First National Financial Corporation Reports Third Quarter 2017 Results, Declares Special Common Share Dividend

TORONTO, Oct. 24, 2017 /CNW/ - First National Financial Corporation (TSX: FN, TSX: FN.PR.A, TSX: FN.PR.B) (the "Company" or "FNFC") today announced its financial results for the three and nine months ended September 30, 2017. The Company derives virtually all of its earnings from its wholly-owned subsidiary, First National Financial LP ("FNFLP" or "First National").

Third Quarter Summary

• Mortgages under administration ("MUA") up year over year by 2% to a record $100.2 billion from $98.6 billion at September 30, 2016
• Total mortgage originations up 2% to $4.9 billion from $4.8 billion a year ago
• Revenue up 4% to $284.3 million from $273.8 million in the 2016 third quarter
• Net income up 14% to $58.8 million ($0.96 per common share) compared to net income of $51.4 million ($0.84 per common share) in the 2016 third quarter
• Pre-FMV EBITDA⁽¹⁾ down 23% to $51.8 million compared to $67.5 million in the 2016 third quarter

Management Commentary
"First National surpassed $100 billion in Mortgages Under Administration in the third quarter, reflecting our Company's growing prominence as a leading provider of mortgage capital, expertise and service to Canada's single family and commercial real estate borrowers," said Stephen Smith, Chairman and Chief Executive Officer. "We're proud of our team for reaching this milestone, and doing so profitability, particularly as new mortgage insurance rules and rising interest rates rapidly changed our marketplace. These new dynamics had the largest impact on our single-family lending business, as evidenced by a 12% reduction in third quarter originations, and will continue to mute growth in the coming quarters. As the market digests these and other rule changes on the horizon, it will be First National's scope and scale, strategic alignment with the mortgage broker community, market diversification and disciplined method of capital allocation that will act as the catalysts for our performance for the remainder of this year and into 2018."

Single-family mortgage originations of $3.2 billion in the third quarter of 2017 were 12% or $450 million lower than a year ago. This decline was evident across the country and most pronounced in the Company's Vancouver, Calgary and Montreal operations where volume declines averaged 19%. In Ontario and the Maritimes, originations were 5% lower year over year. Commercial mortgage originations at $1.7 billion were 47% or $548 million higher than a year ago.

"Our single family and commercial teams absolutely made the most of their respective market opportunities in the quarter by delivering competitive offerings based on value-added customer service," said Moray Tawse, Executive Vice President. "In single family, mortgage insurance rules announced last fall effectively shrank the size of the available market, but by winning our traditional share of new originations and capitalizing on a large volume of renewal opportunities, we kept total single-family production including renewals at $4.9 billion, unchanged from a year ago. On the other hand, activity in the commercial market was robust and we addressed it very effectively, growing new commercial originations by 47% and commercial renewals by $146 million or 87%. We're pleased with these results and satisfied that First National is well positioned for a changing market environment."

Special Dividend
The Company's Board of Directors today announced a special common share dividend in the amount of $1.25 per share, payable on December 15, 2017 to shareholders of record on November 30, 2017. This payment reflects the Board's determination that the Company has generated excess capital in the past several years and that the capital needed for near-term growth can be generated from current operations.

Q3 2017 Summary

First National's MUA increased 2% to $100.2 billion at September 30, 2017 from $98.6 billion at September 30, 2016.  Between June 30, 2017 and September 30, 2017, MUA grew at an annualized rate of 3%, as growth from traditionally strong seasonal market activity was partly offset by the maturity of several CMBS transactions originally included in MUA in 2007. Single-family MUA stood at $77.1 billion while commercial MUA was $23.0 billion at September 30, 2017, compared to $76.8 billion and $21.7 billion respectively a year ago.

Single-family mortgage originations decreased 12% to $3.2 billion from $3.6 billion in the third quarter of 2016, reflecting regulatory changes including revised mortgage insurance rules announced in October 2016. Single family mortgage renewals grew to $1.7 billion in the third quarter of 2017, 31% higher than a year ago. Commercial segment originations increased 47% to $1.7 billion from $1.2 billion in the same period of 2016, while commercial mortgage renewals amounted to $313 million compared to $167 million a year ago. The Company originated and renewed for securitization purposes $2.2 billion of mortgages in the third quarter of 2017 compared to $2.0 billion a year ago.

Revenue increased 4% to $284.3 million from $273.8 million in the third quarter of 2016 primarily due to larger gains on financial instruments this quarter than in the same period a year ago.  Excluding gains on financial instruments in the respective quarters, revenue decreased 2% year over year as the lower volume of single family originations and the impact of large second quarter 2017 gains on financial instruments reduced placement fee revenue.

With interest rates rising steadily over the past six months, the value of fixed rate mortgages held for securitization decreased during the holding period between origination and placement. Accordingly, when these mortgages were placed with institutional investors in the third quarter of 2017, the per unit placement fees were lower than in an otherwise static interest rate environment by about $14.4 million. Because these transactions were economically hedged in the second quarter of 2017, the lower fees are effectively offset by a gain of $14.4 million that was recorded in gains on financial instruments in that second quarter. Accordingly, the Company earned the revenue as expected except in the form of gains on financial instruments in the second quarter as opposed to placement fees in the third quarter.

Other contributors to revenue were: mortgage servicing (up 8% to $38.7 million in the third quarter of 2017 from $35.7 million a year ago); net interest – securitized mortgages (up 7% to $36.5 million from $34.1 million); and mortgage investment income (up 10% to $18.6 million from $16.9 million). Gains on deferred placement fees were 49% lower at $2.2 million from $4.3 million a year ago due to a 15% decline in multi-unit residential mortgages originated for this program and tighter spreads on these transactions.

Securitized mortgages amounted to $26.2 billion at September 30, 2017, up 2% from $25.8 billion a year ago.

Income before income taxes was $80.0 million, up 15% from $69.8 million in the third quarter of 2016. The year-over-year increase primarily reflected $25.9 million in additional gains on financial instruments in the third quarter of 2017 compared to the third quarter a year ago.

Pre-FMV EBITDA⁽¹⁾, which excludes the impact of gain and losses on financial instruments in both periods, decreased 23% to $51.8 million from $67.5 million a year ago. The change reflects the lower placement fee revenue, as noted above, which flowed through to the bottom line. By adding back $14.4 million to the quarter's Pre-FMV EBITDA, management believes a more accurate measurement of performance is presented. Accordingly, earnings on an adjusted basis would be 2% lower than the 2016 third quarter because of tighter mortgage spreads and higher broker fees.

Dividends

The Board declared common share dividends in the third quarter of 2017 of $27.7 million or the annualized equivalent of $1.85 per common share, reflecting an increase announced in March 2017. On an after-tax Pre-FMV⁽¹⁾ basis, the dividend payout ratio for the third quarter of 2017 was 77% compared to 53% in the third quarter of 2016. The Board also paid $0.69 million of dividends on its preferred shares in the third quarter of 2017, unchanged from a year ago.

As noted above, the Company announced a special, one-time dividend of $1.25 per common share, which will be paid on December 15, 2017 to common shareholders of record on November 30, 2017.

Outlook

For the remainder of 2017 and into 2018, the Company anticipates continued lower seasonal origination in the residential segment pursuant to the impact of new mortgage insurance rules announced in October 2016. Together with rising interest rates following the two overnight rate increases announced by the Bank of Canada in July and September, higher costs of portfolio insurance, additional underwriting restrictions recently proposed by OSFI and regional issues including foreign buyer's taxes, the Company believes new single-family origination will continue to be lower by a similar proportion as experienced in its second and third quarter. Although the Company sees growth in single-family renewals, a rising rate environment and increased competition may impact origination in the commercial segment. In order to take advantage of the seasonally strong summer market, the Company introduced various temporary promotions that increased broker fee compensation for new single-family originations. As the mortgages originated under these promotions fund, the higher costs will be capitalized against securitized mortgages or recorded as broker fees expense for mortgages placed with institutional investors.

The Company earned almost $53 million in gains on financial instruments in the nine months ended September 30, 2017. While this revenue increased current period net income, the offsetting economic impact will be felt in the Company's future earnings. Net securitization margins will be lower on new securitizations as the Company issues mortgage backed securities with coupons that will be higher than the period when the securitized mortgages were initially funded. The negative impact will be recognized over the five and ten-year terms of the securitization. However, to the extent that the funded mortgages are placed with institutional customers, as the Company did in the third quarter of 2017, the impact will be immediate with lower placement fees in current period earnings. Depending on how the Company elects to fund these mortgage assets, the negative impact associated with the large gains recorded to date in 2017 could be spread over 5 or ten-year terms or it could be realized in the upcoming fiscal quarters.       

Despite these challenges, the Company will continue to generate income and cash flow from its $26 billion portfolio of mortgages pledged under securitization and $74 billion servicing portfolio and focus on the value inherent in its significant single-family renewal book.

Conference Call and Webcast

The audio of the conference call will be webcast live and archived on First National's website at www.firstnational.ca. A question and answer session for analysts and institutional investors will be held following management's presentation.

A taped rebroadcast of the conference call will be available to listeners until 5pm ET on November 1, 2017. To access the rebroadcast, please dial 647-436-0148 or 888-203-1112 and enter passcode 8187654 followed by the number sign. The webcast is also archived at www.firstnational.ca for three months.

Complete consolidated financial statements for the Company as well as management's discussion and analysis are available at www.sedar.com and at www.firstnational.ca.

About First National Financial Corporation

First National Financial Corporation (TSX: FN, TSX:FN.PR.A, TSX:FN.PR.B) is the parent company of First National Financial LP, a Canadian-based originator, underwriter and servicer of predominantly prime residential (single-family and multi-unit) and commercial mortgages. With more than $100 billion in mortgages under administration, First National is Canada's largest non-bank originator and underwriter of mortgages and is among the top three in market share in the mortgage broker distribution channel.  For more information, please visit www.firstnational.ca.  

¹ Non-GAAP Measures
The Company uses IFRS as its accounting framework. IFRS are generally accepted accounting principles (GAAP) for Canadian publicly accountable enterprises for years beginning on or after January 1, 2011. The Company also refers to certain measures to assist in assessing financial performance. These "non-GAAP measures" such as "Pre-FMV EBITDA" and "After tax Pre-FMV Dividend Payout Ratio" should not be construed as alternatives to net income or loss or other comparable measures determined in accordance with GAAP as an indicator of performance or as a measure of liquidity and cash flow. Non-GAAP measures do not have standard meanings prescribed by GAAP and therefore may not be comparable to similar measures presented by other issuers.

Forward-Looking Information
Certain information included in this news release may constitute forward-looking information within the meaning of securities laws. In some cases, forward-looking information can be identified by the use of terms such as "may", "will, "should", "expect", "plan", "anticipate", "believe", "intend", "estimate", "predict", "potential", "continue" or other similar expressions concerning matters that are not historical facts. Forward-looking information may relate to management's future outlook and anticipated events or results, and may include statements or information regarding the future financial position, business strategy and strategic goals, product development activities, projected costs and capital expenditures, financial results, risk management strategies, hedging activities, geographic expansion, licensing plans, taxes and other plans and objectives of or involving the Company. Particularly, information regarding growth objectives, any future increase in mortgages under administration, future use of securitization vehicles, industry trends and future revenues is forward-looking information. Forward-looking information is based on certain factors and assumptions regarding, among other things, interest rate changes and responses to such changes, the demand for institutionally placed and securitized mortgages, the status of the applicable regulatory regime and the use of mortgage brokers for single family residential mortgages. This forward-looking information should not be read as providing guarantees of future performance or results, and will not necessarily be an accurate indication of whether or not, or the times by which, those results will be achieved. While management considers these assumptions to be reasonable based on information currently available, they may prove to be incorrect. Forward looking-information is subject to certain factors, including risks and uncertainties listed under ''Risk and Uncertainties Affecting the Business'' in the MD&A, that could cause actual results to differ materially from what management currently expects. These factors include reliance on sources of funding, concentration of institutional investors, reliance on relationships with independent mortgage brokers and changes in the interest rate environment. This forward-looking information is as of the date of this release, and is subject to change after such date. However, management and First National disclaim any intention or obligation to update or revise any forward-looking information, whether as a result of new information, future events or otherwise, except as required under applicable securities regulations.

SOURCE First National Financial Corporation