Annual Report 2018 A STRATEGIC INVESTOR IN CANADIAN MORTGAGES 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION DESCRIPTION OF BUSINESS MCAN Mortgage Corporation (“MCAN”) is a public company listed on the Toronto Stock Exchange under the symbol MKP. MCAN is a Loan Company under the Trust and Loan Companies Act (Canada) 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 Canadian mortgages, including single family residential, residential construction, non‐residential construction and commercial loans, as well as other types of securities, loans and real estate investments. We employ leverage by issuing term deposits eligible for Canada Deposit Insurance Corporation deposit insurance. We manage our capital and asset balances based on the regulations and limits of both the Tax Act and the Office of the Superintendent of Financial Institutions. 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. Dividends paid to foreign investors may be subject to withholding taxes. MCAN’s wholly‐owned subsidiary, XMC Mortgage Corporation, is an originator of single family residential mortgage products across Canada. TABLE OF CONTENTS INTERIM CEO’S MESSAGE TO SHAREHOLDERS .............................................................................................................. 3 MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS ................................................................................... 5 CONSOLIDATED FINANCIAL STATEMENTS ................................................................................................................... 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .................................................................................................. 65 DIRECTORS AND EXECUTIVE OFFICERS ...................................................................................................................... 103 CORPORATE INFORMATION ..................................................................................................................................... 104 ‐ 2 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION MESSAGE TO SHAREHOLDERS MCAN Mortgage Corporation (“MCAN”, the “Company” or “we”) reported net income of $36.3 million for the year ended December 31, 2018, down from $39.9 million earned in 2017. In the fourth quarter, we reported net income of $3.5 million, down from $10.8 million in 2017. The fourth quarter was impacted primarily by an unrealized loss recorded on the value of our marketable securities portfolio related to market wide fluctuations and a reduction in equity income from MCAP compared to 2017. Subsequent to year end, the value of the marketable securities portfolio recovered, consistent with the broader market. Earnings per share totalled $1.54 in 2018 compared to $1.72 per share in 2017. Earnings per share in the fourth quarter totalled $0.15 in 2018 compared to $0.47 in 2017. Return on average shareholders’ equity was 11.90% compared to 13.75% in the prior year. On February 22, 2019, the Board of Directors (the “Board”) declared a first quarter dividend of $0.32 per share to be paid March 29, 2019. Corporate Assets Performance 2018 was an unprecedented year in which the combination of new OSFI Guideline B‐20 rules introduced effective January 1, 2018, recent years of housing market price increases and an increasing interest rate environment negatively impacted mortgage affordability and demand. In the context of these conditions, we performed well in terms of growing our assets during the year. While below our targeted 10% long term growth rate, in the context of the market and changes within the Company, we are satisfied with our 4% growth in corporate assets to $1.22 billion at December 31, 2018, up $42 million from December 31, 2017. The corporate mortgage portfolio increased by 7% during 2018 to $922 million from $863 million at December 31, 2017. This portfolio growth is primarily due to improvements in our single family business, specifically in our marketing and underwriting processes for internally originated mortgages and in mortgage acquisitions. Our growth in corporate assets, along with the interest rate increases during the year, led to a 3% increase in net corporate mortgage spread income over the prior year. In 2019, we will continue to focus on growing this portfolio. We have a long history of strong portfolio quality which continued into 2018 as reflected in our low arrears and the impaired mortgage ratio. Corporate mortgage arrears totalled $9.4 million and the impaired corporate mortgage ratio was 0.12% at December 31, 2018, compared to $8.8 million and 0.09%, respectively, as at December 31, 2017. We will ensure continued high quality portfolio performance through consistent application of our strong underwriting standards. Our marketable and non‐marketable securities investments totalled $53 million and $72 million, respectively, at December 31, 2018. Our marketable securities comprise primarily of a portfolio of real estate investment trusts which earned a 5.86% yield in the year. Our marketable and non‐marketable investments provide the Company with income and balance sheet diversity in addition to earnings opportunities and will continue to be a core component of our investment strategy. ‐ 3 ‐ Construction & Commercial Single Family 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Our investment in MCAP continues to perform well. MCAP’s business is anchored by continuing growth in its assets under administration which provides a stable source of income. MCAP had $72.8 billion of assets under administration at the end of its 2018 fiscal year and originated $15.4 billion of mortgages during that year. Equity income from our investment in MCAP totalled $13.2 million in 2018, down $1.2 million from 2017 due to reduced ownership and compressed spreads in the mortgage market. MCAP has a strong and growing business and will continue to be an important strategic partner to MCAN. Securitization Assets In 2018, we securitized $169 million of insured single family mortgages through the National Housing Act (“NHA”) Mortgage‐Backed Securities (“MBS”) program, an increase of $59 million over 2017. However, market dynamics have led to reduced origination volumes and tightened spreads in the overall insured market. These changes led to a reduction in our insured mortgage origination and securitization volumes during 2017 and 2018 compared to previous years, and a reduction in the associated securitization economics. We will continue to securitize mortgages where they contribute to our income. Business Focus During the year, we shifted to a more conservative asset mix with growth focused on single family mortgages. We continue to focus on optimizing our balance sheet relative to our view of risk based on where we believe the economic and real estate cycles, in Canada and the markets where we do business, are currently. On September 24, 2018, we announced a $0.32 per share dividend payable to shareholders on January 2, 2019, a reduction of $0.05 per share, due to our outlook on the mortgage market, the slower than expected growth in the single family business and our shift to a more conservative asset mix. The impact to the Company’s shareholders’ equity will be positive and will further strengthen our balance sheet over time. Our balance sheet at year end was strong with CET 1, Tier 1 and Total Capital ratios of 21.66%. We remain focused on growing our business and delivering a sustainable dividend to shareholders. We have maintained our stated annual long‐term growth target for corporate assets of 10%, however, due to anticipated market conditions, we expect that our growth will be closer to 4 – 6% in the coming year. We appreciate the business relationships with all of our partners and customers and look forward to our continuing mutual business activities in the future. I would like to thank all of the team members at MCAN for their diligence and commitment to our business success and particularly the new executive team for their leadership and dedication. Karen Weaver Chief Executive Officer, Interim ‐ 4 ‐ 2018 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, 2018 and December 31, 2017 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 22, 2019. 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. Effective January 1, 2018, MCAN prospectively adopted IFRS 9, Financial Instruments and did not restate prior period information. Accordingly, financial information as at December 31, 2018 and for the year ended December 31, 2018 is based on IFRS 9 and prior periods are based on International Accounting Standards (“IAS”) 39, Financial Instruments: Recognition and Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. TABLE OF CONTENTS ‐ MD&A A CAUTION ABOUT FORWARD‐LOOKING INFORMATION AND STATEMENTS .................................................................................. 6 HIGHLIGHTS ...................................................................................................................................................................................... 8 SELECTED FINANCIAL INFORMATION ............................................................................................................................................. 11 OUTLOOK ........................................................................................................................................................................................ 14 RESULTS OF OPERATIONS ............................................................................................................................................................... 15 FINANCIAL POSITION ...................................................................................................................................................................... 24 SELECTED QUARTERLY FINANCIAL DATA ........................................................................................................................................ 35 CAPITAL MANAGEMENT ................................................................................................................................................................. 37 SECURITIZATION PROGRAMS ......................................................................................................................................................... 40 RISK GOVERNANCE AND MANAGEMENT ....................................................................................................................................... 41 DESCRIPTION OF CAPITAL STRUCTURE ........................................................................................................................................... 51 OFF‐BALANCE SHEET ARRANGEMENTS ......................................................................................................................................... 52 DIVIDEND POLICY AND RECORD ..................................................................................................................................................... 52 TRANSACTIONS WITH RELATED PARTIES ........................................................................................................................................ 53 FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS .................................................................................................................. 53 PEOPLE ............................................................................................................................................................................................ 53 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS .................................................................................................................. 53 CURRENT PERIOD CHANGES IN ACCOUNTING POLICY .................................................................................................................. 55 STANDARDS ISSUED BUT NOT YET EFFECTIVE ................................................................................................................................ 55 DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING ........................................ 55 NON‐IFRS MEASURES ...................................................................................................................................................................... 57 ‐ 5 ‐ 2018 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 new regulations and changes to existing 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 uncertainty and volatility of real estate markets; • acceptance of our products in the marketplace; • our ability to forecast future changes to borrower credit and credit scores, loan to value ratios and other forward‐looking factors used in assessing expected credit losses; • 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; ‐ 6 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION • adverse legislation or regulation, including recent changes implemented by OSFI and the potential for higher capital and liquidity requirements for real estate lending; • availability of CMB and MBS issuer allocation; • 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; • the success of the business underlying our investment in MCAP, marketable securities and non‐marketable securities; • • our ability to respond to and reposition ourselves within a changing market; • our relationships with our mortgage originators; and • 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 AFS Available for Sale EIM Effective Interest Rate Method ALCO Asset and Liability Committee EIR Effective Interest Rate FVOCI FVPL Fair Value Through Other Comprehensive Income Fair Value Through Profit and Loss HELOC Home Equity Line of Credit MIC 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 CMB Canada Mortgage Bonds IFRIC CMHC Canada Mortgage and Housing Corporation IFRS DRIP Dividend Reinvestment Plan LAR International Accounting Standard International Accounting Standards Board IFRS Interpretations Committee International Financial Reporting Standards Liquidity Adequacy Requirements LP ARA LTV Limited Partner’s At‐Risk Amount Loan to Value (ratio) MBS Mortgage Backed Securities MD&A Management’s Discussion & Analysis Mortgage Investment Corporation NHA National Housing Act OSFI Office of the Superintendent of Financial Institutions PD Probability of Default RAF Risk Appetite Framework SEDAR System for Electronic Document Analysis and Retrieval Solely Payment of Principal and Interest EAD Exposure at Default LCR Liquidity Coverage Ratio SPPI ECL Expected Credit Losses LGD Loss Given Default TSX Toronto Stock Exchange During 2018, we renamed “Financial Investments” as “Non‐Marketable Securities”. ‐ 7 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION HIGHLIGHTS Financial Performance Q4 2018 Net income of $3.5 million in Q4 2018, a decrease of $7.3 million (67%) from $10.8 million in Q4 2017. Unrealized loss on marketable securities of $4.2 million, consisting entirely of a reduction in the fair value of the real estate investment trust (“REIT”) component of our marketable securities portfolio. This unrealized loss negatively impacted earnings per share by $0.17. Subsequent to year end, the value of the marketable securities portfolio recovered, consistent with the broader market. In Q4 2017, we recorded an unrealized gain on marketable securities of $2.3 million through accumulated other comprehensive income in accordance with IAS 39. Equity income from MCAP Commercial LP (“MCAP”) decreased by $2.2 million (40%) from Q4 2017 due to a reduced ownership interest and compressed spreads, which were consistent with the broader market. Earnings per share totalled $0.15 per share in Q4 2018, a decrease of $0.32 (68%) from $0.47 per share in Q4 2017. Return on average shareholders’ equity1 was 4.66% in Q4 2018 compared to 14.63% in Q4 2017. Fiscal 2018 Net income of $36.3 million in fiscal 2018, a decrease of $3.6 million (9%) from $39.9 million in 2017. Income from non‐marketable securities decreased by $3.5 million (39%) from 2017 as a result of lower distribution income from our investment in Crown Realty II Limited Partnership (“Crown LP”) as it sold the last remaining property in its opportunity fund. Equity income from MCAP decreased by $1.2 million (9%) from 2017 due to a reduction in our ownership interest from 14.41% in 2017 to 13.71% at December 31, 2018 and compressed spreads. Unrealized net loss on securities of $3.5 million relating to our marketable securities REIT portfolio, partially offset by $2.6 million and $0.4 million of realized and unrealized net gains on our investments in Crown LP and the KingSett High Yield Fund (“KSHYF”). Earnings per share totalled $1.54 in 2018, a decrease of $0.18 (10%) from $1.72 in 2017. Return on average shareholders’ equity1 was 11.90% in 2018 compared to 13.75% in 2017. Net corporate mortgage spread income increased by $0.9 million (3%) from 2017 due to the average corporate mortgage portfolio balance1 increasing by 2%. The spread of corporate mortgages over term deposits1 remained unchanged at 3.07% from 2017. Corporate Activity Q4 2018 Corporate assets of $1.22 billion at December 31, 2018 decreased by $15 million (1%) from September 30, 2018. Corporate mortgage portfolio decreased by $43 million (4%) in Q4 2018, consisting of $20 million of net portfolio growth and the transfer of $63 million of insured single family to the securitized portfolio. Uninsured single family portfolio increased by $34 million (16%) during Q4 2018 due to a 53% increase in originations from Q3 2018. Insured single family portfolio increased by $35 million during Q4 2018 (excluding the impact of the transfer to the securitized portfolio noted above). New originations of $28 million decreased by $7 million from Q3 2018 but remained consistent with our growth strategy. Construction and commercial portfolios decreased by $53 million (9%) during Q4 2018, consistent with the moderation of our corporate portfolio in this product type. Corporate mortgage originations decreased to $86 million (8%) in Q4 2018 compared to $93 million in Q4 2017, including increases of $29 million and $12 million in uninsured and insured single family, offset by decreases in commercial originations of $33 million and construction originations of $20 million. Fiscal 2018 Corporate assets increased by $42 million (4%) from December 31, 2017, reflecting an increase of $59 million (7%) in the corporate mortgage portfolio. Corporate mortgage portfolio activity included increases of $57 million in uninsured single family, $42 million in construction and $31 million in insured single family, partially offset by decreases of $43 million in uninsured completed inventory and $28 million in commercial. Corporate mortgage originations increased by 32% to $391 million in 2018 from $295 million in 2017, including increases of $76 million and $55 million in uninsured and insured single family, respectively. ‐ 8 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Dividend The Board of Directors (the “Board”) declared a first quarter dividend of $0.32 per share on February 22, 2019 to be paid March 29, 2019 to shareholders of record as of March 15, 2019. Credit Quality The impaired total mortgage ratio1,2,4 increased to 0.12% at December 31, 2018 from 0.03% at September 30, 2018 and 0.09% at December 31, 2017. The impaired corporate mortgage ratio1,2,4 increased to 0.23% at December 31, 2018 from 0.06% at September 30, 2018 and 0.20% at December 31, 2017. Total mortgage arrears1,3 decreased to $16 million at December 31, 2018 from $17 million at September 30, 2018 and $18 million at December 31, 2017. Net write‐offs were nil basis points of the average corporate portfolio in Q4 2018 compared to 1.5 basis points in Q4 2017; annual ratios were 2.8 basis points in fiscal 2018 and 5.7 basis points in 2017. Average loan to value ratio (“LTV”) of our uninsured single family portfolio based on an industry index of current real estate values was 58.2% at December 31, 2018 compared to 57.1% at September 30, 2018 and 52.6% at December 31, 2017. Capital Common Equity Tier 1 (“CET 1”), Tier 1 and Total Capital to risk‐weighted assets ratios1 were 21.66% at December 31, 2018 compared to 20.58% at September 30, 2018 and 21.26% at December 31, 2017. The leverage ratio1 was 11.79% at December 31, 2018 compared to 11.35% at September 30, 2018 and 11.31% at December 31, 2017. The income tax assets to capital ratio1 was 4.64 at December 31, 2018 compared to 4.90 at September 30, 2018 and 4.60 at December 31, 2017. We manage our capital and asset balances based on the regulations and limits of both the Income Tax Act (Canada) (the “Tax Act”) and the Office of the Superintendent of Financial Institutions (“OSFI”). 1 Considered to be a “Non‐IFRS Measure”. For further details, refer to the “Non‐IFRS Measures” section of this MD&A. 2 Represents impaired (stage 3) mortgages under IFRS 9 and impaired mortgages under IAS 39. 3 The mortgage arrears balance was not impacted by the adoption of IFRS 9 as it represents mortgages that are at least one day past due. 4 The impaired mortgage ratios do not include insured mortgages since credit risk is substantially mitigated by mortgage insurance. ‐ 9 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Summary of Three Year Results of Operations Financial Performance In 2016, we recorded net income of $40.2 million, including growth in higher yielding corporate assets which offset lower single family originations. Our investment in MCAP and the non‐marketable securities portfolio contributed $13.5 million and $6.5 million to net income, respectively. This strong financial performance led to $1.75 earnings per share and a 14.74% return on average shareholders’ equity 1. In 2017, we recorded net income of $39.9 million. Although our total assets and corporate mortgage interest income decreased by 3% and 6% respectively from 2016, our spread of corporate mortgages over term deposits 1 increased by 0.15%. The performance from our equity investment in MCAP and non‐marketable securities was strong with $14.4 million and $9.0 million of income respectively. We also earned $0.8 million from the sale of a portion of our investment in MCAP. In 2017, we recorded $1.72 earnings per share and a 13.75% return on average shareholders’ equity 1. In 2018, we recorded net income of $36.3 million, a decrease of 9% from 2017. Notably, net corporate mortgage spread income1 increased by 3% from 2017. Equity income from MCAP was close to that recorded in 2016 at $13.2 million while non‐marketable securities contributed $5.4 million, a decrease of approximately 39% from 2017. We also earned $1.7 million from the sale of a portion of our investment in MCAP. In 2018, we recorded $1.54 earnings per share and a 11.90% return on average shareholders’ equity 1. Corporate Activity In 2016, total invested assets remained consistent from 2015 at $2.28 billion. The mortgage mix was generally evenly distributed between corporate and securitized mortgages. In 2017, total invested assets were $2.22 billion, a decrease of 3% from 2016. Corporate mortgages decreased by $41 million (5%) due to lower origination volumes in single family, partially offset by higher originations in residential construction. In 2018, total invested assets were $2.14 billion, a decrease of 3% from 2017. During the year, we shifted our corporate mortgage portfolio strategy to focus more on single family mortgages. Given the current phase of the real estate cycle, we believe that it is prudent to be more selective and continue to evaluate opportunities in markets for our construction lending portfolio. The average balance of our commercial loan portfolio has remained consistent during 2018 and provides an appropriate risk‐adjusted return. For further information on the construction portfolio, refer to the “Construction and commercial lending” sub‐section of this MD&A. Our securitized mortgages have decreased 13% from 2017, which is due to lower insured originations in 2017 and the natural run off of the portfolio. 1 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. ‐ 10 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SELECTED FINANCIAL INFORMATION Table 1: Income Statement Highlights ‐ Annual (in thousands except for per share amounts and %) For the Years Ended December 31 2018 1 2017 Change from 2017 (%) 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 2 Taxable income per share 2,3 Yields Average mortgage portfolio yield ‐ corporate 2 Term deposit average interest rate 2 Spread of mortgages over term deposits 2 Average mortgage portfolio yield ‐ securitized 2 Financial liabilities from securitization ‐ average interest rate 2 Spread of mortgages over liabilities 2 Average term to maturity (in months) Mortgages ‐ corporate Term deposits $ $ $ $ $ $ 48,124 $ 4,976 53,100 2,015 18,922 36,193 (100) 36,293 $ 1.54 $ 1.43 $ 0.32 $ 52,413 5,613 58,026 876 19,218 39,684 (244) 39,928 $ 51,701 5,778 57,479 ‐ 17,963 39,516 (666) 40,182 1.72 $ 1.31 $ 1.75 1.17 (8%) (11%) (8%) 130% (2%) (9%) (59%) (9%) (10%) 9% 11.90% 13.75% 14.74% (1.85%) 1.29 $ 1.51 $ 1.24 (15%) 5.62% 2.55% 3.07% 2.57% 1.83% 0.74% 11.5 18.7 5.31% 2.24% 3.07% 5.15% 2.23% 2.92% 0.31% 0.31% 0.00% 2.61% 2.73% (0.04%) 1.87% 0.74% 2.02% 0.71% (0.04%) 0.00% 11.3 19.1 12.8 17.4 2% (2%) 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Results from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 2 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. 3 For further information refer to the “Taxable Income” section of this MD&A. ‐ 11 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 2: Income Statement Highlights ‐ Quarterly (in thousands except for per share amounts and %) For the Periods Ended 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 Return on average shareholders' equity 2 Taxable income per share 2,3 Yields Average mortgage portfolio yield ‐ corporate 2 Term deposit average interest rate 2 Spread of mortgages over term deposits 2 Average mortgage portfolio yield ‐ securitized 2 Financial liabilities from securitization ‐ average interest rate 2 Spread of mortgages over liabilities 2 Average term to maturity (in months) Mortgages ‐ corporate Term deposits Q4 2018 1 Q3 2018 1 Change (%) Q4 2017 Change (%) $ $ $ $ $ 7,872 $ 1,082 8,954 ‐ 5,512 3,442 (105) 3,547 $ 13,116 1,276 14,392 314 3,637 11,069 63 11,006 (40%) $ (15%) (38%) (100%) 52% (69%) (267%) (68%) $ 14,359 1,416 15,775 ‐ 5,302 10,473 (334) 10,807 0.15 $ 0.32 $ 0.47 0.37 (68%) $ (14%) $ 0.47 0.37 (45%) (24%) (43%) ‐ 4% (67%) (69%) (67%) (68%) (14%) 4.66% 14.29% (9.63%) 14.63% (9.97%) 0.49 $ 0.13 277% $ 0.34 44% 5.62% 2.69% 2.93% 5.53% 2.61% 2.92% 0.09% 0.08% 0.01% 5.56% 0.06% 0.40% 2.29% 3.27% (0.34%) 2.53% 2.57% (0.04%) 2.57% (0.04%) 1.83% 0.70% 1.83% 0.74% 0.00% (0.04%) 0.02% 1.81% 0.76% (0.06%) 11.5 18.7 12.8 19.2 (10%) (3%) 11.3 19.1 2% (2%) 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Results from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 2 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. 3 For further information refer to the “Taxable Income” section of this MD&A. ‐ 12 ‐ 4% (11%) (3%) 7% (13%) 4% (12%) (4%) 3% 1% 0.40% 0.48% 0.03% 0.03% 8% (26%) (9%) 2% 1% (25%) (24%) 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 3: Balance Sheet Highlights (in thousands except for per share amounts and %) December 31 2018 1 September December 31 December 31 2018 1 2017 2016 Change from 2017 (%) As at Balance Sheet Highlights Assets Corporate Securitization Total assets Mortgages ‐ corporate Mortgages ‐ securitized Liabilities Corporate Securitization Total liabilities $ 1,224,339 $ 1,239,181 $ 1,182,371 $ 1,188,480 1,092,375 $ 2,141,072 $ 2,189,381 $ 2,216,775 $ 2,280,855 1,034,404 916,733 950,200 $ $ 922,390 $ 887,252 $ 904,112 863,384 $ 965,674 $ 919,176 $ 1,016,724 $ 1,071,849 $ 936,443 $ 897,935 927,293 1,071,786 $ 1,834,378 $ 1,886,958 $ 1,919,798 $ 1,999,079 953,405 $ 933,553 904,099 $ 1,015,699 Shareholders' equity $ 306,694 $ 302,423 $ 296,977 $ 281,776 Capital Ratios 2 Income tax assets to capital ratio CET 1, Tier 1 and Total Capital ratios 4 Leverage ratio 3 Credit Quality Impaired mortgage ratio (total) 2,5 Impaired mortgage ratio (corporate) 2,5 Mortgage Arrears 6 Corporate Securitized Total Common Share Information (end of period) Number of common shares outstanding Book value per common share 2 Common share price ‐ close Market capitalization 2 4.64 21.66% 11.79% 0.12% 0.23% 4.90 20.58% 11.35% 0.03% 0.06% 4.60 21.26% 11.31% 0.09% 0.20% 4.87 22.55% 10.46% 0.14% 0.31% 9,435 $ 6,527 15,962 $ 8,398 $ 8,472 16,870 $ 8,766 $ 8,803 17,569 $ 13,041 13,609 26,650 23,798 12.89 $ 13.32 $ 316,989 $ 23,746 12.74 $ 17.50 $ 415,555 $ 23,378 12.70 $ 17.84 $ 417,064 $ 23,075 12.21 14.32 330,434 $ $ $ $ $ 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Results from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 2 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. 3 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. 4 These ratios are presented on the “all‐in” basis, with certain regulatory capital deductions fully phased in. 5 Incorporates impaired (stage 3) mortgages under IFRS 9 and impaired mortgages under IAS 39. 6 The calculation of mortgage arrears was not impacted by the adoption of IFRS 9 as it represents mortgages that are at least one day past due. ‐ 13 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION OUTLOOK Real Estate Market Conditions Canadian residential real estate markets continue to have a mixed performance as regional markets adjust to both regulatory changes and local economic conditions. We expect overall Canadian housing market conditions to experience downward pricing pressure and uncertainty throughout 2019 with sustained headwinds if interest rates continue to rise, challenging affordability. We expect continued weakness in resale markets through 2019 given recent increases in unsold homes in certain markets. This has also led to a reduction in housing starts. In October 2018, the Bank of Canada announced a further increase to its benchmark interest rate to 1.75%. We expect interest rates to continue to increase throughout 2019, placing further pressures on consumer spending and housing/mortgage affordability. Both the Greater Vancouver Area and the Greater Toronto Area markets experienced reduced sales during 2018 as a result of the new mortgage rules, other statutory changes designed to cool the housing markets and overall mortgage and housing market dynamics. The Prairie province economies are expected to continue to be challenged due to oil prices and the complexities in moving oil to markets. Notwithstanding the above, we began to observe some small signs of recovery beginning in the second half of 2018 as buyers continued to adjust to the new mortgage rules and the increasing interest rate environment. We continue to closely monitor the markets where we lend to ensure that we can capitalize on opportunities for growth in our quality portfolio. Regulatory Changes Effective January 1, 2018, additional granularity was added to Guideline B‐20, Residential Mortgage Underwriting Practices and Procedures (“Guideline B‐20”) by OSFI, including a stress test for uninsured mortgages. We believe that the uninsured stress test has reduced the volume of mortgages that we approve based on the borrower’s ability to service the higher mortgage rates used in the stress test. Impact on MCAN MCAN has historically repositioned itself to adapt our portfolio to changing market dynamics. Consistent with our disclosures in the Second Quarter and Third Quarter outlooks, we continue to reposition our mortgage portfolio to focus more on single family mortgages and less on construction lending given the uncertainty in the housing market, the impact of increasing rates, the overall economy and related risk factors. Our construction lending activity is considered to have a higher risk profile compared to our other lending activities. We believe that it is prudent to continue to closely manage lending activities in this business segment as we view that we are approaching the end of a real estate cycle. We believe that single family lending typically provides a more moderate risk profile. Accordingly, we will focus on leveraging the success that we had in this market during the last half of 2018 and continue to grow our single family origination volumes in 2019. To assist with our single family growth plans, we launched programs to attract potential mortgages through the brokerage community and we increased our internal sales capabilities. In addition, through MCAP and other originators, we have increased our single family mortgage acquisitions. We expect to continue to use acquisitions to supplement our own underwriting activities to grow our balance sheet. These acquisition activities are subject to satisfactory loan quality and pricing. We also expect to increase our securitization volumes of insured single family mortgages. All of these single family activities provide the Company with the opportunity to realize a continuing income stream on mortgage renewal which improves long‐term profitability notwithstanding the current mortgage spread environment. We observed historically low spread levels on our single family mortgage originations in 2018 and foresee this continuing into 2019 as we compete with other lenders for originations. Notwithstanding these competitive market conditions, increased interest rates and the regulatory changes related to Guideline B‐20, we are focused on growing our origination volumes. We also expect to continue to invest in sustainable internal operating platforms to ensure that there are efficient processes and systems in place to support profitable growth in our single family business that is in line with our risk management objectives. As we look to maintain the level of our investment in construction and commercial loans during 2019, while at the same time growing the single family business, we do not expect significant growth in our net interest margins in the near term. Beyond 2019, we expect to return to our targeted long term growth in corporate assets of 10% and to realize improved increases in net interest margin. We are starting 2019 with a strong capital position and asset capacity that can be profitably deployed as opportunities arise. We have an eager and committed management team that we announced in the fourth quarter. Collectively, the team has deep industry and Company experience and is focused on driving our business strategy forward. Overall, we believe that our strategy in the near term is prudent given our view of the current risks to the Canadian economy and housing markets. Over the long term we are focused on growing our balance sheet and providing growing returns and sustainable dividends to our shareholders. ‐ 14 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION RESULTS OF OPERATIONS Table 4: Net Income (in thousands except for per share amounts) For the Periods Ended Net Investment Income ‐ Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Non‐marketable securities Marketable securities Fees Interest on cash and other income Realized and unrealized gain (loss) on securities 1,3 Term deposit interest and expenses Mortgage expenses Interest on loans payable Provision for (recovery of) credit losses 1,2 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 Provision for (recovery of) credit losses 1,2 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 Q4 2018 1 Q4 2017 Change (%) Annual 2018 1 Annual Change (%) 2017 $ 13,649 $ 12,109 5,457 1,480 854 321 357 ‐ 20,578 3,292 1,230 898 397 353 (4,156) 15,663 13% $ 51,610 $ 47,765 14,427 13,188 8,850 5,357 3,722 3,464 1,239 1,909 1,051 1,284 ‐ (512) 77,054 76,300 (40%) (17%) 5% 24% (1%) ‐ (24%) 8% (9%) (39%) (7%) 54% 22% ‐ (1%) 6,590 1,048 27 126 7,791 5,233 951 2 33 6,219 26% 10% 1,250% 282% 25% 23,814 4,031 143 188 28,176 20,837 3,877 38 (111) 24,641 14% 4% 276% (269%) 14% 7,872 14,359 (45%) 48,124 52,413 (8%) ‐ ‐ ‐ 5,657 154 5,811 4,208 519 2 4,729 ‐ ‐ ‐ 6,449 82 6,531 4,594 521 ‐ 5,115 ‐ ‐ ‐ 1,701 314 2,015 785 91 876 117% 245% 130% (12%) 88% (11%) (8%) (0%) ‐ (8%) 24,540 360 24,900 17,793 2,133 (2) 19,924 27,028 221 27,249 19,533 2,103 ‐ 21,636 (9%) 63% (9%) (9%) 1% ‐ (8%) 1,082 1,416 (24%) 4,976 5,613 (11%) 2,700 2,812 5,512 2,595 2,707 5,302 4% 4% 4% 11,118 7,804 18,922 10,555 8,663 19,218 10,473 3,442 (105) (334) 3,547 $ 10,807 39,684 36,193 (67%) (69%) (244) (100) (67%) $ 36,293 $ 39,928 0.15 $ 0.32 $ 0.47 0.37 (68%) $ (14%) $ 1.54 $ 1.43 $ 1.72 1.31 5% (10%) (2%) (9%) (59%) (9%) (10%) 9% $ $ $ 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Results from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 2 Under IFRS 9, the methodology for the calculation of mortgage allowances and provisions has changed from IAS 39, therefore provisions under IFRS 9 are not directly comparable to prior periods. 3 Under IFRS 9, fair value changes in certain reclassified financial assets are presented in the income statement and are therefore not directly comparable to prior periods. Under IAS 39, these fair value changes were recorded through other comprehensive income. ‐ 15 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Net Investment Income ‐ Corporate Assets Mortgage interest income Table 5: Net Interest Income and Average Rate by Mortgage Portfolio ‐ Quarterly For the Quarters Ended December 31, 2018 September 30, 2018 December 31, 2017 (in thousands except %) Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income Single family ‐ Insured ‐ Uninsured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non residential Commercial loans ‐ Multi family residential ‐ Other commercial Mortgages ‐ corporate portfolio Term deposits Net corporate mortgage spread income Spread of mortgages over term deposits $ 126,367 $ 245,177 4,400 441,790 10,589 977 2,772 69 7,448 191 3.17% $ 128,440 $ 217,645 4.52% 5,111 6.19% 983 2,499 85 3.06% $ 4.59% 6.59% 84,468 $ 200,797 51,826 696 2,366 885 3.30% 4.72% 6.78% 6.69% 7.15% 436,632 6,927 7,116 110 6.47% 6.30% 376,059 6,995 5,570 100 5.88% 5.69% 70,076 69,515 948 1,244 $ 967,914 $ 13,649 6,590 7,059 917,106 $ 993 74,185 5.37% 7.09% 1,308 73,116 5.62% $ 942,056 $ 13,094 6,334 903,136 2.69% 6,760 $ 701 56,684 5.25% 7.12% 1,791 89,136 5.53% $ 865,965 $ 12,109 5,233 847,523 2.61% 6,876 $ 2.93% 2.92% 4.91% 7.98% 5.56% 2.29% 3.27% Average term to maturity (months) Mortgages ‐ corporate Term deposits 11.5 18.7 12.8 19.2 11.3 19.1 Table 6: Net Interest Income and Average Rate by Mortgage Portfolio ‐ Annual For the Years Ended December 31 2018 2017 (in thousands except %) Single family ‐ Insured ‐ Uninsured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non residential Commercial loans ‐ Multi family residential ‐ Other commercial Mortgages ‐ corporate portfolio Term deposits Net corporate mortgage spread income Spread of mortgages over term deposits Average term to maturity (months) Mortgages ‐ corporate Term deposits Average Balance Interest Income Average Rate 1 Average Balance Interest Income Average Rate 1 $ $ 104,146 $ 216,631 9,675 428,508 6,745 72,878 79,662 918,245 $ 878,944 $ 11.5 18.7 3,232 9,948 558 27,795 438 3,885 5,754 51,610 23,814 27,796 3.10% $ 4.59% 5.76% 6.49% 6.50% 5.33% 7.24% 5.62% $ 2.55% 3.07% 88,473 $ 220,160 44,610 391,310 7,308 45,549 101,609 899,019 $ 870,393 $ 11.3 19.1 2,934 10,185 2,570 21,837 394 2,119 7,726 47,765 20,837 26,928 3.32% 4.63% 5.76% 5.58% 5.40% 4.65% 7.61% 5.31% 2.24% 3.07% 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 and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Non‐recurring items were immaterial for the quarters ended December 31, 2018, September 30, 2018 and December 31, 2017 and the years ended December 31, 2018 and December 31, 2017. Average interest rate and average balance are considered to be non‐IFRS measures. Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. ‐ 16 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Overview Recent increases to the overnight rate by the Bank of Canada have had a positive impact on mortgage interest income and the average interest rate related to the floating rate component of our corporate mortgage portfolio. As at December 31, 2018, floating rate mortgages represented 99% of the construction portfolio (December 31, 2017 ‐ 95%), 58% of the commercial portfolio (December 31, 2017 ‐ 53%) and 55% of the total corporate portfolio (December 31, 2017 ‐ 57%). An increase to the overnight rate of 0.25% early in Q4 2018 was the main reason for the increase in the corporate and construction yields from Q3 2018. The Bank of Canada also increased the overnight rate by 0.25% in both Q1 and Q3 of 2018 after increasing it by 0.50% in the second half of 2017. This cumulative increase of 1.25% has contributed significantly to the increases in the construction yield since 2017. The combined uninsured and insured single family portfolio (excluding uninsured completed inventory) grew by 32% during 2018 and accordingly represented a larger proportion of the corporate portfolio as at December 31, 2018. The comparatively lower yields in this portfolio given its lower risk profile and compressed spreads due to market conditions provided a partial offset in both Q4 2018 and fiscal 2018 to the positive impact of the increases in the overnight rate noted above. Interest rates on new single family originations were lower in 2018 due to competitiveness in the mortgage market as noted above. Average mortgage portfolio yield is a non‐IFRS measure. For a definition of this measure, refer to the “Non‐IFRS Measures” section of this MD&A. Table 7: Mortgage Originations and Renewals (in thousands) For the Periods Ended December 31 Originations Single family ‐ insured Single family ‐ uninsured Single family ‐ uninsured completed inventory Residential construction Non‐residential construction Commercial Q4 2018 Q4 2017 Change (%) Annual 2018 Annual 2017 Change (%) $ $ 27,631 $ 50,805 78,436 3,800 3,697 ‐ ‐ 85,933 $ 15,245 21,529 36,774 ‐ 22,964 702 32,640 93,080 136% 113% ‐ (84%) (100%) (100%) 81% $ 102,213 $ 46,950 45,092 92,042 9,000 124,967 702 68,509 (8%) $ 390,676 $ 295,220 121,050 223,263 10,478 101,920 10,196 44,819 118% 168% 143% 16% (18%) 1352% (35%) 32% Renewals of non‐corporate mortgages 1 Single family ‐ insured $ 12,065 $ 14,981 (19%) $ 59,906 $ 53,833 11% 1 Represents mortgages previously derecognized or held in securitized portfolio that have been renewed into the corporate mortgage portfolio. Single family originations Our uninsured single family portfolio grew by 16% during Q4 2018 and 29% during fiscal 2018 due to continued increases in both internal originations and acquisitions from external origination sources. Our insured single family portfolio increased by 39% during fiscal 2018 but decreased by 20% during Q4 2018 as a result of a securitization transaction. We continue to focus on growing our insured single family corporate mortgage portfolio (including the retention of market Mortgage Backed Securities (“MBS”) on our corporate balance sheet) to allow us to securitize opportunistically through the National Housing Act (“NHA”) MBS program. On a combined basis, the portfolios grew by $88 million during 2018 due to both market dynamics and improved internal sales and productivity initiatives. We also noted in mid‐2018 that we believed that there would be challenges in originating adequate volumes to grow the single family portfolio and that we expected to see reduced spreads as a result of competitive pressures. While we still believe that these risks exist, we were able to grow the portfolio in the second half of 2018 although the average interest rate in both portfolios decreased from 2017. ‐ 17 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Construction and commercial originations Growth in our construction portfolio balance during 2018 was driven by further advances on existing loans. While we are currently closely managing growth in this portfolio given the potential for deteriorating market conditions, we continue to make investments in markets that are balanced between new home sales and unsold resale inventory and in projects geared to the more affordable product segment. The slight decline in the “commercial other” portfolio yield was largely driven by a change in portfolio composition towards loans with a lower risk profile. 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. Mortgage renewal rights Through our XMC Mortgage Corporation (“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 maturity, we have the rights to renew these mortgages, which may contribute to future revenues. As at December 31, 2018, we had the renewal rights to $985 million of single family mortgages (December 31, 2017 ‐ $931 million). Equity income from MCAP In Q4 2018, MCAP’s origination volumes were $3.5 billion, up from $3.2 billion in Q4 2017. For fiscal 2018, MCAP’s origination volumes were $15.4 billion, up from $14.5 billion in 2017. As at November 30, 2018, MCAP had $72.8 billion of assets under administration compared to $72.0 billion as at August 31, 2018 and $65.9 billion as at November 30, 2017. Despite these increases, equity income from MCAP decreased in both the quarter and the year due to our reduced ownership position and compressed spreads. We recognize equity income from MCAP on a one‐month lag such that our Q4 2018 equity income from MCAP is based on MCAP’s net income for the year ended November 30, 2018. 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. Non‐Marketable Securities We received distribution income of $1.1 million from the KSYHF in Q4 2018 (Q4 2017 ‐ $1.2 million) and $0.1 million from Crown LP in Q4 2018 (Q4 2017 ‐ $0.3 million). For fiscal 2018, we received $4.6 million from the KSHYF (2017 ‐ $3.5 million) and $0.8 million from Crown LP (2017 ‐ $5.3 million). As real estate based investments, annual income can be variable. Marketable Securities In Q4 2018, marketable securities income consists primarily of distributions from the REIT portfolio. The yield on this portfolio was 6.35% in Q4 2018 (Q4 2017 ‐ 6.34%); for fiscal 2018 the yield was 5.86% (2017 ‐ 6.32%). The yield has been calculated based on the average portfolio carrying value. The unrealized loss on marketable securities discussed below occurred late in 2018, therefore it did not have a significant impact on the 2018 yields. Fees The increase in fees in 2018 was primarily due to income recognized from construction letter of credit fees. Fees can be volatile dependent on the various types of construction loans within the portfolio. Realized and Unrealized Gain (Loss) on Securities In Q4 2018, we recorded a $4.2 million unrealized loss on our marketable securities portfolio, consisting of REITs. This unrealized loss occurred near the end of 2018 as part of a significant market‐wide decrease in the value of Canadian publicly traded securities. In fiscal 2018, we recorded a $3.5 million unrealized loss on our marketable securities portfolio and $2.6 million and $0.4 million of unrealized net gains on our investments in Crown LP and the KSHYF. In 2017, we recorded an unrealized gain on securities of $2.3 million through accumulated other comprehensive income in accordance with IAS 39. ‐ 18 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Term Deposit Interest and Expenses The increase in average term deposit interest from 2017 was driven by the impact of the aforementioned increases in the Bank of Canada overnight rate on newly issued deposits. Market rate changes on new deposits have a more gradual impact on the average term deposit interest rate given the fixed‐rate nature of the portfolio compared to the corporate mortgage portfolio, in which floating rate loans reprice immediately. The change in the average term deposit balance is comparable to that of the average corporate mortgage portfolio as we primarily use term deposits to fund our corporate mortgage assets. Mortgage Expenses The increase in mortgage expenses, which consist primarily of mortgage servicing fees paid to third party mortgage servicers, is consistent with the increase in the average corporate mortgage portfolio balance from 2017. Other Income ‐ Corporate Assets In Q3 2018 and Q1 2017, MCAP issued additional class B units to other partners of MCAP which decreased our equity interest. As a result of the issuance of the new units at a price in excess of the per‐unit carrying value of the investment, we recorded a dilution gain of $0.3 million in Q3 2018 (Q1 2017 ‐ $0.1 million). In Q1 2018, we sold 200,000 partnership units (Q1 2017 ‐ 100,000) in MCAP at a price of $22.60 per unit (Q1 2017 ‐ $19.47) compared to a net book value of $14.10 per unit (Q1 2017 ‐ $11.62), recognizing a gain on sale of $1.7 million (Q1 2017 ‐ $0.8 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. Our total securitization volumes were $63 million in Q4 2018 (Q4 2017 ‐ $28 million) and $169 million in fiscal 2018 (2017 ‐ $110 million). For further details on these programs, refer to the “Securitization Programs” section of this MD&A. Table 8: Net Interest Income and Average Rate ‐ Securitized Mortgage Portfolio ‐ Quarterly For the Quarters Ended December 31, 2018 September 30, 2018 (in thousands except %) Average Balance Interest Average Rate 1 Income Average Balance Interest Average Rate 1 Income December 31, 2017 Average Interest Average Rate 1 Income Balance Mortgages ‐ securitized portfolio Financial liabilities from securitization Net securitized mortgage spread income Spread of mortgages over liabilities $ 891,876 $ 5,657 4,208 917,589 $ 1,449 2.53% $ 1.83% 934,759 $ 951,222 $ 6,015 4,346 1,669 2.57% $ 1,001,708 $ 1.83% 1,012,852 $ 0.70% 0.74% 6,449 4,594 1,855 2.57% 1.81% 0.76% Table 9: Net Interest Income and Average Rate ‐ Securitized Mortgage Portfolio ‐ Annual For the Years Ended December 31 2018 2017 (in thousands except %) Mortgages ‐ securitized portfolio Financial liabilities from securitization Net securitized mortgage spread income Spread of mortgages over liabilities Average Balance Interest Income Average Rate 1 Average Balance Interest Income Average Rate 1 $ 956,531 $ 972,180 $ 24,540 17,793 6,747 2.57% $ 1,034,699 $ 1.83% 1,046,976 $ 27,028 19,533 7,495 0.74% 2.61% 1.87% 0.74% 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 and prior period adjustments are excluded from the calculation of the average interest rate as applicable. Non‐recurring items were immaterial for the quarters ended December 31, 2018, September 30, 2018 and December 31, 2017 and years December 31, 2018 and December 31, 2017. Average interest rate and average balance are considered to be non‐IFRS measures. Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. ‐ 19 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Net Interest Income ‐ Summary Table 10: Net Interest Income ‐ Quarterly For the Quarters Ended December 31 2018 2017 (in thousands except %) Corporate Cash and cash equivalents Mortgages Other loans Corporate interest earning assets Term deposits Loans payable Corporate interest bearing liabilities Net interest income (Corporate) Securitization Cash held in trust Mortgages Securitization interest earning assets Securitization interest bearing liabilities Net interest income (Securitization) Net Interest Income 2 Average Balance 1 Income / Expense Average Rate 3 Average Balance 1 Income / Expense Average Rate 3 $ 74,496 $ 967,914 2,410 1,044,820 917,106 2,315 919,421 $ $ 35,267 $ 891,876 927,143 917,589 $ $ 320 13,649 33 14,002 6,590 27 6,617 7,385 151 5,657 5,808 4,208 1,600 1.70% 5.62% 5.43% 5.34% 2.69% 4.63% 2.69% 2.65% 1.73% 2.53% 2.50% 1.83% 0.67% 8,985 1.74% $ 94,719 $ 865,965 2,723 963,407 847,523 261 847,784 $ $ 16,324 $ 1,001,708 1,018,032 1,012,852 $ $ 320 12,109 36 12,465 5,233 2 5,235 7,230 58 6,449 6,507 4,594 1,913 1.34% 5.56% 5.25% 5.14% 2.29% 3.04% 2.29% 2.85% 1.41% 2.57% 2.55% 1.81% 0.74% 9,143 1.78% Table 11: Net Interest Income ‐ Annual For the Years Ended December 31 (in thousands except %) Average Balance 1 2018 Income / Expense Average Rate 3 Average Balance 1 Income / Expense Average Rate 3 2017 Corporate Cash and cash equivalents Mortgages Other loans Corporate interest earning assets Term deposits Loans payable Corporate interest bearing liabilities Net interest income (Corporate) $ 84,867 $ 918,245 2,411 1,005,523 878,944 3,342 882,286 $ $ 1,156 51,610 126 52,892 23,814 143 23,957 28,935 1.36% $ 5.62% 5.23% 5.26% 2.55% 4.28% 2.56% $ 2.70% 86,758 $ 899,019 3,286 989,063 870,393 1,096 871,489 $ Securitization Cash held in trust Mortgages Securitization interest earning assets Securitization interest bearing liabilities Net interest income (Securitization) $ 23,312 $ 956,531 979,843 972,180 $ $ 359 24,540 24,899 17,793 7,106 17,083 $ 1.54% $ 1,034,699 2.57% 2.55% 1,051,782 1.83% $ 1,046,976 0.72% $ 883 47,765 168 48,816 20,837 38 20,875 27,941 121 27,028 27,149 19,533 7,616 1.02% 5.31% 5.11% 4.93% 2.24% 3.47% 2.24% 2.69% 0.71% 2.61% 2.58% 1.87% 0.71% Net Interest Income 2 $ 36,041 1.74% $ 35,557 1.68% 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, income from non‐marketable securities, marketable securities income, fees, realized and unrealized gain/loss on securities, 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 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. Non‐recurring items were immaterial for the quarters ended December 31, 2018, September 30, 2018 and December 31, 2017 and the years ended December 31, 2018 and December 31, 2017. Average rate and average balance are considered to be non‐IFRS measures. Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. ‐ 20 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Credit Quality Table 12: Provisions for Credit Losses and Write‐offs (in thousands except basis points) For the Periods Ended December 31 Provision on impaired corporate mortgages 1 Single family uninsured Construction Provision (recovery) on performing corporate mortgages 2 Single family insured Single family uninsured Single family uninsured ‐ completed inventory Construction Commercial Multi family residential Other commercial Other provisions (recoveries) Total corporate provision for (recovery of) credit losses Provision (recovery) on performing securitized mortgages 2 Total provisions for (recoveries of) credit losses Corporate mortgage portfolio data: Provisions for credit losses, net Net write offs Net write offs (basis points) IFRS 9 Q4 2018 IAS 39 Q4 2017 IFRS 9 Annual 2018 IAS 39 Annual 2017 $ $ 162 217 379 43 $ ‐ 43 336 $ 217 553 176 ‐ 176 (1) 241 20 (155) (192) (167) (254) 1 126 ‐ (2) (41) 3 130 (87) 3 (13) 33 9 667 (356) (40) (127) (458) (305) (60) 188 2 $ 128 ‐ 33 $ (2) 186 $ ‐ (207) 142 44 196 (282) (107) (180) (111) ‐ (111) 125 $ $ ‐ ‐ 46 $ 33 $ 1.5 248 $ 256 $ 2.8 69 508 5.7 $ $ $ 1 Represents impaired (stage 3) provision for credit losses on mortgages and mortgage commitments under IFRS 9 and individual provisions for credit losses under IAS 39. 2 Represents performing (stage 1 and 2) provision for credit losses on mortgages and mortgage commitments under IFRS 9 and collective provisions for credit losses under IAS 39. The adoption of IFRS 9 as of January 1, 2018 required MCAN to use forward‐looking economic information in its calculation of expected credit losses (“ECLs”). This change has impacted the calculation of collective and individual allowances on MCAN’s corporate and securitized mortgage portfolios, and accordingly provisions for credit losses for 2018 and 2017 are not directly comparable. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. In 2018, we recorded an allowance relating to economic conditions in the Alberta and Saskatchewan geographical sub‐segment of the uninsured single family portfolio, which was the primary reason behind the increased provisions on impaired and performing mortgages in this portfolio. The provision activity in other lines of business was primarily driven by changes in the respective portfolio balances. Write‐offs in 2018 relate entirely to uninsured single family mortgages, while write‐offs in 2017 include $220,000 relating to the construction portfolio. ‐ 21 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Operating Expenses Table 13: Operating Expenses (in thousands) For the Periods Ended Salaries and benefits General and administrative Q4 2018 $ $ 2,700 $ 2,812 5,512 $ Q4 2017 2,595 2,707 5,302 Change (%) Annual 2018 Annual 2017 Change (%) 4% $ 4% 4% $ 11,118 $ 7,804 18,922 $ 10,555 8,663 19,218 5% (10%) (2%) Although salaries and benefits increased slightly from Q4 2017, the composition of activity in Q4 2018 was significantly different. Salary expense increased as a result of an increased staff complement and increased severance costs, which was partially offset by lower long‐term equity compensation accruals, detailed further in Note 25 to the consolidated financial statements. The increase in salaries and benefits in 2018 was consistent with the rationale noted above for Q4 2018. Q4 2018 general and administrative expenses were comparable to Q4 2017. In fiscal 2018, the decrease in general and administrative expenses was primarily due to a non‐recurring $0.6 million reimbursement of legal expenses. Taxable Income The table below provides a reconciliation between net income for accounting purposes and non‐consolidated 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. As a Mortgage Investment Corporation (“MIC”), we typically pay out all of our taxable income to shareholders through dividends as our MIC status allows us to deduct dividends paid within 90 days of year end from taxable income. Dividends that are deducted in the calculation of taxable income are not included in the table below. Taxable income is considered to be a non‐IFRS measure. For further details, refer to the “Non‐IFRS Measures” section of this MD&A. ‐ 22 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 14: 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 Provision for (recovery of) credit losses 5 Amortization of upfront securitization program costs 3 Securitization program mortgage origination costs 3 Other securitization program cash outflows 3 Unrealized loss on securities 2 Equity income from subsidiaries 2 Deduct: Accounting gain on partial sale of MCAP 4 Add: Taxable gain on partial sale of MCAP 4 Gain on dilution of investment in MCAP 2 Other items Q4 2018 Q4 2017 Annual 2018 Annual 2017 $ 3,547 $ 10,807 $ 36,293 $ 39,928 (3,292) 6,896 (211) 1,941 (1,042) (571) 4,162 562 ‐ ‐ ‐ (295) 11,697 $ (5,457) 1,016 8 1,701 (444) (484) ‐ 819 ‐ ‐ ‐ 26 7,992 (13,188) 3,620 (289) 7,106 (2,755) (1,198) 3,521 (2,023) (1,701) 1,425 (314) (30) 30,467 $ (14,428) 8,729 (147) 6,759 (1,966) (1,479) ‐ (1,134) (785) 535 (91) (686) 35,235 $ $ 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 Excluded from the calculation of taxable income. 3 Securitization program mortgage origination costs and other upfront securitization program costs are deductible in full for tax purposes as mortgages are securitized but are capitalized and amortized for accounting purposes. Therefore, amortization is added back in the calculation of taxable income. 4 For tax purposes, the accounting gain is excluded and only 50% of the taxable gain is included. 5 Provisions on performing mortgages are excluded from the calculation of taxable income; provisions on impaired mortgages are 90% deductible for tax purposes. MCAP executed securitization transactions that created timing differences between accounting and taxable income. These timing differences are expected to reverse over the duration of the transactions and were the primary reason for the decrease in taxable income in fiscal 2018 from fiscal 2017. During 2018, we incurred $2.8 million of origination costs on securitized mortgages (including market MBS held by MCAN) (2017 ‐ $2.0 million). These costs are deductible for income tax purposes in the period that the mortgages are securitized; for accounting purposes they are capitalized and amortized over the term of the associated mortgages. As at December 31, 2018, the unamortized origination fee balance was $9.0 million (December 31, 2017 ‐ $11.9 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. Cash Flows Operating Activities Used cash flows of $4 million for 2018; provided $24 million for 2017. Variances primarily due to lower net cash flows relating to net corporate (mortgage and term deposit) and securitization (mortgage and financial liabilities from securitization) activity in 2018 compared to 2017. Investing Activities Provided cash flows of $13 million for 2018; provided $7 million for 2017. 2018 includes higher net inflows relating to distributions from MCAP and proceeds from a partial sale of our equity investment in MCAP. Financing Activities Used cash flows of $28 million for 2018; used $24 million for 2017. In 2018, there were higher outflows from dividends paid partially offset by higher inflows from the issuance of common shares through the Dividend Reinvestment Plan (“DRIP”). ‐ 23 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION FINANCIAL POSITION Table 15: Assets (in thousands) As at Corporate Assets Cash and cash equivalents Marketable securities Mortgages Non‐marketable securities Other loans Equity investment in MCAP Commercial LP Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets December 31 2018 1 September 30 2018 1 Change (%) December 31 2017 Change (%) $ $ 98,842 53,247 922,390 71,813 2,640 61,593 2,961 10,853 1,224,339 26,002 887,252 3,479 916,733 2,141,072 $ $ 75,236 58,447 965,674 70,727 2,104 59,931 2,971 4,091 1,239,181 27,527 919,176 3,497 950,200 2,189,381 31% $ (9%) (4%) 2% 25% 3% ‐ 165% (1%) 117,571 62,518 863,384 68,190 2,612 59,189 2,672 6,235 1,182,371 (6%) (3%) (1%) (4%) (2%) $ 13,441 1,016,724 4,239 1,034,404 2,216,775 (16%) (15%) 7% 5% 1% 4% 11% 74% 4% 93% (13%) (18%) (11%) (3%) 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Amounts from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. Mortgages ‐ Corporate & Securitized 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. Uninsured ‐ Completed inventory loans Uninsured ‐ completed inventory loans are 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 developers to finance residential construction projects. These loans generally have a floating interest rate and loan terms of 24 months or less. 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 term mortgages (e.g. loans secured by retail/industrial buildings) and high ratio mortgage loans (e.g. loans that do not meet standard residential construction loan parameters). ‐ 24 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 16: Mortgage Summary (in thousands) As at Corporate portfolio: Single family mortgages ‐ Insured ‐ Uninsured ‐ 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 2018 1 September 30 2018 1 Change (%) December 31 2017 Change (%) $ $ $ 111,419 255,545 7,703 422,561 11,018 50,133 64,011 922,390 139,860 221,220 4,095 445,335 10,357 73,547 71,260 965,674 722,726 164,526 887,252 1,809,642 $ 780,036 139,140 919,176 1,884,850 (20%) $ 16% 88% (5%) 6% (32%) (10%) (4%) (7%) 18% (3%) (4%) 80,377 198,354 51,190 386,562 4,840 64,655 77,406 863,384 867,406 149,318 1,016,724 1,880,108 $ 39% 29% (85%) 9% 128% (22%) (17%) 7% (17%) 10% (13%) (4%) 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Amounts from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. Figure 1: Total Corporate and Securitized Mortgage Portfolio (in thousands) ‐ 25 ‐ 2018 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 product type. Figure 3: Mortgage Portfolio Geographic Distribution as at December 31, 2018 (December 31, 2017) ‐ 26 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Arrears and Impaired Mortgages Table 17: Arrears and Impaired Mortgages (in thousands except %) As at Impaired mortgages 2 Corporate Single family ‐ insured Single family ‐ uninsured Residential construction Securitized Total impaired mortgages Impaired mortgage ratio (total) 1,6 Impaired mortgage ratio (corporate) 1,6 Mortgage arrears (past due) 5 Corporate Single family ‐ insured Single family ‐ uninsured Residential construction Total corporate mortgage arrears 1 Total securitized mortgage arrears 1 Total mortgage arrears 1 IFRS 9 staging analysis ‐ corporate portfolio Stage 2 Single family ‐ insured Single family ‐ uninsured Construction ‐ residential Commercial ‐ multi‐family residential Commercial ‐ other Stage 3 Single family ‐ insured Single family ‐ uninsured Construction ‐ residential Total stage 2 and 3 corporate mortgages Allowance for credit losses Corporate Allowance on performing mortgages 3 Allowance on impaired mortgages 4 Securitized ‐ allowance on performing mortgages 3 Total allowance for credit losses IFRS 9 December 31 2018 IFRS 9 September 30 2018 Change (%) IAS 39 December 31 2017 $ $ $ $ $ $ $ $ 1,004 $ 1,602 548 3,154 1,801 4,955 $ 0.12% 0.23% 1,592 581 ‐ 2,173 2,305 4,478 0.03% 0.06% 1,594 $ 7,293 548 9,435 6,527 15,962 $ 2,691 5,707 ‐ 8,398 8,472 16,870 7,743 $ 35,437 60,929 2,079 3,535 109,723 1,004 1,602 548 3,154 15,222 34,188 60,631 2,100 4,934 117,075 1,592 581 ‐ 2,173 (37%) 176% $ ‐ 45% (22%) 11% $ 0.09% 0.17% (41%) $ 28% ‐ 12% (23%) (5%) $ (49%) 4% 1% (1%) (28%) (6%) (37%) 176% ‐ 45% 112,877 $ 119,248 (5%) 832 1,696 ‐ 2,528 ‐ 2,528 0.09% 0.20% 2,854 5,912 ‐ 8,766 8,803 17,569 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a 4,424 $ 430 4,854 14 4,868 $ 4,678 51 4,729 13 4,742 (5%) $ 743% 3% 8% 3% $ 4,748 62 4,810 ‐ 4,810 1 Refer to the "Non‐IFRS Measures" section of this MD&A for a definition of this measure. 2 Represents impaired (stage 3) mortgages under IFRS 9 and impaired mortgages under IAS 39. 3 Represents performing (stage 1 and 2) allowances for credit losses on mortgages and mortgage commitments under IFRS 9 and collective allowances for credit losses under IAS 39. 4 Represents impaired (stage 3) allowances for credit losses on mortgages and mortgage commitments under IFRS 9 and individual allowances for credit losses under IAS 39. 5 The calculation of mortgage arrears was not impacted by the adoption of IFRS 9 as it represents mortgages that are at least one day past due. 6 The impaired mortgage ratios do not include insured mortgages since credit risk is substantially mitigated by mortgage insurance. ‐ 27 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Arrears and Impaired Mortgage Summary The majority of single family and securitized arrears activity occurs in the 1‐30 day category, in which the majority of arrears are resolved and do not migrate to arrears categories over 30 days. We continue to closely monitor these arrears. We have historically had low arrears and impaired balances related to our construction and commercial loan portfolios. Figure 4: Impaired Corporate Mortgage Ratio The ratio as presented above incorporates impaired (stage 3) mortgages under IFRS 9 for data presented after January 1, 2018, while the data prior to this time incorporates impaired mortgages under IAS 39. The adoption of IFRS 9 did not materially impact the impaired mortgage ratios. Refer to the “Non‐IFRS Measures” section of this MD&A for a full definition of impaired mortgage ratios. ‐ 28 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 18: Corporate Mortgages by Risk Rating The table below outlines the corporate portfolio by mortgage type per MCAN's internal mortgage risk rating system and the percentage of the portfolio that each balance represents. For further information refer to Note 8 to the consolidated financial statements. (in thousands except %) As at Single family ‐ insured Insured / Low to Moderate Risk Arrears/Impaired Single family ‐ uninsured Low to Moderate Risk High/Higher Risk Arrears/Impaired Single family ‐ uninsured completed inventory Low to Moderate Risk High/Higher Risk Construction ‐ residential Low to Moderate Risk High/Higher Risk Monitored/Watchlist Arrears/Impaired Construction ‐ non‐residential High/Higher Risk Commercial ‐ multi‐family residential Low to Moderate Risk High/Higher Risk Monitored/Watchlist Commercial ‐ other Low to Moderate Risk High/Higher Risk Construction and commercial lending December 31, 2018 September 30, 2018 $ 109,825 1,594 111,419 99% 1% 100% $ 137,169 2,691 139,860 98% 2% 100% 233,105 15,147 7,293 255,545 91% 6% 3% 100% 199,662 15,851 5,707 221,220 90% 7% 3% 100% 3,760 3,943 7,703 49% 51% 100% ‐ 4,095 4,095 ‐ 100% 100% 49,161 344,090 28,762 548 422,561 12% 81% 7% ‐ 100% 46,627 357,662 41,046 ‐ 445,335 11% 80% 9% ‐ 100% 11,018 11,018 100% 100% 10,357 10,357 100% 100% 24,183 23,871 2,079 50,133 48% 48% 4% 100% 42,409 29,038 2,100 73,547 58% 39% 3% 100% 33,940 30,071 64,011 53% 47% 100% 33,926 37,334 71,260 48% 52% 100% $ 922,390 $ 965,674 Change (%) (20%) (41%) (20%) 17% (4%) 28% 16% ‐ (4%) 88% 5% (4%) (30%) ‐ (5%) 6% 6% (43%) (18%) (1%) (32%) ‐ (20%) (10%) (5%) Our strategy relating to construction lending consists of providing loans to developers, primarily to build housing projects. In selecting residential construction projects to finance, we focus more on the affordable segments of the housing market, such as first time or first move‐up buyers characterized by affordable price points, lower price volatility and steady sales volumes based on continued family formation and migration. This approach mitigates the impact of price volatility and tightened sales activity in the event of market corrections. We only invest in markets where we have experience and local expertise, consisting primarily of major urban markets and their surrounding areas with a preference for proximity to mass transit. ‐ 29 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION We take certain actions to mitigate risk in the construction portfolio, some examples of which are as follows: Targeting experienced borrowers with a successful track record of project completion and loan repayment Targeting smaller multi‐phased projects; as at December 31, 2018 the average outstanding construction loan size was $6 million (December 31, 2017 ‐ $6 million) with a maximum loan commitment of $30 million Requiring evidence of strong pre‐sales prior to loan funding Limiting most loan terms to 24 months or less with extensions requiring additional underwriting and approval Managing concentration risk by diversifying across product type, loan size, geography and borrowers; and Utilizing our relationships with strategic partners for loan participation, servicing and workout expertise Additional Information on Residential Mortgages and Home Equity Lines of Credit (“HELOCs”) In accordance with OSFI Guideline B‐20, 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 individual mortgages that are insured by CMHC or other approved mortgage insurers at origination and mortgages included in groups of 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 19: Single Family Mortgages by Province as at December 31, 2018 (in thousands except %) Insured % Uninsured % HELOCs % Corporate Securitized Insured % Total % Ontario Alberta British Columbia Quebec Atlantic Provinces Other Total $ 71,381 64.1% $ 167,998 37,616 21,599 19.4% 41,829 3.5% 3,657 4.8% 5,471 6.8% 6,677 1.4% 3,872 5,331 7,523 1,547 63.8% $ 14.3% 15.9% 1.4% 2.1% 2.5% 136 81.9% $ 30 18.1% ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ 111,253 100.0% $ 263,248 100.0% $ 166 100.0% $ 532,817 60.1% 195,414 22.0% 7.4% 3.4% 4.3% 2.8% 887,252 100.0% 65,229 29,952 38,287 25,553 $ 772,332 254,659 110,930 38,940 51,281 33,777 61.1% 20.2% 8.8% 3.1% 4.1% 2.7% $ 1,261,919 100.0% Table 20: Single Family Mortgages by Province as at December 31, 2017 (in thousands except %) Insured % Uninsured % HELOCs % Corporate Securitized Insured % Total % $ 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% 114 67.5% $ 48 28.4% 4.1% ‐ ‐ ‐ 56.6% 22.8% 8.9% 4.1% 4.4% 3.2% 169 100.0% $ 1,016,724 100.0% 576,785 231,335 90,174 41,449 44,924 32,057 7 ‐ ‐ ‐ 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% $ ‐ 30 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 21: Single Family Mortgages by Amortization Period as at December 31, 2018 (in thousands except %) Up to 20 Years >20 to 25 Years >25 to 30 Years >30 to 35 Years >35 to 40 Years Total 374,667 100.0% 887,252 100.0% Corporate Securitized Total $ $ $ 56,025 $ 15.0% 109,615 $ 29.2% 203,510 $ 54.3% 5,517 $ 1.5% 196,325 $ 22.1% 461,363 $ 52.1% 192,786 $ 21.7% 36,778 $ 4.1% ‐ $ ‐ ‐ $ ‐ 252,350 $ 20.0% 570,978 $ 45.2% 396,296 $ 31.4% 42,295 $ 3.4% ‐ $ ‐ 1,261,919 100.0% Table 22: 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 Corporate Securitized Total $ $ $ 98,172 $ 29.8% 69,868 $ 21.2% 158,200 $ 48.0% 3,681 $ 1.0% 205,764 $ 20.2% 502,032 $ 49.4% 231,282 $ 22.7% 77,305 $ 7.7% 303,936 $ 22.6% 571,900 $ 42.5% 389,482 $ 28.9% 80,986 $ 6.0% $ $ $ ‐ ‐ 341 ‐ 341 ‐ Total 329,921 100.0% 1,016,724 100.0% 1,346,645 100.0% Table 23: Average Loan to Value (LTV) Ratio for Uninsured Single Family Mortgage Originations (in thousands except %) For the Periods Ended December 31 Q4 Average LTV 2018 Q4 Average Annual Average LTV LTV 2018 2017 Annual Average LTV 2017 Ontario Alberta British Columbia Other $ 38,799 4,732 10,874 200 $ 54,605 70.8% $ 19,135 228 62.0% 1,215 70.8% 951 79.7% 70.1% $ 21,529 67.8% $ 87,926 12,353 80.0% 29,224 72.2% 2,025 78.3% 68.6% $ 131,528 69.8% $ 50,243 971 62.6% 1,760 67.6% 1,118 72.3% 68.7% $ 54,092 68.2% 73.2% 70.0% 76.6% 68.5% ‐ 31 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 24: Average Mortgage Loan to Value (LTV) Ratios at Origination As at Corporate portfolio: Single family mortgages ‐ Insured ‐ Uninsured 1 ‐ Uninsured completed inventory 1 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 2018 September 30 2018 December 31 2017 80.3% 64.9% 59.6% 56.9% 53.0% 65.2% 63.9% 62.8% 84.8% 82.9% 84.5% 73.4% 81.2% 67.3% 60.0% 58.2% 53.1% 67.8% 64.6% 64.7% 85.2% 82.0% 84.7% 74.4% 78.1% 67.5% 64.2% 61.6% 47.0% 67.9% 64.6% 65.3% 85.8% 82.0% 85.3% 76.0% 1 MCAN’s corporate uninsured single family mortgage portfolio (including completed inventory loans) is secured with a weighted average LTV at origination of 64.8% as at December 31, 2018 (December 31, 2017 ‐ 66.8%). Based on an industry index that incorporates current real estate values, the ratios would be 58.2% and 52.6%, respectively. 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. Other Corporate Assets Cash and cash equivalents Cash and cash equivalents, which include cash balances with banks and overnight term deposits, provide liquidity to meet maturing term deposit and new mortgage funding commitments and are considered to be Tier 1 liquid assets. As at December 31, 2018, our cash balance was $99 million (December 31, 2017 ‐ $118 million). For further information, refer to the “Liquidity and Funding Risk” sub‐section of the “Risk Governance and Management” section of this MD&A. Marketable securities Marketable securities, consisting primarily of REITs, provide additional liquidity at yields in excess of cash and cash equivalents. As at December 31, 2018, the portfolio balance was $53 million (December 31, 2017 ‐ $63 million). This decrease was a result of both the sale of individual REITs and a decrease in the fair value of the portfolio. Non‐Marketable Securities We hold a $42 million (December 31, 2017 ‐ $36 million) investment in the KSHYF, in which we have an 7.9% equity interest (December 31, 2017 ‐ 8.1%). The KSHYF invests in mortgages secured by real estate with a focus on mezzanine, subordinate and bridge mortgages. ‐ 32 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION We also hold a $30 million (December 31, 2017 ‐ $32 million) investment in Crown LP, in which we have a 14.1% equity interest (December 31, 2017 ‐ 14.1%). 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 based on building rental rates and current market capitalization rates. During 2018, Crown LP sold the last remaining property in its opportunity fund and paid a distribution of $5.1 million which reduced the carrying value of our investment in Crown LP. The remaining properties held by Crown LP are held in its core fund. Equity investment in MCAP We hold a 13.71% equity interest in MCAP (December 31, 2017 ‐ 14.41%), which represents 4.0 million units held by MCAN (December 31, 2017 ‐ 4.2 million) of the 29.2 million total outstanding MCAP partnership units (December 31, 2017 ‐ 29.1 million). The investment had a net book value of $62 million as at December 31, 2018 (December 31, 2017 ‐ $59 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 $36 million as at December 31, 2018 (December 31, 2017 ‐ $42 million). The difference between the net book value and the LP ARA reflects an unrealized gain that, if realized, would be recognized as a capital gain and applied against MCAN’s tax loss carry forward. For further information on the LP ARA, refer to the “Non‐IFRS Measures” section of this MD&A. During 2018, we received $8.3 million of unitholder distributions from MCAP (2017 ‐ $5.0 million). Since we account for this investment on the equity basis, the receipt of distributions reduces the carrying value of the investment in MCAP. We use the equity basis of accounting for our investment in MCAP as per 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 fair value through profit and loss (”FVPL”) or fair value through other comprehensive income (“FVOCI”). 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 at “fair market value”, which would be determined by an independent valuator agreed upon by both parties. Securitization Assets Securitization assets consist primarily of single family insured mortgages securitized through the market MBS program and CMB program. Additionally, we hold cash in trust, which represents securitized mortgage principal and interest collections from borrowers that are payable to MBS holders. During 2018 we securitized $169 million of mortgages (2017 ‐ $110 million). For further information, refer to the “Securitization Programs” section of this MD&A. ‐ 33 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Liabilities and Shareholders’ Equity Table 25: Liabilities and Shareholders' Equity (in thousands) As at Corporate Liabilities Term deposits Current taxes payable Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders’ Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income December 31 September 30 2018 1 2018 1 Change December 31 2017 (%) Change (%) $ $ $ 919,623 173 3,478 13,169 936,443 935,496 461 3,416 14,032 953,405 897,935 897,935 1,834,378 933,553 933,553 1,886,958 (2%) $ 884,460 $ (62%) 2% (6%) (2%) (4%) (4%) (3%) ‐ 3,572 16,067 904,099 1,015,699 1,015,699 1,919,798 4% ‐ (3%) (18%) 4% (12%) (12%) (4%) 221,869 510 84,315 ‐ 306,694 2,141,072 $ 221,126 510 80,787 ‐ 302,423 2,189,381 ‐ ‐ 4% ‐ 1% (2%) $ 214,664 510 65,365 16,438 296,977 2,216,775 $ 3% ‐ 29% (100%) 3% (3%) 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Amounts from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. To fund our corporate operations, we primarily issue term deposits that are eligible for Canada Deposit Insurance Corporation (“CDIC”) deposit insurance. We source term deposits through a broker distribution network across Canada consisting of third party deposit agents and financial advisors. 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. We believe that our term deposits provide a reliable low‐cost funding source that can be matched against the corporate mortgage portfolio. The role of term deposits in managing liquidity and funding 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. 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 2018 reflects new common shares issued through the DRIP. The DRIP participation rate for fiscal 2018 was 19% (2017 ‐ 16%). For further information, refer to Note 19 to the consolidated financial statements. Retained earnings activity for 2018 consists of net income of $36.3 million and the IFRS 9 transition adjustment of $16.4 million less dividends of $33.8 million. On the adoption of IFRS 9 effective January 1, 2018, the accumulated other comprehensive income balance was reclassified to retained earnings. ‐ 34 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION SELECTED QUARTERLY FINANCIAL DATA Table 26: Selected Quarterly Financial Data (in thousands except per share amounts and where indicated) Net Income Net investment income excluding realized and unrealized gain (loss) ‐ corporate assets 1 Realized and unrealized gain (loss) on securities ‐ corporate assets 1 Other income ‐ corporate assets Net investment income ‐ securitization assets 1 Operating expenses Provision for (recovery of) income taxes Net income Q4/18 1 Q3/18 1 Q2/18 1 Q1/18 1 Q4/17 Q3/17 Q2/17 Q1/17 $ 12,028 $ 12,757 $ 11,722 $ 12,129 $ 14,359 $ 12,918 $ 12,179 $ 12,963 (4,156) ‐ 1,082 8,954 5,512 (105) ‐ 876 1,291 15,130 4,617 248 $ 3,547 $ 11,006 $ 11,125 $ 10,615 $ 10,807 $ 9,918 $ 8,938 $ 10,265 ‐ ‐ 1,532 14,450 4,689 (157) ‐ ‐ 1,416 15,775 5,302 (334) ‐ ‐ 1,374 13,553 4,616 (1) (56) 1,701 1,301 15,075 4,631 (171) 359 314 1,276 14,706 3,637 63 3,341 ‐ 1,317 16,380 5,142 113 Basic and diluted earnings per share Dividends per share $ $ 0.15 $ 0.32 $ 0.47 $ 0.37 $ 0.47 $ 0.37 $ 0.45 $ 0.37 $ 0.47 $ 0.37 $ 0.42 $ 0.32 $ 0.39 $ 0.32 $ 0.44 0.30 Return on average shareholders' equity 2 4.66% 14.29% 14.54% 14.10% 14.63% 13.63% 12.37% 14.37% Assets ($ million) Corporate Securitization Total Liabilities ($ million) Corporate Securitization Total $ 1,224 917 1,133 1,109 $ 2,141 $ 2,189 $ 2,206 $ 2,154 $ 2,216 $ 2,196 $ 2,277 $ 2,242 1,182 1,034 1,239 950 1,148 1,048 1,201 1,076 1,122 1,032 1,212 994 $ 936 898 869 1,088 $ 1,834 $ 1,887 $ 1,900 $ 1,852 $ 1,920 $ 1,905 $ 1,989 $ 1,957 878 1,027 930 1,059 904 1,016 837 1,015 923 977 953 934 Corporate Mortgages Average mortgage portfolio yield 2 Average term deposit interest rate 2 Average mortgage portfolio balance ($ million) 2 Average term to maturity (in months) Mortgages ‐ corporate Term deposits 5.62% 2.69% 5.53% 2.61% 5.65% 2.48% 5.72% 2.38% 5.56% 2.29% 5.25% 2.25% 5.28% 2.21% $ 968 $ 942 $ 913 $ 849 $ 866 $ 908 $ 914 $ 5.12% 2.20% 908 11.5 18.7 12.8 19.2 13.2 17.4 11.3 18.9 11.3 19.1 10.6 18.1 10.6 18.8 10.8 17.4 Securitized mortgages Average mortgage portfolio yield 2 Average financial liability from securitization rate 2 2.53% 1.83% 2.57% 1.83% Average mortgage portfolio balance ($ million) 2 $ 892 $ 935 $ 2.59% 1.83% 2.61% 1.90% 986 $ 1,015 $ 1,002 $ 1,028 $ 1,057 $ 1,052 2.63% 1.83% 2.57% 1.81% 2.57% 1.83% 2.67% 1.93% Capital ratios Income tax assets to capital ratio 2 Leverage ratio 2 CET 1, Tier 1 and Total Capital ratios 2 Credit Quality Impaired mortgage ratio (total) 2 Impaired mortgage ratio (corporate) 2 Mortgage Arrears Corporate 2 Securitized 2 Total 2 4.64 11.79% 21.66% 4.90 11.35% 20.58% 4.60 11.55% 21.47% 4.33 11.74% 21.29% 4.60 11.31% 21.26% 4.50 11.31% 21.34% 4.77 10.82% 21.47% 4.61 10.87% 22.23% 0.12% 0.23% 0.03% 0.06% 0.02% 0.03% 0.10% 0.22% 0.09% 0.20% 0.14% 0.31% 0.12% 0.27% 0.19% 0.44% $ 9,435 $ 8,398 $ 6,739 $ 9,204 $ 8,766 $ 11,317 $ 11,267 $ 33,514 14,797 $ 15,962 $ 16,870 $ 20,718 $ 18,758 $ 17,569 $ 19,099 $ 21,681 $ 48,311 13,979 10,414 6,527 9,554 8,472 8,803 7,782 ‐ 35 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 1 Provisions for credit losses are included in net investment income from both corporate and securitization assets. Effective Q1 2018, we prospectively adopted IFRS 9 and did not restate prior period information. Under IFRS 9, the methodology for the calculation of mortgage allowances and provisions has changed from IAS 39, therefore provisions under IFRS 9 are not directly comparable to prior periods. Additionally, under IFRS 9 fair value changes in certain reclassified financial assets are presented in the income statement and are therefore not directly comparable to prior periods. Under IAS 39, these fair value changes were recorded through other comprehensive income. 2 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. Corporate net investment income has been driven by changes in the corporate mortgage portfolio balance. Additionally, corporate net investment income was impacted by significant distribution income from Crown LP in Q1 2017 and substantial equity income from MCAP in Q2 2017 and Q4 2017. Since the adoption of IFRS 9 effective January 1, 2018, we experienced increased volatility in net income as a result of the recognition of unrealized gains on certain securities through net income. This volatility was especially prominent in Q2 2018 and Q4 2018, generating respective impacts to net income of a $3.3 million unrealized gain and a $4.2 million unrealized loss. Prior to the adoption of IFRS 9, unrealized gains and losses were recognized through accumulated other comprehensive income. Corporate mortgage interest yields have generally increased throughout 2017 and 2018 as a result of increases to the overnight rate by the Bank of Canada given that the majority of the corporate portfolio is floating rate, however changes in the portfolio mix and market conditions have contributed to the slight decrease in 2018. The securitized mortgage portfolio has gradually decreased throughout 2017 and 2018 as a result of a reduction in securitization volumes and the natural run‐off of the securitized portfolio. The securitized net spread has decreased slightly during this time as we have experienced lower overall economics on recent securitizations. The decrease in operating expenses in Q3 2018 was a result of a reduction to our variable compensation accruals and a non‐ recurring $0.6 million reimbursement of legal expenses. Operating expenses increased in Q4 2017 as a result of non‐recurring professional fee accruals. In Q4 2018, we incurred increased salary expense and severance costs, partially offset by lower long‐ term equity compensation accruals. Capital ratios have remained steady across the last eight quarters as the gradual increase in corporate assets has generally been matched by a growing capital base. Capacity tightened in Q3 2018 as a result of the accrual of the fourth quarter dividend during that period. Total arrears and impaired ratios, while low by historical standards, have been volatile on a quarterly basis given the nature of the 1‐30 day arrears classification. Q1 2017 corporate arrears were significantly higher than usual as a result of construction arrears. ‐ 36 ‐ 2018 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 subject to final review and declaration by the Board. Capital growth is achieved through retained earnings, the DRIP, rights offerings and public share offerings. 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. Table 27: 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: corporate mortgage allowances Less: securitization assets 3 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 3 Income tax capital 1 Income tax capital ratios 1 Income tax assets to capital ratio Income tax liabilities to capital ratio December 31 2018 2 September 30 2018 2 December 31 2017 $ $ $ $ $ 2,141,072 $ 6,743 2,147,815 4,466 (908,367) (52,450) (4,328) 1,187,136 $ 2,189,381 $ 4,839 2,194,220 4,680 (944,153) (56,483) (8,436) 1,189,828 $ 2,216,775 5,435 2,222,210 4,750 (1,030,020) (42,411) (7,475) 1,147,054 1,834,378 $ (6,194) 1,828,184 (896,641) 931,543 $ 1,886,958 $ (7,963) 1,878,995 (932,222) 946,773 $ 1,919,798 (7,852) 1,911,946 (1,014,258) 897,688 255,593 $ 243,055 $ 249,366 4.64 3.64 4.90 3.90 4.60 3.60 1 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. 2 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Amounts from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 3 The majority of securitization assets and liabilities on the balance sheet are excluded from income tax assets, liabilities and capital as they are derecognized for income tax purposes. ‐ 37 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Regulatory Capital As a Loan Company under the Trust and Loan Companies Act (the “Trust Act”), OSFI oversees the adequacy of our capital. For this purpose, OSFI has imposed minimum capital‐to‐regulatory (or risk‐weighted) assets ratios and a minimum leverage ratio which is calculated on a different basis from the income tax assets to capital ratio discussed in the “Income Tax Capital” sub‐ section above. Both OSFI and the Basel Committee on Banking Supervision (“BCBS”) promote a resilient banking sector and strong global capital standards. Key components of Basel III impact MCAN through the Capital Adequacy Requirements (“CAR”) and Leverage Requirements Guidelines. OSFI expects all federally regulated financial institutions to meet the minimum capital to risk‐weighted asset ratios of 7% CET 1 Capital, 8.5% Tier 1 Capital and 10.5% Total Capital. The Company’s Common Equity Tier 1 (“CET 1”) capital consists of share capital, contributed surplus, retained earnings and accumulated other comprehensive income. The Company does not hold any additional Tier 1 or Tier 2 capital instruments, therefore its CET 1 capital is equal to its Tier 1 and Total Capital. Our internal target minimum CET 1, Tier 1 and Total Capital ratios are 20%. We maintain prudent capital management practices to ensure that we are adequately capitalized and continue to satisfy minimum standards and internal targets. During 2018, OSFI released a discussion paper relating to the proposed implementation of final Basel III reforms in Canada. The reforms were published by the BCBS in December 2017 and seek to enhance credibility in the calculation of risk‐weighted assets and improve the comparability and transparency of the capital ratios of OSFI‐regulated financial institutions. These proposed reforms could significantly impact the risk‐weighting of the Company’s construction and commercial mortgage portfolios, as the new guidelines could potentially increase the risk‐weighting of these assets from the current level of 100% to 150%. We are currently investigating the impact of these proposed reforms and the associated potential for higher capital requirements on real estate lending in Canada. OSFI has released a revised version of the CAR Guideline effective January 1, 2019. We do not expect these revisions to have a material impact on MCAN’s regulatory capital position or ratios. The adoption of IFRS 9 effective January 1, 2018 did not have a material impact on our regulatory capital or ratios. ‐ 38 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 28: 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) 2 Common Equity Tier 1, Tier 1 and Total Capital (Transitional) 2,3 Deduction for equity investment in MCAP (All‐in adjustment) 2 Common Equity Tier 1, Tier 1 and Total Capital (All‐in) 2,3 Total Exposures/Regulatory Assets 3 Consolidated assets Less: deductions from all‐in Tier 1 Capital 2 Other adjustments 4 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 2018 1 September 30 2018 1 December 31 2017 $ $ $ $ $ $ 221,869 510 84,315 ‐ n/a n/a (30,925) 275,769 2,141,072 (30,925) 1,295 2,111,442 410,020 (205,010) 43,757 (21,879) 226,888 $ 221,126 510 80,787 ‐ n/a n/a $ $ $ (29,689) 272,734 2,189,381 (29,689) 905 2,160,597 440,844 (220,422) 43,715 (21,858) 242,279 214,664 510 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 Total Exposures/Regulatory Assets $ 2,338,330 $ 2,402,876 $ 2,365,124 Leverage ratio 3 Risk weighted assets (all‐in) 2,3 Risk weighted assets (transitional) 2,3 11.79% 11.35% 11.31% $ 1,273,205 n/a $ 1,325,068 n/a $ 1,258,171 1,269,967 Regulatory Capital Ratios 3 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) 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) 21.66% 21.66% 21.66% n/a n/a n/a 20.58% 20.58% 20.58% n/a n/a n/a 21.26% 21.26% 21.26% 21.53% 21.53% 21.53% 1 Effective January 1, 2018 we adopted IFRS 9, Financial Instruments. Results from periods prior to January 1, 2018 are reported in accordance with IAS 39, Financial Instruments: Recognition & Measurement. For further information on the adoption of IFRS 9, refer to Notes 4 and 6 to the consolidated financial statements. 2 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. As of January 1, 2018, the deduction was fully deductible whereas in 2017, the deduction on the transitional basis was equal to 80% of the all‐in adjustment. 3 Refer to the “Non‐IFRS Measures” section of this MD&A for a definition of these measures. 4 Certain items, such as negative cash balances, are excluded from total exposures but included in consolidated assets. ‐ 39 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 29: Regulatory Risk‐Weighted Assets (in thousands except %) As at December 31, 2018 Per Balance Average Risk Weighted Assets Rate Sheet December 31, 2017 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 Non‐marketable securities Other loans Equity investment in MCAP Commercial LP Deferred tax asset Other assets $ 98,842 26,002 53,247 922,390 887,252 71,813 2,640 61,593 2,961 14,332 20% $ 20% 100% 70% 3% 214% 100% 50% 100% 100% Off‐Balance Sheet Items Letters of credit Commitments Charge for operational risk 43,757 410,020 50% 45% $ 117,571 13,441 62,518 863,384 1,016,724 68,190 2,612 59,189 2,672 10,474 20% $ 20% 100% 76% 3% 251% 100% 50% 100% 100% 32,164 317,687 50% 45% 20,028 5,200 53,247 648,833 28,368 153,692 2,640 30,669 2,961 14,332 959,970 21,878 182,744 204,622 108,613 24,097 2,688 62,518 656,384 32,182 170,922 2,612 29,697 2,672 10,474 994,246 16,082 142,043 158,125 105,800 Risk‐Weighted Assets (all‐in) $ 1,273,205 $ 1,258,171 Equity investment in MCAP Commercial LP (transitional adjustment) 1 Risk‐Weighted Assets (transitional) n/a n/a 11,796 $ 1,269,967 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. SECURITIZATION PROGRAMS We are an NHA MBS issuer, which involves the securitization of insured mortgages to create MBS. We issue MBS through our internal market MBS program and the Canada Housing Trust (“CHT”) CMB program. For further information, refer to Note 13 to the consolidated financial statements. Market MBS Program During 2018, we securitized $141 million of MBS through the market MBS program (2017 ‐ $47 million). In 2018, we retained $46 million of the MBS securitized on our corporate balance sheet (2017 ‐ $nil) with the remainder sold to third parties. As at December 31, 2018, we held $68 million of retained MBS on our balance sheet (December 31, 2017 ‐ $29 million), which is included in the insured single family classification within corporate mortgages. ‐ 40 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CMB Program During 2018, we securitized $28 million of insured single family mortgages through the CMB program (2017 ‐ $63 million). Other Considerations 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. However, for income tax purposes, all mortgages securitized by MCAN are excluded from 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. RISK GOVERNANCE AND MANAGEMENT Effective risk management and an established risk management framework support a strong risk culture and help the Company achieve sustainable performance and stable growth while maintaining an appropriate balance between risk and return. The Enterprise Risk Management Framework (“ERMF”) adopted by MCAN outlines MCAN’s approach to risk management, which includes identifying, assessing, monitoring, reporting on and mitigating enterprise‐wide exposures. Risk Governance MCAN has a risk governance structure, whereby the Board is supported by a number of Committees, and an experienced senior management team. This framework is governed through a hierarchy of committees and individual responsibilities as outlined in the diagram below. ‐ 41 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION The Board has oversight accountability for risk governance within MCAN. It provides this oversight and carries out its risk management mandate primarily through the Enterprise Risk Management and Compliance Committee (“ERM&CC”), 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”). MCAN’s Risk Governance structure is illustrated in the following diagram: ‐ 42 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Board of Directors: is responsible for providing stewardship, including direction‐setting and general oversight of the management and operations of the entire Company. The Board provides oversight and carries out its risk management mandate primarily through the ERM&CC, the Audit Committee, and the CR, CG & HR Committee. The Board reviews and approves the Risk Appetite Framework (“RAF”) on a periodic basis and ensures its alignment with the strategic plan. The Board also ensures an effective risk culture by overseeing the implementation, by management, of appropriate systems to identify, quantify and manage the major risks of MCAN’s business. The Enterprise Risk Management and Compliance Committee: is responsible for overseeing risk management and compliance activities across the Company. It ensures the effectiveness of the Company’s RAF and its alignment with the Company’s strategy and ICAAP. It has the responsibility to ensure that the risk management function is independent from the business activity it oversees, and is supported by the terms of the ERMF. The Executive Committee: consists of the Chief Executive Officer (“CEO”) and senior management, and is responsible for developing the strategic plan and a comprehensive set of enterprise wide policies for approval by the Board, including the RAF. They are responsible for fostering a strong risk culture through “tone at the top” and are accountable for identifying and reporting significant risks to the ERM&CC. Three‐Lines‐of‐Defence The Company’s operating model follows the three‐lines‐of‐defence approach to the management of risk. First Line (Business Units): 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 owning, identifying, managing, measuring and monitoring current and emerging risks and compliance with the Company’s policies related to legal and regulatory matters. Second Line (Oversight Functions): provide oversight and challenge to the first line through objectively identifying, measuring, monitoring and reporting known and emerging risks on an enterprise basis. The heads of the oversight functions are independent from operational management and have sufficient stature and authority within the organization to carry out their responsibilities as noted above. 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 overseen by: The Risk function, under the leadership of the Chief Risk Officer (“CRO”) is accountable 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, which includes reporting on the significant business risks. The Finance function, under the leadership of the Chief Financial Officer (“CFO”) is accountable for the accuracy and integrity of the Company’s accounting and financial reporting systems, financial statements, planning and budgeting systems. The CFO ensures legal and regulatory compliance for all financial matters within the Company. The Chief Compliance Officer, Chief Anti Money Laundering Officer & Privacy Officer is accountable 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, and is accountable for the Company’s adherence to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) and the Personal Information Protection and Electronic Documents Act (Canada) with regard to its deposit taking and lending activities. Third Line (Internal Audit): is separate from both the first and second line of defence and provides independent and objective assurance with respect to 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 reports to the Chair of the Audit Committee. Risk Appetite The RAF governs the risk activities undertaken by the Company on an enterprise‐wide basis. The RAF articulates the aggregate level and types of risk MCAN is willing to accept, or to avoid, in order to achieve its business objectives. Key inputs into the RAF include MCAN’s risk capacity and strategy, while the foundational components include risk appetite statements, risk appetite limits, and roles and accountabilities for the Board and senior management in relation to overseeing the implementation and monitoring of the RAF. ‐ 43 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION MCAN’s overarching risk appetite statement is as follows: 1. 2. 3. 4. 5. 6. Focus on sustainable and stable growth of earnings. Maintain a conservative liquidity profile and a strong capital base. Balance the corporate mortgage portfolio. Maintain access to adequate funding and capital markets at all times. Ensure sound management of regulatory compliance and operational risk and maintain a strong risk culture. Ensure financial resiliency in a stressed scenario. MCAN’s RAF includes risk appetite metrics which are quantitative measures based on forward‐looking assumptions to measure and monitor if MCAN is operating within its established risk appetite. RAF level risk appetite metrics are supported by policy level limit structures and controls, as applicable. Stress Testing Stress testing is a key risk management tool that supplements risk management practices by providing an assessment of our capacity to withstand potential adverse events and aids in refining our risk limits and chosen strategies. At least quarterly, MCAN conducts enterprise‐wide stress testing covering a wide range of risks and correlations among risks. Results of stress testing are interpreted in the context of our risk appetite and our specific risk appetite metrics including metrics for capital ratios, earnings volatility and level of stress losses. Enterprise‐wide stress testing and capital and financial planning processes are integrated within the Company. Monitoring and Reporting Risk monitoring and reporting are key components of MCAN’s ERMF and allow both the Board and senior management to execute their oversight and challenge responsibilities with respect to business operations. Risk Management reports risk exposures to senior management and the ERM&CC on a quarterly basis, to ensure business operations are within established risk appetite limits, policy level limits and policy guidelines. Reports include emerging risks, significant changes to MCAN’s risk profile, and ad hoc reporting, as applicable. Material Risk Types MCAN’s material risk types include Liquidity & Funding, Credit, Interest Rate, Market, Operational, Strategic and Reputational risk. Incidents related to these risks can adversely affect our ability to achieve our business objectives or execute our business strategies, and may result in a loss of earnings, capital and/or damage to our reputation. The ERMF addresses how we mitigate these risks by establishing effective policies, limits, and internal controls to monitor and mitigate these risks. 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. ‐ 44 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Liquidity and Funding Risk Liquidity and funding risk is the risk that cash inflows including the ability to raise deposits and access to other sources of funding, 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. On a daily basis, we monitor our liquidity position to ensure that the level of liquid assets held (including insured single family mortgages, which are readily marketable within a time frame of one to three months), together with our ability to raise new deposits, is sufficient to meet our funding commitments, deposit maturity obligations, and other financial obligations. The Board 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. This internal target includes assumptions relating to the value of liquid assets such as the ability to sell these assets in a stressed market scenario. As at December 31, 2018 and December 31, 2017, we met this internal target. 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 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. Prior to year end, the total facility was temporarily increased from $75 million to $125 million until March 31, 2019. 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 have established and maintain liquidity policies and procedures that meet the standards set under the Trust Act and regulations or guidelines issued by OSFI. 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 (“LRMF”) that is reviewed and approved periodically 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 performs multi scenario stress testing that is reviewed monthly by ALCO and quarterly by the ERM&CC. Management monitors trends in deposit concentration with significant term deposit brokers on a monthly basis. Further to the LRMF, 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. OSFI’s Liquidity Adequacy Requirements (“LAR”) guideline currently establishes two 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. As at December 31, 2018, we were in compliance with the LCR and NCCF. 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 KSHYF, refer to the “Off‐Balance Sheet Arrangements” section of this MD&A. ‐ 45 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Table 30: Liquidity Analysis (in thousands) Sources of liquidity Cash and cash equivalents Marketable securities Mortgages ‐ corporate Non‐marketable securities 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 2017 2018 Years $ 98,842 $ 53,218 183,117 ‐ 1,784 336,961 ‐ $ ‐ 436,262 ‐ ‐ 436,262 ‐ $ ‐ 247,661 ‐ 856 248,517 ‐ $ 29 50,560 ‐ ‐ 50,589 ‐ $ ‐ 4,790 71,813 ‐ 76,603 98,842 $ 53,247 922,390 71,813 2,640 1,148,932 117,571 62,518 863,384 68,190 2,612 1,114,275 41,664 13,169 54,833 317,006 ‐ 317,006 472,342 ‐ 472,342 88,611 ‐ 88,611 ‐ ‐ ‐ 919,623 13,169 932,792 884,460 16,067 900,527 Net liquidity surplus (deficit) $ 282,128 $ 119,256 $ (223,825) $ (38,022) $ 76,603 $ 216,140 $ 213,748 Off‐Balance Sheet Unfunded mortgage commitments $ 109,868 $ 124,406 $ 154,798 $ Commitment ‐ KSHYF ‐ ‐ ‐ $ 109,868 $ 124,406 $ 154,798 $ ‐ $ ‐ $ ‐ 20,948 ‐ $ 20,948 $ 389,072 $ 20,948 410,020 $ 291,204 26,483 317,687 Note: The above table excludes securitized assets and liabilities and pledged assets as their use is restricted to securitization program operations. 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 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 ERM&CC and the Board. A CRO Report, which identifies, assesses, ranks and provides trending analysis on all material risks to the Company, is provided to the ERM&CC on a quarterly basis. Monitoring also takes place through our Capital Commitments Committee and Executive Committee, which are both comprised of senior 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 periodically, 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 Board by management. Existing risks in our mortgage portfolio are identified by arrears reporting, portfolio diversification analysis, post funding monitoring 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 on individual mortgages. We assign a credit score and risk rating for all mortgages at the time of underwriting based on the assessed credit quality of the borrower and the value of the underlying real estate. Risk ratings are reviewed annually at a minimum, and more frequently whenever there is an amendment or a material adverse change such as a default or impairment. ‐ 46 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION As part of our credit risk management process, we monitor our loan portfolio for early indicators of potential concerns. The “monitored/watchlist” category includes construction and commercial loans that may experience events such as slow sales, cost overruns or are located in geographic markets in which risks have increased. Loans in this category are included in stage 2 for IFRS 9 arrears classification purposes. Considering factors such as borrower equity, portfolio loan to value ratios and project liquidity, as at December 31, 2018 we have not observed anything specific across the portfolio that we believe would cause a loss of principal in excess of the stage 1 and 2 allowances recorded under IFRS 9. These collective allowances are based on forward‐ looking economic assumptions and other factors discussed in Note 4 to the consolidated financial statements. 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 and our investment in the KSHYF, where maximum credit exposure includes our total remaining commitment. Credit Risk ‐ Impairment Assessment Under IFRS 9 The analysis of MCAN’s IFRS 9 impairment assessment and measurement approach discussed below should be read in conjunction with Note 4 to the consolidated financial statements. Probability of Default The probability of default (“PD”) is driven by historical arrears performance, and incorporates the rate at which mortgages move from performing status to defaulted status. Key macroeconomic variables, borrower credit scores and internal mortgage risk ratings (where applicable) are also used in calculating this rate. Where historical arrears performance is limited or not available, the Company uses external arrears/default data for similar loans and mortgages. Exposure at default The exposure at default (“EAD”) represents the gross carrying amount of the financial instruments subject to the impairment calculation, addressing both the borrower’s ability to increase its exposure while approaching default and potential early repayments. To calculate the EAD for a Stage 1 loan, the Company assesses the possible default events within 12 months for the calculation of the 12 month ECL. However, if a Stage 1 loan that is expected to default in the 12 months from the balance sheet date and is also expected to cure and subsequently default again, then all linked default events are taken into account. For Stage 2 and Stage 3 financial assets, the EAD is considered for events over the lifetime of the instruments. The Company determines EADs by determining the period of exposure and modelling the change in loan exposures over time. Except for some revolving credit facilities, the maximum period over which the ECL is measured is the maximum contractual period. For revolving credit facilities that include both a loan component and an undrawn commitment component, an assessment is made with respect to whether the Company’s exposure to credit losses is not limited to the contractual notice period. Once the period of exposure is determined, the EAD is modelled based on loan terms, prepayment assumptions, commitment drawing patterns and other relevant forward‐looking information. Loss given default Loss given default (“LGD”) is modelled using a common LGD methodology that incorporates specific relevant data where appropriate. The LGD estimation takes into account all relevant and forward‐looking information including but not limited to expected EAD, forecast of future collateral valuations including expected sales costs and discounts, debt structure and cross‐ collateralization, and varies with macroeconomic scenarios. The Company segments its corporate mortgage portfolio into individual lines of business, outlined in Note 8 to the consolidated financial statements. The segmentation is based on key characteristics that are relevant to the estimation of future cash flows. The applied data is based on historically collected loss data and other transaction characteristics as applicable. Additional data and forward‐looking economic scenarios are used in order to determine the IFRS 9 LGD rate for each mortgage. When assessing forward‐looking information, the expectation is based on multiple scenarios. Examples of key inputs include changes in collateral values including property prices for mortgages, regional housing price indexes or other factors that are indicative of losses in the group. Under IFRS 9, LGD rates are estimated for the Stage 1, Stage 2 and Stage 3 IFRS 9 segment of each mortgage. The inputs for these LGD rates are estimated and, where possible, calibrated through back testing against recent recoveries. These are repeated for each economic scenario as appropriate. ‐ 47 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Grouping financial assets measured on a collective basis The Company calculates ECLs either on a collective or individual basis for the corporate mortgage portfolio based on the line of business (per Note 8 to the consolidated financial statements). ECLs are calculated on an individual basis for all mortgages in Stage 3 and are calculated on a collective basis for all mortgages in Stage 1 and Stage 2. Analysis of inputs into the ECL model under multiple economic scenarios An overview of the approach to estimating ECLs is set out in Notes 4 and 5 to the consolidated financial statements. As part of the model input process, macroeconomic data are obtained from third party sources (e.g. rating agencies, bank economic forecasts), and our Risk Management department verifies the quality of data and assumptions in the Company’s ECL models including determining the weights attributable to the multiple scenarios. 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. 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 Board 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 the mortgages with matched‐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. 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. 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, cyber risk and the risk related to accuracy and completeness of borrower information. The remaining risks arise from the small size and entrepreneurial nature of MCAN. 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. We manage operational risk through various committees and processes. Senior management reviews operational measures on a recurring and regular basis. 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 periodically by the Board for changes to coverage and our operations. ‐ 48 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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. MCAN’s Outsourcing Policy, which is approved periodically by the Board, incorporates the relevant requirements of OSFI Guideline B‐10, Outsourcing of Business Activities, Functions and Processes. We periodically review our outsourced arrangements 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. Cyber Risk Within operational risk, cyber risk represents the risk of financial loss, disruption or damage to the Company from a failure of its informational technology systems. 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. 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 a periodic 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 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. 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. We frequently review and enhance our underwriting procedures and control processes to strengthen our ability to detect such inaccurate and misleading information and to better manage this risk. These enhancements include improvements to underwriting staff training, independent income verification procedures, and other quality control and quality assurance processes. In recent years, the Canadian mortgage industry has experienced falsification of supporting documents provided to lenders in the mortgage underwriting process, and during this time we have observed instances of this activity in our own underwriting processes. The implementation of significant changes to OSFI Guideline B‐20 effective January 1, 2018 has reduced the number of borrowers that qualify for new mortgages, which increases the risk of document falsification. To date, 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. Strategic Risk Strategic 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 adjust its cost levels in response to those changes. ‐ 49 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Strategic risk is managed by the CEO and senior management. The Board periodically approves the Company’s strategies and reviews results against those strategies at least quarterly. Reputational Risk Reputational risk is the negative consequence of the occurrence of other risks and can occur from an activity undertaken by the Company, its affiliated companies, or its representatives. The loss of reputation can greatly affect shareholder value through reduced public confidence, a loss of business, legal action, or increased regulatory oversight. Reputation refers to the perception of the enterprise by various stakeholders. Typically, key stakeholder groups include investors, borrowers, depositors, employees, suppliers, regulators, brokers and strategic partners. 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 Company’s 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. 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. Reputational risk appetite is primarily assessed through a qualitative assessment on a quarterly basis whereby the CRO attests if MCAN is operating within appetite based on monitoring of a reputational risk dashboard. Other Risk Factors 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. Changes in Laws and Regulations and Regulatory Compliance Risk 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, limiting pricing and availability of products in the market, 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. Increasing regulations and expectations, both globally and domestically, have increased the cost and resources necessary to meet regulatory expectations for the Company. Mortgage Renewal and Prepayment 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, in the case of insured single family mortgages, proceeds are received from mortgage insurers following the sale of mortgaged properties. 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 obligation. For further information on the Timely Payment obligation, refer to Note 13 to the consolidated financial statements. Prepayment risk includes the acceleration of the amortization of mortgage premiums, as applicable, as a result of early payouts. 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 market volume, real estate prices and adverse economic events. Our inability to respond to meet changes effectively may have an adverse effect on our financial condition and results of operations. ‐ 50 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 at reasonable rates, 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, 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. 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. 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. 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. 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. 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 periodically. 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, 2018, there were 23,798,464 common shares outstanding (December 31, 2017 ‐ 23,377,785). As at February 22, 2019, there were 23,910,417 common shares outstanding. ‐ 51 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION During 2018, we issued 367,942 new common shares under the DRIP (2017 ‐ 295,849), 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%. During 2018, we issued 52,737 new common shares through the Executive Share Purchase Plan (2017 ‐ 6,709). For additional information related to share capital, refer to Note 19 to the consolidated financial statements. OFF‐BALANCE SHEET ARRANGEMENTS We have contractual obligations relating to a premises lease, in addition to outstanding commitments for future fundings of corporate mortgages and our investment in the KSHYF. Table 31: Contractual Obligations (in thousands) Less than one year One to three years Three to five years Over five December 31 December 31 2017 years 2018 Mortgage funding commitments Commitment ‐ KSHYF Premises lease $ 234,274 $ ‐ 890 $ 235,164 $ 154,798 $ ‐ 1,857 156,655 $ ‐ $ ‐ 1,897 1,897 $ ‐ $ 20,948 3,856 24,804 $ 389,072 $ 20,948 8,500 418,520 $ 291,204 26,483 8,652 326,339 We retain mortgage servicing obligations relating to securitized mortgages where balance sheet derecognition has been achieved. For further information, refer to Note 13 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 27 to the consolidated financial statements. 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 have not recorded a provision. During 2018, we reversed $0.6 million of previously incurred and accrued legal expenses relating to this litigation after receiving funds for reimbursement. DIVIDEND POLICY AND RECORD Our dividend policy is to pay out substantially all of our taxable income to our shareholders. These dividends are taxable to our shareholders as interest income. In addition, as a MIC, we can pay certain capital gains dividends which are taxed as capital gains to our shareholders. 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: Table 32: Dividends Per Share For the Years Ended December 31 2018 2017 2016 First Quarter Second Quarter Third Quarter Fourth Quarter $ $ 0.37 0.37 0.37 0.32 1.43 $ $ 0.30 0.32 0.32 0.37 1.31 $ $ 0.29 0.29 0.29 0.30 1.17 ‐ 52 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Figure 5: Dividend History TRANSACTIONS WITH RELATED PARTIES Related party transactions for the quarters and years ended December 31, 2018 and December 31, 2017 and related party balances as at December 31, 2018 and December 31, 2017 are discussed in Note 25 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, non‐marketable securities, 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 liquidity, credit, interest rate and market risk. A discussion of these risks and how they 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 financial 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, 2018, we had 89 employees (December 31, 2017 ‐ 69). 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, changes in 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. ‐ 53 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 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. 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. Allowances on impaired mortgages include all of the accumulated provisions for losses to reduce the assets to their estimated realizable value. Allowances depend on asset class, as different classes have varying underlying risks. Future changes in circumstances could materially affect net realizable values and lead to an increase or decrease in the allowance for credit losses. The measurement of impairment losses under both IFRS 9 and IAS 39 across all categories of financial assets requires judgment, in particular, the estimation of the amount and timing of future cash flows and collateral values and the assessment of a significant increase in credit risk. These estimates are driven by a number of factors, changes in which can result in different levels of allowances. The Company’s ECL calculations are model outputs with a number of underlying assumptions regarding the choice of variable inputs and their interdependencies. Elements of the ECL models that are considered accounting judgments and estimates include: The Company’s criteria for assessing if there has been a significant increase in credit risk which results in allowances being measured on a lifetime versus 12 month ECL basis; The segmentation of financial assets for the purposes of assessing ECL on a collective basis; Development of ECL models, including the various formulas and the choice of inputs; and Determination of associations between macroeconomic scenarios and economic inputs such as unemployment levels and collateral values, and the effect on PDs, EADs and LGDs. We review our ECL models on a quarterly basis. We continue to monitor asset performance and economic conditions, including considering regionally specific issues to assess the adequacy of the current provisioning policies. The inputs and models used for calculating ECLs may not always capture all characteristics of the market at the date of the consolidated financial statements. To reflect this, we may make temporary qualitative adjustments or overlays using expert credit judgment when such differences are material. 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, as applicable, using the effective interest rate method. Income 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. ‐ 54 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION 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 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. Income 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. CURRENT PERIOD CHANGES IN ACCOUNTING POLICY On January 1, 2018, we adopted IFRS 9, Financial Instruments, which replaces IAS 39, Financial Instruments: Recognition and Measurement. As permitted, we have not restated comparative information for 2017 for financial instruments in the scope of IFRS 9. All comparative period information is presented in accordance with the accounting policies as described in the annual consolidated financial statements for the year ended December 31, 2017. For further information on the adoption of IFRS 9 refer to Notes 4 and 6 to the consolidated financial statements. STANDARDS ISSUED BUT NOT YET EFFECTIVE Standards issued but not yet effective include IFRS 16, Leases and IFRS Interpretations Committee (“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 DC&P. As of December 31, 2018, 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, 2018. ‐ 55 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION Ernst & Young LLP, our Independent Registered Chartered Professional Accountants, have audited our consolidated financial statements for the year ended December 31, 2018. Changes in ICFR There were no changes in our ICFR that occurred during the period beginning on January 1, 2018 and ending on December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our control framework. 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. ‐ 56 ‐ 2018 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 and Risk Weighted Asset Ratios These measures provided in this MD&A are in accordance with guidelines issued by OSFI and are located on Table 28 of this MD&A and Note 29 to the consolidated financial statements. 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, 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. ‐ 57 ‐ 2018 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 are 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. Karen Weaver Chief Executive Officer, Interim Dipti Patel Vice President and Chief Financial Officer Toronto, Canada, February 22, 2019 ‐ 58 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION INDEPENDENT AUDITOR’S REPORT To the Shareholders and Directors of MCAN Mortgage Corporation Opinion We have audited the consolidated financial statements of MCAN Mortgage Corporation and its subsidiaries (the “Company”), which comprise the consolidated balance sheets as at December 31, 2018 and 2017, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies. In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as at December 31, 2018 and 2017, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards (“IFRS”). Basis for Opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Other Information Management is responsible for the other information. The other information comprises: Management’s Discussion and Analysis The information, other than the consolidated financial statements and our auditor’s report thereon, in the Annual Report Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information, and in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. We obtained Management’s Discussion & Analysis and the Annual Report prior to the date of this auditor’s report. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact in this auditor’s report. We have nothing to report in this regard. Responsibilities of Management and Those Charged with Governance for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRSs, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. ‐ 59 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Company’s financial reporting process. Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit 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 Company’s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Michael Cox. Toronto, Canada February 22, 2019 ‐ 60 ‐ 2018 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 Non‐marketable securities Other loans Equity investment in MCAP Commercial LP Deferred tax asset Other assets Securitization Assets Cash held in trust Mortgages Other assets Liabilities and Shareholders' Equity Liabilities Corporate Liabilities Term deposits Current taxes payable Deferred tax liabilities Other liabilities Securitization Liabilities Financial liabilities from securitization Shareholders' Equity Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Note 2018 1 2017 7 8 9 10 11 16 12 14 12 15 16 16 17 18 19 21 $ $ $ $ 98,842 53,247 922,390 71,813 2,640 61,593 2,961 10,853 1,224,339 26,002 887,252 3,479 916,733 2,141,072 919,623 173 3,478 13,169 936,443 897,935 897,935 1,834,378 221,869 510 84,315 ‐ 306,694 2,141,072 $ $ $ $ 117,571 62,518 863,384 68,190 2,612 59,189 2,672 6,235 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 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. 1 The amounts pertaining to 2018 have been prepared in accordance with IFRS 9, Financial Instruments; prior period amounts have not been restated and have been prepared in accordance with IAS 39, Financial Instruments: Recognition and Measurement. For further information please refer to Note 6. On behalf of the Board: Karen Weaver Chief Executive Officer, Interim Gordon Herridge Director, Chair of the Audit Committee ‐ 61 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands of Canadian dollars except for per share amounts) Years Ended December 31 Note 2018 1 2017 Net Investment Income ‐ Corporate Assets Mortgage interest Equity income from MCAP Commercial LP Non‐marketable securities Marketable securities Fees Interest on cash and other income Realized and unrealized gain (loss) on securities 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 Provision for (recovery of) credit losses Operating Expenses Salaries and benefits General and administrative Net Income Before Income Taxes Provision for (recovery of) income taxes Current Deferred Net Income Basic and diluted earnings per share Dividends per share Weighted average number of basic and diluted shares (000's) 11 22 23 24 11 11 23 24 16 16 $ $ $ $ 51,610 13,188 5,357 3,464 1,909 1,284 (512) 76,300 23,814 4,031 143 188 28,176 48,124 1,701 314 2,015 24,540 360 24,900 17,793 2,133 (2) 19,924 4,976 11,118 7,804 18,922 36,193 283 (383) (100) 36,293 1.54 1.43 23,615 $ $ $ $ 47,765 14,427 8,850 3,722 1,239 1,051 ‐ 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 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. 1 The amounts pertaining to 2018 have been prepared in accordance with IFRS 9, Financial Instruments; prior period amounts have not been restated and have been prepared in accordance with IAS 39, Financial Instruments: Recognition and Measurement. For further information please refer to Note 6. ‐ 62 ‐ 2018 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 realized gains on sale of marketable securities to net income Change in unrealized gain on available for sale non‐marketable securities Transfer of income distribution from available for sale non‐marketable securities to net income Transfer of realized gains on available for sale non‐marketable securities to net income Less: deferred taxes 2018 2017 $ 36,293 $ 39,928 ‐ ‐ ‐ ‐ ‐ ‐ ‐ 2,283 (19) 4,258 (986) (4,324) 122 1,334 Comprehensive income $ 36,293 $ 41,262 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 IFRS 9 transitional adjustment Net income Dividends declared Balance, end of year Accumulated other comprehensive income Balance, beginning of year IFRS 9 transitional adjustment Other comprehensive income Balance, end of year Note 2018 2017 19 $ 214,664 $ 7,205 221,869 210,239 4,425 214,664 510 ‐ 510 510 ‐ 510 65,365 16,420 36,293 (33,763) 84,315 16,438 (16,438) ‐ ‐ 55,923 n/a 39,928 (30,486) 65,365 15,104 n/a 1,334 16,438 6 6 Total shareholders' equity $ 306,694 $ 296,977 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. ‐ 63 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of Canadian dollars) Years Ended December 31 2018 2017 Cash flows from (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 investment in MCAP Commercial LP Provision for (recovery of) credit losses Net unrealized loss on securities Amortization of securitized mortgage and liability transaction costs Amortization of other assets Amortization of mortgage discounts Changes in operating assets and liabilities: Marketable securities Corporate and securitized mortgages Non‐marketable securities Other loans Other assets Cash held in trust Term deposits Financial liabilities from securitization Other liabilities Cash flows from (for) operating activities Investing Activities Distributions from MCAP Commercial LP Proceeds on sale of investment in MCAP Commercial LP Acquisition of capital and intangible assets Cash flows from (for) investing activities Financing Activities Issue of common shares Dividends paid Cash flows from (for) financing activities Increase (decrease) 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 securities $ 36,293 $ 39,928 283 (383) (13,188) (1,701) (314) 186 512 4,950 504 (17) 5,750 66,717 (615) (28) (4,175) (12,561) 35,163 (119,146) (1,969) (3,739) 8,278 4,521 (197) 12,602 7,205 (34,797) (27,592) (18,729) 117,571 98,842 $ ‐ (244) (14,427) (785) (91) (111) ‐ 5,374 550 (91) (5,128) 91,780 (11,978) 972 (1,752) 2,283 (27,406) (57,201) 1,982 23,655 4,971 1,947 (401) 6,517 4,425 (28,758) (24,333) 5,839 111,732 117,571 75,496 $ 38,965 7,867 74,011 35,989 11,535 $ $ 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. ‐ 64 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note Page 1. Corporate Information .......................................................................................................................................... 66 2. Basis of Preparation .............................................................................................................................................. 66 3. Basis of Consolidation ........................................................................................................................................... 66 4. Summary of Significant Accounting Policies ......................................................................................................... 66 5. Significant Accounting Judgments and Estimates ................................................................................................. 76 6. Transition to IFRS 9 ............................................................................................................................................... 77 7. Marketable Securities ........................................................................................................................................... 78 8. Mortgages ‐ Corporate .......................................................................................................................................... 79 9. Non‐Marketable Securities ................................................................................................................................... 85 10. Other Loans........................................................................................................................................................... 86 11. Equity Investment in MCAP Commercial LP ......................................................................................................... 86 12. Other Assets .......................................................................................................................................................... 87 13. Securitization Activities ......................................................................................................................................... 88 14. Mortgages ‐ Securitized ........................................................................................................................................ 89 15. Term Deposits ....................................................................................................................................................... 91 16. Income Taxes ........................................................................................................................................................ 92 17. Other Liabilities ..................................................................................................................................................... 92 18. Financial Liabilities from Securitization ................................................................................................................ 93 19. Share Capital ......................................................................................................................................................... 93 20. Dividends .............................................................................................................................................................. 93 21. Accumulated Other Comprehensive Income ........................................................................................................ 94 22. Realized and Unrealized Gain (Loss) on Securities ............................................................................................... 94 23. Mortgage Expenses ............................................................................................................................................... 94 24. Provision for (Recovery of) Credit Losses ............................................................................................................. 95 25. Related Party Disclosures ..................................................................................................................................... 95 26. Commitments and Contingencies ......................................................................................................................... 97 27. Credit Facilities...................................................................................................................................................... 97 28. Interest Rate Sensitivity ........................................................................................................................................ 98 29. Capital Management ............................................................................................................................................ 99 30. Financial Instruments ......................................................................................................................................... 100 31. Comparative Amounts ........................................................................................................................................ 102 ‐ 65 ‐ 2018 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 is incorporated in Canada with its head office located at 200 King Street West, Suite 600, Toronto, Ontario, Canada. MCAN is listed on the Toronto Stock Exchange under the symbol MKP. MCAN’s objective is to generate a reliable stream of income by investing in a diversified portfolio of Canadian mortgages, including single family residential, residential construction, non‐residential construction and commercial loans, as well as other types of securities, loans and real estate investments. MCAN employs leverage by issuing term deposits eligible for Canada Deposit Insurance Corporation deposit insurance. The Company manages its capital and asset balances based on the regulations and limits of both the Tax Act and OSFI. MCAN’s term deposits are sourced through a network of independent financial agents. MCAN’s wholly‐owned subsidiary, XMC Mortgage Corporation, is an originator of single family residential mortgage products across Canada. The consolidated financial statements were approved in accordance with a resolution of the Board of Directors (the “Board”) on February 22, 2019. 2. Basis of Preparation The consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The consolidated financial statements have been prepared on a historical cost basis, except for marketable securities, foreclosed real estate and non‐marketable securities designated as fair value reported through profit and loss (“FVPL”), which have been measured at fair value. The consolidated financial statements are presented in Canadian dollars. The disclosures that accompany the consolidated financial statements include the significant accounting policies applied (Note 4) and the significant judgments and estimates (Note 5) applicable to the preparation of the consolidated financial statements. Certain disclosures are included in the shaded sections of the “Risk Governance and Management” section of Management’s Discussion and Analysis of Operations (the “MD&A”), as permitted by IFRS, and form an integral part 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 National Housing Act (“NHA”) Mortgage‐ Backed Securities (“MBS”) program and subsequently sold to third parties. These assets are funded by the cash received from the sale of the associated securities, from which the Company records a financial liability from securitization. 3. Basis of Consolidation The consolidated financial statements include the balances of MCAN and its wholly owned subsidiaries as at December 31, 2018, after the elimination of intercompany transactions and balances. The Company consolidates those entities which it controls. The Company has control 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. 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 2018 and 2017 are also discussed below. ‐ 66 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (1) Accounting for financial instruments under IFRS 9, Financial Instruments (“IFRS 9”) On January 1, 2018, the Company adopted IFRS 9, which replaces IAS 39, Financial Instruments: Recognition and Measurement. The Company, as permitted, has not restated comparative information for 2017 for financial instruments in the scope of IFRS 9. All comparative period information is presented in accordance with IAS 39. Refer to Note 4(2) for accounting policies under IAS 39 applied for the comparative period. Differences arising from the adoption of IFRS 9 have been recognized directly in retained earnings as of January 1, 2018 and are disclosed in Note 6. The adoption of IFRS 9 has resulted in changes to the Company’s accounting policies for recognition, classification and measurement of financial assets and liabilities and impairment of financial assets. IFRS 9 also amends IFRS 7, Financial Instruments: Disclosures, which the Company also adopted as of January 1, 2018, to introduce expanded qualitative and quantitative disclosures related to IFRS 9. Classification and measurement 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. To determine their classification and measurement category, IFRS 9 requires all financial assets to be assessed based on a combination of the entity’s business model for managing the assets and the instruments’ contractual cash flow characteristics. 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. The Company’s classification of its financial assets and liabilities and the quantitative impact of applying IFRS 9 as at January 1, 2018 is disclosed in Note 6. 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 effective interest rate method (“EIM”), except for transaction costs which are related to financial assets or financial liabilities at fair value through profit and loss (“FVPL”), which are expensed. a. Debt instruments at amortized cost The Company only measures debt instruments at amortized cost if both of the following conditions are met: The financial asset is held within a business model with the objective to hold financial assets in order to collect contractual cash flows. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding. Business model assessment The Company determines its business model at the level that best reflects how it manages groups of financial assets to achieve its business objective. The business model is not assessed on an instrument‐by‐instrument basis, but at a higher level of aggregated portfolios and is based on observable factors such as: • How the performance of the business model and the financial assets held within that business model are • evaluated and reported to the entity's key management personnel; The risks that affect the performance of the business model (and the financial assets held within that business model) and, in particular, the way those risks are managed; • How managers of the business are compensated (for example, whether the compensation is based on the fair value of the assets managed or on the contractual cash flows collected); and The expected frequency, value and timing of sales are also important aspects of the Company’s assessment. • The SPPI test As a second step of its classification process, the Company assesses the contractual terms of financial instruments to identify whether they meet the SPPI test. “Principal” for the purpose of this test is defined as the fair value of the financial asset at initial recognition and may change over the life of the financial asset (for example, if there are repayments of principal or amortization of the premium/discount). ‐ 67 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) In contrast, contractual terms that introduce a more than a minimal exposure to risks or volatility in the contractual cash flows that are unrelated to a basic lending arrangement do not give rise to contractual cash flows that are SPPI on the amount outstanding. In such cases, the financial asset is required to be measured at FVPL. b. Financial assets and liabilities at FVPL Financial assets and financial liabilities in this category are those that are not held for trading purposes and have been either designated by management upon initial recognition or are mandatorily required to be measured at fair value under IFRS 9. Financial assets at FVPL are recorded in the consolidated balance sheets at fair value. Changes in fair value are recorded in profit and loss. Interest earned or incurred on instruments designated at FVPL is accrued in interest income using the effective interest rate (“EIR”), taking into account any discount/premium and qualifying transaction costs being an integral part of the instrument. Interest earned on assets mandatorily required to be measured at FVPL is recorded using contractual interest rates. Dividend income from equity instruments measured at FVPL is recorded in profit and loss when the right to the payment has been established. c. Financial liabilities The accounting for financial liabilities remains largely the same as it was under IAS 39. 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. Impairment The adoption of IFRS 9 has fundamentally changed the Company’s accounting for impairment by replacing IAS 39’s incurred loss approach with a forward‐looking expected credit loss (“ECL”) approach. IFRS 9 requires the Company to record an allowance for ECLs for all mortgages and other debt financial assets not held at FVPL, together with mortgage commitments and financial guarantee contracts not measured at FVPL. Overview of ECL principles The ECL allowance is based on the credit losses expected to arise over the life of the asset (the lifetime expected credit loss), unless there has been no significant increase in credit risk (“SICR”) since origination, in which case the allowance is based on the 12 months’ expected credit loss. The Company groups its financial assets into Stage 1, Stage 2 and Stage 3, as described below: Stage 1: When mortgages are first recognized, the Company recognizes an allowance based on 12 month ECLs, which represent lifetime ECLs related to default events that are expected to occur within 12 months after the reporting date. Stage 1 mortgages also include facilities where the credit risk has subsequently improved such that the increase in credit risk since initial recognition is no longer significant and the mortgages have been reclassified from Stage 2. Stage 2: When a mortgage has shown a SICR since origination, the Company records an allowance for the lifetime ECLs. Stage 2 mortgages also include facilities where the credit risk has improved and the mortgage has been reclassified from Stage 3. Stage 3: The Company records an allowance for the lifetime ECLs for mortgages considered to be credit‐impaired (as outlined below in “Definition of default and cure”). Both lifetime ECLs and 12 month ECLs are calculated on either an individual basis or a collective basis, depending on the nature of the underlying portfolio of financial instruments. ‐ 68 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) Significant increase in credit risk The Company has established a policy to assess, at the end of each reporting period, whether a financial instrument’s credit risk has increased significantly since initial recognition, by considering the change in the risk of default occurring over the remaining life of the financial instrument. The primary indicators of SICR are relative changes in credit scores for single family mortgages and changes in internal risk ratings for construction and commercial mortgages. The Company also applies a secondary qualitative method for identifying a SICR, such as changes in macroeconomic circumstances or the application of management’s judgment. In certain cases, the Company may also consider that certain events are a SICR as opposed to a default. For a definition of default and cure, refer to the “Definition of default and cure” sub‐section of this note. IFRS 9 provides a rebuttable presumption that a SICR has occurred if contractual payments are more than 30 days past due. The Company has not rebutted this presumption. Calculation of ECLs The Company calculates ECLs based on three probability‐weighted scenarios to measure the expected cash shortfalls, discounted at an approximation to the EIR. The cash shortfall is the difference between the cash flows that are due to the Company in accordance with the contract and the cash flows that the Company expects to receive. The mechanics of the ECL calculations are outlined below and the key elements are as follows: PD: The Probability of Default (“PD”) is an estimate of the likelihood of default over a given time horizon. A default may only happen at a certain time over the assessed period, if the facility has not been previously derecognized and is still in the portfolio. EAD: The Exposure at Default (“EAD”) is an estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of principal and interest, whether scheduled by contract or otherwise, expected drawdowns on committed facilities, and accrued interest from missed payments. LGD: The Loss Given Default (“LGD”) is an estimate of the loss arising in the case where a default occurs at a given time. It is based on the difference between the contractual cash flows due and those that the lender would expect to receive, including from the realization of any collateral. It is usually expressed as a percentage of the EAD. The ECLs are calculated through three probability‐weighted forward‐looking scenarios (base, favourable, and unfavourable). Each of these is associated with different PDs, EADs and LGDs. When relevant, the assessment of multiple scenarios also incorporates how defaulted mortgages are expected to be recovered, including the probability that the mortgages will cure and the value of collateral or the amount that might be received from selling the asset. The maximum period for which the credit losses are determined is the contractual life of a financial instrument unless the Company has the legal right to call the instrument earlier. Mortgage commitments and letters of credit Undrawn mortgage commitments and letters of credit are commitments under which, over the duration of the commitment, the Company is required to advance funds to the borrower. These contracts are in the scope of the ECL requirements. The nominal contractual value of letters of credit and undrawn mortgage commitments, where the mortgage agreed to be provided is on market terms, are not recorded in the consolidated balance sheet. When estimating lifetime ECLs for undrawn mortgage commitments, the Company estimates the portion of the mortgage commitment that will be drawn down over its expected life. Definition of default and cure The Company considers a financial instrument defaulted and therefore Stage 3 (credit‐impaired) for ECL calculations in all cases when the borrower becomes 90 days past due on its contractual payments. In certain other cases, where qualitative thresholds indicate unlikeliness to pay as a result of a credit event, the Company carefully considers whether the event should result in an assessment at Stage 2 or 3 for ECL calculations. The combined impact of several events may cause financial assets to become defaulted as opposed to one discrete event. It is the Company’s policy to consider a financial instrument as “cured” and therefore re‐classified out of Stage 3 when none of the default criteria have been present for at least twelve consecutive months. The decision whether to classify an asset as Stage 2 or Stage 1 once cured depends on the assessment of whether the SICR will reverse. The Company has also set probation periods for an asset to return to Stage 1. ‐ 69 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) Forward‐looking information In its ECL models, the Company relies on a broad range of forward‐looking information as economic inputs, such as: House price indices Real gross domestic product Unemployment rates Market mortgage rates Foreign exchange rate Interest rates The inputs and models used for calculating ECLs may not always capture all characteristics of the market at the date of the consolidated financial statements. To reflect this, the Company may make temporary qualitative adjustments or overlays using expert credit judgment. Modified financial assets In a case where the borrower experiences financial difficulties, the Company may grant certain concessionary modifications to the terms and conditions of a mortgage. If the Company determines that a modification results in an expiry of cash flows, the original financial asset is derecognized while a new asset is recognized based on the new contractual terms. SICR is assessed relative to the risk of default on the date of modification. If the Company determines that a modification does not result in derecognition, SICR is assessed based on the risk of default at initial recognition of the original asset. Expected cash flows arising from the modified contractual terms are considered when calculating the ECL for the modified asset. For mortgages that have been modified while having a lifetime ECL, the mortgages can revert to having a 12‐month ECL after a period of performance and improvement in the borrower’s financial condition. Write‐offs The Company’s accounting policy under IFRS 9 remains the same as it was under IAS 39. Financial assets are written off either partially or in their entirety only when the Company believes that there are no reasonable expected future recoveries. If the amount to be written off is greater than the accumulated loss allowance, the difference is first treated as an addition to the allowance that is then applied against the gross carrying amount. Any subsequent recoveries are credited to provisions for losses. (2) Accounting for financial instruments prior to January 1, 2018 (IAS 39) Classification and measurement All financial instruments are recognized on the trade date and 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. Under IAS 39, subsequent measurement and accounting treatment depended principally on the classification of financial instruments at initial recognition. The classification of an instrument in the measurement categories specified depended on several factors, including the purpose and management’s intention for which the financial instruments were acquired and their contractual characteristics. Under IAS 39, the Company classified its financial instruments in the measurement categories noted below: a. Loans and receivables The loans and receivables category included mortgages, other loans, non‐derivative financial assets and certain non‐ marketable securities with fixed or determinable payments that were not quoted in an active market, other than: Those that the Company intended to sell immediately or in the near term and those that the Company upon initial recognition designated at fair value; Those that the Company, upon initial recognition, designated as available for sale; or Those for which the Company might not have recovered substantially all of its initial investment, other than because of credit deterioration. ‐ 70 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) After initial measurement, financial assets classified as loans and receivables were subsequently measured at amortized cost using the EIM, less any allowance for impairment. Amortized cost was calculated by considering any discount or premium on acquisition and fees and costs that were an integral part of the EIM. The amortization was included in mortgage interest income or interest on cash and other income in the consolidated statements of income. The losses arising from impairment were recognized in the consolidated statements of income. b. Available for sale securities Available for sale securities included marketable securities and non‐marketable securities. Equity investments classified as available for sale were those that were neither classified as held for trading nor designated at fair value through the consolidated statements of income. Certain marketable securities were intended to be held for an indefinite period of time but could have been sold in response to needs for liquidity or in response to changes in the market conditions. c. Financial liabilities The classification and measurement of the Company’s financial liabilities under IAS 39 was the same as it currently is under IFRS 9. Impairment The Company assessed at each consolidated financial statement date whether there was any objective evidence that a financial asset or a group of financial assets was impaired. A financial asset or a group of financial assets was deemed to be impaired if, and only if, there was objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (an incurred “loss event”) and that loss event (or events) had an impact on the estimated future cash flows of the financial asset or the group of financial assets that could be reliably estimated. Impaired mortgages included uninsured mortgages that were more than 90 days in arrears or were less than 90 days in arrears but for which management did not have reasonable assurance that the full amount of principal and interest would be collected in a timely manner. An insured mortgage was considered to be impaired when the mortgage was 365 days past due, whether or not collection was in doubt. Evidence of impairment may have included indications that the borrower or a group of borrowers was experiencing significant financial difficulty, the probability that they would enter bankruptcy or other financial reorganization, default or delinquency in interest or principal payments and where observable data indicated that there was a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults. a. Financial assets carried at amortized cost For financial assets carried at amortized cost, the Company first assessed individually whether objective evidence of impairment existed for financial assets that were significant, or collectively for financial assets that were not individually significant. If the Company determined that no objective evidence of impairment existed for an individually assessed financial asset, it included the asset in a group of financial assets with similar credit risk characteristics and collectively assessed them for impairment. Assets that were individually assessed for impairment and for which an impairment loss was, or continued to be, recognized were not included in a collective assessment of impairment. If there was objective evidence that an impairment loss had occurred, the amount of the loss was 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 had not yet been incurred). The carrying amount of the asset was reduced through the use of an allowance account and the amount of the loss was recognized in the consolidated statements of income. Interest income continued 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 was recorded as part of the related interest income component. Mortgages, together with the associated allowance, were written off when there was no realistic prospect of future recovery and all collateral had been realized. If, in a subsequent period, the amount of the estimated impairment loss increased or decreased because of an event that occurred after the impairment was recognized, the previously recognized impairment loss was increased or reduced by adjusting the allowance account. If a write‐off was later recovered, the recovery was credited to the provision for credit losses. ‐ 71 ‐ 2018 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 was discounted at the financial asset’s original EIR. If a mortgage had a variable interest rate, the discount rate for measuring any impairment loss was 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 were 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 were mapped to rating agency assessments of corporate bonds. Corporate bond historical default rates were 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 were collectively evaluated for impairment were estimated on the basis of historical loss experience for assets with credit risk characteristics similar to those in the group. Historical loss experience was adjusted on the basis of observable data to reflect the effects of current conditions on which the historical loss experience was 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 were reviewed regularly to reduce any differences between loss estimates and actual loss experience. b. Available for sale non‐marketable securities For available for sale non‐marketable securities, the Company assessed at the consolidated financial statement date whether there was objective evidence that an investment or a group of investments was impaired. In the case of equity investments classified as available for sale, one of the indications of impairment was a significant or prolonged decline in the fair value of the investment below its cost. “Significant” was evaluated against the original cost of the investment and “prolonged” against the period in which the fair value had been below its original cost. Where there was 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 ‐ was removed from other comprehensive income and recognized in the consolidated statements of income. Impairment losses on equity investments were not reversed through the consolidated statements of income; increases in their fair value after impairment were recognized directly in other comprehensive income. In the case of debt instruments classified as available for sale, impairment was assessed based on the same criteria as financial assets carried at amortized cost. However, the amount recorded for impairment was 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 continued 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 was recorded to the related interest income component. If, in a subsequent year, the fair value of a debt instrument increased and the increase could be objectively related to an event occurring after the impairment loss was recognized in the consolidated statements of income, the impairment loss was reversed through 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. ‐ 72 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) 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. (4) Derecognition of financial assets and financial liabilities (i) Financial assets Under both IFRS 9 and IAS 39, 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 Under both IFRS 9 and IAS 39, a financial liability is derecognized when the obligation under the liability is discharged, 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. (5) 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 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 or deferred taxes within the MIC entity, however provisions are recorded as applicable in all subsidiaries of MCAN. (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. Current tax related to items recognized directly to accumulated other comprehensive income was recognized in equity and not in the consolidated statements of income. ‐ 73 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (ii) Deferred tax The Company follows the asset and liability method of accounting for income taxes, whereby deferred tax assets and liabilities are recognized for the expected future tax impact of temporary differences between the carrying amounts of certain assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted or substantively enacted tax rates applicable to taxable income in the period in which those temporary differences are expected to be recovered or settled. Deferred tax assets are only recognized for deductible temporary differences, carry forward of unused tax losses to the extent that it is probable that taxable income will be available and the carry forward of unused tax losses can be used. (6) 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. (7) 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. 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 Company 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 Company, adjustments shall be made for the effects of significant transactions or events that occur between that date and the date of the Company’s consolidated financial statements. Where necessary, adjustments are made to harmonize the accounting policies of the associate with those of the Company. The Company determines at each consolidated financial statement date whether there is any objective evidence that the investment in the associate is impaired. The Company calculates the amount of impairment as the difference between the recoverable amount of the investment in 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. (8) Revenue recognition (IFRS 9 & IAS 39) Interest income or expense For all financial assets measured at amortized cost and interest bearing financial assets classified as available for sale under IAS 39, 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. IFRS 15, Revenue from Contracts with Customers (“IFRS 15”) On January 1, 2018, the Company adopted IFRS 15, Revenue from Contracts with Customers that established 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. The standard does not apply to revenue associated with financial instruments under IFRS 9, therefore it did not impact the majority of the Company’s revenue. The adoption of IFRS 15 has had no material impact on the Company’s consolidated financial statements. ‐ 74 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) (9) 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. (10) Share‐based compensation payment transactions The cost of cash‐settled transactions is measured initially at fair value at the grant date. 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. IFRS 2, Share‐based Payment (“IFRS 2”) On January 1, 2018, the Company adopted amendments to IFRS 2, Share‐based Payment that clarified the accounting for the effects on 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 to IFRS 2 have had no impact on the Company’s consolidated financial statements. (11) 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. (12) Provisions Provisions for legal claims are recognized when (a) the Company 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. (13) 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 16, Leases (“IFRS 16”) IFRS 16, Leases sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e., the customer (“lessee”) and the supplier (“lessor”). IFRS 16 is effective for annual periods beginning on or after January 1, 2019. All leases result in a company (the lessee) obtaining the right to use an asset at the start of the lease and, if lease payments are made over time, also obtaining financing. Accordingly, IFRS 16 eliminates the classification of leases as either operating leases or finance leases as is required by IAS 17, Leases and, instead, introduces a single lessee accounting model. Applying that model, a lessee is required to recognize: (a) assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value; and (b) depreciation of lease assets separately from interest on lease liabilities in the consolidated statements of income. As a result of the adoption of IFRS 16, the Company expects to recognize a right‐of‐use asset of approximately $6,550 relating to its premises lease. The Company also expects to recognize a liability for the lease component of the future payments of approximately $6,550. The Company does not expect the adoption of IFRS 16 to have an impact on retained earnings. ‐ 75 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 4. Summary of Significant Accounting Policies (continued) IFRIC 23, Uncertainty over Income Tax Treatments (“IFRIC 23”) This Interpretation clarifies how to apply the recognition and measurement requirements in IAS 12, Income Taxes (“IAS 12”) 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 does not expect the adoption of IFRIC 23 to impact its consolidated financial statements. 5. Significant Accounting Judgments and Estimates The preparation of the Company’s consolidated financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities, at the end of the reporting period. However, uncertainty about these assumptions and estimates could result in outcomes that require a material adjustment to the carrying amount of the asset or liability affected in future periods. 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. Although MCAN’s voting interest in MCAP was less than 20% as at December 31, 2018, 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. Income 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 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 or deferred taxes within the MIC entity, however provisions are recorded as applicable in all subsidiaries of MCAN. 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 judgement 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. 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 of financial assets The measurement of impairment losses both under IFRS 9 and IAS 39 across all categories of financial assets requires judgment, in particular, the estimation of the amount and timing of future cash flows and collateral values when determining impairment losses. These estimates are driven by a number of factors, changes in which, can result in different levels of allowances. ‐ 76 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 5. Significant Accounting Judgments and Estimates (continued) Under IFRS 9, the Company’s ECL calculations are model outputs with a number of underlying assumptions regarding the choice of variable inputs and their interdependencies. Elements of the ECL models that are considered accounting judgments and estimates include: The Company’s criteria for assessing if there has been a SICR which results in allowances being measured on a lifetime versus 12 month ECL basis; The segmentation of financial assets for the purposes of assessing ECL on a collective basis; Development of ECL models, including the various formulas and the choice of inputs; Determination of associations between macroeconomic scenarios and, economic inputs, such as unemployment levels and collateral values, and the effect on PDs, EADs and LGDs; and Forward‐looking information used as economic inputs. The Company may also make temporary qualitative adjustments or overlays using expert credit judgment in the calculations of ECLs, which represent accounting judgments and estimates. 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. 6. Transition to IFRS 9 A reconciliation between the carrying amounts under IAS 39 to the balances reported under IFRS 9 as of January 1, 2018 is as follows: (a) IFRS 9 transition summary Financial instrument Category 4 IAS 39 Amount Remeasurement Amount Category 4 Note IFRS 9 Financial assets Cash and cash equivalents Marketable securities Mortgages ‐ corporate Non‐marketable securities Other loans Cash held in trust Mortgages ‐ securitized Other assets Financial liabilities Term deposits Financial liabilities from securitization L&R AFS L&R AFS L&R L&R L&R FVPL AC AC $ 117,571 $ 62,518 863,384 68,190 2,612 13,441 1,016,724 4,239 2,148,679 $ 884,460 $ 1,015,699 1,900,159 $ $ $ $ 1 2 3 $ ‐ ‐ (1) ‐ ‐ ‐ (17) ‐ (18) $ 117,571 62,518 863,383 68,190 2,612 13,441 1,016,707 4,239 2,148,661 ‐ ‐ ‐ $ $ 884,460 1,015,699 1,900,159 AC FVPL AC FVPL AC AC AC FVPL AC AC 1 Marketable securities are considered to be equity instruments and the Company did not elect to carry them at FVOCI, therefore they are carried at FVPL. 2 Corporate mortgages had their ECL recalculated and other adjustments made upon the adoption of IFRS 9. 3 Non‐marketable securities are considered to be equity instruments and the Company did not elect to carry them at FVOCI, therefore they are carried at FVPL. 4 Category acronyms are as follows: L&R ‐ loans and receivables; AFS ‐ available for sale; FVPL ‐ fair value through profit and loss; AC ‐ amortized cost. ‐ 77 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 6. Transition to IFRS 9 (continued) As an “investment in associate” under IAS 28, the equity investment in MCAP is not directly in the scope of the classification and measurement principles of IFRS 9, which govern financial instruments. Since MCAP’s fiscal year end is November 30, MCAP did not adopt IFRS 9 until December 1, 2018. However, IAS 28 requires the Company to consistently apply its accounting policies in accounting for investments in associates, and therefore the principles of IFRS 9 (including applicable policy choices by the Company), have been reflected in equity income from MCAP and the carrying value of the equity investment. The adoption of IFRS 9 by MCAP is not expected to have a material impact on the Company’s consolidated financial statements. (b) Impact of IFRS 9 transition on retained earnings and accumulated other comprehensive income Retained earnings Closing balance under IAS 39, December 31, 2017 Recognition of expected credit losses on corporate mortgages Recognition of expected credit losses on securitized mortgages Other adjustments ‐ corporate mortgages Reclassification of AFS non‐marketable securities to FVPL Reclassification of AFS marketable securities to FVPL Opening balance under IFRS 9, January 1, 2018 Accumulated other comprehensive income Closing balance under IAS 39, December 31, 2017 Reclassification of AFS non‐marketable securities to FVPL Reclassification of AFS marketable securities to FVPL Opening balance under IFRS 9, January 1, 2018 (c) Reconciliation of mortgage allowances under IAS 39 and IFRS 9 Corporate Insured single family Uninsured single family Uninsured ‐ completed inventory Construction ‐ residential Construction ‐ non‐residential Commercial ‐ multi family residential Commercial ‐ other Corporate total Securitized Total 7. Marketable Securities As at December 31 Real estate investment trusts Corporate bonds $ 65,365 (52) (17) 51 13,125 3,313 81,785 16,438 (13,125) (3,313) ‐ $ $ $ IAS 39 Remeasurement IFRS 9 $ $ ‐ 910 220 2,536 32 423 689 4,810 ‐ $ 4,810 $ 2 $ (526) 180 38 22 184 152 52 17 69 $ 2 384 400 2,574 54 607 841 4,862 17 4,879 2018 53,218 29 53,247 $ $ 2017 61,973 545 62,518 $ $ For details of realized and unrealized gains on marketable securities, refer to Note 22. ‐ 78 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (a) Summary As at December 31, 2018 (IFRS 9) Corporate portfolio: Single family mortgages ‐ Insured ‐ Uninsured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non‐residential Commercial loans ‐ Multi family residential ‐ Other commercial As at December 31, 2017 (IAS 39) Corporate portfolio: Single family mortgages ‐ Insured ‐ Uninsured ‐ Uninsured ‐ completed inventory Construction loans ‐ Residential ‐ Non‐residential Commercial loans ‐ Multi family residential ‐ Other commercial Net Principal 111,419 255,545 7,703 422,561 11,018 Gross Principal Allowance Stage 1 Stage 2 Stage 3 Total $ $ 111,419 256,687 7,747 $ ‐ 738 44 425,272 11,082 2,146 64 50,613 64,424 468 393 ‐ 191 ‐ 348 ‐ 12 20 $ 927,244 $ 3,853 $ 571 $ $ ‐ $ ‐ $ 213 ‐ 217 ‐ 1,142 44 2,711 64 ‐ ‐ 430 $ 480 413 4,854 $ 50,133 64,011 922,390 Gross Principal Collective Allowance Individual Total Net Principal $ $ 80,377 199,264 51,410 $ ‐ 848 220 $ ‐ 62 ‐ $ ‐ 910 220 80,377 198,354 51,190 389,098 4,872 65,078 78,095 2,536 32 423 689 ‐ ‐ ‐ ‐ $ 868,194 $ 4,748 $ 62 $ 2,536 32 423 689 4,810 $ 386,562 4,840 64,655 77,406 863,384 Gross principal as presented in the tables above includes unamortized capitalized transaction costs and accrued interest. (b) Mortgages by Risk Rating The Company’s internal risk rating system involves judgment and combines multiple factors to arrive at a borrower‐specific score to assess the borrower’s probability of default and ultimately classify the mortgage into one of the categories listed in the table below. For single family mortgages, these factors include the loan to value ratio, the borrower’s ability to service debt, property location and credit score. For construction, commercial and completed inventory loans, these factors include borrower net worth, project presales, experience with the borrower, project location and loan to value ratio. The internal risk ratings presented in the table below are defined as follows: Very Low/Low: Mortgages that have below average probability of default with credit risk that is lower than the Company’s risk appetite and risk tolerance levels. Normal/Moderate: Mortgages that have an average probability of default with credit risk that is within the Company’s risk appetite and risk tolerance. High/Higher: Mortgages that may have a higher probability of default but are within the Company’s risk appetite or have subsequently experienced an increase in credit risk. The proportion of mortgages originated in this category is managed to the Company’s overall risk appetite and tolerance levels. Monitored/Watchlist/Arrears: Mortgages that are past due but less than 90 days in arrears or mortgages for which an escalated concern has arisen. Impaired/Default: Mortgages that are over 90 days past due or mortgages for which there is objective evidence of impairment. ‐ 79 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) The table below shows the credit quality of the Company’s corporate mortgage portfolio based on the Company’s internal risk rating system and stage classification. The Company’s policy that outlines whether ECL allowances are calculated on an impaired or performing basis are set out in Note 4. As at December 31, 2018 Stage 1 Stage 2 Stage 3 Total Insured single family Insured performing Arrears Impaired/default Uninsured single family Very low risk Low risk Normal risk Moderate risk High risk Arrears Impaired/default Uninsured completed inventory Moderate risk High risk Construction ‐ Residential Moderate risk High risk Higher risk Monitored/Watchlist Arrears Construction ‐ Non‐residential High risk Higher risk Commercial ‐ Multi family residential Normal risk Moderate risk Higher risk Monitored/Watchlist Commercial ‐ Other Low risk Normal risk Moderate risk High risk Higher risk $ 102,672 $ 7,153 $ $ $ $ $ $ $ ‐ ‐ 102,672 45,412 60,761 82,884 15,718 13,731 ‐ ‐ 218,506 3,760 3,943 7,703 49,161 167,063 144,860 ‐ ‐ 361,084 5,891 5,127 11,018 10,060 14,123 23,871 ‐ 48,054 3,081 18,885 11,974 7,184 19,352 60,476 $ $ $ $ $ $ 590 ‐ 7,743 6,234 6,147 11,020 4,929 1,416 5,691 ‐ 35,437 ‐ ‐ ‐ ‐ 2,336 29,831 28,762 ‐ 60,929 ‐ ‐ ‐ ‐ ‐ ‐ 2,079 2,079 ‐ ‐ ‐ ‐ 3,535 3,535 $ $ $ $ $ $ ‐ ‐ 1,004 1,004 ‐ ‐ ‐ ‐ ‐ ‐ 1,602 1,602 ‐ ‐ ‐ ‐ ‐ ‐ ‐ 548 548 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ $ $ $ $ $ $ 109,825 590 1,004 111,419 51,646 66,908 93,904 20,647 15,147 5,691 1,602 255,545 3,760 3,943 7,703 49,161 169,399 174,691 28,762 548 422,561 5,891 5,127 11,018 10,060 14,123 23,871 2,079 50,133 3,081 18,885 11,974 7,184 22,887 64,011 $ 809,513 $ 109,723 $ 3,154 $ 922,390 ‐ 80 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) (c) Mortgage Allowances Details of the allowance for credit losses for the current year recorded under IFRS 9 are as follows: Stage 1 Stage 2 Stage 3 Total Insured single family Allowance, January 1, 2018 $ 2 $ Net remeasurement of allowance 1 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Write‐offs Allowance, December 31, 2018 Uninsured single family Allowance, January 1, 2018 Transfer to stage 1 3 Transfer to stage 2 3 Transfer to stage 3 3 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Write‐offs Allowance, December 31, 2018 Uninsured completed inventory Allowance, January 1, 2018 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Allowance, December 31, 2018 Construction ‐ Residential Allowance, January 1, 2018 Transfer to stage 1 3 Transfer to stage 2 3 Transfer to stage 3 3 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Reclassification of mortgages Allowance, December 31, 2018 11 (2) 9 (11) ‐ $ ‐ ‐ ‐ ‐ ‐ ‐ $ ‐ ‐ ‐ ‐ ‐ ‐ 2 11 (2) 9 (11) ‐ $ 205 $ 58 $ 121 $ 384 164 (275) (9) 302 439 (87) 534 (1) 738 (164) 275 (71) 125 1 (33) 133 ‐ 191 $ 338 $ 62 $ (42) 73 (325) (294) 44 ‐ ‐ (62) (62) ‐ $ 2,239 $ 335 $ 113 (125) (27) 211 786 (1,021) (63) (30) 2,146 (91) 125 ‐ (8) ‐ (13) 13 ‐ 348 ‐ ‐ 80 460 ‐ (204) 336 (244) 213 ‐ ‐ ‐ ‐ ‐ ‐ ‐ (22) ‐ 27 212 ‐ ‐ 217 ‐ 217 ‐ ‐ ‐ 887 440 (324) 1,003 (245) 1,142 $ 400 (42) 73 (387) (356) 44 $ 2,574 ‐ ‐ ‐ 415 786 (1,034) 167 (30) 2,711 ‐ 81 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) Stage 1 Stage 2 Stage 3 Total Construction ‐ Non‐residential Allowance, January 1, 2018 $ 54 $ Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Allowance, December 31, 2018 Commercial ‐ Multi‐family Allowance, January 1, 2018 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Allowance, December 31, 2018 Commercial ‐ Other Allowance, January 1, 2018 Transfer to stage 1 3 Transfer to stage 2 3 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses Reclassification of mortgages Allowance, December 31, 2018 Total Allowance, January 1, 2018 (18) 46 (18) 10 64 $ ‐ ‐ ‐ ‐ ‐ ‐ $ 563 $ 44 $ (70) 314 (339) (95) 468 (4) ‐ (28) (32) 12 $ 597 $ 244 $ 53 (76) (383) 458 (286) (234) 30 393 (53) 76 (85) ‐ (162) (224) ‐ 20 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ 54 (18) 46 (18) 10 64 $ 607 (74) 314 (367) (127) 480 $ 841 ‐ ‐ (468) 458 (448) (458) 30 413 $ 3,998 $ 743 $ 121 $ 4,862 Transfer to stage 1 3 Transfer to stage 2 3 Transfer to stage 3 3 Net remeasurement of allowance 1 New originations or purchases 4 Mortgages derecognized or repaid 2 Total provision for (recovery of) credit losses 330 (476) (36) 11 2,116 (2,078) (133) (308) 476 (71) 28 1 (298) (172) Write‐offs Allowance, December 31, 2018 (12) 3,853 $ $ ‐ 571 $ (22) ‐ 107 672 ‐ (204) 553 (244) 430 $ ‐ ‐ ‐ 711 2,117 (2,580) 248 (256) 4,854 1 Represents the change in the allowance related to changes in model inputs and assumptions. This includes remeasurement between twelve‐month and lifetime ECLs following stage transfers, changes to forward‐looking macroeconomic conditions, changes in the level of risk, and changes to other parameters used in the ECL model. 2 Reflects the decrease in the allowance related to mortgages that were repaid or derecognized during the period. 3 Represents movements between ECL stages and excludes the impact to the allowance of remeasurement between twelve‐month and lifetime ECLs and changes in risk. 4 Reflects the increase in allowance related to mortgages newly recognized during the period. This includes mortgages that were newly originated, purchased, or derecognized following a modification of terms. ‐ 82 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) In calculating the ECL, the Company employs internally developed models that utilize forward‐looking economic factors to determine the parameters for PD, LGD, and EAD. Three forward‐looking probability‐weighted macroeconomic forecasts (favourable, unfavourable, and base case forecast) are generated as part of the ECL process. The macroeconomic variables used in these forecasts are projected over the forecast period and could have a material impact in determining ECLs. Outcomes under the favourable and unfavourable forecasts are generated based on historical distributions relative to the base case forecast. A cross‐functional internal management committee reviews the proposed probability weights assigned to each of the three forecasts. The above committee may apply judgment to adjust the weights when changes are noted in relevant macroeconomic indicators. The allowance for credit losses is sensitive to the inputs used in the Company’s ECL models, the macroeconomic variables used in the three forward‐looking forecasts and the probability weights assigned to those forecasts. Changes in these items would have an impact on the measurement of ECLs. The following table represents the average values of the macroeconomic variables used in these forecasts: Macroeconomic variables Housing Price Index (annual change) Canada Greater Toronto Area Greater Vancouver Area Gross domestic product (annual change) Unemployment rate Interest rates Prime rate 5 year Government of Canada bond 5 year mortgage rate2 Canadian/US dollar exchange rate2 Base Favourable Unfavourable Next 12 months1 2 to 5 Next 12 Years1 months1 2 to 5 Next 12 Years1 months1 2 to 5 Years1 0.50% 0.81% 0.22% 1.78% 5.73% 0.50% 0.64% 0.72% 1.78% 5.87% 1.60% 2.05% 2.34% 2.32% 5.11% 0.63% 0.81% 0.93% 1.84% 4.79% (1.74%) (2.23%) (2.54%) (2.35%) 7.19% (0.22%) (0.28%) (0.32%) 1.26% 7.92% 4.33% 2.50% 4.51% 1.31 $ 4.76% 2.86% 4.61% 1.28 $ 4.83% 2.50% 4.49% 1.44 $ 5.26% 3.35% 4.93% 1.42 $ 4.08% 1.31% 4.14% 1.63 $ 4.51% 0.51% 3.32% 1.74 $ 1 The numbers represent the average values over the quoted period. 2 Variables are derived from regression models which consider the other macroeconomic variables. Assuming a 100% base case economic forecast with the incorporation of the impact of the migration of mortgages between stages, with all other assumptions held constant, the allowance for performing mortgages would be approximately $3,953 as at December 31, 2018 compared to the reported allowance for performing mortgages of $4,424. Assuming a 100% unfavourable economic forecast with the incorporation of the impact of the migration of mortgages between stages, with all other assumptions held constant, the allowance for performing mortgages would be approximately $5,541 as at December 31, 2018 compared to the reported allowance for performing mortgages of $4,424. Details of the allowances for mortgage credit losses for the prior year comparative period under IAS 39 are as follows: For the Year Ended December 31, 2017 Collective Individual Total Balance, beginning of year Provisions for (recoveries of) losses Reversal of provisions Write‐offs, net Balance, end of year $ $ 4,859 (107) ‐ (4) 4,748 $ $ 390 345 (169) (504) 62 $ $ 5,249 238 (169) (508) 4,810 ‐ 83 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) (d) Arrears and Impaired Mortgages Mortgages past due but not impaired are as follows: As at December 31, 2018 (IFRS 9) 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days Total Single family ‐ insured Single family ‐ uninsured As at December 31, 2017 (IAS 39) Single family ‐ insured Single family ‐ uninsured $ $ $ $ 490 5,097 5,587 1 to 30 days 1,296 3,303 4,599 $ $ $ $ 100 311 411 31 to 60 days 157 225 382 $ $ $ $ ‐ 283 283 61 to 90 days ‐ 688 688 $ $ $ $ ‐ ‐ ‐ Over 90 days 569 ‐ 569 $ $ $ $ 590 5,691 6,281 Total 2,022 4,216 6,238 Impaired mortgages (net of individual allowances) are as follows: As at Ontario Alberta British Columbia Quebec Atlantic Provinces Other December 31, 2018 (IFRS 9) SF Insured SF Uninsured Construction December 31, 2017 (IAS 39) Total SF Insured SF Uninsured Total $ $ 146 276 ‐ 165 417 ‐ 1,004 $ 323 312 488 ‐ ‐ 479 $ 548 $ ‐ ‐ ‐ ‐ ‐ $ 1,602 $ 548 $ 1,017 $ 588 488 165 417 479 3,154 $ ‐ 32 ‐ 526 ‐ 274 832 $ $ 86 1,546 ‐ ‐ 64 ‐ 1,696 $ $ 86 1,578 ‐ 526 64 274 2,528 (e) Geographic Analysis As at December 31, 2018 (IFRS 9) Single Family Construction Commercial Total Ontario Alberta British Columbia Quebec Atlantic Provinces Other $ $ 239,515 59,245 45,701 8,988 12,994 8,224 374,667 $ $ 195,662 28,943 197,322 11,652 ‐ ‐ 433,579 $ $ 64,891 2,079 47,174 ‐ ‐ ‐ 114,144 As at December 31, 2017 (IAS 39) Single Family Construction Commercial 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 $ $ $ $ 500,068 90,267 290,197 20,640 12,994 8,224 922,390 Total 477,704 111,017 242,613 9,357 13,681 9,012 863,384 54.2% 9.8% 31.5% 2.2% 1.4% 0.9% 100.0% 55.3% 12.9% 28.1% 1.1% 1.6% 1.0% 100.0% ‐ 84 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 8. Mortgages ‐ Corporate (continued) (f) Other Information The weighted average yield of the Company’s corporate mortgage portfolio as at the dates below is 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 Corporate Portfolio Outstanding commitments for future fundings of mortgages 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 2018 3.11% 4.49% 6.30% 6.26% 7.47% 5.40% 6.74% 5.39% 2017 3.22% 4.72% 6.17% 5.58% 5.25% 5.11% 7.81% 5.36% 2018 2017 $ $ 26,875 27,954 209 332,786 203 630 415 389,072 $ $ 27,797 9,535 1,955 246,550 2,720 1,362 1,285 291,204 Only a portion of the mortgage commitments issued by the Company are expected to fund. Accordingly, these amounts do not necessarily represent future cash requirements of the Company. The fair value of the corporate mortgage portfolio as at December 31, 2018 was $927,079 (December 31, 2017 ‐ $869,147). 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 28. As at December 31, 2018, single family insured mortgages included $67,972 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, 2017 ‐ $28,597). 9. Non‐Marketable Securities As at December 31 Investment ‐ KingSett High Yield Fund Investment ‐ Crown Realty II Limited Partnership 2018 2017 $ $ 42,202 29,611 71,813 $ $ 36,153 32,037 68,190 The Company holds an investment in the KingSett High Yield Fund (“KSHYF”), in which it has an 7.9% equity interest (December 31, 2017 ‐ 8.1%). The KSHYF invests in mortgages secured by real estate with a focus on mezzanine, subordinate and bridge mortgages. As mortgage advances are made by the KSHYF, the Company advances its proportionate share. The KSHYF pays a base distribution of 9% per annum, and distributes any additional income earned on a quarterly basis. As at December 31, 2018, the Company’s total remaining commitment to the KSHYF was $20,948 (December 31, 2017 ‐ $26,483), consisting of $nil of capital advances for the KSHYF (December 31, 2017 ‐ $5,483) and $20,948 that supports credit facilities throughout the life of the KSHYF (December 31, 2017 ‐ $21,000). The fair value of the KSHYF is based on its redemption value. ‐ 85 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 9. Non‐Marketable Securities (continued) The Company holds an investment in Crown Realty II Limited Partnership (“Crown LP”), in which it has a 14.1% equity interest (December 31, 2017 ‐ 14.1%). 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 based on building rental rates and current market capitalization rates. During 2018, Crown LP sold the last remaining property in its opportunity fund and paid a distribution of $5,070 which reduced the carrying value of the investment in Crown LP. The remaining properties held by Crown LP are held in its core fund. For details of realized and unrealized gains on non‐marketable securities, refer to Note 22. 10. Other Loans As at December 31 Loans receivable ‐ Executive Share Purchase Plan Loans receivable ‐ other 11. Equity Investment in MCAP Commercial LP Note 25 2018 2017 $ $ 1,784 $ 856 2,640 $ 1,141 1,471 2,612 As at December 31, 2018, the Company held a 13.71% equity interest in MCAP (December 31, 2017 ‐ 14.41%), consisting of 14.1% of voting class A units (December 31, 2017 ‐ 14.7%), 0% of non‐voting class B units (December 31, 2017 ‐ 0%) and 16.0% of non‐voting class C units (December 31, 2017 ‐ 16.7%). The equity interest represents 4.0 million units held by MCAN (December 31, 2017 ‐ 4.2 million) of the 29.2 million total outstanding MCAP partnership units (December 31, 2017 ‐ 29.1 million). The following key transactions occurred in 2018: MCAP issued 252,588 new class B units at a price in excess of the carrying value per unit, resulting in a dilution gain of $314. MCAN sold 200,000 partnership units in MCAP at a price of $22.60 per unit, recognizing a gain on sale of $1,701. 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 180,568 additional class B units to other partners of MCAP at a price in excess of the carrying value per unit, resulting in a dilution gain of $91. 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 at “fair market value”, which would be determined by an independent valuator agreed upon by both parties. ‐ 86 ‐ 2018 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. Other Assets As at December 31 Corporate assets: Intangible assets, net Capital assets, net Prepaid expenses Related party receivable ‐ MCAP Receivables Foreclosed real estate 2018 59,189 13,188 314 (2,820) (8,278) 61,593 $ $ 2017 50,805 14,427 91 (1,163) (4,971) 59,189 $ $ 2018 2017 $ 34,919,316 34,458,933 460,383 $ 29,719,416 29,279,919 439,497 2018 2017 $ 532,538 94,555 $ 499,379 99,598 2018 2017 $ $ 581 794 985 8,032 26 435 10,853 $ $ 918 766 841 3,135 140 435 6,235 The related party receivable from MCAP consists primarily of net principal and interest collected by MCAP in its role as a mortgage servicer, which is remitted to MCAN on the next business day. Other securitization assets, totalling $3,479 as at December 31, 2018 (December 31, 2017 ‐ $4,239), consist of interest‐only strips from Canada Mortgage Bonds (“CMB”) program multi‐family securitizations and prepaid expenses. ‐ 87 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 12. Other Assets (continued) The capital assets and intangible assets continuity is as follows: Cost At January 1, 2017 Additions At December 31, 2017 Additions At December 31, 2018 Amortization At January 1, 2017 Amortization for the year At December 31, 2017 Amortization for the year At December 31, 2018 Net Book Value At December 31, 2017 At December 31, 2018 Furniture & Fixtures Computer Hardware Leasehold Improvements Capital Assets Total Intangible Assets $ $ 816 8 824 5 829 800 5 805 7 812 $ 1,716 64 1,780 173 1,953 1,482 96 1,578 104 1,682 1,837 30 1,867 9 1,876 1,276 46 1,322 48 1,370 $ 4,369 $ 102 4,471 187 4,658 3,558 147 3,705 159 3,864 $ 19 17 $ 202 271 $ 545 506 $ 766 794 $ 5,246 227 5,473 7 5,480 4,226 329 4,555 344 4,899 918 581 13. 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. 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. Pursuant to the NHA MBS program, MBS investors receive monthly cash flows consisting of interest and scheduled and unscheduled principal payments. Canada Mortgage and Housing Corporation (“CMHC”) makes principal and interest payments in the event of any MBS default by the issuer, thus fulfilling the Timely Payment obligation to investors. 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. In the case of mortgage defaults, MCAN is required to make scheduled principal and interest payments to investors as part of the Timely Payment obligation 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. Market MBS Program During 2018, MCAN securitized $140,525 of MBS through the market MBS program (2017 ‐ $47,050). In 2018, MCAN retained $46,352 of the MBS securitized on its corporate balance sheet (2017 ‐ $nil) with the remainder sold to third parties. CMB Program During 2018, MCAN securitized $28,417 of insured single family mortgages through the CMB program (2017 ‐ $62,653). Other Accounting Considerations The primary risks associated with the market MBS program and CMB program are prepayment, liquidity and funding risk, including the requirement to fund 100% of any cash shortfall related to the above‐noted Timely Payment obligation. Please refer to the “Risk Governance and Management” section of the MD&A where these risks are discussed further. ‐ 88 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 13. Securitization Activities (continued) 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, 2018 was $887,252 (December 31, 2017 ‐ $1,016,724) (Note 14). The financial liabilities from securitization balance as at December 31, 2018 was $897,935 (December 31, 2017 ‐ $1,015,699) (Note 18). Transferred financial assets that are derecognized in their entirety but where the Company has a continuing involvement In previous years, MCAN sold MBS and in some cases sold the associated interest‐only strips to third parties. Accordingly, MCAN then derecognized 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. Accordingly, 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, 2018. The MBS mature as follows: December 31, 2018 December 31, 2017 $ $ 94,348 108,990 $ $ 72,403 73,786 $ $ 9,440 9,678 $ $ 176,191 192,454 2020 2021 2026 Total 14. Mortgages ‐ Securitized (a) Summary As at December 31, 2018 (IFRS 9) Gross Principal Stage 1 Allowance Stage 2 Single family insured ‐ Market MBS program Single family insured ‐ CMB program $ $ 722,730 $ 164,536 887,266 $ 4 $ 4 8 $ ‐ $ 6 6 $ Total 4 $ 10 14 $ Net Principal 722,726 164,526 887,252 Net Principal Gross Principal Allowance $ $ 867,406 $ 149,318 1,016,724 $ ‐ $ ‐ ‐ $ 867,406 149,318 1,016,724 As at December 31, 2017 (IAS 39) Single family insured ‐ Market MBS program Single family insured ‐ CMB program (b) Mortgages by Risk Rating The table below shows the credit quality of the Company’s securitized mortgage portfolio based on the Company’s internal risk rating system and stage classification. The Company’s policy that outlines whether ECL allowances are calculated on an impaired or performing basis are set out in Note 4. The Company’s internal risk rating system combines multiple factors to arrive at a borrower credit score and ultimately classify the mortgage into one of the categories listed in the table below. These factors include the loan to value ratio, the borrower’s ability to service debt, property location and credit score. ‐ 89 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 14. Mortgages ‐ Securitized (continued) As at December 31, 2018 Stage 1 Stage 2 Stage 3 Total Market MBS program Insured performing Arrears Impaired/default CMB program Insured performing Arrears Impaired/default (c) Mortgage Allowances $ 653,635 $ 63,057 $ ‐ ‐ 653,635 4,618 ‐ 67,675 $ $ 157,624 ‐ ‐ 157,624 $ 6,409 108 ‐ 6,517 ‐ ‐ 1,416 1,416 ‐ ‐ 385 385 $ $ 716,692 4,618 1,416 722,726 164,033 108 385 164,526 $ 811,259 $ 74,192 $ 1,801 $ 887,252 The allowance for credit losses on the securitized portfolio recorded under IFRS 9 at December 31, 2018 was $14 (December 31, 2017 recorded under IAS 39 ‐ $nil). There was a recovery of credit losses on this portfolio recorded under IFRS 9 during 2018 of $2 (2017 recorded under IAS 39 ‐ $nil). (d) Arrears and Impaired Mortgages Securitized mortgages past due but not impaired are as follows: As at December 31, 2018 (IFRS 9) Single family ‐ Market MBS Program Single family ‐ CMB Program As at December 31, 2017 (IAS 39) Single family ‐ Market MBS program Single family ‐ CMB program 1 to 30 days 31 to 60 days 61 to 90 days Over 90 days $ $ 3,184 ‐ 3,184 $ $ 797 108 905 $ $ 637 ‐ 637 $ $ ‐ ‐ ‐ 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 Total 4,618 108 4,726 Total 8,523 280 8,803 $ $ $ $ Impaired securitized mortgages are as follows: As at Ontario Alberta British Columbia Other December 31, 2018 (IFRS 9) CMB Market MBS Total December 31, 2017 (IAS 39) CMB Market MBS Total $ $ ‐ 385 ‐ ‐ 385 $ $ $ 311 467 205 433 311 $ 852 205 433 1,416 $ 1,801 $ ‐ ‐ ‐ ‐ ‐ $ $ ‐ ‐ ‐ ‐ ‐ $ $ ‐ ‐ ‐ ‐ ‐ ‐ 90 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 14. Mortgages ‐ Securitized (continued) (e) Geographic Analysis As at Ontario Alberta British Columbia Quebec Atlantic Provinces Other (f) Other Information December 31, 2018 (IFRS 9) December 31, 2017 (IAS 39) $ $ 532,817 195,414 65,229 29,952 38,287 25,553 887,252 60.1% 22.0% 7.4% 3.4% 4.3% 2.8% 100.0% $ 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% Certain capitalized transaction costs are included in mortgages and are amortized using the EIM. As at December 31, 2018, the unamortized capitalized cost balance was $3,932 (December 31, 2017 ‐ $6,536). The fair value of the securitized mortgage portfolio as at December 31, 2018 was $891,938 (December 31, 2017 ‐ $1,031,154). 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 15. Term Deposits As at December 31 Maturity Date Within 3 Months 3 Months to 1 Year 1 to 3 Years 3 to 5 Years Total 2018 2.47% 2.34% 2.44% 2017 2.49% 2.22% 2.45% 2018 2017 $ $ 41,664 317,006 472,342 88,611 919,623 $ $ 98,760 314,574 318,321 152,805 884,460 Weighted Average Interest Rate 2.72% 2.34% The estimated fair value of term deposits as at December 31, 2018 was $917,663 (December 31, 2017 ‐ $882,553), and is determined by discounting the contractual cash flows using market interest rates currently offered for deposits of similar remaining maturities. ‐ 91 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 16. 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) Non‐marketable securities Relating to loss carry forward benefit Other The composition of the deferred tax asset and liability is as follows: As at December 31 Deferred tax asset Loss carry forward benefit Other Deferred tax liability Non‐marketable securities Other 2018 36,193 0% ‐ (100) (100) 2017 39,684 0% ‐ (244) (244) $ $ $ $ 2018 2017 $ 283 $ ‐ (80) (696) 393 (383) (100) 2018 2,754 207 2,961 3,444 34 3,478 $ $ $ $ $ 596 (580) (260) (244) (244) 2017 2,058 614 2,672 3,524 48 3,572 $ $ $ $ $ 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 non‐marketable securities were $nil in 2018 (2017 ‐ $ 122). The Company has loss carry forward amounts in the non‐consolidated MIC entity of $8,250 (December 31, 2017 ‐ $11,269), the benefit of which has not been recorded in deferred tax assets. This balance only includes assessed fiscal years and does not incorporate taxable income for 2018. Tax loss carry forwards expire after 20 years, as follows: 2033 2034 2036 17. Other Liabilities As at December 31 Accounts payable and accrued charges Dividends payable ‐ 92 ‐ $ $ 2,508 5,535 207 8,250 2018 $ $ 5,553 7,616 13,169 $ $ 2017 7,417 8,650 16,067 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 18. Financial Liabilities from Securitization As at December 31 Financial liabilities ‐ Market MBS program Financial liabilities ‐ CMB program Note 13 13 2018 2017 $ $ 734,525 163,410 897,935 $ $ 868,244 147,455 1,015,699 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 Financial liabilities from securitization mature as follows: As at December 31 2018 2019 2020 2021 2022 2023 19. Share Capital 2018 1.87% 1.80% 1.86% 2017 1.83% 1.64% 1.80% 2018 2017 $ $ ‐ 323,635 310,763 98,671 78,060 86,806 897,935 $ $ 99,020 397,944 349,519 90,813 78,403 ‐ 1,015,699 Number of Shares 2018 Number of Shares 2017 Balance, beginning of year Issued Dividend reinvestment plan Executive Share Purchase Plan Balance, end of year 23,377,785 $ 214,664 23,075,227 $ 210,239 367,942 52,737 23,798,464 6,462 743 221,869 $ 295,849 6,709 23,377,785 4,325 100 214,664 $ The authorized share capital of the Company consists of unlimited common shares with no par value. The Company issues 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 2018 fourth quarter dividend was 18% (2017 fourth quarter ‐ 17%). For details on the Executive Share Purchase Plan, refer to Note 25. The Company had no potentially dilutive instruments as at December 31, 2018 or December 31, 2017. 20. Dividends On February 22, 2019, the Board declared a quarterly dividend of $0.32 per share payable March 29, 2019 to shareholders of record as of March 15, 2019. ‐ 93 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 21. Accumulated Other Comprehensive Income Under IAS 39, accumulated other comprehensive income consisted of unrealized gains and losses on available for sale marketable securities and non‐marketable securities. Upon the adoption of IFRS 9 on January 1, 2018, all available for sale assets were reclassified to FVPL, therefore as at this date the accumulated other comprehensive income balance was reclassified to retained earnings. As at December 31 Unrealized gain on available for sale marketable securities Unrealized gain on available for sale non‐marketable securities Less: deferred taxes 2018 2017 ‐ ‐ ‐ ‐ ‐ $ 3,313 15,183 (2,058) 13,125 $ 16,438 $ $ 22. Realized and Unrealized Gain (Loss) on Securities Upon the adoption of IFRS 9 on January 1, 2018, marketable securities and non‐marketable securities were reclassified to FVPL, with fair value changes recorded through profit and loss. Under IAS 39, fair value changes were recorded through accumulated other comprehensive income. Years Ended December 31 Realized and unrealized gain (loss) on marketable securities Realized and unrealized gain (loss) on non‐marketable securities 23. Mortgage Expenses Corporate Assets Years Ended December 31 Mortgage servicing expense Letter of credit expense Other mortgage expenses 2018 2017 (3,521) 3,009 (512) $ $ ‐ ‐ ‐ 2018 2,918 732 381 4,031 $ $ 2017 2,991 588 298 3,877 $ $ $ $ Letter of credit expense relates to outstanding letters of credit in the Company’s credit facility, discussed in Note 27. Securitization Assets Mortgage expenses associated with securitization assets consist primarily of mortgage servicing expenses. ‐ 94 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 24. Provision for (Recovery of) Credit Losses Years Ended December 31 Note 2018 2017 IFRS 9 provisions (recoveries) ‐ corporate Stage 1 ‐ provisions on performing mortgages Stage 2 ‐ provisions on performing mortgages Stage 3 ‐ provisions on impaired mortgages IAS 39 provisions (recoveries) ‐ corporate Collective provisions Individual provisions Other provisions (recoveries), net Corporate provision for (recovery of) credit losses IFRS 9 classifications ‐ securitized mortgages Stage 1 ‐ provisions on performing mortgages Stage 2 ‐ provisions on performing mortgages Securitized provision for (recovery of) credit losses 25. Related Party Disclosures 8 8 8 8 8 $ $ (133) (172) 553 248 n/a n/a (60) 188 (7) 5 (2) $ $ n/a n/a n/a n/a (107) 176 (180) (111) n/a n/a n/a Transactions between the Company and its subsidiaries meet the definition of related party transactions. If these transactions are eliminated on consolidation, they are not disclosed as related party transactions. In 2018, the Company entered into related party transactions with MCAP as follows: Purchase of corporate services of $nil (2017 ‐ $100) Purchase of mortgage origination and administration services of $3,338 (2017 ‐ $3,794) Received mortgage fees of $3,320 (2017 ‐ $4,270) Purchase of $12,744 of uninsured single family mortgages (2017 ‐ $4,496) All related party transactions noted above were in the normal course of business. Key management personnel of the Company consists of individuals that have authority and responsibility for planning, directing and controlling the activities of the Company, directly or indirectly. Key management personnel includes the members of the Board. The compensation of key management personnel is as follows: Years Ended December 31 Short term employee benefits (salaries, benefits and director fees) Share‐based payments (DSU, RSU, PSU) Termination benefits Executive Share Purchase Plan 2018 3,590 (271) 570 3,889 $ $ 2017 3,524 959 ‐ 4,483 $ $ 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. As at December 31, 2018, $1,784 of loans were outstanding under the Share Purchase Plan (December 31, 2017 ‐ $1,141). During 2018, the Company advanced $743 of new loans under the Share Purchase Plan (2017 ‐ $100). ‐ 95 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 25. Related Party Disclosures (continued) The loans under the Share Purchase Plan bear interest at prime plus 1% (4.95%) as at December 31, 2018 (December 31, 2017 ‐ prime plus 1% (4.20%)) and have a five‐year term. The shares are pledged as security for the loans and had a fair value of $2,563 as at December 31, 2018 (December 31, 2017 ‐ $2,554). In 2018, MCAN recognized $54 of interest income (2017 ‐ $49) on the Share Purchase Plan loans. Deferred Share Units Plan The Company has a Deferred Share Units Plan (the “DSU Plan”) whereby the Board grants units under the DSU Plan to certain members of senior management of the Company (the “DSU Participants”). Each unit is equivalent in value to one common share of the Company. The DSU Participants are entitled to receive cash for each unit following their individual retirement/termination dates. The individual unit values are based on the average market value of the Company’s common shares for the five days preceding the retirement/termination date. During 2018, the Company paid out $1,029 (2017 ‐ $nil) upon the departure of the President and Chief Executive Officer, representing 62,723 outstanding units (2017 ‐ nil). During 2018, the Company granted 12,250 new units to the DSU Participants under the DSU Plan (2017 ‐ nil). The DSU Plan had 12,250 units outstanding as at December 31, 2018, none of which had vested (December 31, 2017 ‐ 57,790). The compensation expense recognized related to the DSU Plan for 2018 was $23 (2017 ‐ $257). As at December 31, 2018, the accrued DSU Plan liability was $16 (December 31, 2017 ‐ $1,022). Restricted Share Units Plan The Company has a Restricted Share Units Plan (the “RSU Plan”) whereby the Board grants units under the RSU Plan to certain members of senior management of the Company (the “RSU Participants”). Each unit is equivalent in value to one common share of the Company. The RSU Participants are entitled to receive cash for each unit three years subsequent to the awarding of the units subject to continued employment with the Company. The individual unit values are based on the value of the Company’s common shares at the time of payment. In addition, the RSU Participants are entitled to receive dividend distributions in the form of additional units. All RSU units vest after three years. During 2018, 31,429 units vested (2017 ‐ 14,093). At the time of vesting, the Company paid the RSU Participants $581 (2017 ‐ $216). During 2018, the Company granted 5,508 new units to the RSU Participants under the RSU Plan (2017 ‐ 5,873). During 2018, 1,824 units were forfeited (2017 ‐ nil). The RSU Plan had 15,322 units outstanding as at December 31, 2018 (December 31, 2017 ‐ 40,014), of which no units had vested (December 31, 2017 ‐ nil). The compensation expense recognized related to the RSU Plan for 2018 was $235 (2017 ‐ $342). As at December 31, 2018, the accrued RSU Plan liability was $107 (December 31, 2017 ‐ $453). Performance Share Units Plan The Company has established a Performance Share Units Plan (the “PSU Plan”) whereby the Board grants 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. ‐ 96 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 25. Related Party Disclosures (continued) 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 Q1 2018, the Company granted 31,446 new units to the PSU Participants under the PSU Plan (2017 ‐ 44,277). As at December 31, 2018, no units had vested (December 31, 2017 ‐ nil). In 2018, 55,143 units were forfeited (2017 ‐ nil). As at December 31, 2018, 59,104 units were outstanding (December 31, 2017 ‐ 74,791). However, as at December 31, 2018, the accrued PSU Plan liability was $nil (December 31, 2017 ‐ $492). In Q4 2018, the PSU Plan liability was written off, as the Company expects to ultimately apply a 0% Performance Factor to the units outstanding as at December 31, 2018. Compensation expense related to the PSU Plan for 2018 was a recovery of $(492) (2017 ‐ expense of $436). 26. 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 KSHYF investment, refer to Note 9. The Company also has contractual obligations associated with its premises lease. Less than One to one year three years Three to Over five December 31 December 31 2017 five years years 2018 Mortgage funding commitments Commitment ‐ KSHYF Premises lease $ 234,274 $ ‐ 890 $ 235,164 $ 154,798 $ ‐ 1,857 156,655 $ ‐ $ ‐ 1,897 1,897 $ ‐ $ 20,948 3,856 24,804 $ 389,072 $ 20,948 8,500 418,520 $ 291,204 26,483 8,652 326,339 The Company incurred $1,054 of premises lease expenses during 2018 (2017 ‐ $676), 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. 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. During 2018, the Company reversed $574 of previously incurred and accrued legal expenses relating to this litigation after receiving confirmation of reimbursement. 27. Credit Facilities The Company has a demand loan revolver facility from a Canadian Schedule I Chartered bank bearing interest at prime plus 0.75% (4.70%) as at December 31, 2018 (December 31, 2017 ‐ prime plus 0.75% (3.95%)). The facility is due and payable upon demand. Prior to year end, the total facility limit was temporarily increased from $75,000 to $125,000 until March 31, 2019. As at December 31, 2018, the outstanding overdraft balance was $nil (December 31, 2017 ‐ $nil). ‐ 97 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 27. Credit Facilities (continued) Under the facility, there is a sublimit for issued letters of credit. 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, 2018, there were letters of credit in the amount of $43,757 issued (December 31, 2017 ‐ $32,164) and additional letters of credit in the amount of $28,541 committed but not issued (December 31, 2017 ‐ $31,521). 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, 2018, the outstanding facility balance was $nil (December 31, 2017 ‐ $nil). 28. Interest Rate Sensitivity The interest rate sensitivity analysis is based on the Company’s consolidated balance sheets as at December 31, 2018 and December 31, 2017 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. The following tables present the assets and liabilities of the Company by interest rate sensitivity. Yield spread represents the difference between the weighted average interest rate of the assets and liabilities in a certain category. As at December 31, 2018 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 $ 604,741 $ 26,002 630,743 43,522 $ 23,040 66,562 203,181 $ 309,887 513,068 117,245 $ 401,423 518,668 50,588 $ 46,826 $ 152,902 203,490 ‐ 46,826 158,236 $ 1,224,339 916,733 2,141,072 3,479 161,715 ‐ ‐ ‐ ‐ 41,664 8,373 50,037 317,006 315,263 632,269 472,342 409,435 881,777 88,611 164,864 253,475 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 16,820 ‐ 16,820 936,443 897,935 1,834,378 306,694 306,694 GAP $ 630,743 $ 16,525 $ (119,201) $ (363,109) $ (49,985) $ 46,826 $ (161,799) $ ‐ YIELD SPREAD 5.12% 2.31% 1.32% 0.76% 0.36% 10.57% ‐ 98 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 28. 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 $ 177,465 $ 132,596 $ 25,668 $ 41,402 $ 677 32,235 126,688 304,153 720,383 852,979 168,976 194,644 ‐ 41,402 162,119 $ 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) $ (212,805) $ (127,377) $ 41,402 $ (150,258) $ ‐ YIELD SPREAD 4.43% 3.16% 2.22% 1.14% 0.42% 11.26% An immediate and sustained parallel 1% increase to market interest rates as at December 31, 2018 would have an estimated positive effect of $5,107 (December 31, 2017 ‐ $4,253) to net income over the following twelve month period. An immediate and sustained parallel 1% decrease to market interest rates as at December 31, 2018 would have an estimated adverse effect of $4,682 (December 31, 2017 ‐ $2,061) to net income over the following twelve month period. An increase of 0.25% to capitalization rates as at December 31, 2018 would result in a decrease to the fair value of non‐ marketable securities by $1,007 (December 31, 2017 ‐ $1,151). A decrease of 0.25% to capitalization rates as at December 31, 2018 would result in an increase to the fair value of non‐marketable securities by $972 (December 31, 2017 ‐ $1,183). 29. 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 further information, refer to the “Capital Management” section of the MD&A. 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. For further information on the Company’s regulatory capital management, refer to the “Regulatory Capital” sub‐section of the “Capital Management” section of the MD&A. ‐ 99 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 29. Capital Management (continued) As at December 31 Regulatory Ratios (OSFI) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Deduction for equity investment in MCAP (Transitional adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (Transitional) Deduction for equity investment in MCAP (All‐in adjustment) 1 Common Equity Tier 1, Tier 1 and Total Capital (All‐in) Total Exposures/Regulatory Assets Consolidated assets Less: deductions from all‐in Tier 1 Capital 1 Other adjustments 2 Total On‐Balance Sheet Exposures Mortgage and investment funding commitments Less: conversion to credit equivalent amount (50%) Letters of credit Less: conversion to credit equivalent amount (50%) Off‐Balance Sheet Items 2018 2017 $ $ $ 221,869 510 84,315 ‐ n/a n/a (30,925) 275,769 2,141,072 (30,925) 1,295 2,111,442 410,020 (205,010) 43,757 (21,879) 226,888 $ $ $ 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 Total Exposures/Regulatory Assets $ 2,338,330 $ 2,365,124 Leverage ratio 11.79% 11.31% 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. As of January 1, 2018, the deduction was fully deductible whereas in 2017, the deduction on the transitional basis was equal to 80% of the all‐in adjustment. 2 Certain items, such as negative cash balances, are excluded from total exposures but included in consolidated assets. As at December 31, 2018 and December 31, 2017, the Company was in compliance with the capital guidelines issued by OSFI under Basel III. Income Tax Capital As a MIC under the Tax Act, the Company is limited to an income tax liabilities to capital ratio of 5:1 (or an income tax assets to capital ratio of 6:1), based on the non‐consolidated balance sheet in the MIC entity measured at its tax value. For further information on the Company’s income tax capital management, refer to the “Income Tax Capital” sub‐section of the “Capital Management” section of the MD&A. 30. 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, non‐marketable securities, 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 non‐marketable securities) 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 non‐marketable securities 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. ‐ 100 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 30. Financial Instruments (continued) As at December 31, 2018 Level 1 Level 2 Level 3 Total Carrying Value Assets measured at fair value Cash and cash equivalents Marketable securities Non‐marketable securities ‐ Crown LP 1 Non‐marketable securities ‐ KSHYF 2 Securitization program cash held in trust Assets for which fair values are disclosed Mortgages ‐ corporate 3 Other loans 4 Mortgages ‐ securitized 3 Liabilities measured at fair value Other liabilities ‐ corporate 5 Liabilities for which fair values are disclosed Term deposits 6 Financial liabilities from securitization 7 $ 98,842 53,218 ‐ ‐ 26,002 $ 178,062 $ $ $ $ $ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ $ $ $ $ $ $ ‐ 29 ‐ ‐ ‐ 29 $ $ ‐ ‐ 29,611 42,202 ‐ 71,813 $ 98,842 53,247 29,611 42,202 26,002 $ 249,904 $ 98,842 53,247 29,611 42,202 26,002 $ 249,904 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ 927,079 2,640 891,938 $ 1,821,657 $ 927,079 2,640 891,938 $ 1,821,657 $ 922,390 2,640 887,252 $ 1,812,282 $ 13,169 $ 13,169 $ 13,169 $ 917,663 894,038 $ 1,811,701 $ 917,663 894,038 $ 1,811,701 $ 919,623 897,935 $ 1,817,558 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 Non‐marketable securities ‐ Crown LP 1 Non‐marketable securities ‐ KSHYF 2 Securitization program cash held in trust Assets for which fair values are disclosed Mortgages ‐ corporate 3 Other loans 4 Mortgages ‐ securitized 3 Liabilities measured at fair value Other liabilities ‐ corporate 5 Liabilities for which fair values are disclosed Term deposits 6 Financial liabilities from securitization 7 $ 117,571 61,973 ‐ ‐ 13,441 $ 192,985 $ $ $ $ $ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ $ $ $ $ $ $ $ ‐ $ 545 ‐ ‐ ‐ 545 $ ‐ ‐ 32,037 36,153 ‐ 68,190 $ 117,571 62,518 32,037 36,153 13,441 $ 261,720 $ 117,571 62,518 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 KSHYF. 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 term 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. ‐ 101 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION (Dollar amounts in thousands except for per share amounts) 30. Financial Instruments (continued) The following table shows the continuity of Level 3 financial assets recorded at fair value: Balance, December 31, 2017 Advances Repayments Changes in fair value, recognized in net income Balance, December 31, 2018 $ $ 68,190 5,685 (5,071) 3,009 71,813 There were no transfers between levels during the years ended December 31, 2018 or December 31, 2017. Risk Management The types of risks to which the Company is exposed include but are not limited to liquidity and funding risk, credit risk, interest rate risk 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 periodically 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. The shaded sections of the MD&A relating to liquidity and funding, credit, interest rate and market risks inherent with financial instruments form an integral part of these consolidated financial statements. The management of credit risk associated with the Company’s assessment of impairment under IFRS 9 is also discussed in the MD&A section noted above. 31. 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 ‐ 2018 ANNUAL REPORT | MCAN MORTGAGE CORPORATION EXECUTIVE OFFICERS Karen Weaver Chief Executive Officer, Interim Dipti Patel Vice President and Chief Financial Officer Joseph Shaw Vice President and Chief Investment Officer Martin Beaudry Vice President, Single Family Mortgage Operations Carl Brown Vice President, Operations and Treasurer Emily Randle Vice President and Chief Risk Officer Mike Jensen Vice President and Chief Compliance Officer (Chief Anti Money Laundering & Privacy Officer) Sylvia Pinto Vice President, Corporate Secretary & Governance Officer DIRECTORS Verna Cuthbert Corporate Director, MCAN Mortgage Corporation Member of Enterprise Risk Management and Compliance Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Director since September 2013 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 Gordon Herridge Corporate Director, MCAN Mortgage Corporation Chair of Audit Committee Member of Enterprise Risk Management and Compliance Committee Director since May 2018 Loraine McIntosh Corporate Director, MCAN Mortgage Corporation Chair of Enterprise Risk Management and Compliance Committee Member of Audit Committee Director since May 2017 Gaelen Morphet Corporate Director, MCAN Mortgage Corporation Member of Audit Committee Member of Conduct Review, Corporate Governance and Human Resources Committee Director since January 2018 Derek Sutherland President, Canadazil Capital Inc. Member of Enterprise Risk Management and Compliance Committee Director since May 2017 Ian Sutherland Chair, MCAN Mortgage Corporation Director since January 1991 Karen Weaver Chief Executive Officer, Interim, MCAN Mortgage Corporation Director since November 2011 W. Terrence Wright Counsel, Pitblado LLP Chair of Conduct Review, Corporate Governance and Human Resources Committee Member of Enterprise Risk Management and Compliance Committee Director since September 2013 ‐ 103 ‐ 2018 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 2018 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 mcanexecutive@mcanmortgage.com. General Information For general enquiries about MCAN Mortgage Corporation, please write to Ms. Sylvia Pinto, Corporate Secretary (head office details at left) or e‐mail mcanexecutive@mcanmortgage.com Annual and Special Meeting of Shareholders Wednesday, May 8, 2019 4:30pm (local time) Vantage Venues 150 King Street West, 27th Floor Toronto, Ontario All shareholders and prospective investors are invited to attend. ‐ 104 ‐ MCAN Mortgage Corporation 600-200 King Street West, Toronto, ON M5H 3T4 Toll Free Phone: Toronto Phone: Fax: Email: (855) 213-6226 (416) 572-4880 (416) 598-4142 mcanexecutive@mcanmortgage.com www.mcanmortgage.com