands) As at Corporate portfolio: Single family mortgages ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non‐residential Commercial loans ‐ Multi family residential ‐ Other commercial Securitized portfolio: Single family insured ‐ Market MBS program Single family insured ‐ CMB program December 31 December 31 2016 2017 Change from 2016 (%) ($) $ $ $ $ $ $ 117,571 62,518 863,384 68,190 2,612 59,189 435 2,672 5,800 1,182,371 $ 111,732 55,126 904,112 57,264 3,584 50,805 529 1,782 3,546 1,188,480 13,441 1,016,724 4,239 1,034,404 2,216,775 15,724 1,071,849 4,802 1,092,375 $ 2,280,855 December 31 December 31 2016 2017 $ 198,354 80,377 51,190 386,562 4,840 64,655 77,406 863,384 248,065 108,334 18,162 379,212 7,851 34,521 107,967 904,112 5,839 7,392 (40,728) 10,926 (972) 8,384 (94) 890 2,254 (6,109) (2,283) (55,125) (563) (57,971) (64,080) 5% 13% (5%) 19% (27%) 17% (18%) 50% 64% (1%) (15%) (5%) (12%) (5%) (3%) Change from 2016 (%) ($) (49,711) (27,957) 33,028 7,350 (3,011) 30,134 (30,561) (40,728) (20%) (26%) 182% 2% (38%) 87% (28%) (5%) (11%) 49% (5%) (5%) 867,406 149,318 1,016,724 1,880,108 $ 971,548 100,301 1,071,849 1,975,961 $ (104,142) 49,017 (55,125) (95,853) $ ‐ 21 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Corporate and Securitized Mortgage Portfolio Analysis Q4 2017 Summary Our year‐end construction and commercial portfolios were comparable to 2016 on a combined basis. In these portfolios, we continue to target experienced builders in construction market segments where the cost to build has not increased in line with cumulative real estate appreciation in the housing resale market from recent years. Construction lending is based on specific conditions required prior to funding, which act as a risk mitigant given concerns about inflated valuations in certain real estate markets. During 2017, we transferred certain existing construction projects to the completed inventory portfolio upon the substantial completion of units which led to an increase in the average completed inventory portfolio. On a combined basis, the two portfolios increased modestly from 2016. We have also targeted growth in our commercial loan portfolio, as it provides a different risk profile from single family while providing appropriate risk‐adjusted returns. The uninsured single family portfolio has decreased steadily since the end of 2015. Given the significant increase in valuations in the single family market segment in recent years, especially the GTA, we continue to take a conservative approach to our underwriting and credit standards. In late 2017, OSFI finalized significant regulatory changes to single family mortgage underwriting practices that are effective January 1, 2018. We believe that our existing underwriting standards are consistent with the new B‐20 guidelines. The new B‐20 guidelines require a 200 basis point stress test on the borrower qualifying rate, which will further enhance credit protection on newly originated mortgages. We expect that this stress test may have some impact on the proportion of mortgages that we approve. Given our available asset capacity, the market repositioning and rule changes, we feel that we are well positioned to capitalize on this asset class by way of internal originations or from mortgage acquisitions. In late 2017, we commenced new acquisition programs for uninsured single family mortgages from MCAP and another third party origination source. We have targeted additional sources for uninsured single family mortgage origination given the attractive risk‐adjusted returns and our excess balance sheet capacity. Mortgages in the insured single family portfolio are generally destined for our securitized portfolio, but recent changes to mortgage regulations have made the insured single family market more competitive. This has led to a reduction in mortgage refinance volumes, a tightening of securitization spreads and a reduction in overall economics. Figure 1: Total Corporate and Securitized Mortgage Portfolio (in thousands) ‐ 22 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Figure 2: Corporate Mortgage Portfolio Composition by Product Type (in thousands) Note: Amounts in parentheses represent the percentage of the corporate portfolio represented by the individual mortgage portfolio. Figure 3: Mortgage Portfolio Geographic Distribution as at December 31, 2017 (December 31, 2016) During 2017, we continued to focus on reducing our exposure to Alberta in the corporate mortgage portfolio while increasing exposure to Ontario and British Columbia. Corporate Mortgages Single family mortgages We invest in insured and uninsured single family mortgages in Canada, primarily originated through XMC 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 noted in the Corporate Mortgage Summary, in late 2017 we commenced new acquisition programs for uninsured single family mortgages from third party sources, including MCAP. 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. ‐ 23 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Completed inventory loans Completed inventory loans are credit facilities extended to developers to provide interim mortgage financing on residential units (condominium or freehold) that are close to completion. Qualification criteria for the completed inventory classification include no substantial remaining construction risk, commencement of occupancy permits, potential sale and closing with a purchaser within 3‐4 months or units being at least at a drywall stage with completion of plumbing and electrical. 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 multi family residential loans (e.g. loans secured by apartment buildings), and other commercial loans, which consist of commercial term mortgages (e.g. loans secured by retail/industrial buildings) and high ratio mortgage loans (e.g. second mortgages on residential construction projects). Other items The Canadian mortgage industry continues to experience falsification of supporting documents provided to lenders in the mortgage underwriting process, and we have observed this activity in our own underwriting processes. We have enhanced and continue to enhance our underwriting processes, and we maintain a rigorous due diligence process. To date, the impact of this document falsification has not had a material impact on MCAN or its financial position or performance. We do not expect to experience any material impact to our financial position or performance in the future relating to such document falsification. Mortgage renewal rights Through our XMC origination platform, 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, 2017, we had the renewal rights to $931 million of single family mortgages (December 31, 2016 ‐ $1.1 billion). The majority of these renewal rights relate to mortgages held on the consolidated balance sheet as corporate or securitized mortgages, while $42 million relates to off‐balance sheet mortgages sold to third parties on a whole loan basis (December 31, 2016 ‐ $130 million). The decrease from 2016 was consistent with the reduction in our single family corporate and securitized portfolios during that period. ‐ 24 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Arrears and Impaired Mortgages 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 Total securitized mortgage arrears 1 Total mortgage arrears 1 Collective allowance Individual allowance Total allowance December 31 2017 September 30 2017 December 31 2016 $ $ $ $ $ $ 1,696 832 2,528 ‐ 2,528 0.09% 0.20% 5,912 2,854 8,766 8,803 17,569 4,748 62 4,810 $ $ $ $ $ $ 2,675 622 3,297 185 3,482 0.14% 0.31% 7,399 3,918 11,317 7,782 19,099 4,744 52 4,796 $ $ $ $ $ $ 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 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 closely monitor our mortgage portfolio for early indicators of potential performance concerns by maintaining a “watch list” for these loans, whether they are in arrears or not. During 2017, a land developer in Western Canada filed for protection under the Companies’ Creditors Arrangement Act (“CCAA”). We have $15.8 million of outstanding mortgages from the borrower legal entity that are not in arrears as at December 31, 2017. The borrower legal entity is controlled by the developer (who previously acted as loan guarantor) but is not part of the bankruptcy proceedings. To keep the loans out of the developer’s CCAA proceedings and avoid claims on the loans from the developer’s creditors, we have waived the current default of the guarantor on the loan. In the event that the individual loans enter into arrears, based on the value of the underlying collateral we currently do not believe that we would incur a loss of principal or interest. Accordingly, we have not recorded an individual allowance on either loan. ‐ 25 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Figure 4: Impaired Corporate Mortgage Ratio Table 13: Mortgage Originations (in thousands) For the Quarters Ended December 31 Single family ‐ insured Single family ‐ uninsured Single family ‐ uninsured completed inventory Residential construction Non‐residential construction Commercial Q4 2017 15,245 21,529 ‐ 22,964 702 32,640 93,080 $ $ $ $ Q4 2016 Annual 2017 Annual 2016 46,950 43,895 $ 45,092 6,998 9,000 ‐ 124,967 21,951 702 ‐ 15,725 68,509 88,569 $ 295,220 $ $ 144,241 23,993 17,214 78,662 638 79,294 344,042 New uninsured single family origination volumes have increased modestly in 2017, although the portfolio has decreased significantly over the last two years. Given the significant increase in valuations in the single family market segment in recent years, especially the GTA, we continue to take a conservative approach to our underwriting and credit standards. We believe that this conservative approach to uninsured single family mortgage origination has been an appropriate course of action given the current risk environment. In late 2017, we commenced new acquisition programs for uninsured single family mortgages from MCAP and another third party origination source. Q4 and fiscal 2017 acquisition volumes of $4.6 million are included in the table above. We will seek to identify additional sources for uninsured single family mortgage origination consistent with our risk and quality standards, given the attractive risk‐adjusted returns and our excess balance sheet capacity. Insured single family originations have decreased as a result of changes to mortgage regulations enacted within the last year that have made that market segment more competitive and have led to tightened securitization spreads. In late 2017, OSFI announced the finalization of significant changes to Guideline B‐20, Residential Mortgage Underwriting Practices and Procedures, effective January 1, 2018. We believe that our existing underwriting standards are consistent with the new B‐20 guidelines. The new standards require a 200 basis point stress test on the borrower qualifying rate, which will further enhance the credit quality of newly originated mortgages. We expect that this stress test may have some impact on the proportion of mortgages that we approve. Our available asset capacity, market repositioning and these rule changes position us well to capitalize on this asset class by way of internal originations or from mortgage acquisitions. Construction, commercial and completed inventory originations represent first advances on newly originated loans, i.e. they exclude additional fundings on existing loans in the portfolio or reclassifications between portfolios. Originations in these asset classes have increased from 2016 as we have increased our focus on these portfolios. ‐ 26 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 ‐ Multi family residential ‐ Other commercial Securitized portfolio: Single family insured ‐ Market MBS Program Single family insured ‐ CMB Program December 31 2017 September 30 2017 December 31 2016 67.5% 64.2% 78.1% 61.6% 47.0% 67.9% 64.6% 65.3% 85.8% 82.0% 85.3% 76.0% 68.5% 63.6% 79.3% 62.5% 59.0% 69.5% 63.5% 66.0% 85.9% 81.8% 85.4% 76.4% 72.2% 63.8% 77.9% 58.8% 58.4% 70.2% 66.3% 66.2% 86.2% 83.1% 85.9% 76.8% Note: The LTV ratios in the above table represent the LTV at origination, not as at the reporting dates. 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, 2017 (in thousands except %) Insured % Uninsured % HELOCs % Corporate Securitized Insured % Total % Ontario Alberta British Columbia Quebec Atlantic Provinces Other Total $ 47,391 59.1% $ 159,788 47,396 14,932 18.6% 25,169 3.8% 4,853 5.6% 6,539 8.9% 5,799 4.0% 3,026 4,504 7,142 3,213 64.1% $ 19.0% 10.1% 1.9% 2.6% 2.3% $ 80,208 100.0% $ 249,544 100.0% $ 114 67.5% $ 48 28.4% 4.1% ‐ ‐ ‐ 576,785 56.6% 231,335 22.8% 8.9% 4.1% 4.4% 3.2% 169 100.0% $ 1,016,724 100.0% 90,174 41,449 44,924 32,057 7 ‐ ‐ ‐ $ 784,078 293,711 118,376 50,806 58,605 41,069 58.2% 21.8% 8.8% 3.8% 4.4% 3.0% $ 1,346,645 100.0% ‐ 27 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 16: 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 47,312 20,311 18.8% 24,947 2.7% 6,777 5.1% 8,103 8.0% 5,842 2.2% 2,953 5,495 8,616 2,332 65.1% $ 17.8% 9.4% 2.5% 3.0% 2.2% $ 108,081 100.0% $ 266,227 100.0% $ 160 63.2% $ 51 20.2% 42 16.6% ‐ ‐ ‐ 57.1% 21.6% 10.1% 4.0% 3.9% 3.3% 253 100.0% $ 1,071,849 100.0% 613,036 231,027 107,980 42,715 41,407 35,684 ‐ ‐ ‐ $ 854,816 298,701 135,922 54,987 58,126 43,858 59.1% 20.7% 9.4% 3.8% 4.0% 3.0% $ 1,446,410 100.0% Table 17: Single Family Mortgages by Amortization Period as at December 31, 2017 (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 $ $ $ 98,172 $ 29.8% 69,868 $ 21.2% 158,200 $ 48.0% 3,681 $ 1.0% $ ‐ ‐ 329,921 100.0% 205,764 $ 20.2% 502,032 $ 49.4% 231,282 $ 22.7% 77,305 $ 7.7% 341 $ ‐ 1,016,724 100.0% 303,936 $ 22.6% 571,900 $ 42.5% 389,482 $ 28.9% 80,986 $ 6.0% 341 $ ‐ 1,346,645 100.0% Table 18: 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 $ ‐ 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% 232,098 $ 16.1% 656,828 $ 45.4% 459,202 $ 31.7% 97,829 $ 6.8% 453 $ ‐ 1,446,410 100.0% 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 2017 YTD Average LTV 2017 Q4 Average LTV 2016 YTD Average LTV 2016 Ontario Alberta British Columbia Other $ 19,135 228 1,215 951 $ 21,529 67.8% $ 50,243 971 80.0% 1,760 72.2% 78.3% 1,118 68.6% $ 54,092 68.2% $ 73.2% 70.0% 76.6% 68.5% $ 6,064 ‐ 750 184 6,998 ‐ 74.4% $ 30,627 5,525 4,502 57.7% 80.0% 553 72.8% $ 41,207 74.0% 69.3% 67.3% 72.8% 72.7% ‐ 28 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 66.8% as at December 31, 2017 (December 31, 2016 ‐ 71.6%). Based on an industry index that incorporates current real estate values, the ratios would be 52.6% and 56.5%, respectively. As noted earlier in this MD&A, we have observed a significant increase in real estate values in recent years in certain markets, which is reflected in the current LTV ratios. Other Corporate Assets Cash and cash equivalents Cash and cash equivalents, which include cash balances with banks and overnight term deposits, increased by $6 million in 2017. 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 $7 million in 2017, which included a $2.3 million increase in the net unrealized gain on the portfolio that was reflected in accumulated other comprehensive income. 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. Financial investments Financial investments include a $32 million investment in Crown LP, in which we have a 14.1% equity interest (December 31, 2016 ‐ $33 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, which occur annually at year‐end. As property acquisitions are made by Crown LP, we advance our proportionate share to finance the acquisitions. During 2017, we recorded a $4.4 million gross increase in the unrealized gain on the investment in Crown LP (2016 ‐ $7.2 million), which is recognized in the consolidated statements of comprehensive income net of deferred taxes. Additionally, we recognized $5.3 million of gross income from the Crown LP investment in 2017 (2016 ‐ $4.1 million), which is reflected in income from financial investments and other loans, with a corresponding deferred tax expense recorded. The recognition of income upon the receipt of partnership distributions from Crown LP is offset by a corresponding reduction to accumulated other comprehensive income. We hold a $36 million investment in the KingSett High Yield Fund (“the Fund”), in which we have an 8.1% equity interest (December 31, 2016 ‐ $24 million). The Fund invests in mortgages secured by real estate with a focus on mezzanine, subordinate and bridge mortgages. We carry our investment in the Fund 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 2017 return was 13.1% (2016 ‐ 11.8%). 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 throughout the life of the Fund. During 2017, KingSett announced an agreement to acquire $1.2 billion in commercial mortgages from Home Capital. Certain of these mortgages have been and will be sold into the Fund. During 2017, we advanced $12.2 million with respect to our funding commitment in the Fund, and subsequent to year end we advanced an additional $2.7 million. Equity investment in MCAP We hold a 14.41% equity interest in MCAP, which represents 4.2 million units held by MCAN of the 29.1 million total outstanding MCAP partnership units. The investment had a net book value of $59 million as at December 31, 2017 (December 31, 2016 ‐ $51 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 $42 million as at December 31, 2017 (December 31, 2016 ‐ $39 million). For further information on the LP ARA, refer to the “Non‐IFRS Measures” section of this MD&A. ‐ 29 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 being phased in by 20% on an annual basis to 2018 such that the deduction is 80% in 2017. 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 $14.5 billion in 2017 (2016 ‐ $15.9 billion). MCAP had $65.9 billion of assets under administration as at November 30, 2017 (November 30, 2016 ‐ $60.6 billion). Since MCAP’s fiscal year end is November 30th, we record equity income from MCAP on a one‐month lag. To the extent that MCAP has a material transaction during the one‐month lag, we are required to reflect the transaction in the month in which it occurred. 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 over MCAP through our entitlement to a position on MCAP’s Board of Directors. If we experience further dilution our influence may be diminished and 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. Amongst the interparty rights in the MCAP partnership agreement, the majority partner in MCAP has the right to acquire MCAN’s entire partnership interest in MCAP for “fair market value”, which would be determined by an independent valuator agreed upon by both parties. Adoption of IFRS 9 We will adopt IFRS 9, Financial Instruments, effective January 1, 2018. As part of the adoption of IFRS 9, we will reclassify our marketable securities portfolio, our investment in Crown LP and our investment in the KingSett High Yield Fund. Under IAS 39, the three investments were classified as available for sale with fair value changes recorded through accumulated other comprehensive income. Under IFRS 9, these investments will be reclassified as fair value reported through profit and loss (“FVPL”), with unrealized gains and losses recorded in net income. We believe that this change in accounting treatment better aligns fair value changes in these investments, as the total return earned from these investments will be reflected in the consolidated income statement. For further information on the adoption of IFRS 9, refer to Note 4 to the consolidated financial statements. Securitization Assets Securitization assets consist primarily of single family insured mortgages securitized through the market MBS program and CMB program. During 2017 we recognized $110 million of new securitized mortgages on our balance sheet through the market MBS program and CMB program. For further information, refer to the “Securitization Programs” section of this MD&A. ‐ 30 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 20: Liabilities and Shareholders' Equity (in thousands) As at Corporate Liabilities Term deposits Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders’ Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income December 31 2017 December 31 2016 Change from 2016 (%) ($) $ 884,460 3,572 16,067 904,099 $ $ 911,866 3,050 12,377 927,293 (27,406) 522 3,690 (23,194) 1,015,699 1,015,699 1,919,798 214,664 510 65,365 16,438 296,977 2,216,775 $ 1,071,786 1,071,786 1,999,079 210,239 510 55,923 15,104 281,776 $ 2,280,855 $ (56,087) (56,087) (79,281) 4,425 ‐ 9,442 1,334 15,201 (64,080) (3%) 17% 30% (3%) (5%) (5%) (4%) 2% ‐ 17% 9% 5% (3%) To fund our corporate operations, we issue term deposits that are eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance. We do not accept deposits that can be cashed prior to maturity or paid on demand except in the event of the death of a depositor. 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, where we have sold MBS to third parties but have not derecognized the related mortgages from our balance sheet. Activity in 2017 consisted of the creation of $110 million of new liabilities from our participation in the market MBS program and CMB program less $166 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 2017 reflects new common shares issued through the Dividend Reinvestment Plan (“DRIP”) and the Executive Share Purchase Plan (“ESPP”). For further information, refer to Note 21 to the consolidated financial statements. Retained earnings activity for 2017 consists of net income of $39.9 million less dividends of $30.5 million. Accumulated other comprehensive income represents unrealized gains or losses on available for sale marketable securities and financial investments. Activity in 2017 includes a $5.3 million gross decrease related to distributions received from Crown LP; on receipt of the distribution we transferred this balance from accumulated other comprehensive income to net income. Additionally, we recorded a $2.3 million increase in the unrealized gain on the marketable securities portfolio and a $4.3 million increase in the unrealized gain on our financial investments in Crown LP and the KingSett High Yield Fund. ‐ 31 ‐ 2017 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 Q4/17 Q3/17 Q2/17 Q1/17 Q4/16 Q3/16 Q2/16 Q1/16 $ 14,359 $ 12,913 $ 12,178 $ 12,963 $ 11,684 $ 12,396 $ 16,996 $ 10,625 ‐ ‐ 876 ‐ ‐ ‐ ‐ ‐ 1,416 15,775 5,302 10,473 (334) $ 10,807 $ 1,534 14,447 4,686 9,761 (157) 9,918 $ 1,372 13,550 4,613 8,937 (1) 1,291 15,130 4,617 10,513 248 8,938 $ 10,265 $ 1,519 13,203 4,471 8,732 (268) 9,000 $ 1,594 13,990 4,323 9,667 (108) 9,775 $ 13,636 $ 1,421 18,417 4,650 13,767 131 1,244 11,869 4,519 7,350 (421) 7,771 Basic and diluted earnings per share Dividends per share $ $ 0.47 $ 0.37 $ 0.42 $ 0.32 $ 0.39 $ 0.32 $ 0.44 $ 0.30 $ 0.39 $ 0.30 $ 0.43 $ 0.29 $ 0.59 $ 0.29 $ 0.34 0.29 Return on average shareholders' equity 1 14.63% 13.63% 12.37% 14.37% 12.94% 14.08% 20.10% 11.80% Average mortgage portfolio yield ‐ corporate 1 Average term deposit interest rate 1 Average mortgage portfolio balance ‐ corporate ($ million) Average mortgage portfolio yield ‐ securitized 1 Average financial liability from securitization rate 1 Average mortgage portfolio balance ‐ securitized ($ million) 5.56% 2.29% 5.25% 2.25% 5.28% 2.21% 5.12% 2.20% 4.99% 2.20% 5.14% 2.22% 5.21% 2.22% 5.27% 2.25% $ 866 $ 908 $ 914 $ 908 $ 954 $ 1,008 $ 1,017 $ 969 2.57% 2.63% 2.67% 2.61% 2.74% 2.74% 2.73% 2.69% 1.81% 1.83% 1.93% 1.90% 2.01% 2.01% 2.02% 2.01% $ 1,002 $ 1,028 $ 1,057 $ 1,052 $ 1,032 $ 1,032 $ 1,028 $ 1,049 1 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. Net investment income from corporate and securitization assets is largely driven by changes in the average mortgage portfolio balance and interest rate. Additionally, corporate net investment income was impacted by significant distribution income from Crown LP in Q2 2016 and Q1 2017 and substantial equity income from MCAP in Q2 2016, Q2 2017 and Q4 2017. Operating expenses increased in Q4 2017 as a result of non‐recurring professional fee accruals. Table 22: Ten Year Financial Summary (in thousands except per share amounts) December 31 2017 (IFRS) 2016 (IFRS) 2015 (IFRS) 2014 (IFRS) 2013 (IFRS) 2012 (IFRS) 2011 (IFRS) 2010 (IFRS) 2009 (CGAAP) 2008 (CGAAP) $ $ Net Income 39,928 40,182 32,857 25,446 30,805 16,494 24,262 31,667 24,742 30,348 Earnings Dividends Per Share Per Share 1.31 1.72 $ $ 1.17 1.75 1.13 1.51 1.12 1.23 1.15 1.57 1.42 0.94 1.81 1.50 1.19 2.20 1.44 1.73 0.96 2.14 Assets1 1,182,371 1,188,480 1,155,046 1,044,579 1,027,176 950,686 753,799 538,118 506,683 570,154 $ Shareholders’ Equity 296,977 281,776 258,802 225,303 214,900 177,781 158,465 125,079 122,879 116,609 Market Capitalization 417,064 $ 330,434 276,573 299,635 265,993 262,393 225,951 200,249 194,766 129,438 1 2010‐2017 consist of corporate assets only as reported under IFRS. 2008‐2009 consist of total assets as reported under Canadian Generally Accepted Accounting Principles (“CGAAP”). ‐ 32 ‐ 2017 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 Financial investments and other loans Marketable securities Fees Interest on cash and cash equivalents 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 2017 September 30 2017 December 31 2016 $ $ $ $ 12,109 5,457 1,517 854 321 320 20,578 5,233 951 2 33 6,219 $ 11,973 3,260 2,327 928 360 264 19,112 5,447 972 ‐ (220) 6,199 $ 11,728 3,209 933 889 638 206 17,603 5,492 1,013 ‐ (586) 5,919 14,359 12,913 11,684 6,449 82 6,531 4,594 521 5,115 1,416 2,595 2,707 5,302 10,473 (334) 10,807 0.47 0.37 $ $ $ 6,784 66 6,850 4,780 536 5,316 1,534 2,777 1,909 4,686 9,761 (157) 9,918 0.42 0.32 $ $ $ 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 ‐ 33 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Q4 2017 vs. Q4 2016 Net Investment Income ‐ Corporate Assets Table 24: Interest Income and Average Rate by Mortgage Portfolio (Corporate) For the Quarters Ended December 31 2017 2016 (in thousands except %) Single family ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non residential Commercial loans ‐ Multi family residential ‐ Other commercial 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 $ 200,797 $ 84,468 51,826 376,059 6,995 2,366 696 885 5,570 100 56,684 89,136 865,965 $ 847,523 701 1,791 12,109 5,233 $ $ 1,001,708 $ 1,012,852 6,449 4,594 4.72% $ 3.30% 6.78% 271,126 $ 125,902 17,888 5.88% 5.69% 387,536 7,852 4.91% 7.98% 5.56% $ 2.29% 3.27% 44,137 99,706 954,147 $ 934,475 2.57% $ 1,032,208 $ 1.81% 0.76% 1,046,078 3,104 755 244 5,152 108 553 1,812 11,728 5,492 7,122 5,250 4.56% 3.12% 5.42% 5.29% 5.45% 4.99% 7.31% 4.99% 2.20% 2.79% 2.74% 2.01% 0.73% 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, 2017 and December 31, 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. Changes in the average portfolio balance from Q4 2016 are generally consistent with the fiscal 2017 discussion in the “Net Investment Income ‐ Corporate Assets” sub‐section of the “Results of Operations” section of this MD&A. The significant increase in the corporate mortgage yield from Q4 2016 is partly due to the two 0.25% increases in the overnight rate by the Bank of Canada during 2017 which had a positive impact on the floating rate component of our corporate mortgage portfolio. These rate increases contributed approximately 0.48% and 0.31%, respectively, to the average interest rate for the construction and total corporate portfolios in Q4 2017, as approximately 96% and 61% of those respective portfolios are floating rate and repriced following the rate increases. In Q4 2017, we also recognized additional corporate mortgage interest income from the acceleration of mortgage commitment fee amortization on the early payout of certain completed inventory, residential construction and commercial loans. The uninsured single family portfolio declined throughout 2017 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 2016 as a result of higher penalty income. Activity in the construction, commercial and completed inventory portfolios, outside of the yield items noted above, is consistent with the fiscal 2017 discussion in the “Net Investment Income ‐ Corporate Assets” sub‐section of the “Results of Operations” section of this MD&A. 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 significant increase in equity income from MCAP in Q4 2017 is a result of higher net interest income on securitized mortgages, higher servicing revenue as a result of an increase in assets under administration and lower origination expenses due to lower origination volumes, partially offset by lower mortgage origination fee income and financial instrument gains. ‐ 34 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION The increase in income from financial investments and other loans in Q4 2017 is primarily due to the significant increase in our investment in the KingSett High Yield Fund. Net Investment Income ‐ Securitization Assets Spread income from securitization assets decreased slightly from Q4 2016 as a result of a smaller average portfolio balance. In Q4 2017, our total securitization volumes were $28 million (Q4 2016 ‐ $74 million). 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 2017 2016 Average Balance 1 Income / Expense Average Rate 3 Average Balance 1 Income / Expense Average Rate 3 (in thousands except %) Assets Cash and cash equivalents Marketable securities Mortgages Financial investments Other loans Corporate interest earning assets Short term investments Mortgages Securitized interest earning assets Total interest earning assets Non interest earning assets Total assets $ 94,719 $ 60,911 865,965 33,062 2,723 1,057,380 16,324 1,001,708 1,018,032 2,075,412 91,809 $ 2,167,221 $ $ 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 $ 2,167,221 $ 847,523 $ 261 847,784 1,012,852 1,860,636 11,170 295,415 320 854 12,109 1,154 36 14,473 58 6,449 6,507 20,980 327 21,307 5,233 2 5,235 4,594 9,829 ‐ ‐ 9,829 1.34% 6.34% 5.56% 13.85% 5.25% 5.43% 1.41% 2.57% 2.54% 4.01% ‐ 3.90% 2.29% 3.04% 2.29% 1.81% 2.07% ‐ ‐ 1.80% $ 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 $ ‐ 934,475 1,046,078 1,980,553 9,044 278,260 $ 2,267,857 $ 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% Net Interest Income 2 $ 11,478 $ 10,149 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, 2017 and December 31, 2016. 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. ‐ 35 ‐ 2017 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 2017 September 30 December 31 2016 2017 $ $ $ $ $ 43 $ 104 $ (2) (41) 3 43 3 (13) (10) $ (58) 1 (122) (85) (264) (60) (324) $ 33 $ (220) $ $ $ 46 33 1.5 (160) $ 98 $ 4.3 50 (148) (1) (67) (37) (253) (383) (636) (586) (203) 39 1.6 The change in the corporate mortgage collective provision from Q4 2016 to Q4 2017 was largely driven by portfolio activity. 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 2017 September 30 2017 December 31 2016 $ $ 2,595 $ 2,707 5,302 $ 2,777 $ 1,909 4,686 $ 2,129 2,342 4,471 The increase in both salaries and benefits and general and administrative expenses from Q4 2016 is consistent with the fiscal 2017 discussion in the “Operating Expenses” sub‐section of the “Results of Operations” section of this MD&A. Additionally, general and administrative expenses increased from Q3 2017 and Q4 2016 as a result of non‐recurring professional fee accruals. Table 28: Income Taxes (in thousands) For the Quarters Ended Deferred tax provision (recovery) December 31 2017 September 30 2017 December 31 2016 $ $ (334) $ (334) $ (157) $ (157) $ (268) (268) The deferred tax provision (recovery) is driven by taxable income (losses) recognized in subsidiaries. ‐ 36 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Q4 2017 vs. Q3 2017 Net Investment Income ‐ Corporate Assets Table 29: Interest Income and Average Rate by Mortgage Portfolio (Corporate) For the Quarters Ended (in thousands except %) December 31, 2017 September 30, 2017 Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income Single family ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non residential Commercial loans ‐ Multi family residential ‐ Other commercial Mortgages ‐ corporate portfolio Term deposits Spread of mortgages over term deposits Mortgages ‐ securitized portfolio Financial liabilities from securitization Spread of mortgages over liabilities $ 200,797 $ 84,468 51,826 376,059 6,995 2,366 696 885 5,570 100 56,684 89,136 865,965 $ 847,523 701 1,791 12,109 5,233 $ $ 1,001,708 $ 1,012,852 6,449 4,594 4.72% $ 3.30% 6.78% 211,218 $ 81,821 63,510 5.88% 5.69% 399,689 7,200 4.91% 7.98% 5.56% $ 2.29% 3.27% 44,999 99,798 908,235 $ 893,865 2.57% $ 1,028,172 $ 1.81% 0.76% 1,042,893 2,386 694 872 5,550 96 527 1,848 11,973 5,447 6,784 4,780 4.52% 3.40% 5.45% 5.51% 5.29% 4.64% 7.36% 5.25% 2.25% 3.00% 2.63% 1.83% 0.80% 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, 2017 and September 30, 2017. 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. The two 0.25% increases in the overnight rate from the Bank of Canada during Q3 2017 contributed approximately 0.21% and 0.14%, respectively, to the average interest rate for the construction and total corporate portfolios in Q4 2017 compared to Q3 2017, as approximately 96% and 61% of those respective portfolios are floating rate and repriced following the rate increases. The acceleration of mortgage commitment fee amortization on the early payout of certain completed inventory, residential construction and commercial loans noted in the “Q4 2017 vs. Q4 2016” discussion also impacted the increase in average yield from Q3 2017. ‐ 37 ‐ 2017 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 (%) 2017 2017 ($) $ $ $ 117,571 62,518 863,384 68,190 2,612 59,189 435 2,672 5,800 1,182,371 $ 97,202 57,792 867,069 60,603 2,829 55,022 435 2,381 4,211 1,147,544 13,441 1,016,724 4,239 1,034,404 2,216,775 17,240 1,026,657 4,347 1,048,244 $ 2,195,788 $ 884,460 3,572 16,067 904,099 869,059 3,259 6,110 878,428 1,015,699 1,015,699 1,919,798 1,027,090 1,027,090 1,905,518 214,664 510 65,365 16,438 296,977 $ 2,216,775 214,664 510 63,208 11,888 290,270 $ 2,195,788 $ $ $ $ 20,369 4,726 (3,685) 7,587 (217) 4,167 ‐ 291 1,589 34,827 (3,799) (9,933) (108) (13,840) 20,987 15,401 313 9,957 25,671 (11,391) (11,391) 14,280 ‐ ‐ 2,157 4,550 6,707 20,987 21% 8% ‐ 13% (8%) 8% ‐ 12% 38% 3% (22%) (1%) (2%) (1%) 1% 2% 10% 163% 3% (1%) (1%) 1% ‐ ‐ 3% 38% 2% 1% ‐ 38 ‐ 2017 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 ‐ Multi family residential ‐ Other commercial Securitized portfolio: Single family insured ‐ Market MBS program Single family insured ‐ CMB program SECURITIZATION PROGRAMS December 31 2017 September 30 Change from Prior Quarter (%) 2017 ($) $ 198,354 $ 80,377 51,190 $ 198,210 81,639 60,540 386,562 4,840 64,655 77,406 863,384 383,720 7,183 44,783 90,994 867,069 867,406 149,318 1,016,724 1,880,108 $ 895,677 130,980 1,026,657 1,893,726 $ $ 144 (1,262) (9,350) 2,842 (2,343) 19,872 (13,588) (3,685) (28,271) 18,338 (9,933) (13,618) ‐ (2%) (15%) 1% (33%) 44% (15%) ‐ (3%) 14% (1%) (1%) 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, MBS investors 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 2017, we securitized $47 million of MBS to third parties (2016 ‐ $42 million). This mortgage transaction, in addition to the majority of our previous market MBS securitizations, did not achieve derecognition for accounting purposes as we retained significant continuing involvement with the mortgages. As such, the associated mortgages remained on the balance sheet while a corresponding liability was incurred. The mortgage interest income and interest expense associated with the financial liability from securitization related to these mortgages are recognized on the accrual basis over the term of the mortgages. We may issue market MBS through the NHA MBS program and retain the underlying MBS security for liquidity purposes instead of selling it to a third party. As at December 31, 2017, we held $29 million of retained MBS on our balance sheet (December 31, 2016 ‐ $37 million), which is included in the insured single family classification within corporate mortgages. ‐ 39 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 requires the reinvestment by the issuer of mortgage principal repayments received during their term into certain permitted assets. 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 $63 million of insured single family mortgages through the CMB program during 2017 (2016 ‐ $100 million). Similar to the market MBS program, we do not derecognize the securitized mortgages from the consolidated balance sheet when we retain significant continuing involvement with the assets such that the associated mortgages remain on the consolidated balance sheet while a corresponding liability is 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, we securitized $86 million of insured multi family mortgages through the CMB program, but did not securitize any in 2017. Upon the securitization of multi family mortgages, we generally achieve derecognition as control over the assets is transferred. In 2016, we recognized an upfront gain of $0.4 million, which is included in other securitization income. Additionally, we recognized a receivable in the amount of estimated discounted spread income to be earned over the term of the securitized mortgages, which is included in other securitization assets. 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 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 ‐ 2017 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 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 Adjustment 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 Adjustment 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 2017 September 30 2017 December 31 2016 $ $ $ $ $ $ 2,216,775 $ 5,435 2,222,210 4,750 (1,030,020) (42,411) (7,475) 1,147,054 $ 2,195,788 $ 6,375 2,202,163 4,742 (1,042,199) (35,933) (5,953) 1,122,820 $ 2,280,855 6,918 2,287,773 4,897 (1,089,358) (37,049) (5,605) 1,160,658 1,919,798 $ (7,852) 1,911,946 (1,014,258) 1,905,518 $ (6,778) 1,898,740 (1,025,622) 897,688 $ 873,118 $ 1,999,079 (6,500) 1,992,579 (1,070,117) 922,462 249,366 $ 249,702 $ 238,196 286,801 $ 312,967 $ 208,970 4.60 3.60 4.50 3.50 4.87 3.87 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. 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. ‐ 41 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 having a materially adverse effect on the Company’s business plan. 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). 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 2017, the “transitional” basis phases the adjustment in by a factor of 80%, 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 72% in 2017. 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. As of January 1, 2018, we revised these targets to 18% to reflect our ongoing assessment of our risk appetite and risk profile. 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. OSFI enacted revisions to the CAR Guideline effective January 1, 2017. The key revisions that relate to MCAN are as follows: 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. This revision has not impacted the risk‐weighting of MCAN’s insured single family mortgage portfolio. A revision to the risk‐weighting of equity investments in funds. MCAN has adopted the “look through” approach that incorporates the risk‐weighting of assets held inside the fund and the leverage used by the fund. This revision has impacted the risk‐weighting of the financial investments in Crown LP and the KingSett High Yield Fund and caused decreases in the capital to risk‐weighted assets ratios of 1.89% on both the all‐in and transitional bases at December 31, 2017. OSFI recently enacted revisions to the CAR Guideline to be effective January 1, 2018. We do not expect any of these revisions to have a material impact on our regulatory capital position. ‐ 42 ‐ 2017 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 2017 September 30 2017 December 31 2016 $ $ $ $ $ $ $ $ 214,664 510 65,365 16,438 (23,593) 273,384 (5,898) 267,486 2,216,775 (29,491) 2,915 2,190,199 317,687 (158,844) 32,164 (16,082) 174,925 $ $ $ $ 214,664 510 63,208 11,888 (20,796) 269,474 (5,199) 264,275 2,195,788 (25,995) 2,385 2,172,178 295,223 (147,612) 34,491 (17,246) 164,856 210,239 510 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 Total Exposures/Regulatory Assets $ 2,365,124 $ 2,337,034 $ 2,476,415 Leverage ratio 2 Risk weighted assets (transitional) 2 Risk weighted assets (all‐in) 2 11.31% 11.31% 10.46% $ $ 1,269,967 1,258,171 $ $ 1,248,729 1,238,331 $ $ 1,167,226 1,149,124 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) 21.53% 21.53% 21.53% 21.26% 21.26% 21.26% 21.58% 21.58% 21.58% 21.34% 21.34% 21.34% 22.98% 22.98% 22.98% 22.55% 22.55% 22.55% 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 2017, the deduction on the transitional basis is equal to 80% of the all‐in adjustment (2016 ‐ 60%). 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 34: Regulatory Risk‐Weighted Assets (in thousands except %) As at December 31, 2017 Per Balance Average Risk Weighted Assets Rate Sheet December 31, 2016 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 $ 117,571 13,441 62,518 863,384 1,016,724 68,190 2,612 59,189 435 2,672 10,039 20% $ 20% 100% 76% 3% 251% 100% 50% 100% 100% 100% Off‐Balance Sheet Items Letters of credit Commitments Charge for operational risk 32,164 317,687 50% 45% $ 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% 30,537 402,861 50% 46% 24,097 2,688 62,518 656,384 32,182 170,922 2,612 29,697 435 2,672 10,039 994,246 16,082 142,043 158,125 105,800 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 Risk‐Weighted Assets (all‐in) 1,258,171 1,149,124 Equity investment in MCAP (transitional adjustment) 1 Risk‐Weighted Assets (transitional) 11,796 $ 1,269,967 18,102 $ 1,167,226 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 sufficient capital 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 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. 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 Investment Committee of the Board (“ICB”) on a quarterly basis. We fund our corporate operations by issuing term deposits that are eligible for CDIC deposit insurance. We do not accept deposits that can be cashed prior to maturity or paid on demand except in the event of the death of a depositor. 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 30 to the consolidated financial statements. ‐ 44 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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, 2020. As at December 31, 2017, 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. As at December 31, 2017, we were also in compliance with our internal liquidity ratios. 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 Tier 1 & 2 and Total liquid assets to a minimum of 60% and 100% of term deposit liabilities maturing within 100 days, respectively. 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 2017 September 30 2017 December 31 2016 $ 117,571 $ 97,202 $ 111,732 62,518 (14,391) 28,597 76,724 51,440 (17,442) 33,998 57,792 (13,314) 29,671 74,149 51,711 (17,276) 34,435 55,126 (13,007) 36,915 79,034 69,899 (24,293) 45,606 Total liquid assets 1 100 day term deposit maturities $ $ 228,293 $ 205,786 103,632 $ 124,672 $ $ 236,372 130,357 Liquidity ratios 1 Tier 1 & 2 liquid assets to 100 day term deposit maturities Total liquid assets to 100 day term deposit maturities 187% 220% 137% 165% 146% 181% 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 ‐ 2017 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. For further information on our off‐balance sheet commitment associated with our investment in the KingSett High Yield Fund, refer to the “Off‐Balance Sheet Arrangements” section of this MD&A. 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 2016 2017 Years $ 117,571 $ 61,986 135,612 ‐ 1,141 316,310 ‐ $ 504 430,017 ‐ ‐ 430,521 ‐ $ ‐ 266,674 36,153 1,471 304,298 ‐ $ ‐ 25,689 ‐ ‐ 25,689 ‐ $ 28 5,392 32,037 ‐ 37,457 117,571 $ 62,518 863,384 68,190 2,612 1,114,275 111,732 55,126 904,112 57,264 3,584 1,131,818 98,760 16,067 114,827 314,574 ‐ 314,574 318,321 ‐ 318,321 152,805 ‐ 152,805 ‐ ‐ ‐ 884,460 16,067 900,527 911,866 12,377 924,243 Net liquidity surplus (deficit) $ 201,483 $ 115,947 $ (14,023) $ (127,116) $ 37,457 $ 213,748 $ 207,575 Off‐Balance Sheet Unfunded mortgage commitments $ 99,507 $ 70,092 $ 121,605 $ Commitment ‐ KingSett High Yield Fund 26,483 ‐ ‐ $ 99,507 $ 70,092 $ 148,088 $ ‐ $ ‐ ‐ $ ‐ $ 291,204 $ 364,161 ‐ ‐ $ 26,483 317,687 $ 38,700 402,861 Note: The above table excludes securitized assets and liabilities and pledged assets as their use is restricted to securitization program operations. 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, regulatory compliance 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 Enterprise Risk Management and Compliance Committee (“ERMCC”) 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. ‐ 46 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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‐defence approach to the management of risk. The business units headed by the CEO are the first line of defence in the Company’s management of risk. The first line of defence has ownership of known and emerging risks whereby it acknowledges and manages the risks that it incurs or may incur in conducting its activities. The first line of defence is responsible for planning, directing and controlling the day‐to‐day operations of a significant activity/enterprise‐wide process and for identifying and managing the known and emerging inherent risks in products, activities, processes and systems for which it is accountable. The second line of defence provides oversight in objectively identifying, measuring, monitoring and reporting known and emerging risks on an enterprise basis. The heads of the oversight functions have sufficient stature and authority within the organization and are independent from operational management. They have unfettered access and, for functional purposes, a direct reporting line to the Board and/or the relevant Board Committee through quarterly (or more immediate if necessary) Committee reporting and through quarterly in‐camera sessions. These activities are provided by: The Chief Risk Officer (“CRO”), who is responsible for identifying, measuring, monitoring and reporting on the risks of the organization on an enterprise‐wide and disaggregated level, independently of operational management, 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 and assessed by the first line of defence of the Company. The CRO reports directly to the CEO. The Chief Financial Officer (“CFO”), who is responsible for the accuracy and integrity of the Company’s accounting and financial reporting systems, financial statements, planning and budgeting systems and documents, and providing the technology tools to monitor risks of the Company. The CFO ensures legal and regulatory compliance for all financial matters within the Company. The CFO reports directly to the CEO. The Chief Compliance Officer (“CCO”), who is responsible for measuring, and reporting on, compliance with the Company’s policies and procedures that have been designed to manage and mitigate legal and regulatory compliance risk. The CCO reports directly to the CEO. 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 CAMLO reports to the CRO. The Internal Audit function is the third line of defence. The third line of defence is separate from both the first and second line of defence, and provides an objective review and testing of the organization’s risk management controls, processes, systems and of the effectiveness of the first and second line of defence functions. The Chief Audit Officer (“CAO”) reports directly to the Chair of the Audit Committee. ‐ 47 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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: MCAN’s strategy, including business objectives, business plans and stakeholder expectations are reflected in the risk appetite. The approach engages both top down senior management and Board leadership and bottom up involvement of employees at all levels. Risk appetite considerations are 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 reflects good industry practices and relevant regulatory guidance. The approach is forward looking and enables adaptation to changing business and market conditions; it also gives 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: Defines 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. Gives consideration to all material risks reflecting all key aspects of the business. Contains both qualitative and quantitative elements to define acceptable risk levels within MCAN’s risk capacity. Sets out limits and targets to enable the Board and senior management to assess MCAN’s performance and current risk levels relative to risk appetite. Considers 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 ‐ 2017 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 ERMCC, 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 Investment Committee of the Board (“ICB”). MCAN’s Risk Governance structure is illustrated in the following diagram: ‐ 49 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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, and 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 29 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 ICB is responsible for the approval of liquidity policies. The Asset and Liability Committee (“ALCO”), which is comprised of management, is responsible for liquidity management oversight. We have an internal target of a standard level of liquid investments (cash 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, 2017 and December 31, 2016, we met this internal target. In addition, all insured 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 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. We also have an agreement with a Canadian Schedule I Chartered bank that enables the Company to execute repurchase agreements for liquidity purposes. This facility provides 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 (or more frequently when needed) stress testing which is reviewed by ALCO and the ICB. Management monitors trends in deposit concentration with significant term deposit brokers on a monthly basis. Further to the Liquidity Risk Management Framework, we maintain a Contingency Funding Plan that details the strategies and action plans to respond to stress events that could materially impair our access to funding and liquidity. 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. 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, depositors, 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 ‐ 50 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION leadership. Failure to effectively manage reputational risk can result in reduced market capitalization, loss of client loyalty, reduced access to deposit funding 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. 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, business model and business activities for external events or business results, changes in the competitive environment 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. 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 Enterprise Risk Management 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. Accordingly, there is a risk that the services provided by third parties will fail to adequately meet our standards. 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. ‐ 51 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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. 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 undertake a cyber security assessment on an annual basis. We employ the use of external security experts to assist and continuously 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. 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 ICB. A CRO Report, which identifies, assesses, ranks and provides trending analysis on all material risks to the Company, is provided to the ERMCC on a quarterly basis. Monitoring also takes place through our Capital Commitments Committee and Executive 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 and portfolio metrics, which are a key component of quarterly market reports provided to the ICB. 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. ‐ 52 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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. 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, where maximum credit exposure also includes outstanding commitments for future mortgage fundings. 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 and maturity dates. Changes in interest rates where we have mismatched repricing and maturity 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 31 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 strategically matching the terms of corporate assets and term 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 ICB 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 bond forwards or we may fund them with long‐term fixed‐rate term deposits. 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. 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 ‐ 2017 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 MCAN 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 Compliance Risk Changes in laws and regulations, including interpretation or implementation, may affect the Company by limiting the products or services that we can provide, limiting pricing/availability of products in the market 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 ‐ 2017 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. General Risk Management Ultimately, risk management is monitored and controlled at the highest level of the Company. 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. DESCRIPTION OF CAPITAL STRUCTURE Our authorized share capital consists of an unlimited number of common shares with no par value. At December 31, 2017, there were 23,377,785 common shares outstanding (December 31, 2016 ‐ 23,075,227). As at February 23, 2018, there were 23,461,529 common shares outstanding. During 2017, we issued 295,849 new common shares under the DRIP (2016 ‐ 280,376), 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%. In 2017, we issued 6,709 common shares through the Executive Share Purchase Plan (2016 ‐ 12,418). For additional information related to share capital, refer to Note 21 to the consolidated financial statements. ‐ 55 ‐ 2017 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 are obligated to advance additional fundings on the investment at any time subject to capital calls by KingSett. 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 years Three to five years Over five December 31 December 31 2016 2017 years $ 169,599 $ 121,605 $ ‐ $ ‐ $ 291,204 $ 364,161 ‐ 903 $ 170,502 $ 26,483 1,711 149,799 $ ‐ 1,735 1,735 $ ‐ 4,303 4,303 $ 26,483 8,652 326,339 $ 38,700 4,569 407,430 We retain mortgage servicing obligations relating to securitized mortgages where balance sheet derecognition has been achieved. For further information, refer to Note 14 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 30 to the consolidated financial statements. As at December 31, 2017, of our total single family mortgage renewal rights of $931 million (December 31, 2016 ‐ $1.1 billion), $42 million related to off‐balance sheet mortgages sold to third parties on a whole loan basis (December 31, 2016 ‐ $130 million). MCAP is actively defending a claim arising from a power of sale process with respect to a defaulted land development loan previously funded by MCAN. The plaintiff has claimed improvident sale and has claimed damages of approximately $6 million. MCAP was awarded a judgment for approximately $500,000 against the same plaintiff in related proceedings. We may be subject to the indemnification of MCAP for certain liabilities that may be incurred as part of the proceedings under a mortgage servicing agreement between the two parties. Based on, among other things, the current status of the proceedings, we do not expect to incur any material liability arising out of this indemnification obligation to MCAP and accordingly we have not recorded a provision. 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 2017 2016 2015 $ $ 0.30 0.32 0.32 0.37 1.31 $ $ 0.29 0.29 0.29 0.30 1.17 $ $ 0.28 0.28 0.28 0.29 1.13 Consistent with the prior quarter, the Board declared a first quarter dividend of $0.37 per share, to be paid on March 29, 2018 to shareholders of record as of March 15, 2018. ‐ 56 ‐ 2017 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, 2017 and December 31, 2016 are discussed in Note 28 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, 2017, we had 69 employees (December 31, 2016 ‐ 61). ‐ 57 ‐ 2017 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 ERMCC. 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, 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 may 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 by 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 net realizable values, 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. ‐ 58 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 prior to the adoption of IFRS 9 on January 1, 2018. For further information on IFRS, please refer to Note 4 to the consolidated financial statements. 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 the tax treatment of income and expenses 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 associated with these assets 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. ‐ 59 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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. STANDARDS ISSUED BUT NOT YET EFFECTIVE Standards issued but not yet effective include IFRS 9, Financial Instruments, IFRS 15, Revenue from Contracts with Customers, IFRS 16, Leases, IFRS 2, Share‐based Payment Transactions and IFRIC 23, Uncertainty over Income Tax Treatments. For further information on these standards, refer to Note 4 to the 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, 2017, 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 Administrators – 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 in accordance with the Integrated (2013) 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, 2017. Ernst & Young LLP, our Independent Registered Chartered Accountants, have audited our consolidated financial statements for the year ended December 31, 2017. Changes in ICFR There were no changes in our ICFR that occurred during the period beginning on January 1, 2017 and ending on December 31, 2017 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. ‐ 60 ‐ 2017 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 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 interest 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 32 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. ‐ 61 ‐ 2017 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, 2018 ‐ 62 ‐ 2017 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, 2017 and 2016, 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, 2017 and 2016, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Toronto, Canada February 23, 2018 ‐ 63 ‐ 2017 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 Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders' Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Note 2017 2016 6 7 8 9 10 11 12 18 13 15 16 13 17 18 19 20 21 23 $ $ $ $ 117,571 62,518 863,384 68,190 2,612 59,189 435 2,672 5,800 1,182,371 13,441 1,016,724 4,239 1,034,404 2,216,775 884,460 3,572 16,067 904,099 1,015,699 1,015,699 1,919,798 214,664 510 65,365 16,438 296,977 2,216,775 $ $ $ $ 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 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 ‐ 64 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands of Canadian dollars except for per share amounts) Years Ended December 31 Note 2017 2016 Net Investment Income ‐ Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Financial investments and other loans Marketable securities Fees Interest on cash and cash equivalents Whole loan gain on sale income Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses Other Income ‐ Corporate Assets Gain on sale of investment in MCAP Commercial LP 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 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 (000s) 11 9 24 27 25 26 11 11 14 25 18 18 $ $ $ $ 47,765 14,427 9,018 3,722 1,239 883 ‐ 77,054 20,837 3,877 38 (111) 24,641 52,413 785 91 876 27,028 221 27,249 19,533 2,103 21,636 5,613 10,555 8,663 19,218 39,684 ‐ (244) (244) 39,928 1.72 1.31 23,265 $ $ $ $ 50,670 13,509 6,487 3,622 2,547 604 324 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 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. ‐ 65 ‐ 2017 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 2017 2016 $ 39,928 $ 40,182 2,283 (19) 4,258 (986) (4,324) 122 1,334 3,981 (361) 6,999 (3,181) (967) (660) 5,811 Comprehensive income $ 41,262 $ 45,993 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands of Canadian dollars) Years Ended December 31 Share capital Balance, beginning of year Share capital issued Balance, end of year Contributed surplus Balance, beginning of year Changes to contributed surplus Balance, end of year Retained earnings Balance, beginning of year Net income Dividends declared Balance, end of year Accumulated other comprehensive income Balance, beginning of year Other comprehensive income Balance, end of year Note 2017 2016 $ 21 210,239 $ 4,425 214,664 206,382 3,857 210,239 510 ‐ 510 510 ‐ 510 55,923 39,928 (30,486) 65,365 42,617 40,182 (26,876) 55,923 15,104 1,334 16,438 9,293 5,811 15,104 Total shareholders' equity $ 296,977 $ 281,776 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of Canadian dollars) Years Ended December 31 2017 2016 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 Gain on sale of investment in MCAP Commercial LP Gain on dilution of 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 Changes in operating assets and liabilities: Marketable securities Mortgages Financial investments Other loans Other assets Cash held in trust Term deposits Financial liabilities from securitization Other liabilities Cash flows from operating activities Investing Activities Distributions from MCAP Commercial LP Decrease in foreclosed real estate Proceeds on sale of investment in MCAP Commercial LP 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 year Cash and cash equivalents, end of year Supplementary Information Interest received Interest paid Distributions received from investments $ 39,928 $ 40,182 ‐ (244) (14,427) (785) (91) (111) 5,374 550 (91) (5,128) 91,780 (11,978) 972 (1,846) 2,283 (27,406) (57,201) 1,982 23,561 4,971 94 1,947 (401) 6,611 4,425 (28,758) (24,333) 5,839 111,732 117,571 74,011 35,989 11,535 $ $ (100) (566) (13,509) ‐ ‐ (210) 5,550 353 (95) (10,770) 39,614 (12,620) 592 (2,651) (2,612) 8,825 517 (150) 52,350 6,895 ‐ ‐ (572) 6,323 3,857 (26,560) (22,703) 35,970 75,762 111,732 2016 75,969 40,098 9,451 $ $ 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note Page 1. Corporate Information .......................................................................................................................................... 69 2. Basis of Preparation .............................................................................................................................................. 69 3. Basis of Consolidation ........................................................................................................................................... 70 4. Summary of Significant Accounting Policies ......................................................................................................... 70 5. Significant Accounting Judgments and Estimates ................................................................................................. 80 6. Cash and Cash Equivalents .................................................................................................................................... 82 7. Marketable Securities ........................................................................................................................................... 82 8. Mortgages ‐ Corporate .......................................................................................................................................... 82 9. Financial Investments ........................................................................................................................................... 85 10. Other Loans........................................................................................................................................................... 86 11. Equity Investment in MCAP Commercial LP ......................................................................................................... 86 12. Foreclosed Real Estate .......................................................................................................................................... 87 13. Other Assets .......................................................................................................................................................... 87 14. Securitization Activities ......................................................................................................................................... 88 15. Cash Held in Trust ................................................................................................................................................. 90 16. Mortgages ‐ Securitized ........................................................................................................................................ 90 17. Term Deposits ....................................................................................................................................................... 91 18. Income Taxes ........................................................................................................................................................ 91 19. Other Liabilities ..................................................................................................................................................... 92 20. Financial Liabilities from Securitization ................................................................................................................ 92 21. Share Capital ......................................................................................................................................................... 93 22. Dividends .............................................................................................................................................................. 93 23. Accumulated Other Comprehensive Income ........................................................................................................ 93 24. Fees ....................................................................................................................................................................... 93 25. Mortgage Expenses ............................................................................................................................................... 94 26. Provision for Credit Losses .................................................................................................................................... 94 27. Whole Loan Gain on Sale Income ......................................................................................................................... 94 28. Related Party Disclosures ..................................................................................................................................... 94 29. Commitments and Contingencies ......................................................................................................................... 96 30. Credit Facilities...................................................................................................................................................... 97 31. Interest Rate Sensitivity ........................................................................................................................................ 97 32. Capital Management ............................................................................................................................................ 99 33. Financial Instruments ......................................................................................................................................... 100 34. Comparative Amounts ........................................................................................................................................ 102 ‐ 68 ‐ 2017 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 diversified 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 taxed in the hands of our shareholders as capital gains dividends and interest income, respectively, to the extent that they are held in a non‐registered plan. MCAN’s primary wholly owned subsidiary, XMC Mortgage Corporation (“XMC”) (formerly Xceed Mortgage Corporation), is an originator of residential first‐charge mortgage products across Canada. As such, XMC operates primarily in one industry segment through its sales team and mortgage brokers. XMC is incorporated in the Province of Ontario. The Company renamed the subsidiary to XMC during 2017. MCAN is also a National Housing Act (“NHA”) mortgage‐backed securities (“MBS”) issuer. For further details, refer to Note 14. MCAN is incorporated in Canada. MCAN and XMC’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 23, 2018. 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, 2017, 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 financial investments, which have been designated as available for sale and are 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. ‐ 69 ‐ 2017 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, 2017. 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 2017 and 2016 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 depend 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. ‐ 70 ‐ 2017 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 and financial investments. 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: 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. ‐ 71 ‐ 2017 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: 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: 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 financial instruments not traded in active markets, 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. ‐ 72 ‐ 2017 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. ‐ 73 ‐ 2017 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, 2017, the Company did not have any outstanding transactions that are subject to netting contracts with third parties. ‐ 74 ‐ 2017 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: 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: 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 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. ‐ 75 ‐ 2017 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 over 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. ‐ 76 ‐ 2017 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 28. 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 remeasured 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 Five Three years straight line to five years straight line Lease term and one renewal straight line Computer software 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: 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. ‐ 77 ‐ 2017 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 Company (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 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 and replaces IAS 39, Financial Instruments: Recognition and Measurement. Project Plan/Implementation The Company 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 IFRS 9 Committee provides periodic reporting on the status of the implementation plan to the Audit Committee of the Board. Our project plan and implementation are substantially complete at this point in time. 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 general allowance being recorded on financial assets regardless of whether there has been an actual loss event. IFRS 9 requires the ECL model to consider past events, current market conditions and reasonable supportable information about future economic conditions (through the use of multiple probability‐weighted scenarios) in determining whether there has been a significant increase in credit risk (“SICR”) since origination, and in calculating the amount of ECL. In determining SICR, IFRS 9 provides a rebuttable presumption that credit risk has increased significantly when contractual payments are more than 30 days past due. The Company does not plan to rebut this presumption. Additionally, IFRS 9 requires MCAN to apply expert credit judgment in calculating ECL. The expected credit loss model requires the recognition of the portion of the ECL resulting from default events that are possible within the next 12 months at origination and the recognition of lifetime ECL on financial assets that have experienced an SICR since origination. Financial assets are classified into one of three “stages” for the purposes of ECL recognition at each reporting date, as follows: Stage 1: Financial instruments that are not credit impaired and do not reflect an SICR since origination; the portion of the ECL resulting from default events that are possible within the next 12 months is recognized. Stage 2: Financial instruments that are not credit impaired but reflect an SICR since origination; lifetime ECL is recognized. Stage 3: Financial instruments that have objective evidence of credit impairment; lifetime ECL is recognized as specific allowance. IFRS 9 also provides a rebuttable presumption that objective evidence of impairment exists when contractual payments are 90 days or more past due. The Company does not plan to rebut this presumption. ‐ 78 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) 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 classified as amortized cost, fair value reported through other comprehensive income (“FVOCI”) with unrealized gains and losses recognized in other comprehensive income or fair value reported through profit and loss (“FVPL”) with unrealized gains and losses recognized in net income. Equity instruments are measured at FVPL or FVOCI; if an equity instrument is measured at FVOCI then the recycling of gains and losses to the consolidated statement of income is not allowed. Hedge Accounting IFRS 9 has new hedge accounting principles that are designed 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 adoption of IFRS 9 hedge accounting rules. Transition Impact MCAN expects the transition to IFRS 9 on January 1, 2018 to impact the Company as follows: Corporate Mortgages: MCAN will remeasure the allowances for credit losses in its corporate mortgage portfolio as at the transition date. The Company currently estimates that the impact of the transition to IFRS 9 on its corporate mortgage allowances will be insignificant, subject to refinement. Equity investment in MCAP: Under IAS 28, MCAN’s accounting for its equity investment in MCAP must be consistent with the IFRS accounting policies reflected in its consolidated financial statements. Accordingly, the equity investment in MCAP must incorporate IFRS 9 as at the transition date. The Company is currently assessing and quantifying the impact of the transition to IFRS 9 on its equity investment in MCAP. Marketable securities: MCAN will reclassify its marketable securities portfolio from available for sale under IAS 39 to FVPL under IFRS 9. This reclassification will result in the transfer of the unrealized gain on marketable securities as at the transition date from accumulated other comprehensive income to retained earnings. Financial Investments ‐ Crown LP: MCAN will reclassify its financial investment in Crown LP from available for sale under IAS 39 to FVPL under IFRS 9. This reclassification will result in the transfer of the unrealized gain on the investment in Crown LP as at the transition date from accumulated other comprehensive income to retained earnings. Financial Investments ‐ KingSett High Yield Fund: MCAN will reclassify its financial investment in the KingSett High Yield Fund from available for sale under IAS 39 to FVPL under IFRS 9. This reclassification will result in the transfer of the fair value adjustment on the investment in the KingSett High Yield Fund as at the transition date from accumulated other comprehensive income to retained earnings. The reclassification of marketable securities and financial investments from available for sale under IAS 39 to FVPL under IFRS 9 will result in a transfer of $16,438 from accumulated other comprehensive to retained earnings on January 1, 2018. The Company expects that the transition to IFRS 9 will not materially impact the carrying value of any other financial assets or liabilities as at January 1, 2018. MCAN will not restate financial information from comparative periods. IFRS 15, Revenue from Contracts with Customers IFRS 15 establishes a five‐step model to account for revenue arising from contracts with customers. Under IFRS 15, revenue is recognized at an amount that reflects the consideration to which an entity expects in exchange for transferring goods or services to a customer. IFRS 15 is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. The standard does not apply to revenue associated with financial instruments under IFRS 9, therefore it will not impact the majority of the Company’s revenue. The Company does not expect a material impact on its consolidated financial statements as a result of the adoption of IFRS 15. ‐ 79 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) IFRS 2, Share‐based Payment Transactions In June 2016, the IASB issued amendments to IFRS 2 that clarify the accounting for the effects of vesting conditions on the measurement of a cash‐settled share‐based payment transaction; the classification of a share‐based payment transaction with net settlement features for withholding tax obligations; and accounting where a modification to the terms and conditions of a share‐based payment transaction changes its classification from cash settled to equity settled. The amendments are effective for annual periods beginning on or after January 1, 2018. The Company does not expect a material impact on its consolidated financial statements as a result of the amendments to IFRS 2. 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”). 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. IFRS 16 is effective for annual periods beginning on or after January 1, 2019. The Company is currently assessing the impact of adopting IFRS 16 on its consolidated financial statements. IFRIC 23, Uncertainty over Income Tax Treatments This interpretation clarifies how to apply the recognition and measurement requirements in IAS 12, Income Taxes when there is uncertainty over income tax treatments. In such a circumstance, the Company shall recognize and measure its current or deferred tax asset or liability applying the requirements in IAS 12 based on taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates determined applying this Interpretation. This interpretation is effective for annual periods beginning on or after January 1, 2019. The Company has not yet determined the impact of this interpretation on the 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 Significant influence represents the power to participate in the financial and operating policy decisions of an investee, but does not represent control or joint control over the entity. In determining whether it has significant influence over an entity, the Company makes certain judgments to form the basis for the Company’s policies in accounting for its equity investments. ‐ 80 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 5. Significant Accounting Judgments and Estimates (continued) 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. (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 may include the use of mathematical models. The inputs to these models are derived from observable market data where possible, but where observable market data is 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 6. 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 30 for an analysis of the Company’s available credit facilities. 7. Marketable Securities As at December 31 Real estate investment trusts Corporate bonds 2017 61,973 545 62,518 $ $ 2016 53,953 1,173 55,126 $ $ Marketable securities are designated as available for sale. Corporate bonds mature between 2018 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. 8. Mortgages ‐ Corporate (a) Summary As at December 31, 2017 Corporate portfolio: Single family mortgages ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non‐residential Commercial loans ‐ Multi family residential ‐ Other commercial As at December 31, 2016 Corporate portfolio: Single family mortgages ‐ Uninsured ‐ Insured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non‐residential Commercial loans ‐ Multi family residential ‐ Other commercial Gross Principal Collective Allowance Individual Total Net Principal $ 199,264 $ 80,377 51,410 389,098 4,872 65,078 78,095 848 ‐ 220 2,536 32 423 689 $ 62 $ ‐ ‐ ‐ ‐ ‐ ‐ $ 868,194 $ 4,748 $ 62 $ Gross Principal Collective Allowance Individual $ $ 249,296 108,334 18,240 381,904 7,902 34,747 108,938 909,361 $ 1,061 $ 170 $ ‐ 78 2,472 51 226 971 ‐ ‐ 220 ‐ ‐ ‐ $ 4,859 $ 390 $ $ 910 ‐ 220 198,354 80,377 51,190 2,536 32 423 689 4,810 Total 1,231 ‐ 78 2,692 51 226 971 5,249 $ $ $ 386,562 4,840 64,655 77,406 863,384 Net Principal 248,065 108,334 18,162 379,212 7,851 34,521 107,967 904,112 Gross principal as presented in the tables above includes unamortized capitalized transaction costs and accrued interest. ‐ 82 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) 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 the Canada Mortgage and Housing Corporation (“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. Commercial loans include multi family residential loans (e.g. loans secured by apartment buildings), and other commercial loans, which consist of commercial term mortgages (e.g. loans secured by retail/industrial 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 ‐ multi family residential Commercial ‐ other Total 2017 4.72% 6.17% 3.22% 5.58% 5.25% 5.11% 7.81% 5.36% 2016 4.57% 5.23% 3.14% 5.16% 5.41% 4.41% 7.05% 4.90% 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 ‐ multi family residential Commercial ‐ other Total 2017 2016 $ $ 27,797 9,535 1,955 246,550 2,720 1,362 1,285 291,204 $ $ 32,139 3,026 1,229 311,653 203 ‐ 15,911 364,161 The fair value of the corporate mortgage portfolio as at December 31, 2017 was $869,147 (December 31, 2016 ‐ $913,016). 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 31. As at December 31, 2017, single family insured mortgages included $28,597 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, 2016 ‐ $36,915). ‐ 83 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) (b) Geographic Analysis As at December 31, 2017 Single Family Construction Commercial Total Ontario Alberta British Columbia Quebec Atlantic Provinces Other $ $ 207,293 62,376 28,202 9,357 13,681 9,012 329,921 $ $ 179,088 34,736 177,578 ‐ ‐ ‐ 391,402 $ $ 91,323 13,905 36,833 ‐ ‐ ‐ 142,061 As at December 31, 2016 Single Family Construction Commercial Ontario Alberta British Columbia Quebec Atlantic Provinces Other (c) Mortgage Allowances $ $ 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 $ $ $ $ 477,704 111,017 242,613 9,357 13,681 9,012 863,384 Total 479,493 180,844 172,587 12,272 16,719 42,197 904,112 55.3% 12.9% 28.1% 1.1% 1.6% 1.0% 100.0% 53.0% 20.0% 19.1% 1.4% 1.8% 4.7% 100.0% Details of the allowances for mortgage credit losses for the current and prior years are as follows: Collective Individual Balance, beginning of year Provisions Reversals of provisions Write‐offs, net Balance, end of year $ $ 4,859 (107) ‐ (4) 4,748 $ $ 390 345 (169) (504) 62 $ $ 2017 Total 5,249 238 (169) (508) 4,810 $ $ Collective Individual 4,920 (58) ‐ (3) 4,859 $ $ 339 364 (77) (236) 390 $ $ 2016 Total 5,259 306 (77) (239) 5,249 (d) Arrears and Impaired Mortgages Mortgages past due but not impaired are as follows: As at December 31, 2017 Single family ‐ uninsured Single family ‐ insured 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days Total $ $ 3,303 1,296 4,599 $ $ 225 157 382 $ $ 688 ‐ 688 $ $ ‐ 569 569 $ $ 4,216 2,022 6,238 ‐ 84 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) As at December 31, 2016 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 $ $ 1,083 76 1,159 $ $ 1,044 ‐ 1,044 $ $ ‐ 888 888 $ $ Total 6,119 3,045 9,164 Impaired mortgages (net of individual allowances) are as follows: As at SF Insured SF Uninsured Total SF Insured SF Uninsured Total December 31, 2017 December 31, 2016 Ontario Alberta Quebec Atlantic Provinces Other $ $ ‐ 32 526 ‐ 274 832 $ 86 1,546 ‐ 64 ‐ $ 86 $ 1,578 526 64 274 $ 129 623 366 ‐ ‐ $ 1,696 $ 2,528 $ 1,118 $ 1,079 1,228 333 119 ‐ 2,759 $ $ 1,208 1,851 699 119 ‐ 3,877 9. Financial Investments As at December 31 Investment ‐ Crown Realty II Limited Partnership Investment ‐ KingSett High Yield Fund 2017 2016 $ $ 32,037 $ 36,153 68,190 $ 33,207 24,057 57,264 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, which occur annually at year‐end. As property acquisitions are made by Crown LP, the Company advances its proportionate share to finance the acquisitions. During 2017, the Company recorded a $4,380 gross increase in the unrealized gain on the investment in Crown LP (2016 ‐ $7,242), which is recognized in the consolidated statements of comprehensive income net of deferred taxes. Additionally, the Company recognized $5,310 of gross income from the Crown LP investment in 2017 (2016 ‐ $4,148), which is reflected in income from financial investments and other loans, with a corresponding deferred tax expense recorded. The recognition of income upon the receipt of partnership distributions from Crown LP is offset by a corresponding reduction to accumulated other comprehensive income. The Company holds an investment in the KingSett High Yield Fund (“the Fund”), in which it has an 8.1% 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 throughout the life of the Fund. As at December 31, 2017, the Company’s unfunded commitment was $26,483 (December 31, 2016 ‐ $38,700). Both investments noted above are designated as available for sale, with changes in fair value recognized in the consolidated statements of comprehensive income. ‐ 85 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 10. Other Loans As at December 31 Loans receivable ‐ Executive Share Purchase Plan Loans receivable ‐ other All other loans are classified as loans and receivables. 11. Equity Investment in MCAP Commercial LP Note 28 2017 2016 $ $ 1,141 $ 1,471 2,612 $ 1,535 2,049 3,584 As at December 31, 2017, the Company held a 14.41% equity interest in MCAP (December 31, 2016 ‐ 14.74%), consisting of 14.7% of voting class A units (December 31, 2016 ‐ 15.0%), 0% of non‐voting class B units (December 31, 2016 ‐ 0%) and 16.7% of non‐voting class C units (December 31, 2016 ‐ 17.0%). The equity interest represents 4.2 million units held by MCAN of the 29.1 million total outstanding MCAP partnership units. MCAN holds a 14.7% voting interest in MCAP through its class A units (December 31, 2016 ‐ 15.0%). The following key transactions occurred in 2017: MCAN sold 100,000 partnership units in MCAP at a price of $19.47 per unit, recognizing a gain on sale of $785. MCAP also issued additional class B units to other partners of MCAP which decreased MCAN’s equity interest in MCAP from 14.74% to 14.35% at the time of the transaction. As a result of the issuance of the new units at a price in excess of the carrying value per unit, MCAN recorded a dilution gain of $91. MCAP redeemed 114,500 partnership units held by another partner in MCAP, which increased MCAN’s equity interest in MCAP from 14.35% to 14.41%. 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, 2017, 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. Amongst the interparty rights in the MCAP partnership agreement, the majority partner in MCAP has the right to acquire MCAN’s entire partnership interest in MCAP for “fair market value”, which would be determined by an independent valuator agreed upon by both parties. ‐ 86 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 11. Equity Investment in MCAP Commercial LP (continued) Years Ended December 31 Balance, beginning of year Equity income Dilution gain Carrying value of portion of investment sold 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 12. Foreclosed Real Estate 2017 50,805 14,427 91 (1,163) (4,971) 59,189 $ $ 2016 44,191 13,509 ‐ ‐ (6,895) 50,805 $ $ 2017 2016 $ 29,719,416 29,279,919 439,497 $ 28,436,501 28,060,296 376,205 2017 2016 $ $ 499,379 99,598 $ $ 516,896 91,678 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. 13. Other Assets As at December 31 Corporate assets: Intangible assets, net Capital assets, net Prepaid expenses Related party receivable ‐ MCAP Receivables 2017 2016 $ $ 918 766 841 3,135 140 5,800 $ $ 1,020 811 778 876 61 3,546 Other securitization assets, totalling $4,239 as at December 31, 2017 (December 31, 2016 ‐ $4,802), consist of interest‐only strips from Canada Mortgage Bonds (“CMB”) program multi‐family securitizations (Note 14) and prepaid expenses. Other assets are carried at cost. ‐ 87 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 13. Other Assets (continued) The capital assets and intangible assets continuity is as follows: Cost At January 1, 2016 Additions At December 31, 2016 Additions At December 31, 2017 Amortization At January 1, 2016 Amortization for the year At December 31, 2016 Amortization for the year At December 31, 2017 Net Book Value At December 31, 2016 At December 31, 2017 Furniture & Fixtures Computer Hardware Leasehold Improvements Capital Assets Total Intangible Assets $ $ 816 ‐ 816 8 824 795 5 800 5 805 $ 1,701 15 1,716 64 1,780 1,389 93 1,482 96 1,578 1,837 ‐ 1,837 30 1,867 1,225 51 1,276 46 1,322 $ 4,354 $ 15 4,369 102 4,471 3,409 149 3,558 147 3,705 $ 16 19 $ 234 202 $ 561 545 $ 811 766 $ 4,690 556 5,246 227 5,473 4,022 204 4,226 329 4,555 1,020 918 14. 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”) CMB program. In both programs, the Company originates or purchases mortgages for securitization. Pursuant to the NHA MBS program, MBS investors 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. 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 2017, MCAN securitized $47,050 of MBS to third parties (2016 ‐ $41,728). 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. 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 requires the reinvestment by the issuer of mortgage principal repayments received during their term into certain permitted assets. 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 2017, MCAN securitized $62,653 of insured single family mortgages through the CMB program (2016 ‐ $100,377). Similar to the market MBS program, the Company does not derecognize the securitized mortgages from its consolidated balance sheet when it retains significant continuing involvement with the assets such that the associated mortgages remain on the consolidated balance sheet while a corresponding liability is 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. ‐ 88 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 14. Securitization Activities (Continued) During 2016, the Company securitized $85,526 of insured multi family mortgages through the CMB program, but did not securitize any in 2017. Upon the securitization of multi family mortgages, the Company generally achieves derecognition as control over the assets is transferred. In 2016, the Company recognized an upfront gain of $394, which is included in other securitization income. Additionally, the Company recognized a receivable in the amount of estimated discounted spread income to be earned over the term of the securitized mortgages, which is included in other securitization assets. 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 32). 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 32). 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, 2017 was $1,016,724 (December 31, 2016 ‐ $1,071,849) (Note 16). The financial liabilities from securitization balance as at December 31, 2017 was $1,015,699 (December 31, 2016 ‐ $1,071,786) (Note 20). Transferred financial assets that are derecognized in their entirety but where the Company has a continuing involvement MCAN sells MBS and in some cases sells the associated interest‐only strips to third parties. Accordingly, MCAN then 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. MCAN’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 was not reflected as an asset or liability on MCAN’s consolidated balance sheet as at December 31, 2017. The MBS mature as follows: 2017 2020 2021 2026 Total December 31, 2017 December 31, 2016 $ $ ‐ 122,016 $ $ 108,990 132,075 $ $ 73,786 75,142 $ $ 9,678 9,911 $ $ 192,454 339,144 ‐ 89 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 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 14 and 20). (a) Summary As at December 31 Single family insured ‐ Market MBS program Single family insured ‐ CMB program 2017 2016 $ $ 867,406 149,318 1,016,724 $ 971,548 100,301 $ 1,071,849 Certain capitalized transaction costs are included in mortgages and are amortized using the EIM. As at December 31, 2017, the unamortized capitalized cost balance was $6,536 (December 31, 2016 ‐ $10,110). 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, 2017 was $1,031,154 (December 31, 2016 ‐ $1,106,997). 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 (b) Geographic Analysis As at Ontario Alberta British Columbia Quebec Atlantic Provinces Other 2017 2.49% 2.22% 2.45% 2016 2.50% 2.21% 2.47% December 31, 2017 December 31, 2016 $ $ 576,785 231,335 90,174 41,449 44,924 32,057 1,016,724 56.7% 22.8% 8.9% 4.1% 4.4% 3.1% 100.0% $ 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% Securitized mortgages past due but not impaired are as follows: As at December 31, 2017 Single family ‐ Market MBS Program Single family ‐ CMB Program 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 $ $ 5,207 280 5,487 $ $ 1,941 ‐ 1,941 $ $ 263 ‐ 263 $ $ 1,112 ‐ 1,112 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days $ $ 6,922 336 7,258 $ $ 2,948 649 3,597 $ $ 769 ‐ 769 $ $ 1,398 ‐ 1,398 Total 8,523 280 8,803 Total 12,037 985 13,022 $ $ $ $ ‐ 90 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 16. Mortgages – Securitized (continued) Impaired securitized mortgages are as follows: As at Quebec 17. Term Deposits December 31, 2017 December 31, 2016 CMB Market MBS Total CMB Market MBS Total $ $ ‐ ‐ $ $ ‐ ‐ $ $ ‐ $ $ ‐ ‐ ‐ $ $ 587 587 $ $ 587 587 Term deposits are issued to various individuals and institutions with contracted terms between 30 days and five years. The Company does not accept deposits that can be cashed prior to maturity or paid on demand except in the event of the death of a depositor. The Company’s term deposits are eligible for CDIC deposit insurance. Term deposits maturities and the weighted average interest rate are as follows: Within 3 Months 3 Months to 1 Year One to three years Three to five years Total Average Rate December 31, 2017 December 31, 2016 $ $ 98,760 119,472 $ $ 314,574 327,739 $ $ 318,321 336,926 $ $ 152,805 127,729 $ $ 884,460 911,866 2.34% 2.21% 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, 2017 was $882,553 (December 31, 2016 ‐ $913,071), and is determined by discounting the contractual cash flows using market interest rates currently offered for deposits of similar remaining maturities. 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 investments Relating to loss carry forward benefit Other 2017 39,684 0% ‐ (244) (244) 2017 ‐ 596 (580) (260) (244) 2016 39,516 0% ‐ (666) (666) 2016 (100) 91 (568) (89) (666) $ $ $ $ $ $ $ $ ‐ 91 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 18. Income Taxes (continued) 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 Other 2017 2,058 614 2,672 3,524 48 3,572 $ $ $ $ 2016 1,478 304 1,782 3,050 ‐ 3,050 $ $ $ $ The loss carry forward benefit reflected in the deferred tax asset relates to losses in subsidiaries to which the Company has attributed a future benefit. Deferred taxes recorded in accumulated other comprehensive income relating to financial investments were $(122) in 2017 (2016 ‐ $660). The Company has loss carry forward amounts in the non‐consolidated MIC entity of $11,269 (December 31, 2016 ‐ $11,052), the benefit of which has not been recorded in deferred tax assets. Tax activity for 2017 has not been reflected in the table below as the Company’s 2017 tax position has not been finalized. Tax loss carry forwards expire after 20 years, as follows: 2033 2034 2036 19. Other Liabilities As at December 31 Accounts payable and accrued charges Dividends payable 20. Financial Liabilities from Securitization $ $ 5,527 5,535 207 11,269 2017 $ $ 7,417 8,650 16,067 $ $ 2016 5,454 6,923 12,377 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 14 14 2017 2016 $ $ 868,244 147,455 1,015,699 $ 972,263 99,523 $ 1,071,786 The weighted average interest rate of financial liabilities from securitization is as follows: As at December 31 Financial liabilities ‐ Market MBS program Financial liabilities ‐ CMB program 2017 1.83% 1.64% 1.80% 2016 1.84% 1.42% 1.80% ‐ 92 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 20. Financial Liabilities from Securitization (continued) Financial liabilities from securitization mature as follows: 2018 2019 2020 2021 2022 Total December 31, 2017 December 31, 2016 $ $ 99,020 $ 120,825 $ 397,944 468,304 $ $ 349,519 383,134 $ $ 90,813 99,523 $ $ 78,403 $ 1,015,699 ‐ $ 1,071,786 21. Share Capital The authorized share capital of the Company consists of unlimited common shares with no par value. Number of Shares 2017 Number of Shares 2016 Balance, beginning of year Issued Dividend reinvestment plan Executive Share Purchase Plan Balance, end of year 23,075,227 $ 210,239 22,782,433 $ 206,382 295,849 6,709 23,377,785 $ 4,325 100 214,664 280,376 12,418 23,075,227 $ 3,680 177 210,239 During 2017, the Company issued 295,849 (2016 ‐ 280,376) 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 2017 fourth quarter dividend was 17% (2016 fourth quarter ‐ 15%). For details on the Executive Share Purchase Plan, refer to Note 28. The Company had no potentially dilutive instruments as at December 31, 2017 or December 31, 2016. 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 $0.37 per share payable on March 29, 2018 to shareholders of record as of March 15, 2018. 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 2017 2016 To be reclassified to the income statement in subsequent periods: Unrealized gain on available for sale marketable securities $ 3,313 $ 1,049 Unrealized gain on available for sale financial investments Less: deferred taxes 15,183 (2,058) 13,125 16,235 (2,180) 14,055 $ 16,438 $ 15,104 24. Fees Fees consist of ancillary fees earned on the Company’s corporate mortgage portfolio, such as letter of credit and amendment fees. ‐ 93 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 25. Mortgage Expenses Corporate Assets Years Ended December 31 Mortgage servicing expense Letter of credit expense Other mortgage expenses 2017 2,991 588 298 3,877 $ $ 2016 3,109 605 279 3,993 $ $ Letter of credit expense relates to outstanding letters of credit in the Company’s credit facility, discussed in Note 30. Securitization Assets Mortgage expenses associated with securitization assets consist primarily of mortgage servicing expenses. 26. Provision for Credit Losses Years Ended December 31 Mortgages ‐ collective provisions (recoveries), net Mortgages ‐ individual provisions (reversals), net Other provisions (recoveries), net 27. Whole Loan Gain on Sale Income Note 8 8 $ $ 2017 (107) 176 (180) (111) $ $ 2016 (58) 287 (439) (210) In 2016, the Company sold $13,343 of insured single family mortgages to a third party on a whole‐loan basis and recorded a gain on sale of $324. The Company did not sell any mortgages during 2017. 28. Related Party Disclosures 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. The consolidated financial statements include the financial statements of the Company and its equity‐accounted associate, MCAP. The Company holds a 14.41% equity interest in MCAP (December 31, 2016 ‐ 14.74%), 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. In 2017, the Company purchased certain corporate services from MCAP in the amount of $100 (2016 ‐ $144) and purchased certain mortgage servicing and administration services from MCAP in the amount of $3,794 (2016 ‐ $3,904). The Company received $4,270 of mortgage fees from MCAP in 2017 (2016 ‐ $3,907). Related party balances with MCAP are reflected in other assets and other liabilities on the consolidated balance sheet where applicable. In 2017, the Company purchased $4,496 of uninsured single family mortgages from MCAP (2016 ‐ $nil). The Company held construction loans totalling $638 as at December 31, 2016 for which the borrower is a close family member of a member of the Board. These loans paid out during 2017. In 2017, the Company earned interest income of $15 (2016 ‐ $110) on these loans. The outstanding commitment for future fundings of these loans as at December 31, 2017 was $nil (December 31, 2016 ‐ $1,998). The loans were contracted at market terms. All related party transactions noted above were in the normal course of business. ‐ 94 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 28. Related Party Disclosures (continued) 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 2017 3,524 959 4,483 $ $ 2016 3,337 424 3,761 $ $ 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 2017, the Company advanced $100 of new loans under the Share Purchase Plan (2016 ‐ $177). As at December 31, 2017, $1,141 of loans were outstanding (December 31, 2016 ‐ $1,535). The loans under the Share Purchase Plan bear interest at prime plus 1% (4.20%) as at December 31, 2017 (December 31, 2016 ‐ prime plus 1% (3.70%)) and have a five‐year term. The shares are pledged as security for the loans and had a fair value of $2,554 as at December 31, 2017 (December 31, 2016 ‐ $2,753). In 2017, MCAN recognized $49 of interest income (2016 ‐ $56) on the Share Purchase Plan loans. 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, 2017, all 57,790 units issued had vested (December 31, 2016 ‐ 53,234). The Company recognizes compensation expenses associated with the DSU Plan over the vesting period. The compensation expense recognized related to the DSU Plan for 2017 was $257 (2016 ‐ $184). As at December 31, 2017, the accrued DSU Plan liability was $1,022 (December 31, 2016 ‐ $766). 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. In 2017, the Company granted 5,873 new units to the RSU Participants under the RSU Plan (2016 ‐ 3,808). Additionally, 14,093 units vested during 2017 (2016 ‐ 9,452). At the time of vesting, the Company paid the RSU participants $216 (2016 ‐ $133). As at December 31, 2017, 40,014 units were outstanding (December 31, 2016 ‐ 46,785) of which no units had vested (December 31, 2016 ‐ nil). ‐ 95 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 28. Related Party Disclosures (continued) The Company recognizes compensation recoveries or expenses associated with the RSU Plan over the vesting period. The compensation expense recognized related to the RSU Plan for 2017 was $342 (2016 ‐ $231). As at December 31, 2017, the accrued RSU Plan liability was $453 (December 31, 2016 ‐ $326). 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 2017, the Company granted 44,277 new units to the PSU Participants under the PSU Plan (2016 ‐ 26,796). As at December 31, 2017, 74,791 units were outstanding (December 31, 2016 ‐ 27,328). As at December 31, 2017, no units had vested (December 31, 2016 ‐ nil). The Company recognizes compensation recoveries or expenses associated with the PSU Plan over the vesting period. The compensation expense recognized related to the PSU Plan for 2017 was $436 (2016 ‐ $56). As at December 31, 2017, the accrued PSU Plan liability was $492 (December 31, 2016 ‐ $56). 29. 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 information on mortgage funding commitments, refer to Note 8. For further details on the commitment associated with the KingSett High Yield Fund investment, refer to Note 9. The Company also has contractual obligations associated with its premises lease. In 2017, the Company entered into an agreement to increase the size of its leased premises and the duration of the lease. The increased lease obligation is reflected in the table below. One to Less than one year three years Three to Over five December 31 December 31 2016 five years years 2017 Mortgage funding commitments Commitment ‐ KingSett High Yield Fund Operating lease $ 169,599 $ ‐ 903 $ 170,502 $ 121,605 $ 26,483 1,711 149,799 $ ‐ $ ‐ 1,735 1,735 $ ‐ $ ‐ 4,303 4,303 $ 291,204 $ 26,483 8,652 326,339 $ 364,161 38,700 4,569 407,430 The Company incurred $676 of operating lease expenses during 2017 (2016 ‐ $548), 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. ‐ 96 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 29. Commitments and Contingencies (continued) MCAP is actively defending a claim arising from a power of sale process with respect to a defaulted land development loan previously funded by MCAN. The plaintiff has claimed improvident sale and has claimed damages of approximately $6,000. MCAP was awarded a judgment for approximately $500 against the same plaintiff in related proceedings. MCAN may be subject to the indemnification of MCAP for certain liabilities that may be incurred as part of the proceedings under a mortgage servicing agreement between the two parties. Based on, among other things, the current status of the proceedings, the Company does not expect to incur any material liability arising out of this indemnification obligation to MCAP and accordingly has not recorded a provision. 30. 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% (3.95%) as at December 31, 2017 (December 31, 2016 ‐ 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, 2017, the outstanding overdraft balance was $nil (December 31, 2016 ‐ $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, 2017, there were letters of credit in the amount of $32,164 issued (December 31, 2016 ‐ $30,537) and additional letters of credit in the amount of $31,521 committed but not issued (December 31, 2016 ‐ $26,138). The Company has 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. As at December 31, 2017, the outstanding facility balance was $nil (December 31, 2016 ‐ $nil). 31. 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. The interest rate sensitivity analysis is based on the Company’s consolidated balance sheets as at December 31, 2017 and December 31, 2016 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 Investment 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. ‐ 97 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 31. Interest Rate Sensitivity (continued) As at December 31, 2017 Floating Rate Within 3 Months 3 Months to 1 Year 1 to 3 Years 3 to 5 years Over 5 Non Interest Sensitive years Total Assets Corporate Securitization Liabilities Corporate Securitization Shareholders' Equity $ 611,563 $ 13,441 625,004 31,558 $ 677 32,235 177,465 $ 126,688 304,153 168,748 $ 720,383 889,131 25,668 $ 168,976 194,644 5,250 $ ‐ 5,250 162,119 $ 1,182,371 1,034,404 2,216,775 4,239 166,358 ‐ ‐ ‐ ‐ 98,760 ‐ 98,760 314,574 99,020 413,594 318,321 747,463 1,065,784 152,805 169,216 322,021 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 19,639 ‐ 19,639 904,099 1,015,699 1,919,798 296,977 296,977 GAP $ 625,004 $ (66,525) $ (109,441) $ (176,653) $ (127,377) $ 5,250 $ (150,258) $ ‐ YIELD SPREAD 4.43% 3.16% 2.22% 1.52% 0.42% 2.94% 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 Non Interest Sensitive Years 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% Certain construction and commercial mortgages are subject to the greater of a minimum interest rate (ranging between 3.75% and 10.25%) or a prime based interest rate. To the extent that the minimum rate exceeds the prime based rate as at December 31, 2017, these mortgages have been reflected in the table above as fixed rate mortgages, as follows: within 3 months ‐ $nil (December 31, 2016 ‐ $41,304), 3 months to 1 year ‐ $807 (December 31, 2016 ‐ $60,947) and 1 to 5 years ‐ $nil (December 31, 2016 ‐ $28,973). An immediate and sustained parallel 1% increase to market interest rates as at December 31, 2017 would have an estimated positive effect of $4,253 (December 31, 2016 ‐ $1,478) to net income over the following twelve month period. An immediate and sustained parallel 1% decrease to market interest rates as at December 31, 2017 would have an estimated adverse effect of $2,061 (December 31, 2016 ‐ $1,835) to net income over the following twelve month period. An immediate and sustained parallel 1% increase (decrease) to market interest rates as at December 31, 2017 would have an estimated adverse (positive) effect of $2 (December 31, 2016 ‐ $9) on accumulated other comprehensive income. When calculating the effect of an immediate and sustained parallel 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. ‐ 98 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 32. 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. 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 2017 2016 $ $ $ 214,664 510 65,365 16,438 (23,593) 273,384 (5,898) 267,486 2,216,775 (29,491) 2,915 2,190,199 317,687 (158,844) 32,164 (16,082) 174,925 $ $ $ 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 Total Exposures/Regulatory Assets $ 2,365,124 $ 2,476,415 Leverage ratio 11.31% 10.46% 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 2017, the deduction on the transitional basis is equal to 80% of the all‐in adjustment (2016 ‐ 60%). 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, 2017 and December 31, 2016, the Company was in compliance with the capital guidelines issued by OSFI under Basel III. ‐ 99 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 32. Capital Management (continued) 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. 33. 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 tables summarize financial assets reported at fair value and financial assets and liabilities for which fair values are disclosed. As at December 31, 2017 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 $ 117,571 61,973 ‐ ‐ 13,441 $ 192,985 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 $ $ $ $ $ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ $ $ $ $ $ $ ‐ 545 ‐ ‐ ‐ 545 $ $ ‐ ‐ $ 117,571 62,518 $ 117,571 62,518 32,037 36,153 ‐ 68,190 32,037 36,153 13,441 $ 261,720 32,037 36,153 13,441 $ 261,720 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ 869,147 2,612 1,031,154 $ 1,902,913 $ 869,147 2,612 1,031,154 $ 1,902,913 $ 863,384 2,612 1,016,724 $ 1,882,720 $ 16,067 $ 16,067 $ 16,067 $ 882,553 1,010,975 $ 1,893,528 $ 882,553 1,010,975 $ 1,893,528 $ 884,460 1,015,699 $ 1,900,159 1 Fair value of investment is based on the underlying real estate properties determined by the discounted 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 33. Financial Instruments (continued) 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 $ 111,732 53,953 ‐ ‐ 15,724 $ 181,409 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 $ $ $ $ $ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ $ $ $ $ $ $ 1,173 ‐ ‐ ‐ 1,173 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ ‐ ‐ $ 111,732 55,126 $ 111,732 55,126 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 discounted 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, 2016 Advances Repayments Changes in fair value, recognized in other comprehensive income Balance, December 31, 2017 $ $ 57,264 12,219 (5,551) 4,258 68,190 An increase of 0.25% to capitalization rates as at December 31, 2017 would result in a decrease to the fair value of financial investments by $1,151 (December 31, 2016 ‐ $1,144). A decrease of 0.25% to capitalization rates as at December 31, 2017 would result in an increase to the fair value of financial investments by $1,183 (December 31, 2016 ‐ $1,123). There were no transfers between levels during the years ended December 31, 2017 or December 31, 2016. ‐ 101 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 33. 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. 34. 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 ‐ 2017 ANNUAL REPORT | MCAN MORTGAGE CORPORATION DIRECTORS Verna Cuthbert Corporate Director, MCAN Mortgage Corporation Member of Investment Committee Member of Enterprise Risk Management and Compliance Committee Director since September 2013 EXECUTIVE OFFICERS William Jandrisits President and Chief Executive Officer Jeffrey Bouganim Senior Vice President and Chief Financial Officer Susan Doré Corporate Director, MCAN Mortgage Corporation Member of Audit Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Director since May 2010 Leonard Zaidener Vice President, Investments Robert Horton Vice President and Chief Risk Officer Martin Beaudry Vice President, Single Family Mortgage Operations Carl Brown Vice President, Operations Business Continuity/Disaster Recovery Coordinator Jeffrey Lum Vice President, Treasury and Securitization Sylvia Pinto Vice President, Chief Compliance Officer & Corporate Secretary Emily Randle Vice President, Credit Risk Monitoring and Management William Jandrisits President and Chief Executive Officer, MCAN Mortgage Corporation Director since August 2010 Brian A. Johnson Partner, Crown Capital Partners and Crown Realty Partners Chair of Conduct Review, Corporate Governance and Human Resources Committee Chair of Investment Committee Director since January 2001 Loraine McIntosh Corporate Director, MCAN Mortgage Corporation Member of Audit Committee Member of Enterprise Risk Management and Compliance Committee Director since May 2017 Gaelen Morphet Corporate Director Member of Investment Committee Director since January 2018 Derek Sutherland President, Canadazil Capital Inc. Member of Enterprise Risk Management and Compliance Committee Member of Investment Committee Director since May 2017 Ian Sutherland Chair, MCAN Mortgage Corporation Director since January 1991 Karen Weaver Corporate Director, MCAN Mortgage Corporation Chair of Audit Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Director since November 2011 W. Terrence Wright Counsel, Pitblado LLP Member of Audit Committee Chair of Enterprise Risk Management and Compliance Committee Director since September 2013 ‐ 103 ‐ 2017 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.xmcmortgage.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 2017 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 General Meeting of Shareholders Tuesday, May 8, 2018 4:30pm (local time) Vantage Venues 150 King Street West, 27th Floor Toronto, Ontario All shareholders and prospective investors are invited to attend. ‐ 104 ‐