Home Capital Reports Solid Results for the Third Quarter: Basic Earnings per Share of $1.40; Return on Equity of 27.0%; Third Quarter Adjusted Net Income Increases 23.7% over 2010 Adjusted Net Income

TORONTO, Nov. 2, 2011 /CNW/ - Home Capital today reported another quarter of strong performance for the three months ended September 30, 2011. The Company implemented International Financial Reporting Standards (IFRS) as of January 1, 2011 and prior period results have been restated to an IFRS basis. Key results for the third quarter of 2011 included:

  • Net income was $48.4 million in the third quarter and $139.7 million for the nine months ended September 30, 2011.  On an adjusted basis, net income was $48.4 million for the quarter and $142.2 million year to date, representing increases of 23.7% for the quarter and 25.4% year to date over adjusted net income of $39.1 million and $113.4 million in the comparable periods 2010.  These results continue to exceed the Company's 2011 objective of 15-20% growth in adjusted net income. Net income increased by $0.2 million compared to the second quarter of 2011. Results for the third quarter were negatively impacted by $4.1 million in unrealized losses on derivatives due to the volatile interest rate environment in the quarter. Core pretax earnings of $95.0 million (net interest income after provision plus fee and other income) was up 7.0% over the second quarter core earnings of $88.8 million.

  • Adjusted basic and diluted earnings per share were $1.40 and $1.39 for the third quarter and $4.10 and $4.09 year to date.  This represents an increase of 23.9% and 23.0%, respectively, from $1.13 adjusted basic and diluted earnings per share in the third quarter of 2010 and an increase of 25.4% and 25.5%, respectively, over the $3.27 and $3.26 adjusted basic and diluted earnings per share for nine months ended September 30, 2010.

  • Net interest income rose to $87.6 million in the third quarter and to $245.5 million year to date. This represents an increase of 28.6% over the $68.1 million recorded in the third quarter of 2010 and 28.2% over the $191.6 million recorded for the nine months ended September 30, 2010. The growth reflects strong loan growth year over year. Net interest income increased 7.7%, from $81.3 million in the second quarter of 2011 on higher average loan balances and improved net interest margin.

  • Net interest margin was 2.14% in the third quarter up from 2.00% in the third quarter of 2010 and 2.06% recorded in the second quarter of 2011. Net interest margin on non-securitized assets improved to 3.11% compared to 2.67% the third quarter of 2010 and 3.04% in the second quarter of 2011. Net interest margin on securitized assets of 1.33% also increased from 1.27% recorded in the third quarter of 2010 and 1.27% in the second quarter of 2011.

  • Return on equity at 27.0% remained robust in the quarter and continues well in excess of the Company's minimum performance objective of 20%.

  • The credit quality of the loans portfolio remained solid in the quarter. Net non-performing loans ended the quarter at 0.32% of the total loans portfolio at September 30, 2011 compared to 0.26% at September 30, 2010 and 0.23% at June 30, 2011. While this measure is up over comparable periods it is still within the Company's expected and acceptable ranges. The provision for credit losses in the quarter was 0.06% of gross loans on an annualized basis compared to 0.07% in the third quarter of 2010 and 0.03% in the second quarter of 2011 and within the Company's objective of 0.05% to 0.15% of gross loans.

  • Home Trust's Tier 1 and Total capital ratios remains very strong at 17.7% and 21.0%, respectively, at September 30, 2011 and well above the Company's minimum targets.  Home Trust's asset to capital multiple was 14.0 at September 30, 2011 compared to 13.5 at June 30, 2011, putting the Company in a comfortable position to continue growing its assets, revenue and net income.

  • Total assets, which include securitized mortgages, were $17.07 billion at September 30, 2011, an increase of $1.55 billion or 10.0% from the $15.52 billion at December 31, 2010 and $637.5 million or 3.9% over the $16.43 billion at the end of the second quarter. This represents an annualized growth rate in total assets of 13.3%. Total loans grew to $15.78 billion from $14.09 billion at December 31, 2010, and from $15.32 billion at the end of the second quarter representing an annualized growth rate of 16.0%. Total assets and loan growth remain within the Company's 2011 growth objective of 13-18% for 2011.

  • The total value of mortgages originated in the third quarter of 2011 was $1.30 billion, for a year to date total of $3.87 billion. This is up 8.6% over the $1.20 billion originated in the second quarter of 2011 and a decline from the $1.68 billion and $5.02 billion in originations in the comparable periods of 2010. This reflects the Company's strategy to reduce originations of insured mortgage products, which are generally securitized, and increase focus on originations of higher yielding traditional mortgages.

  • The Company originated $941.1 million of traditional mortgages in the third quarter and $2.57 billion year to date compared to $728.6 million and $2.17 billion in the comparative periods of 2010 and $870.8 million in the second quarter of 2011.

  • Accelerator (insured) mortgage originations were $293.5 million in the third quarter of 2011 and $915.1 million year to date compared to $716.9 million and $2.08 billion in the comparable periods of 2010 and $172.4 million in the second quarter of 2011.  The regulatory and accounting treatment of insured securitized mortgages upon adoption of IFRS has introduced new capital constraints and effectively increased the cost of capital allocated to Accelerator mortgages. Consequently, the Company scaled back lending in this segment in favour of higher margin products within the Company's risk appetite. The Company continues to explore opportunities that may ultimately lead to future growth in this product segment.

  • Multi-unit residential originations were $7.0 million for the third quarter of 2011 and $130.5 million year to date compared to $133.9 million and $481.4 million in the same periods of 2010 and $34.5 million in the second quarter of 2011. A significant portion of multi-unit residential mortgages originated in 2010 were insured and securitized and the reduction in origination volume is a result of narrowing margins and the cost of increased capital required to support this product.

  • Non-residential mortgage advances were $32.4 million in the third quarter of 2011 and $140.7 million year to date compared to $40.6 million and $146.9 million in the comparable periods of 2010 and $59.6 million in the second quarter of 2011. Store and apartment advances were $26.8 million for the quarter and $87.4 million for the year to date, compared to $23.5 million and $75.1 million in the same periods of 2010 and $35.5 million in the second quarter of 2011.

  • As a source of funding, the Company securitized and sold $396.8 million in insured residential mortgages compared to $1.13 billion in the third quarter of 2010 and $335.8 million in the second quarter of 2011.

  • The Company opened 1,758 new Equityline Visa accounts in the third quarter compared to 1,796 accounts opened in the third quarter of 2010.

As discussed in the second quarter report, in early July 2011 Home Trust successfully went live with a new software platform from the SAP® for Banking solution portfolio. The Company is pleased with the additional functionality, expanded capacity and improved efficiencies the new platform provides. Along with the implementation of the new platform, the Company launched a centralized operations group and an organizational effectiveness initiative with the mandate to drive improved operational discipline and cost management. Management is confident that with the new energy and focus on operational and transactional excellence, the Company will reduce or maintain costs through the next growth phase.

During the quarter, the Company continued to strengthen its control functions to support future growth and strategic priorities. Additional resources, expanded expertise, enhanced training and innovative tools have been introduced in risk management, internal audit and compliance. The Company intends to continue the process of sharpening and enhancing the Company's control environment, control functions and corporate governance while maintaining the Company's prudent risk appetite and disciplined risk management. These enhancements are important components in supporting the Company's strategic priorities and are key contributors to continued above average shareholder returns, strong financial position and growth.

As discussed in previous quarterly reports, the Company successfully implemented the new Canadian GAAP accounting framework, IFRS, on January 1, 2011, with a transition date of January 1, 2010.  Transition as at January 1, 2010 required restatement of the Company's 2010 financial information from its original Canadian GAAP basis to the IFRS basis.  This allows for inclusion of comparative information in the 2011 financial statements and management discussion and analysis. The primary impact of IFRS for the Company was a change in the accounting for securitization transactions. The Company now records securitized mortgages as on-balance sheet mortgages along with secured borrowing, representing the funding received from the transaction. Interest income on the mortgages and interest expense on the liabilities is recognized over the passage of time. On January 1, 2010, the IFRS adjustment reduced the Company's shareholders' equity by $86.7 million, representing the difference between prior periods' net income under the previous Canadian GAAP compared to IFRS. Net income for 2010 on an IFRS basis was $154.8 million compared to $180.9 million under the previous Canadian GAAP. These adjustments are more fully explained on pages 26 to 29 of this MD&A.

Despite the global economic uncertainty, the Company continues to observe resilient and stable real estate markets across the country and expects demand to remain steady for the rest of 2011 and into 2012. The credit quality of the loan portfolio remains strong, reflecting the Company's continued focus on diligent underwriting and collection standards. The Company maintains a solid capital position and prudent liquidity and is confident that it is well positioned to deal with the impact of global economic uncertainty that may affect the Canadian economy. While the stabilization of Canadian housing markets allowed for renewed focus on the Company's traditional mortgage portfolio, Equityline Visa and geographic growth strategies, the Company remains proactive and prudent in its lending practices, taking into account local economic and market conditions.

Subsequent to the end of the quarter, and in light of the Company's solid performance, profitability and strong financial position, the Board of Directors declared a quarterly dividend of $0.20 per Common share, payable on December 1, 2011 to shareholders of record at the close of business on November 15, 2011.

With solid performance in all aspects of Home Capital's business, management is confident that the Company will generate above average earnings and shareholder performance for the remainder of 2011 and into 2012, and will meet or exceed all of its stated objectives for 2011.

(signed)             (signed)
GERALD M. SOLOWAY 
Chief Executive Officer   
November 2, 2011  






KEVIN P.D. SMITH
Chairman of the Board

                                                                                        

Additional information concerning the Company's targets and related expectations for 2011, including the risks and assumptions underlying these expectations, may be found in Management's Discussion and Analysis (MD&A) of this quarterly report.

Third Quarter Results Conference Call

The conference call will take place on Thursday, November 3, 2011, at 10:30 a.m. Participants are asked to call 5 to 15 minutes in advance, 647-427-7450 in Toronto or toll-free 1-888-231-8191 throughout North America. The call will also be accessible in listen-only mode via the Internet at www.homecapital.com.

Conference Call Archive

A telephone replay of the call will be available between 1:30 p.m. Thursday, November 3, 2011 and midnight Thursday, November 10, 2011 by calling 416-849-0833 or 1-855-859-2056 (enter passcode 16331367). The archived audio webcast will be available for 90 days on CNW Group's website at www.newswire.ca and Home Capital's website at www.homecapital.com.

FINANCIAL HIGHLIGHTS

(Unaudited)                
(000s, except Per Share and Percentage Amounts)   For the three months ended   For the nine months ended
For the period ended September 30   2011    2010    2011    2010 
OPERATING RESULTS                
Net Income $ 48,417  $ 47,621  $ 139,747  $ 124,643 
Adjusted Net Income   48,417    39,138    142,172    113,377 
Total Revenue   200,288    187,195    583,469    511,205 
Earnings per Share Basic/Diluted $ 1.40/1.39 $ 1.37/1.37 $ 4.03/4.02 $ 3.59/3.58
Adjusted Earnings per Share Basic/Diluted   1.40/1.39   1.13/1.13   4.10/4.09   3.27/3.26
Return on Shareholders' Equity   27.0%   32.8%   27.4%   30.0%
Return on Average Assets   1.2%   1.4%   1.1%   1.3%
Net Interest Margin   2.14%   2.00%   2.06%   2.04%
Net Interest Margin Non-Securitized Assets (TEB)   3.11%   2.67%   3.04%   2.71%
Net Interest Margin Securitized Assets   1.33%   1.27%   1.26%   1.22%
Provision as a Percentage of Gross Loans (annualized)   0.06%   0.07%   0.04%   0.04%
Efficiency Ratio (TEB)   27.4%   26.3%   28.2%   27.6%
As at September 30 December 31 September 30    
  2011   2010 2010     
BALANCE SHEET HIGHLIGHTS                
Total Assets $ 17,072,125 $ 15,518,818 $ 14,194,460    
Total Loans   15,782,646   14,091,755   12,815,997    
Securitized Loans   8,502,466   8,116,636   6,574,568    
Liquid Assets   577,834   951,271   1,152,812    
Deposits   7,220,517   6,595,979   6,787,530    
Shareholders' Equity   731,216   628,585   604,749    
FINANCIAL STRENGTH                
Capital Measures                
Risk-Weighted Assets $ 4,269,175 $ 3,777,267 $ 3,793,878    
Tier 1 Capital Ratio   17.7%   18.1%   16.9%    
Total Capital Ratio   21.0%   19.4%   18.1%    
Credit Quality                
Non-Performing Loans as a Percentage of Gross Loans   0.32%   0.24%   0.26%    
Allowance as a Percentage of Gross Non-Performing Loans   62.6%   88.1%   87.6%    
Share Information                
Book Value per Common Share $ 21.10 $ 18.14 $ 17.44    
Common Share Price - Close $ 43.60 $ 51.79 $ 44.49    
Market Capitalization $ 1,510,696 $ 1,794,316 $ 1,542,869    
Number of Common Shares Outstanding   34,649   34,646   34,679    

1 2010 figures have been restated to an IFRS basis; please see information under IFRS section of this unaudited interim
consolidated financial report.

2 See definition of Adjusted Net Income under Non-GAAP Measures on page 6 and reconciliation on page 10 of this unaudited
interim consolidated financial report.

3 These key performance indicators have not been recalculated on an adjusted net income basis.

4 See definition of Taxable Equivalent Basis (TEB) under Non-GAAP Measures of this unaudited interim consolidated
financial report.

5 These figures relate to the Company's operating subsidiary, Home Trust Company. 2010 has not been recalculated on an IFRS basis.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Caution Regarding Forward-Looking Statements

From time to time Home Capital Group Inc. (the "Company" or "Home Capital") makes written and verbal forward-looking statements. These are included in the Annual Report, periodic reports to shareholders, regulatory filings, press releases, Company presentations and other Company communications. Forward-looking statements are made in connection with business objectives and targets, Company strategies, operations, anticipated financial results and the outlook for the Company, its industry, and the Canadian economy. These statements regarding expected future performance are "financial outlooks" within the meaning of National Instrument 51-102.  Please see the risk factors, which are set forth in detail on pages 37 through 48 of the Company's 2010 Annual Report, as well as its other publicly filed information, which may be located at www.sedar.com, for the material factors that could cause the Company's actual results to differ materially from these statements.  Forward-looking statements can be found in the Report to the Shareholders and the Outlook Section in this quarterly report.   Forward-looking statements are typically identified by words such as "will,"  "believe," "expect," "anticipate," "estimate," "plan," "may," and "could" or other similar expressions.

By their very nature, these statements require the Company to make assumptions and are subject to inherent risks and uncertainties, general and specific, which may cause actual results to differ materially from the expectations expressed in the forward-looking statements.  These risks and uncertainties include, but are not limited to, global capital market activity, changes in government monetary and economic policies, changes in interest rates, inflation levels and general economic conditions, legislative and regulatory developments, competition and technological change. The preceding list is not exhaustive of possible factors.

These and other factors should be considered carefully and readers are cautioned not to place undue reliance on these forward-looking statements. The Company does not undertake to update any forward-looking statements, whether written or verbal, that may be made from time to time by it or on its behalf, except as required by securities laws.

Assumptions about the performance of the Canadian economy in 2011 and its effect on Home Capital's business are material factors the Company considers when setting its objectives and outlook.  In determining expectations for economic growth, both broadly and in the financial services sector, the Company primarily considers historical economic data provided by the Canadian government and its agencies.  In setting and reviewing the outlook and objectives for 2011, management's expectations assume:

  • The Canadian economy will produce modest growth in 2011, but will be heavily influenced by the economic conditions in the US and international markets.  Inflation will generally be within the Bank of Canada's target of 1-3%.

  • Interest rates will remain at current rates for the remainder of 2011 as the Bank of Canada leaves its target for the overnight rate at its current level.

  • The housing market will remain resilient to global uncertainty with balanced supply and demand conditions in most regions.  Declining housing starts and flat resale activity on stable prices will continue with the market stabilizing from previous activity levels.

  • Unemployment will improve slightly or remain stable as the economy grows, while a larger labour force marginally offsets job growth. Consumer debt levels will remain serviceable by Canadian households.

  • Net interest margins overall are expected to remain in the current range.  Margins are expected to remain stable or modestly improve on the traditional portfolio and securitized portfolio throughout 2011 and yields on the securities portfolio may improve.

  • Credit quality will remain sound with actual losses within Home Capital's historical range of acceptable levels.

Non-GAAP Measures

The Company has adopted IFRS as its accounting framework. IFRS are the generally accepted accounting principles (GAAP) for Canadian publically accountable enterprises for years beginning on or after January 1, 2011. The Company uses a number of financial measures to assess its performance.  Some of these measures are not calculated in accordance with GAAP, are not defined by GAAP, and do not have standardized meanings that would ensure consistency and comparability between companies using these measures.  The non-GAAP measures used in this Management's Discussion and Analysis (MD&A) are defined as follows:

Adjusted Net Income and Adjusted Earnings Per Share

Gains (losses), net of tax, that are associated with unmatched derivative volatility in 2010 and the loss recorded early in the first quarter of 2011 as the Company realigned its hedging strategy, are adjusted against net income to present adjusted net income.

Pre-tax Core Earnings

Pre-tax core earnings is a profitability measure that presents core earnings from lending operations. The Company calculates this measure as net interest income after provision for credit losses plus fees and other income.

Return on Shareholders' Equity

Return on equity is a profitability measure that presents the annualized net income available to common shareholders' equity as a percentage of the capital deployed to earn the income.  The Company calculates its return on equity using average common shareholders' equity, including all components of shareholders' equity.

Return on Assets

Return on assets is a profitability measure that presents the annualized net income as a percentage of the average total assets for the period deployed to earn the income.

Efficiency or Productivity Ratio

Management uses the efficiency ratio as a measure of the Company's efficiency.  This ratio represents non-interest expenses as a percentage of total revenue, net of interest expense. The Company also looks at the same ratio on a taxable equivalent basis and will include this adjustment in arriving at the efficiency ratio, on a taxable equivalent basis.  A lower ratio indicates better efficiency.

Net Interest Margin

Net interest margin is calculated by taking net interest income, on a taxable equivalent basis, divided by average total assets.

Tier 1 and Total Capital Ratios

The capital ratios provided in this MD&A are those of the Company's wholly owned subsidiary Home Trust Company.  The calculations are in accordance with guidelines issued by Office of the Superintendent of Financial Institutions Canada (OSFI).  Refer to Note 9(C) of the Unaudited Interim Consolidated Financial Statements.

Taxable Equivalent Basis (TEB)

Most banks and trust companies analyze and discuss their financial results on a TEB to provide uniform measurement and comparison of net interest income. Net interest income (as presented in the consolidated statements of income) includes tax-exempt income from certain securities. The adjustment to TEB used in this MD&A increases income and the provision for income taxes to what they would have been had the income from tax-exempt securities been taxed at the statutory tax rate. The TEB adjustments of $1.9 million for the third quarter of 2011 ($2.0 million in the third quarter of 2010) increased interest income as used in the calculation of net interest margin. TEB does not have a standard meaning prescribed by GAAP and therefore may not be comparable to similar measures used by other companies. Net interest income and income taxes are discussed on a TEB basis throughout this MD&A.

Regulatory Filings

The Company's continuous disclosure materials, including interim filings, annual Management's Discussion and Analysis and audited consolidated financial statements, Annual Information Form, Notice of Annual Meeting of Shareholders and Proxy Circular are available on the Company's web site at www.homecapital.com, and on the Canadian Securities Administrators' website at www.sedar.com.

Management's Discussion and Analysis of Operating Performance

This MD&A should be read in conjunction with the unaudited interim consolidated financial statements for the period ended September 30, 2011 included herein, and the audited consolidated financial statements and MD&A for the year ended December 31, 2010. These are available on the Canadian Securities Administrators' website at www.sedar.com and on pages 61 through 88 of the Company's 2010 Annual Report. Except as described in these unaudited interim consolidated financial statements and MD&A, all other factors discussed and referred to in the MD&A for fiscal 2010 remain substantially unchanged. These unaudited interim consolidated financial statements and MD&A have been prepared based on information available as at November 2, 2011. As in prior quarters, the Company's Audit Committee reviewed this document, and prior to its release the Company's Board of Directors approved it, on the Audit Committee's recommendation.

BUSINESS PROFILE

Business Segments and Portfolios

The Company divides its business into three segments. These segments and the related activities and portfolios are described below.

Mortgage Lending

This segment comprises single family residential lending and multi-unit residential lending as well as non-residential lending. The single-family residential portfolio includes the Company's traditional or "Classic" mortgage loans and Accelerator mortgages.  The Company's traditional mortgage portfolio consists of mortgages with loan to value ratios of 80% or less, where the focus is on serving selected segments of the Canadian financial services marketplace that are not the focus of the major financial institutions. Accelerator mortgages are insured, with loan to value ratios generally exceeding 80%, at the time of origination, and are generally securitized and sold through Canada Mortgage Housing Corporation (CMHC) sponsored mortgage-backed securities (MBS) and Canada Mortgage Bond (CMB) programs.

Multi-unit residential lending includes both insured and uninsured mortgage loans. Non-residential lending includes store and apartment mortgages, commercial mortgages and warehouse commercial mortgages.

Consumer Lending

Consumer lending includes Visa lending and other consumer retail lending for durable household goods, such as water heaters and larger ticket home improvement items. Consumer retail lending loans are supported by holdbacks or guarantees from the distributors of such items and/or collateral charges on real property. The Company's Equityline Visa product, secured by real property, represents 97.4% of the Visa portfolio. The Company also offers cash secured Visa products. The consumer lending segment also includes the operations of PSiGate which offers payment card services.

Other

The Company's other segment includes management of the Company's treasury portfolio and general corporate activities.

Mission, Vision and Values

The Company's mission is to focus on well-defined niches in the Canadian financial marketplace that generate above average returns, have below average risk profiles, and are not adequately served by traditional financial institutions.

Home Capital's vision is to be a "Best in Class" financial services company, delivering first class products and services to Canadians with a strong emphasis on customer service.

The Company has a set of values that are integral to its day-to-day business. These values are the cornerstone of Home Capital's vision and play a key role in the Company achieving both its strategic and financial performance goals:

  • Consistently enhance shareholder value by adhering to our strategies and principles with a focus on customer service
  • Act with respect, trust and integrity in all interactions with our customers, employees and business partners
  • Personal responsibility to deliver the highest level of customer service to our clients, supported by our enthusiasm, teamwork and desire for continuous improvement
  • Make a positive difference to our community and environment through fundraising, community involvement and sustainable environmental initiatives

The Company's key long-term objective is to deliver superior shareholder value.

Over the past decade, the Company has sought to achieve a return on common equity of at least 20%, and has exceeded this benchmark in each of the past 13 years without exception. Management also seeks to align its capital with the risk profile of the business through an understanding of the nature and level of risk being taken and how these risks attract regulatory and risk based capital.

2011 OBJECTIVES AND PERFORMANCE

Home Capital published its financial objectives for 2011 on page 14 of the Company's 2010 Annual Report. The following table compares actual performance to date against each of these objectives.

                                     
Table 1: 2011 Targets and Performance                                    
                                       
                  For the nine months ended September 30, 2011
          2011 Targets1       Actual Results     Amount       Increase over 2010
Growth in adjusted net income         15%-20%       25.4%     $ 142,172       $ 28,795
Growth in adjusted diluted earnings per share         15%-20%       25.5%       4.09         0.83
Growth in total assets         13%-18%       13.3%       17,072,125         1,553,307
Growth in total loans         13%-18%       16.0%       15,782,646         1,690,891
Return on shareholders' equity         20.0%       27.4%                  
Efficiency ratio (TEB)         28.0% - 34.0%       28.2%                  
Capital ratios                                    
  Tier 1         Minimum of 13%       17.7%                    
  Total         Minimum of 14%       21.0%                    
Provision as a percentage of gross loans (annualized)         0.05% - 0.15%       0.06%                  

1 Objectives and results for adjusted net income and diluted earnings per share are for the current year.

2 Targets are based on adjusted 2010 IFRS net income.  See definition of Adjusted Net Income under Non-GAAP Measures on page 6 and reconciliation on page 10 of this third quarter report.  Change represents change over same period last year

3 Change represents growth over December 31, 2010 on an annualized basis.

4 Based on the Company's wholly owned subsidiary, Home Trust Company.

The Company implemented the new Canadian GAAP financial reporting framework, International Financial Reporting Standards (IFRS) on January 1, 2011, with a transition date of January 1, 2010.  Transition as at January 1, 2010 required restatement of the Company's 2010 financial information from its original Canadian GAAP basis to the IFRS basis. This allows for inclusion of comparative information in the 2011 financial statements.  On transition, IFRS required the application of certain mandatory and optional transition exemptions.  The details of the restatement and the mandatory and selected optional exemptions, which the Company applied on transition, are set out in Note 18 to the accompanying unaudited interim consolidated financial statements.

As IFRS represents a new Canadian GAAP accounting framework, it is generally not appropriate to directly compare the Company's financial position and results of operations as stated under IFRS to the financial position and results of operations as stated under original Canadian GAAP.  Comparative information in this MD&A has been restated to the IFRS basis. Please see the International Financial Reporting Standards section of this MD&A for further information.

INCOME STATEMENT REVIEW                    
                       
Table 2: Income Statement Highlights                    
        For the three months ended     For the nine months ended      
(000s, except %)   September 30   September 30     September 30   September 30  
      2011   2010  % Change   2011    2010  % Change
Net Interest Income                    
Non-securitized Assets                    
  Non-securitized loans interest $ 104,418 $ 89,872  16.2% $ 291,733  $ 263,584  10.7%
  Dividends and other interest   6,014   7,064  (14.9)%   17,897    20,636  (13.3)%
  Interest on deposits   49,387   47,846  3.2%   141,374    140,382  0.7%
  Interest on senior debt   2,011     3,279   
      59,034    49,090  20.3%   164,977    143,838  14.7%
Net Interest Income                    
Securitized Loans and Assets                    
  Interest from securitized loans and assets   84,195   66,255  27.1%   248,615    174,708  42.3%
  Interest on securitization liabilities   55,617   47,234  17.7%   168,052    126,975  32.4%
      28,578   19,021  50.2%   80,563    47,733  68.8%
Net interest income   87,612   68,111  28.6%   245,540    191,571  28.2%
Provision for credit losses   2,349   2,167  8.4%   4,540    3,615  25.6%
        85,263   65,944  29.3%   241,000    187,956  28.2%
Non-Interest Income                        
Fees and other income   9,697   7,127  36.1%   26,703    22,069  21.0%
  Gain on sale of loan portfolio   -   3,917  (100.0)%     3,917  (100.0)%
  Realized net gains and unrealized losses                    
  on securities   1,224   1,347  (9.1)%   5,394    10,725  (49.7)%
  Net realized and unrealized gain (loss)                    
  on derivatives   (5,260)   11,613  (145.3)%   (6,873)   15,566  (144.2)%
      5,661   24,004  (76.4)%   25,224    52,277  (51.7)%
Non-Interest Expenses   26,036   24,756  5.2%   77,895    68,867  13.1%
Income before income taxes   64,888   65,192  (0.5)%   188,329    171,366  9.9%
Income taxes   16,471   17,571  (6.3)%   48,582    46,723  4.0%
NET INCOME $ 48,417 $ 47,621  1.7% $ 139,747  $ 124,643  12.1%
Basic Earnings per Share $ 1.40 $ 1.37  2.2% $ 4.03  $ 3.59  12.3%
Diluted Earnings per Share $ 1.39 $ 1.37  1.5% $ 4.02  $ 3.58  12.3%
                       
Adjusted Net Income                    
Adjustment for unmatched derivative positions                    
(net of tax)   -   (8,483) (100.0)%   2,425    (11,266) (121.5)%
ADJUSTED NET INCOME $ 48,417 $ 39,138  23.7% $ 142,172  $ 113,377  25.4%
Adjusted Basic Earnings per Share $ 1.40 $ 1.13  23.9% $ 4.10  $ 3.27  25.4%
Adjusted Diluted Earnings per Share $ 1.39 $ 1.13  23.0% $ 4.09  $ 3.26  25.5%
Adjusted net income is defined in the Non-GAAP measures section of this MD&A and 2010 amounts are reconciled to net income on page 29 of this quarterly report.

Net Interest Income                        
                         
Table 3: Net Interest Income and Margin                    
  For the three months ended For the nine months ended
(000s, except %) September 30, 2011 September 30, 2010 September 30, 2011 September 30, 2010
  Income/ Average Income/ Average Income/ Average Income/ Average
  Expense Rate Expense Rate Expense Rate Expense Rate
Assets                        
Cash and cash resources $ 733  0.63% $ 1,028  1.19% $ 2,400  0.72% $ 3,393  1.05%
Securities   5,281  4.79%   6,036  3.65%   15,497  4.54%   17,243  3.58%
Non-securitized loans   104,418  6.03%   89,872  5.67%   291,733  5.94%   263,584  5.84%
Taxable equivalent adjustment   1,866  -   1,993  -   5,291  -   6,121  -
Total on non-securitized interest earning assets   112,298  5.63%   98,929  5.27%   314,921  5.54%   290,341  5.35%
Securitized loans   84,195  3.91%   66,255  4.41%   248,615  3.89%   174,708  4.45%
Other assets   -   -   -   -
Total Assets $ 196,493  4.70% $ 165,184  4.84% $ 563,536  4.63% $ 465,049  4.94%
Liabilities and Shareholders' Equity                        
Deposits $ 49,387  2.88% $ 47,846  2.87% $ 141,374  2.85% $ 140,382  2.91%
Securitization liabilities   55,617  2.58%   47,234  3.14%   168,052  2.63%   126,975  3.24%
Other liabilities and shareholders' equity   2,011  5.30%   -   3,279  4.68%   -
Total Liabilities and Shareholders' Equity $ 107,015  2.56% $ 95,080  2.79% $ 312,705  2.57% $ 267,357  2.84%
Net Interest Income $ 89,478  - $ 70,104  - $ 250,831  - $ 197,692  -
Tax Equivalent Adjustment   (1,866) -   (1,993) -   (5,291) -   (6,121) -
Net Interest Income per Financial                        
Statements $ 87,61   $ 68,111    $ 245,540    $ 191,571   
Net Interest Margin Non-securitized                        
Interest Earning Assets     3.11%     2.67%     3.04%     2.71%
Net Interest Margin Securitized Assets     1.33%     1.27%     1.26%     1.22%
Total Net Interest Margin     2.14%     2.00%     2.06%     2.04%
Spread of Non-securitized Loans over                        
Deposits Only     3.15%     2.80%     3.09%     2.94%
                         
The average rate is an average calculated with reference to opening and closing monthly balances and as such may not be as precise if daily balances were used.
Net interest margin is calculated on a TEB

Table 4: Interest Income and Average Rate by Loan Portfolio
  For the three months ended For the nine months ended
(000s, except %)       September 30, 2011       September 30, 2011
  Average Interest Average Average Interest Average
  Assets Income Rate Assets Income Rate
Traditional single-family residential mortgages $ 5,094,713  $ 72,479  5.69% $ 4,649,769  $ 195,631  5.61%
Accelerator single-family residential mortgages   219,082    1,636  2.99%   273,207    5,766  2.81%
Multi-unit residential mortgages   126,338    1,795  5.68%   199,442    9,228  6.17%
Securitized residential mortgages   8,613,299    84,195  3.91%   8,521,508    248,615  3.89%
Non-residential mortgages   953,959    15,660  6.57%   923,021    44,338  6.40%
Personal and credit card loans   532,475    12,848  9.65%   502,995    36,770  9.75%
Total average loans $ 15,539,866  $ 188,613  4.85% $ 15,069,942  $ 540,348  4.78%
                     
                     
                     
  For the three months ended   For the nine months ended
(000s, except %)       September 30, 2010       September 30, 2010
  Average Interest Average Average Interest Average
  Assets Income Rate Assets Income Rate
Traditional single-family residential mortgages $ 4,027,066  $ 59,195  5.88% $ 3,885,137  $ 172,877  5.93%
Accelerator single-family residential mortgages   899,776    5,881  2.61%   757,310    16,956  2.99%
Multi-unit residential mortgages   262,714    3,317  5.05%   236,700    8,462  4.77%
Securitized residential mortgages   6,009,524    66,255  4.41%   5,234,697    174,708  4.45%
Non-residential mortgages   731,144    10,822  5.92%   716,941    33,818  6.29%
Personal and credit card loans   423,079    10,657  10.08%   411,525    31,471  10.20%
Total average loans $ 12,353,303  $ 156,127  5.06% $ 11,242,310  $ 438,292  5.20%

1 The average is an average calculated with reference to opening and closing monthly balances.

Net Interest Income

Net interest income increased 28.6% and 28.2% for the three and nine months ended September 30, 2011, respectively, over the amounts recorded in the comparable periods of 2010. Total net interest income increased 7.7% over the $81.3 million earned in the second quarter of 2011.

Net interest income rose over comparable 2010 amounts primarily due to increases in the average loan portfolio balances of $3.19 billion and $3.83 billion, over the three and nine months ended September 30, 2010, respectively. The increase over the second quarter of 2011 is due to increases in the average loan balances of $430.3 million and improved net interest margin.

Total net interest margin, including the securitized portfolio, was 2.14% for the third quarter and 2.06% year to date compared to 2.00% and 2.04% in the same periods of 2010. Net interest margin was affected by the increases in the relative weighting of securitized mortgages in the loan portfolio and by changes in the net interest margin on non-securitized assets. During 2010 the relative weighting of securitized mortgages in the portfolio increased from 42.8% at January 1, 2010 to 51.3% at September 30, 2010, and then to 57.6% at December 31, 2010. Since December 31, 2010 it has declined to 53.9% at September 30, 2011. The increase in the higher margin non-securitized assets over the period increased the net interest margin and was partially offset by the increased weighting of lower margin securitized mortgages in the portfolio.

The net interest margin on non-securitized assets has improved over the comparable periods of 2010 as the average yield on the non-securitized loan portfolio increased over 2010 reflecting the improved average rates and higher balances in the non-residential portfolio and increased average rate in the multi-unit residential portfolios, while the Company's average deposit rates have remained relatively flat over the same period. Average rates on the securities portfolio have also improved as the Company rebalanced the liquid assets and focused on improving margins.

The net interest margin on securitized assets has remained relatively consistent quarter over quarter as the portfolio begins to slowly decline, impacted primarily by fluctuations in prepayment penalties which are recorded in securitized net interest income. The Company expects the net interest margin for this portfolio to remain relatively flat or to modestly decrease over the next 12 months. The average yield on the securitized loan portfolio was down 50 basis points to 3.91% in the quarter, compared to 4.41% in the same quarter of 2010, as the securitized loan portfolio includes a significant proportion of variable rate mortgages which lower the overall yield. Offsetting this is a decrease in the average rate on securitization liabilities of 56 basis points to 2.58%, compared to 3.14% in the third quarter of 2010. This reduction is due to lower securitization funding rates over the latter half of 2010, including variable rate funding, and the accounting classifications that result from the application of hedge accounting to interest rate swaps in 2011, which lowered funding costs.

In the third quarter of 2011 the average rate earned on the total loan portfolio declined 21 basis points from the third quarter of 2010. With the exception of multi-unit residential mortgages and non-residential mortgages, average mortgage rates have declined in response to lower market rates. The continued low Government of Canada bond yields have contributed to lower rates in the fixed-rate mortgage market. Accelerator mortgages include fewer variable rate mortgages compared to comparative periods thus increasing the average rate for this portfolio. The Company generally holds these mortgages for securitization or replacement assets for the CMB.

The average rate earned on the personal and credit card portfolio is 43 basis points lower than 2010, as the Company expanded its offering of Equityline Visa to include a lower rate product to customers with higher credit scores. Increases in fully secured water heater receivables at lower average rates also lowered the overall rate on the portfolio. At the same time, average assets increased over the period leading to higher interest income from these products.

Non-Interest Income

For the three and nine months ended September 30, 2011 fees and other income increased 36.1% and 21.0%, respectively, to $9.7 million and $26.7 million, respectively, from $7.1 million and $22.1 million in the three and nine months ended September 30, 2010. These amounts include net mortgage and Visa account administration fees and increase as the size of the loan portfolio increases and are also influenced by the overall mix of the portfolio. Fees have grown at a slightly higher pace than the overall loan portfolio growth due to the focus on the Company's traditional mortgage portfolio. Fees and other income also increased 12.2% from the $8.7 million recorded in second quarter of 2011.

The Company recognized a net gain of $2.0 million and $7.3 million on the sale of certain available for sale securities during the three and nine months ended September 30, 2011, compared to a net gain of $1.3 million and $10.7 million in the comparable periods of 2010 and a net gain of $3.2 million in the second quarter of 2011. The Company takes advantage of improvements in securities markets and will rebalance the investment portfolio as market conditions warrant. The Company recognized $0.8 million in impairments through profit and loss on available for sale equity securities in the third quarter of 2011 compared to $nil in 2010 and $1.1 million in the second quarter of 2011.

Gains (losses) on derivatives include net losses due to hedge ineffectiveness of $1.1 million in the third quarter and net gains of $0.2 million year to date on the Company's fair value and cash flow interest rate hedges. Gains (losses) on derivatives also include $4.1 million in unrealized losses for the third quarter and $3.5 million in unrealized losses year to date for fair value changes in interest rate swaps that are not designated in hedge accounting relationships. On an economic basis these losses are offset by gains in the fair value of other net assets but such gains are not recorded through profit and loss. The Company expects that the amount and direction of fair value adjustments will vary from quarter to quarter. Management closely monitors the fair value changes. The Company did not apply hedge accounting in 2010 and therefore the 2010 derivatives gains (losses) amounts reflect the fair value changes of the derivative positions.

In January 2011 the Company restructured certain derivative positions to achieve hedge accounting under IFRS. While the Company designated the restructured interest rate swaps and bond forwards in hedge accounting relationships from the restructure date forward, in the period prior to designation the Company recognized a net unrealized loss of $3.3 million in the first quarter of 2011. This amount is adjusted from income for performance measurement purposes.  In 2010 the Company was not applying hedge accounting to its hedges of interest rate risk and, as such, all of the unrealized fair value gains and losses on derivatives were recorded through income as they occurred. Please see the Derivatives and Hedging section of this MD&A and Note 14 of the unaudited consolidated financial statements.

Non-Interest Expenses

Total non-interest expenses of $26.0 million in the quarter and $77.9 million year to date increased 5.2% and 13.1%, respectively, over the comparable periods of 2010, primarily due to increased staffing and costs associated with the implementation of the new core banking system. Non-interest expenses decreased $0.6 million compared to $26.6 million recorded in the second quarter of 2011. The efficiency ratio (TEB) remains low at 27.4% and compares to 26.3% in the third quarter of 2010 and 27.9% in the second quarter of 2011. These levels reflect continued low costs compared to revenues net of interest expense. The Company continues to manage expenses in a disciplined and measured manner and aligns its expense management strategy with its growth targets and objectives. In conjunction with the implementation of the new core banking system and to take advantage of the new functionality and efficiencies of the new system, the Company launched a centralized operations group and an organizational effectiveness initiative. The new group and initiative will continue to foster business growth and superior customer service while driving improved operational discipline and cost management, which is expected to reduce or maintain costs through the Company's next growth phase.

Salaries and staff benefits were $13.5 million and $39.3 million for the three and nine months ended September 30, 2011 compared to $11.8 million and $34.3 million in the comparable periods of 2010 reflecting staffing mix changes, merit increases and increased overtime related to the implementation of the new core banking platform. Staff salaries increased marginally from the $13.3 million recorded in the second quarter of 2011. At the end of the quarter, the Company employed 552 staff consistent with 552 staff one year ago.

Other operating expenses were $10.5 million during the quarter and $32.8 million year to date, down from $11.2 million in the third quarter of 2010 and up from the $29.5 million for the nine months ended September 30, 2010. Other operating expenses declined by $1.0 million from the $11.5 million recorded in the second quarter of 2011. Late in 2010 and early 2011 expenses generally increased to support business growth and the implementation of the new core banking system. In particular, the Company has experienced increased information technology costs including additional advisory support and additional costs associated with the implementation of a new core banking system that are not eligible for capitalization.  These moderated in the third quarter compared to the first and second quarter of 2011 as the core banking system implementation currently requires less support.

Provision for Credit Losses                
                 
Table 5: Provision for Credit Losses             
                 
  For the three months ended For the nine months ended
(000s, except %) September 30 September 30 September 30 September 30
    2011    2010    2011    2010 
Collective provision $ $ 202  $ 237  $ 1,353 
Individual provision   2,349    1,965    4,303    2,262 
Total provision $ 2,349  $ 2,167  $ 4,540  $ 3,615 
Provision as % of gross loans (annualized)   0.06%   0.07%   0.04%   0.04%
Net write-offs $ 2,170  $ 1,766  $ 5,830  $ 3,164 
Net write-offs as % of gross loans (annualized)   0.05%   0.06%   0.05%   0.03%

Table 6: Net Non-Performing Loans & Allowances    
             
            As at
(000s, except %) September 30 December 31 September 30
    2011    2010    2010 
Net non-performing loans $ 49,795  $ 34,225  $ 33,914 
Gross loans   15,785,845    14,096,652    12,817,711 
Net non-performing loans as % of gross loans   0.32%   0.24%   0.26%
Collective allowance $ 29,390  $ 29,153  $ 29,146 
Individual allowance   3,773    5,300    2,062 
Total allowance $ 33,163  $ 34,453  $ 31,208 

The provision for credit losses is charged to the income statement by an amount that brings the individual and collective allowances for credit losses to the level determined by management to be adequate to cover incurred losses, including losses that are not yet specifically identified. Factors which influence the provisions for credit losses include the formation of new impaired loans, the level of write-offs, management's assessment of the level of collective and individual allowances required based on available data, including current credit performance of the portfolio, external economic factors, the composition of the portfolio, and the overall growth in the loans portfolio.

Individual provisions remain at relatively low levels being $2.3 million for the quarter and $4.3 million year to date, compared to $2.0 million and $2.3 million in the comparable periods of 2010. The provisions in the comparable nine months of  2010 were particularly low as a result of higher than usual loan loss recoveries in the first half of 2010, which lowered provisions and net write-offs. Provisions as a percentage of gross loans at 0.06% on an annualized basis remain well within the target range of 0.05% to 0.15%, reflecting prudent and conservative credit and portfolio management.

During the quarter the Company became aware of alleged irregularities regarding three of its loans with a total principal amount of $4.6 million. These loans were advanced to the same borrower, a Toronto residential condominium corporation.  The registered security documents associated with these loans provide the Company with a secured priority claim against the condominium corporation, the condominium structure and the underlying residential units.  Provided that the security is valid, the Company would expect to recover any losses on such loans. The borrower is disputing the validity of the Company's security in the Ontario Court. It is not currently possible to reasonably determine the outcome of this matter or to estimate the amount of loss, if any. A specific provision has not been recorded for these loans but these loans have been classified as non-performing residential loans.

While net non-performing loans has increased over the comparable periods of 2010 and over the $35.2 million recorded in the second quarter of 2011 the level remains within the expected and acceptable levels. The increase in net non-performing loans is primarily attributed to the $4.6 million in irregularities noted above, as well as, a general slowdown in the sales of properties in possession and the timing of sales of these properties. Net write-offs are expected to remain within the Company's targets while provisions as a percentage of gross loans remain with the 0.05%-0.15% target range.

The collective allowance balance at September 30, 2011 increased marginally over December 31, 2010 and is flat over the second quarter of 2011. The Company continues to observe strong credit performance in the loans portfolio as reflected in the following factors:

  • A relatively low rate of non-performing loans. Non-performing loans as a percentage of gross loans remains within historical averages, ending the quarter at 0.32% compared to 0.26% at the end of September 30, 2010 and 0.23% at June 30, 2011. Credit losses and non-performing loans are within the range of the Company's historical averages. The Company continues to employ prudent strategies to maintain the credit quality of the loans portfolio.
  • Stable real estate markets, overall net write-offs within expected lower ranges and a continued and focused effort at working out non-performing loans. Gross write-offs in the residential mortgage portfolio are consistent with the Company's expectations and experience over the long term.  Personal and credit card loan portfolio write-offs are within expected levels. The Company's ongoing risk management philosophy includes close monitoring of non-performing loans and the employment of proactive measures to minimize losses, as described in the Credit Risk section of the 2010 Annual Report under the heading Risk Management.
  • Stable risk profile of the loans portfolio and general Canadian economic factors that influence management's assessment of the level of collective allowance (please see the Credit Risk section of this MD&A for more information).

Income Taxes

The income tax expense amounted to $16.5 million (effective tax rate of 25.4%) for the third quarter of 2011. The effective tax rate was 27.0% for same period in 2010. The lower effective tax rate during the quarter is attributed to adjustments to the tax provision to effectively report the current assessed tax liability. Due to the nature of the Company's revenue and expense streams, an effective tax rate of approximately 26.5% to 28.0% should be sustainable.

Comprehensive Income

Comprehensive income is the aggregate of net income and other comprehensive income (OCI). Comprehensive income was $38.0 million and $123.5 million for the three and nine months ended September 30, 2011, compared to $52.7 million and $118.5 million for the same periods in 2010. Charges of $10.4 million and $16.2 million were recorded through OCI for the three and nine months ended September 30, 2011, compared to gains of $5.0 million for the comparable quarter of 2010 and charges of $6.1 million for the nine months ended September 30, 2010.

OCI includes changes in unrealized gains or losses on available for sale securities, transfers of previously unrealized net gains and losses to net income, once they have been realized, and the impact of cash flow hedges and transfers to income of unrealized losses on investments considered impaired.

The Company recognized transfers to net income of $1.5 million in net gains for the quarter and $6.0 million in net gains for the nine months ended September 30, 2011 related to the sale of certain available for sale securities and impairment charges on available sale securities. This compares to a net transfer of $1.7 million and $9.3 million of gains to net income in the comparable periods in 2010 and $2.7 million of gains in the second quarter of 2011. OCI decreased by $9.2 million in the third quarter and decreased by $9.3 million year to date due to unrealized changes in the fair value of available for sale securities, compared to net increases of $8.8 million and $2.5 million for the comparable periods of 2010. Included in the net gains transferred to net income for the quarter was $0.8 million and $1.9 million year to date on impairment losses on available for sale securities

There was a net loss recorded in OCI of $3.4 million and $6.7 million for the quarter and year to date, respectively, related to cash flow hedging. The Company did not apply cash flow hedging in the second quarter of 2010.

BALANCE SHEET REVIEW

Table 7: Balance Sheet Highlights 

The table below presents the balance sheet position of the Company at September 30, 2011, June 30, 2011
and December 31 2010, along with percentage changes.

              As at   % Change
(000s, except %) September 30 June 30 December 31 September 30, 2011 September 30, 2011
      2011    2011    2010  - June 30, 2011 - December 31, 2010
Cash resources $ 417,701  $ 543,062  $ 846,824  (23.1)% (50.7)%
Securities   648,641    419,056    427,122  54.8% 51.9%
  Residential mortgages   5,782,855    5,221,290    4,683,527  10.8% 23.5%
  Securitized residential mortgages   8,502,466    8,623,284    8,116,636  (1.4)% 4.8%
  Non-residential mortgages   951,203    953,420    838,253  (0.2)% 13.5%
  Personal and credit card loans   546,122    521,151    453,339  4.8% 20.5%
Total Loans   15,782,646    15,319,145    14,091,755  3.0% 12.0%
  Collective allowance for credit losses   (29,390)   (29,390)   (29,153) 0.8%
      15,753,256    15,289,755    14,062,602  3.0% 12.0%
Other assets   252,527    182,726    182,270  38.2% 38.5%
Total assets $ 17,072,125  $ 16,434,599  $ 15,518,818  3.9% 10.0%
                   
Deposits $ 7,220,517  $ 6,734,129  $ 6,595,979  7.2% 9.5%
Senior debt   153,998    149,670    2.9%
Securitization liabilities   8,753,126    8,653,247    8,104,578  1.2% 8.0%
      16,127,641    15,537,046    14,700,557  3.8% 9.7%
Other liabilities   213,268    195,618    189,676  9.0% 12.4%
Total liabilities   16,340,909    15,732,664    14,890,233  3.9% 9.7%
Shareholders' equity   731,216    701,935    628,585  4.2% 16.3%
Total liabilities and shareholders' equity $ 17,072,125  $ 16,434,599  $ 15,518,818  3.9% 10.0%

Cash Resources and Securities

Although combined cash resources and securities as at September 30, 2011 decreased by $207.6 million compared to December 31, 2010, the Company maintains prudent liquidity by investing a portion of the liquidity assets in the Company's originated MBS. These securities are classified as residential mortgages on the balance sheet, as required by IFRS.  Home Trust's total liquidity and securities portfolio for liquidity management purposes is summarized as follows:

Table 8: Liquidity Resources (Home Trust)

             
(000s) September 30 June 30 December 31
  2011  2011  2010 
Cash resources $ 342,262  $ 475,055  $ 894,543 
Securities   440,489    392,074    356,755 
MBS included in residential mortgages   268,056    368,245    114,732 
Total cash and investments   1,050,807    1,235,374    1,366,030 
Less: securities held for investments   (375,957)   (357,825)   (322,504)
Less: restricted cash   (97,016)   (88,762)   (92,255)
Total assets held for liquidity purposes $ 577,834  $ 788,787  $ 951,271 

The securities portfolio has increased by $221.5 million since December 31, 2010.  This includes assets amounting to $208.2 million pledged under the CMB program as replacement assets compared to $3.0 million at December 31, 2010. These assets include treasury bills and third party CMHC-insured MBS. The Company continues to invest in conservative assets while seeking appropriate returns. During the three and nine months ending September 30, 2011, the Company took advantage of market opportunities and sold certain securities, realizing a net pre-tax gain of $2.0 million and $7.3 million, respectively, compared to $1.3 million and $10.7 million during the same periods in 2010. The disposals and acquisitions over the first nine months of 2011 allowed the Company to diversify its single name counterparty risk and industry concentration risk.

Loans Portfolio

Chart 1: Portfolio Composition by Product Type


To see Chart 1, please click here: http://files.newswire.ca/984/Chart1LoansPortfolio.pdf

 

Table 9: Mortgage Production                
  For the three months ended   For the nine months ended
(000s) September 30 September 30 September 30 September 30
  2011  2010  2011  2010 
Traditional single family residential mortgages $ 941,093  $ 728,563  $ 2,565,582  $ 2,169,874 
Accelerator single family residential mortgages   293,526    716,879    915,071    2,083,762 
Multi-unit residential mortgages   6,960    133,855    130,483    481,441 
Non-residential mortgages   32,380    40,617    140,655    146,905 
Store and apartments   26,833    23,495    87,413    75,146 
Warehouse commercial mortgages     39,300    29,750    60,050 
Total mortgage advances $ 1,300,792  $ 1,682,709  $ 3,868,954  $ 5,017,178 

Mortgage production in the third quarter declined $381.9 million from the same period in 2010 and increased $103.3 million over the second quarter of 2011. The increase over the second quarter was focused in the Company's traditional portfolio driven by strong demand from that market segment. There was also an increase in Accelerator volumes to support CMB replacement asset requirements. Beginning late last year, the Company scaled back lending in Accelerator and multi-unit residential securitized mortgages.  This was in response to the cost of allocating capital to support insured securitized mortgages, which resulted from the implementation of IFRS and the regulatory framework. The accounting change effectively caused an additional cost of capital (which is an opportunity cost) and reduced the relative profitability of the Company's Accelerator and insured multi-unit residential mortgage products. As such, new mortgage production was more heavily weighted to the Company's traditional single-family loans reflecting the focus on higher margin products within the Company's risk appetite. The Company expects the trend towards a higher weighting of traditional product to continue, unless new off-balance sheet products become available or there are changes to the regulatory treatment of these insured securitized mortgages. The current regulatory treatment of insured mortgages tends to constrain the growth that would otherwise be available.

Other Assets

Other assets, primarily consisting of accrued interest receivable, other prepaid assets and capital assets, generally increases in proportion to the increase in total loans and general business growth.

Liabilities

The Company issued $150.0 million principal amount of 5.2% debentures on May 4, 2011. The debentures pay interest semi-annually on November 4 and May 4 in each year, commencing on November 4, 2011.  The debentures mature on May 4, 2016 and are redeemable at the option of the Company at a redemption price equal to the greater of the Canada Yield Price and par, together with accrued and unpaid interest.

Securitization liabilities, including MBS and CMB liabilities, increased from December 31, 2010, by $648.5 million and by $99.9 million from June 30, 2011. The Company securitized $396.8 million and $1.60 billion of assets for the three and nine months ended September 30, 2011, respectively, compared to $1.13 billion and $3.31 billion for the three and nine months ended September 30, 2010. The securitization amounts include mortgages that are used as replacement assets in the CMB program, which amounts do not result in a net increase in the securitization liability. The average coupon on new securitization liabilities was 1.87% and 2.20% for the three and nine months ended September 30, 2011, compared to 2.16% and 2.15% for the same periods in 2010.  The average yield on the mortgages securitized was 4.26% and 4.22% for the three and nine months ended September 30, 2011, compared to 4.19% and 4.52% for the same periods in 2010.

From time to time, the Company securitizes mortgages and holds some of the related MBS. These MBS are carried on the balance sheet at amortized cost as part of residential mortgage loans. In these cases the securities are held as future replacement assets for the CMB program or as part of the liquidity pool (see Table 8: Liquidity Resources).

Other liabilities increased $17.7 million over June 30, 2011 and $23.6 million over December 31, 2010 due to general expansion of the business and the timing of payments.

Shareholders' Equity

The increase in total shareholders' equity since December 31, 2010 was internally generated from net income during the nine months ended September 30, 2011 of $139.7 million, plus $5.1 million in amounts related to stock based compensation, less $20.1 million for dividends to shareholders, $5.9 million related to the repurchase of shares and a decrease of $16.2 million in accumulated other comprehensive income.

At September 30, 2011, the book value per common share was $21.10, compared to $18.14 at December 31, 2010 and $17.44 at September 30, 2010.

Derivatives and Hedging

From time to time, as part of its financing and liquidity management activities, the Company enters into transactions under CMHC-sponsored MBS programs, in which it transfers financial assets to CMHC sponsored securitization entities.  These transfers do not qualify for derecognition under GAAP. As such, the transaction is treated as a secured financing transaction and results in the recognition of a secured borrowing which may have a fixed coupon rate. The fixed interest rate in the secured borrowing above will be determined based on market rates at the time of issuance, plus an applicable credit spread.  The Company is exposed to cash flow variability on the future interest payments resulting from variability in market interest rates between the dates on which the Company originates the underlying mortgages and the actual date the secured borrowing (securitization transaction) is settled.  The Company uses forward contracts to sell Government of Canada bonds and interest rate swaps to hedge the variability in these future interest cash flows. The forward bond contracts and interest rate swap contracts will be settled at the time of the securitization transaction.

Beginning in December of 2010, the Company started applying cash flow hedge accounting to the bond forward hedges and certain interest rate swaps in 2011. The intent of hedge accounting is to recognize the effective matching of the gain or loss on the bond forwards and interest rate swaps with the interest cash flows of the secured borrowing as the Company records the expense. In the three and nine months ended September 30, 2011, the Company settled $75.0 million and $375.0 million in bond forwards respectively, recording net losses of $3.1 million and $6.9 million in other comprehensive income. These losses reflect a decline in bond yields over the period of the hedge and have been deferred through accumulated other comprehensive income. These losses will be recognized in income over the term of the related MBS, as part of the interest expense on the hedged secured borrowing. During the three and nine months ended September 30, 2011, the Company transferred $0.2 million and $0.3 million to interest expense from accumulated other comprehensive income related to cash flow hedges on the secured borrowing. The Company also recognized $nil and $0.6 million for the three and nine months ended September 30, 2011 in losses into income through net realized and unrealized gain (loss) on derivatives on these bond forwards, due to hedge ineffectiveness. At September 30, 2011, the Company held interest rate swaps of $25.0 million in anticipation of future securitizations.  These contracts had a positive fair value of $0.2 million at September 30, 2011. The unrealized gain was recorded in other comprehensive income. Prior to December 2010, the Company recognized unrealized and realized gains and losses on the bond forwards through income as they occurred, as hedge accounting was not in place.

The Company is exposed to fluctuations in the fair value of fixed rate liabilities due to changes in market interest rates. To hedge this risk, the Company enters into interest rate swaps. Beginning in January 2011 the Company started applying hedge accounting to the majority of these hedges. The intent of hedge accounting is to have the fair value changes in the interest rate swap offset, within a reasonable range, the changes in the fair value of the fixed rate borrowing resulting from changes in the interest rate environment. Any unmatched fair value change is recorded in income as hedge ineffectiveness through net realized and unrealized gain (loss) on derivatives. The total notional value of the interest rate swaps at September 30, 2011 was $1.69 billion. For the three and nine months ended September 30 of 2011, unrealized gains of $54.2 million and $59.2 million were recorded on the interest swaps and were offset by an unrealized gain on the hedged risk of the fixed rate liability of $55.3 million and $58.8 million, respectively. Net hedge ineffectiveness losses of $1.1 million and gains of $0.4 million for the three and nine months ended September 30, 2011, respectively, were recorded in the income statement through net realized and unrealized gain (loss) on derivatives.

The Company also has certain interest rate swaps that are not designated or do not qualify for hedge accounting relationships and therefore are adjusted to fair value without an offsetting hedged amount. These swaps had notional amounts of $118.1 million at September 30, 2011.  Unrealized losses of $4.1 million and $3.6 million for the three and nine months ended September 30, 2011, respectively, were recorded in income through net realized and unrealized gain (loss) on derivatives.

Prior to January 2011, interest rate swaps were not designated in hedge accounting relationships and the fair value change was recorded in income without a recorded offsetting fair value change in the hedged risk. This resulted in income volatility in 2010 as measured using IFRS. In January 2011, the interest rate swaps were restructured to rebalance the interest rate hedges and to meet hedge accounting requirements. During the period between December 31, 2010 and the restructuring and hedge designation date, there was an unrealized loss on fair value changes of $3.7 million that was recorded in income through net realized and unrealized gain (loss) on derivatives.  For performance measurement purposes, this loss, net of tax, has been removed from the calculation of adjusted net income and adjusted earnings per share.

Please see Note 14 of the unaudited interim consolidated financial statements for further information.

Off-Balance Sheet Arrangements

In the normal course of its business, the Company offers credit products to meet the financial needs of its customers. Outstanding commitments for future advances on mortgage loans amounted to $508.2 million at September 30, 2011 ($450.8 million - Q2 2011; $459.0 million - Q4 2010). Included within the outstanding commitments are unutilized non-residential loan advances of $75.1 million at September 30, 2011 ($80.5 million - Q2 2011; $45.4 million - Q4 2010).  Commitments for the loans remain open for various dates through December 2011.  As at September 30, 2011, unutilized credit card balances amounted to $86.2 million ($84.4 million - Q2 2011; $76.5 million - Q4 2010). Outstanding commitments for future advances for the Equityline Visa portfolio were $2.1 million at September 30, 2011 ($4.7 million - Q2 2011; $5.1 million - Q4 2010).

CAPITAL MANAGEMENT

Home Trust calculates capital ratios and regulatory capital based on capital adequacy rules issued by OSFI, which are based on the "International Convergence on Capital Management and Capital Standard - A Revised Framework" (Basel II).

Under Basel II, Home Trust calculates risk-weighted assets for each of credit and operational risk.  Home Trust's capital structure and risk-weighted assets were as follows:

Table 10: Regulatory Capital

          As at
(000s, except % and multiples) September 30 December 31 September 30
    2011   2010 2   2010 2
Capital stock $ 23,497 $ 23,497 $ 23,497
Retained earnings   674,314   658,530   615,786
Adjustment for transition to measurement under IFRS   61,486   -   -
Contributed surplus   951   951   951
Accumulated (net after tax) unrealized losses on available for sale equity securities   (6,039)   -   -
Net tier 1 capital   754,209   682,978   640,234
Subordinated debt   115,000   15,000   15,000
Accumulated (net after tax) unrealized gains on available for sale equity securities   -   4,545   2,646
Eligible general allowance for credit losses   29,390   29,153   29,146
Total capital $ 898,599 $ 731,676 $ 687,026
Risk-weighted assets for            
Credit risk $ 3,831,000 $ 3,423,017 $ 3,453,515
Operational risk   438,175   354,250   340,363
Total risk-weighted assets $ 4,269,175 $ 3,777,267 $ 3,793,878
Tier 1 capital ratio   17.7%   18.1%   16.9%
Total capital ratio   21.0%   19.4%   18.1%
Asset to capital multiple   14.0    10.5    11.5 

1 Based on the Company's wholly owned subsidiary, Home Trust Company.

2 Regulatory Capital was calculated in accordance with previous Canadian GAAP in 2010

Home Trust's Tier 1 and Total capital ratios continue to significantly exceed OSFI's well-capitalized targets of 7.0% for Tier 1 and 10.0% for Total capital, as well as Home Trust's internal capital targets.

Home Trust elected to apply OSFI's IFRS transitional relief to the IFRS opening retained earnings adjustment. Home Trust is permitted to amortize the effect of the transition adjustment on regulatory capital over the eight quarters ending December 31, 2012. The amount added to regulatory capital will reduce to zero over this time.

Late in 2010, additional clarification was provided on the proposed Basel III requirements.  As anticipated, Basel III will affect capital and liquidity requirements in Canada with a phased-in approach beginning in 2013.  The Company has completed an analysis of the proposed Basel III requirements and has identified the following components as applicable:

  • Liquidity Coverage Ratio (LCR). LCR establishes a common measure of liquidity risk and requires institutions to maintain sufficient liquid assets to cover a minimum 30 days of cash flow requirements in a stress situation.  As at September 30, 2011 Home had sufficient liquid assets to meet the minimum LCR.
  • Revised definition of common equity Tier 1 capital.  Basel III proposes a number of deductions that begin in 2014 with a 20% reduction climbing to a 100% deduction in 2018. In particular unconsolidated investments in financial institutions will result in a deduction from capital.  After fully accounting for all deductions, Home Trust's capital ratios would continue to exceed both internal and regulatory minimum and 'well capitalized' levels.
  • Introduction of a 'conservation buffer' and 'pro-cyclical buffer'.  A capital conservation buffer of common equity equal to 2.5% of risk-weighted assets (RWA) will be phased-in between 2016 and 2019 and will ultimately require a minimum tangible common equity ratio of 7.0% and a Total capital ratio of 10.5%.  As at September 30, 2011 Home Trust had sufficient capital resources to adopt the conservation buffer.  A further 'countercyclical buffer' with a range of 0% to 2.5% of RWA in common equity will be required based on national circumstances with the intent of preventing 'overheating' or 'asset bubbles'.  As at September 30, 2011 Home Trust had sufficient capital resources to adopt the 'countercyclical buffer' at the top of the range.

RISK MANAGEMENT

The Company is exposed to various types of risks inherent to the nature of the business activities it conducts. The types of risk to which the Company is subject include, among others, credit, liquidity, interest rate and operational risks. The Company has adopted enterprise risk management (ERM) as a methodology for managing all sources of risks. Supporting the Company's ERM structure is a governance framework that includes Board of Director and senior management oversight, independent monitoring and measurement by the ERM function, policies, management standards, guidelines and procedures appropriate to each business activity and source of risk. The processes and controls are subject to periodic testing by the Company's internal audit group. The Board of Directors reviews and approves the policies at least annually. The Company's key risk management practices remain in place and are continually reviewed and enhanced from those outlined on pages 37 through 48 in the MD&A section of the Company's 2010 Annual Report.

Credit Risk

This is the risk of the loss of principal and/or interest from the failure of debtors and/or counterparties, for any reason, to honour their financial or contractual obligations to the Company. Senior management, the Chief Credit Officer, the ERM function, the Audit Committee and the Risk and Capital Committee of the Board of Directors, monitor the Company's exposure to credit risk. These parties undertake reviews of credit policies, lending practices, the adequacy of loan loss reserves and credit risk based capital. It is the Company's policy that different levels of senior management approve credit, based upon the level of risk and amount of the loan. The Risk and Capital Committee and the Board of Directors review compliance with credit risk requirements on a quarterly basis.

As part of credit risk management of the mortgage portfolio, senior management and the ERM function monitor various portfolio characteristics, including the characteristics in the following table.

Table 11: Mortgage Portfolio            
             
(000s, except %) September 30 December 31 September 30
    2011    2010    2010 
Total mortgage portfolio balance (net of individual allowance) $ 15,236,524  $ 13,638,416  $ 12,387,790 
Percentage of residential mortgages   93.8%   93.9%   93.7%
Percentage of non-residential mortgages   6.2%   6.1%   6.3%
Percentage of insured residential mortgages   64.7%   72.8%   67.6%
Percentage of first mortgages   99.4%   99.2%   99.2%
Percentage of mortgages current   97.9%   98.2%   98.2%
Percentage of mortgages over 60 days past due   0.8%   0.4%   0.8%

The composition of the mortgage portfolio is well within the internal policy limits approved by the Company's Risk and Capital Committee. The relative proportion of non-residential mortgages was relatively stable over the last twelve months. As a proportion of the total portfolio, the Company anticipates that the non-residential portfolio will remain relatively stable or exhibit modest growth in the foreseeable future.

Refer to Note 5 of the unaudited interim consolidated financial statements for a further breakdown of the loan portfolio by geographic region.

Insured mortgages reduce the credit risk to the Company. The insured portion of the mortgage portfolio has declined from December 31, 2010 due to a higher proportion of originations in the Company's traditional mortgage products, which are generally not insured.  Mortgages in the traditional program have lower loan to value ratios than the insured Accelerator product. For the three months ended September 30, 2011, the average loan to value on origination of the traditional mortgage product was 69.3%, compared to 70.9% last quarter and 69.4% in the third quarter of 2010.

The Company reduces credit risk on residential mortgages through collateral in the form of real property. In that regard, first mortgages continue to represent almost the entire portfolio. At September 30, 2011, the average loan to value of the total portfolio, which includes both insured and uninsured mortgages, was 70.1% compared to 67.6% last quarter and 68.6% at September 30, 2010.

Senior management and ERM closely monitor the credit performance of the mortgage loans portfolio. The portfolio continues to perform well with arrears that are well within expected levels. At the quarter end 97.9% of the portfolio was current and 0.8% was over 60 days in arrears, which is within historical norms.

At September 30, 2011 the gross credit card receivable balance totaled $388.3 million, of which virtually all is secured either by cash deposits or residential property. Within the secured credit card portfolio, Equityline Visa credit cards represent the principal driver of receivable balances. Equityline Visa credit cards are secured by collateral residential mortgages, and this portfolio segment amounted to $379.9 million or 97.8% of the total credit card receivable balance as at September 30, 2011 compared to 97.5% at December 31, 2010. Cash deposits for secured credit card accounts amounted to $12.9 million at September 30, 2011 and are included in the Company's deposits. Additionally, the Equityline Visa portfolio has a loan to value of 72.0% at September 30, 2011 compared to a loan to value of 72.3% at December 31, 2010. At September 30, 2011, $3.8 million or 1.0% of the credit card portfolio was over 60 days in arrears, compared to $8.1 million or 2.4% at December 31, 2010.

Net non-performing loans remain within expected and acceptable ranges.  As part of the Company's ongoing business strategy, experienced employees undertake reviews of all non-performing loans greater than 60 days to analyze patterns and drivers, and then reflect emerging drivers in the Company's lending criteria. This analytical approach and attention to emerging trends has resulted in continued low write-offs relative to the gross loans portfolio. Write-offs, net of recoveries, during the quarter totaled $2.2 million or 0.05% of gross loans compared to $1.8 million or 0.06%, respectively, in the comparable quarter of 2010 and $2.2 million or 0.06% in the second quarter of 2011. The Company continually monitors arrears and write-offs carefully and deals prudently and effectively with non-performing loans.

The Company maintains a collective allowance that, in management's judgement, is sufficient to absorb probable incurred losses in its loans portfolio. At September 30, 2011, the Company held a collective allowance of $29.4 million, consistent with the second quarter of 2011 and marginally higher than the $29.2 million held at December 31, 2010. The Company monitors the adequacy of the collective allowance on a monthly basis. The Company has security in the form of real property or cash deposits against loans representing virtually all of the total loans portfolio. The Company's evaluation of the adequacy of the collective allowance takes into account asset quality, borrowers' creditworthiness, property location, past loss experience and current economic conditions. The Company periodically reviews the methods utilized in assessing the collective allowance, giving due consideration to changes in economic conditions, interest rates and local housing market conditions.

Liquidity Risk

Liquidity risk is the risk that the Company would be unable to generate or obtain cash or equivalents in a timely manner, and at a reasonable cost, to meet its commitments (both on- and off-balance sheet) as they become due.

The Company's liquidity management framework includes a policy relating to several key elements. These include the minimum levels of liquid assets to be held at all times, the composition of the liquid assets to be maintained, the daily monitoring of the liquidity position by senior management and the ERM function, monthly monitoring by the Asset, Liability Management Committee (ALCO) and quarterly reporting to the Risk and Capital Committee of the Board of Directors.

The Company holds liquid assets in the form of cash and bank deposits, treasury bills, bankers' acceptances, government bonds, debentures, mortgage backed securities and Canadian bank bonds to comply with its liquidity policy. At September 30, 2011, liquid assets amounted to $577.8 million, compared to $788.8 million at the end of the second quarter and $951.3 million recorded at December 31, 2010.

The Company's policy is to maintain a minimum 20% of 100-day obligations in liquid assets and at September 30, 2011, the Company had 31.8% of 100-day liabilities in liquid assets.

Another tool used in managing liquidity is a model that considers two stress scenarios. In the "immediate" scenario, the Company experiences a significant decline in new deposits over a one-month period. In the "ongoing" scenario, the situation is similarly stressed but is spread out over the course of one year. In each scenario, the Company must hold sufficient liquid assets to meet the potential and certain obligations for a period of one year beyond the time frame of the scenario. These scenarios require the Company to make assumptions regarding the probable behaviour and timing of cash flows for each type of asset and liability. The Company's liquidity ratio is the total of liquid assets, adjusted by the estimates in each scenario, divided by the adjusted liabilities. At September 30, 2011 liquid assets amounted to 186% under the immediate scenario and 145% under the ongoing scenario compared to 174% and 137%, respectively, at December 31, 2010. The Company continues to monitor these scenarios and will take appropriate actions should the need arise.

Structural Interest Rate Risk

Structural interest rate risk is the risk of lost earnings or capital due to sudden changes in interest rates. The objective of structural interest rate risk management is to ensure that the Company is able to realize stable and predictable earnings over specific time periods despite interest rate fluctuations. The Company has adopted an approach to the management of its asset and liability positions that is designed to provide reasonable assurance that interest rate fluctuations will not materially impact future earnings, and to the best of its abilities matches liabilities to assets through its actions in the deposit market in priority to accessing off-balance sheet solutions. The Company's ALCO manages exposure arising from interest rate and liquidity risk, and reports quarterly to the Board of Directors.

The interest rate sensitivity position as at September 30, 2011 is presented in Note 15 in the accompanying unaudited interim consolidated financial statements. The table provided there represents the Company's position at a point in time, and the gap represents the difference between assets and liabilities in each maturity category.  Note 15 summarizes assets and liabilities, in terms of their contractual amounts. Over the lifetime of certain assets, some contractual obligations such as residential mortgages will be terminated prior to their stated maturity at the election of the borrower. Similarly, some contractual off-balance sheet mortgage commitments may be made but not materialize. In measuring its interest rate risk exposure, the Company will make assumptions about these factors, taking into account aspects such as past borrower behavior

To assist in matching assets and liabilities, the Company utilizes, among others, two interest rate risk sensitivity models which measure the relationship between changes in interest rates and the resulting impact on both future net interest income and the economic value of shareholders' equity. The following table provides the potential after tax impact of immediate and sustained 100 basis point and 200 basis point increases and decreases in interest rates on net interest income and on the economic value of shareholders' equity.

Table 12: Impact of Interest Rate Shifts            
                   
(000s) September 30 September 30 September 30 September 30
    2011  2010  2011  2010 
    Increase in interest rates Decrease in interest rates
100 basis point shift                
  Impact on net interest income, after tax                
  (for the next 12 months) $ 8,686  $ 5,998  $ (8,686) $ (5,998)
  Impact on net present value of shareholders' equity   2,100    14,500    (4,231)   (17,273)
                   
200 basis point shift                
  Impact on net interest income, after tax                
  (for the next 12 months) $ 17,372  $ 11,996  $ (17,372) $ (11,996)
  Impact on net present value of shareholders' equity   2,178    26,380    (13,129)   (43,824)

As described in the Derivatives and Hedging section of this MD&A, the Company may enter into derivative contracts to economically hedge the interest rate risk on future funding under securitization. The purpose is to manage interest rate exposures during the period between the date a mortgage commitment is made and the date the mortgage loan is securitized. At September 30, 2011, the Company held notional $25.0 million ($252.2 million - December 31, 2010) in derivative positions to hedge this risk. Additionally, through the Company's participation in CMHC's CMB program, the Company is required to enter into specific interest rate swap contracts to hedge interest rate risk.  Refer to Derivatives and Hedging section of this MD&A and Note 14 of these unaudited interim consolidated financial statements for additional information.

RESULTS BY BUSINESS SEGMENT

The following section discusses the mortgage lending, consumer lending and other segments for the three and nine month periods ended September 30, 2011 (refer to Note 16 of these unaudited interim consolidated financial statements).  The mortgage lending segment continues to be the primary driver of the Company's overall growth while the consumer lending segment continues to provide a diversified income source.

Mortgage Lending
                     
Table 13: Summary of Mortgage Lending Results          
        For the three months ended     For the nine months ended
(000s, except %) September 30 September 30 % Change September 30 September 30 % Change
    2011    2010      2011    2010   
Net interest income $ 72,203  $ 51,971  38.9% $ 199,574  $ 145,692  37.0%
Net income   42,117    35,044  20.2%   112,494    88,949  26.5%
Total assets $ 15,613,159  $ 12,463,168  25.3% $ 15,613,159  $ 12,463,168  25.3%

The mortgage lending segment continues its strong performance in the second quarter, recording increases in net income of 20.2% over the comparable quarter of 2010 and 26.5% on a year to date basis. Net income also increased 10.2% over the $38.2 million recorded in the second quarter of 2011. Net interest income continues to grow on higher loan balances and net interest margin reflecting continued strong demand for the Company's products through enhanced broker relationships, superior customer service and stable real estate markets across most of the country.

Expenses increased $0.5 million and $4.9 million, respectively, for the three and nine months ended September 30, 2011, compared to the same periods of 2010. The increases relate to higher costs associated with a significant growth in mortgage loans under administration and additional costs associated with the implementation of the Company's new core banking system. There were accompanying increases in income tax associated with higher income. Provisions for credit losses for the mortgage lending segment remain within expected and acceptable ranges and were $1.9 million and $3.9 million respectively, for the three and nine month periods compared to $1.7 million and $2.9 million for the same periods of 2010. Please see the Provision for Credit Losses section of this MD&A for further discussion.

Consumer Lending - Credit Cards and Retail Services
                     
Table 14: Summary of Consumer Lending Results
        For the three months ended       For the nine months ended
(000s, except %) September 30 September 30 % Change September 30 September 30 % Change
    2011    2010      2011    2010   
Net interest income $ 10,974  $ 8,692  26.3% $ 31,143  $ 26,771  16.3%
Net income   7,585    8,598  (11.8)%   22,529    20,860  8.0%
Total assets $ 580,999  $ 487,704  19.1% $ 580,999  $ 487,704  19.1%

Consumer lending, which includes Visa, retail lending and payment card services, continues to generate positive returns for the Company. Net interest income for the third quarter of 2011 increased by 26.3% compared to the same period in 2010, primarily due to an increase in outstanding receivables.  The Company anticipates net interest income in this portfolio to continue to grow through 2011, as loan balances in this portfolio grow. The average net interest margin earned on the Visa portfolio was 8.4% during the third quarter in 2011, compared to 8.5% in the third quarter of 2010 and 8.8% in the second quarter of 2011.  The average net interest margin earned in the consumer lending portfolio was 7.6% during the quarter ended September 30, 2011, compared to 8.2% in the comparable period of 2010 and 7.7% in the second quarter of 2011.  The decrease in interest margin is primarily due to higher cost of funds.

Net income was positively impacted by the sale of a loan portfolio in the third quarter of 2010 that did not reoccur.  As such, net income in the second quarter decreased by 11.8% over the comparable quarter of 2010. Fees and other income increased over the prior period on a higher number of accounts compared to 2010. Expenses have increased to support the business growth and the Company continues to effectively manage its expenditures while at the same time increasing the size of both its Visa and retail lending portfolios.

During the third quarter of 2011, 1,758 Equityline Visa accounts with $47.3 million in authorized credit limits were issued, compared to 1,796 accounts with $49.0 million in authorized credit limits issued in the third quarter of 2010 and 2,108 accounts with $57.1 in authorized limits in the second quarter of 2011. The Equityline Visa accounts are fully secured by residential real estate. The Company anticipates the strength in this product line to continue through both the "one stop" bundled mortgage with Equityline Visa, and strategic business and marketing initiatives within the Company's risk appetite.

The Company's consumer lending portfolio also includes the results from its retail lending operations.  The largest component of retail lending, representing 84.1% of the portfolio, is water heater loans.  There were 13,434 new water heater accounts added during the third quarter of 2011, an increase of 60.1% over the second quarter of 2011.  Water heater receivables increased by $16.5 million during the quarter to $138.4 million. The Company anticipates continued measured growth in the water heater line of business and is currently exploring this channel for other opportunities.

Consumer lending also includes the results of PSiGate which contributed $0.4 million to net income for the quarter and $1.4 million year to date, compared to $0.4 million and $1.1 million in the comparable periods of 2010 and $0.5 million in the second quarter of 2011.

Other
                     
Table 15: Summary of Other Results
        For the three months ended       For the nine months ended
(000s, except %) September 30 September 30 % Change September 30 September 30 % Change
    2011    2010      2011    2010   
Net interest income $ 4,435  $ 7,448  (40.5)% $ 14,823  $ 19,108  (22.4)%
Net income   (1,285)   3,979  (132.3)%   4,724    14,834  (68.2)%
Total assets $ 877,967  $ 1,243,588  (29.4)% $ 877,967  $ 1,243,588  (29.4)%

The other segment is comprised of the operating result from the Company's treasury portfolio and corporate activities.

The decline in net interest income is attributable to lower average balance of non-mortgage investments held by the Company compared to comparative periods. Net income was impacted in the quarter by an unrealized losses on derivatives of $4.1 million offset by realized gains on securities sales of $2.2 million and unrealized losses on impairment of available for sale securities of $0.8 million.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Impact of Adoption of International Financial Standards (IFRS)

General

The Company implemented revised Canadian GAAP, which uses IFRS as its financial reporting framework, on January 1, 2011, with a transition date of January 1, 2010.  Transition as at January 1, 2010 required restatement of the Company's 2010 financial information from its original Canadian GAAP basis to the IFRS basis. This allows for inclusion of comparative information in the 2011 financial statements.  On transition, IFRS requires the application of certain mandatory and optional transition exemptions.  The details of the restatement and the mandatory and selected optional exemptions, which the Company applied on transition, are set out in Note 18 to the accompanying unaudited interim consolidated financial statements.

As IFRS represents a new accounting framework, it is generally not appropriate to directly compare the Company's financial position and results of operations as stated under IFRS to the financial position and results of operations as stated under previous Canadian GAAP.

While many of the accounting principles and standards comprising IFRS are similar to previous Canadian GAAP, certain standards and rules are fundamentally different, resulting in significant changes to previously reported financial results and financial position.  The most significant differences relate to the accounting treatment of securitization transactions, including the timing of income and expense recognition, and the treatment of assets and liabilities arising from securitization activities.  Under previous Canadian GAAP, the assets securitized by the Company were removed from the balance sheet and a gain was calculated by comparing the fair value of consideration received and receivable to the carrying value of the assets at the time of securitization.  The securitization transaction triggered income and expense recognition. Under IFRS, the proceeds received on the securitization are considered a secured loan. Interest income associated with the securitized assets is recognized on an effective interest rate method, amortizing origination costs over the term of the mortgage. Interest expense is recognized on the secured loan over the term of the securitization, amortizing transaction costs and the discount or premium over that term.  Under IFRS, income and expenses are recognized with the passage of time.

As the Company has previously discussed, the restatement of the Company's financial results from previous Canadian GAAP to IFRS results in a significant adjustment related to certain derivatives which the Company uses to hedge interest rate risk associated with its securitization programs.  The Company has generally used bond forwards and interest rate swaps to hedge interest rate risk associated the commitments and accumulation of mortgages held for securitization and interest rate risk associated with the obligations assumed through the securitizations.  Under previous Canadian GAAP, the hedging instruments and the hedged items were all carried at fair value and changes in fair value tended to offset each other.  Under IFRS, the hedging instruments used in 2010 must be accounted for at fair value, whereas the hedged items are accounted for at amortized cost.  This results in an accounting mismatch.  This mismatch has an impact on the measurement of income from quarter to quarter, with gains recognized in some quarters and losses in others.  These gains and losses are not a reflection of an economic relationship, but rather an accounting mismatch.  The Company has taken steps to eliminate or significantly reduce this mismatch in 2011.  The Company will analyze its performance through 2011 by comparison to 2010 IFRS results, after adjustment, for this mismatch (adjusted net income and adjusted earnings per share).

Retained Earnings and Accumulated Other Comprehensive Income as at January 1, 2010

On restatement of the Company's 2010 financial statements to the IFRS basis, the cumulative gains recognized on securitizations before January 1, 2010 have been deducted from retained earnings and the net interest income attributed to the securitized assets and related debt accumulated to December 31, 2009 was added to retained earnings. This resulted in a net reduction of retained earnings as at January 1, 2010 of $75.6 million.  Consequently, this amount will be recognized in future periods, including a portion in 2011. Accumulated other comprehensive income was reduced by $11.1 million to remove the fair value adjustments for the securitization receivables which are not part of the IFRS balance sheet.

Net Income and Earnings per Share

As a result of the implementation of IFRS, net income recognized in the third quarter of 2010 was restated from $45.5 million to $47.6 million.  This restatement included an unmatched pre-tax gain on derivatives of $8.5 million.  On a basis that adjusts for the unmatched gain on derivatives, the net income for the third quarter of 2010 was $39.1 million. The Company's IFRS earnings per share for the third quarter of 2010 were $1.37 for both basic and diluted, compared to $1.31 for both basic and diluted under previous Canadian GAAP.  On an adjusted net income basis, the IFRS basic and diluted earnings per share were $1.13.  The Company uses adjusted net income and adjusted earnings per share for performance evaluation to eliminate the gains and losses on derivatives which arise from the adoption of the IFRS framework.  For the most part, such gains and losses will not occur in 2011 or in future periods as a result of revised interest rate risk management procedures and the application of hedge accounting.

Net Interest Income and Net Interest Margin

Under IFRS, all mortgages currently administered by the Company are included on the balance sheet, including securitized insured mortgages, along with a liability representing the funding of these mortgages through securitization.  A significant portion of securitized mortgages are Accelerator mortgages which generally carry lower interest rates than the Company's traditional mortgages and earn lower interest spreads against the funding.  Consequently, while total interest income and net interest income increased on conversion to IFRS, the total net interest margin declined.  The Company's net interest margin for the third quarter of 2010 was 2.00% on the IFRS basis compared to 2.63% on the Canadian GAAP basis.

Return on Equity

On restatement to the IFRS basis, the Company includes in liabilities the value of funds received on securitization of mortgage pools.  The Company also reduced net income and the stated value of retained earnings and accumulated other comprehensive income as at January 1, 2010, as described above.  On the IFRS basis, return on equity for the three months ended September 30, 2010 was 32.8% compared to 27.0% reported under Canadian GAAP. Return on equity under IFRS has not been recalculated on an adjusted net income basis.

Capital Measures

The Company's Board of Directors, senior management and its prudential regulator, OSFI, set certain limits on the Company's activities based on measures of capital adequacy and leverage of Home Trust.  The primary measures are Home Trust's Tier 1 and Total capital ratios and ACM.  The conversion to IFRS does not significantly affect the Tier 1 and Total capital ratios.  The regulatory requirement to include all assets under administration, except those securitized prior to March 31, 2010 under CMHC's CMB and MBS programs, has the impact of increasing the ACM at January 1, 2011 from 10.5 under Canadian GAAP to 15.1 times under IFRS.  In this regard, to maintain growth objectives, Home Trust increased its regulatory capital base in early May 2011 through the issue of $100.0 million in subordinated debt to Home Capital which issued $150.0 million in external senior debt.

Other Assets and Liabilities and Other Performance Indicators

The restatement of the Company's accounts and financial statements to the IFRS basis has an impact on other asset and liability categories and other performance indicators, such as credit ratios, credit provision ratios, efficiency ratio and return on assets. Readers are cautioned to take care when making comparisons to previous period reports.

Impact on Operating Results and Key Performance Indicators

The following table compares previous Canadian GAAP and IFRS operating results and key performance indicators for the periods ended September 30, 2010

    For the three months ended For the nine months ended
(000s, except %) September 30 September 30 September 30 September 30
  2010  2010  2010  2010 
  IFRS Canadian GAAP IFRS Canadian GAAP
Net Interest Income                
Non-securitized assets $ 49,090  $ 49,099  $ 143,838  $ 144,029 
Securitized assets   19,021    -   47,733   
    68,111    49,099    191,571    144,029 
Provision for credit losses   2,167    2,113    3,615    3,652 
      65,944    46,986    187,956    140,377 
Securitization Income     21,320      70,309 
Other Non-interest Income   24,004    15,488    52,277    34,474 
    89,948    83,794    240,233    245,160 
                 
Non-interest Expenses 24,756  23,535    68,867    67,071 
                 
Income before taxes   65,192    60,259    171,366    178,089 
Income taxes   17,571    14,809    46,723    47,527 
NET INCOME $ 47,621  $ 45,450  $ 124,643  $ 130,562 
Basic Earnings per Share $ 1.37  $ 1.31  $ 3.59  $ 3.76 
Diluted Earnings per Share $ 1.37  $ 1.31  $ 3.58  $ 3.75 
                 
Adjusted Net Income                
Adjustment for unmatched derivative positions (net of tax)   (8,483)     (11,266)  
ADJUSTED NET INCOME $ 39,138  $ 45,450  $ 113,377  $ 130,562 
Adjusted Basic Earnings per Share $ 1.13  $ 1.31  $ 3.27  $ 3.76 
Adjusted Diluted Earnings per Share $ 1.13  $ 1.31  $ 3.26  $ 3.75 
                 
Net interest margin   2.00%   2.63%   2.04%   2.68%
Return on shareholders' equity   32.8%   27.0%   30.0%   27.1%
Return on average assets   1.4%   2.4%   1.3%   2.3%
Efficiency ratio (TEB)   26.3%   26.8%   27.6%   26.3%
Non-performing loans as a percentage of gross loans   0.26%   0.57%   0.26%   0.57%
Allowance as a percentage of gross non-performing loans   87.6%   86.6%   87.6%   86.6%
Annualized provision as a percentage of gross loans   0.07%   0.14%   0.04%   0.08%

Quarterly IFRS Operating Results and Key Performance Indicators

The following table provides the quarterly IFRS operating results and key performance indicators for 2010.

                       
(000s, except per share and %)                   2010 
      Q4   Q3   Q2   Q1   Total
Net Interest Income Non-Securitized Assets                    
  Non-securitized loans interest $ 90,195  $ 89,872  $ 88,235  $ 85,477  $ 353,779 
  Dividends and other interest   7,375    7,064    6,482    7,090    28,011 
  Interest on deposits   47,988    47,846    47,184    45,352    188,370 
      49,582    49,090    47,533    47,215    193,420 
Net Interest Income Securitized Assets                    
  Securitized loans interest   76,583    66,255    55,469    52,984    251,291 
  Interest on securitization liabilities   53,706    47,234    40,800    38,941    180,681 
      22,877    19,021    14,669    14,043    70,610 
Total Net Interest Income   72,459    68,111    62,202    61,258    264,030 
  Provision for credit losses   5,816    2,167    537    911    9,431 
        66,643    65,944    61,665    60,347    254,599 
Non-interest Income                    
  Fees and other income   8,621    7,127    7,126    7,816    30,690 
  Net gain (loss) on securities   (985)   1,347    5,488    3,890    9,740 
  Net gain on sale of loan portfolio     3,917        3,917 
  Net gain (loss) on derivatives   (5,745)   11,613    7,607    (3,654)   9,821 
      1,891    24,004    20,221    8,052    54,168 
Non-interest Expenses   26,610    24,756    24,358    19,753    95,477 
Income before taxes   41,924    65,192    57,528    48,646    213,290 
Income taxes   11,816    17,571    16,213    12,939    58,539 
NET INCOME $ 30,108  $ 47,621  $ 41,315  $ 35,707  $ 154,751 
Basic Earnings per Share $ 0.87  $ 1.37  $ 1.19  $ 1.03  $ 4.46 
Diluted Earnings per Share $ 0.87  $ 1.37  $ 1.19  $ 1.03  $ 4.45 
                       
Adjusted Net Income                    
Adjustment for unmatched derivative positions                    
(net of tax) $ 4,124  $ (8,483) $ (5,463) $ 2,680  $ (7,142)
ADJUSTED NET INCOME $ 34,232  $ 39,138  $ 35,852  $ 38,387  $ 147,609 
Adjusted Basic Earnings per Share $ 0.99  $ 1.13  $ 1.03  $ 1.11  $ 4.25 
Adjusted Diluted Earnings per Share $ 0.98  $ 1.13  $ 1.03  $ 1.10  $ 4.24 
                       
Return on shareholders' equity   19.5%   32.8%   30.4%   27.6%   27.3%
Return on average assets   0.8%   1.4%   1.3%   1.2%   1.2%
Efficiency ratio (TEB)   35.0%   26.3%   28.8%   27.7%   28.7%
Non-performing loans as a percentage of gross loans   0.24%   0.26%   0.34%   0.47%   0.24%
Net interest margin non-securitized interest earning assets   2.71%   2.67%   2.72%   2.73%   2.71%
Net interest margin securitized assets   1.26%   1.27%   1.19%   1.27%   1.23%
Total net interest margin   1.95%   2.00%   2.06%   2.12%   2.01%
Annualized provision as a percentage of gross loans   0.17%   0.07%   0.02%   0.04%   0.07%

1 Reclassification adjustments were made between dividends and other interest and securitized loans interest in Q2 and Q3 from what was presented in the 2011 First Quarter Report.

2 The net gain (loss) on derivatives in 2010 results from the accounting mismatch discussed on page 26 under General Impacts of Adoption of IFRS. This amount is eliminated from net income on an after tax basis to arrive at adjusted net income.

3 These key performance indicators have not been recalculated based on adjusted net income.

4 The efficiency ratio is calculated as non-interest expenses as a percentage of total revenue, net of interest expense.

5 Numbers have been restated to reflect improvements in average balance calculations.

ACCOUNTING STANDARDS AND POLICIES

Critical accounting estimates that require management to make significant judgements, some of which are inherently uncertain, are outlined on page 39 of the unaudited consolidated financial statements included in this quarterly report. These estimates are critical as they involve material amounts and require management to make determinations that, by their very nature, include uncertainties. The preparation of unaudited interim consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions, mainly concerning the valuation of items, which affect the amounts reported. Actual results could differ from those estimates. Accounting policies requiring critical accounting estimates include the allowance for credit losses, financial instruments measured at fair value, impairment of available for sale securities, stock based compensation, goodwill, amortization of capital assets and intangibles and deferred income tax amounts. Further information can be found under Notes 4, 5, 6, 12, and 14 of these unaudited interim consolidated financial statements.

Future Changes in Accounting Standards

All accounting standards effective for periods beginning on or after January 1, 2011 have been adopted as part of the transition to IFRS. The following new IFRS pronouncements have been issued but are not effective and may have a future impact on the Company:

IFRS 7 Financial Instruments: Disclosures

Beginning with the 2012 annual financial statements the Company will adopt amendments to IFRS 7 regarding Disclosures - Transfers of Financial Assets (IFRS 7), which requires additional disclosures on transfer transactions of financial assets (e.g. securitization transactions). There will be no impact to the operating results or financial position of the Company as this standard affects disclosures only.

IFRS 9 Financial Instruments

As of January 1, 2013 the Company will be required to adopt IFRS 9, Financial Instruments (IFRS 9), which is the first phase of the International Accounting Standards Board's (IASB) project to replace IAS 39, Financial Instruments; Recognition and Measurement. The IASB has proposed to change the effective date from January 1, 2013 to January 1, 2015.  However, a final decision as to this proposed change to the effective date has yet to be made.  IFRS 9 provides new requirements for how an entity should classify and measure financial assets and liabilities that are in the scope of IAS 39.  Management is currently evaluating the potential impact that the adoption of IFRS 9 will have on the Company's consolidated financial statements.

IFRS 10 Consolidated Financial Statements

As of January 1, 2013 the Company will be required to adopt IFRS 10 Consolidated Financial Statements (IFRS 10).  Under IFRS 10, consolidated financial statements will include all controlled entities under a single control model.  Management is currently evaluating the potential impact that the adoption of IFRS 10 will have on the Company's consolidated financial statements.

IFRS 12 Disclosure of Interests in Other Entities

As of January 1, 2013 the Company will be required to adopt IFRS 12 Disclosure of Interests in Other Entities (IFRS 12).  IFRS 12 provides disclosure requirements about subsidiaries, joint ventures and associates, as well as unconsolidated structured entities and replaces existing disclosure requirements.  The requirements of IFRS 12 will not have an impact on the results of operations or financial position of the Company as they are disclosure requirements only.

IFRS 13 Fair Value Measurement

As of January 1, 2013 the Company will be required to adopt IFRS 13 Fair Value Measurement (IFRS 13).  IFRS 13 establishes a single source of guidance for fair value measurements when fair value is required or permitted by IFRS and provides for enhanced disclosures when fair value is applied.  Management is currently evaluating the potential impact that the adoption of IFRS 13 will have on the Company's consolidated financial statements.

IAS 27 Separate Financial Statements

As of January 1, 2013 the Company will be required to adopt the reissued IAS 27 Separate Financial Statements (IAS 27).  As the consolidation guidance will now be included in IFRS 10, IAS 27 will only prescribe the accounting and disclosure requirements for investments in subsidiaries, joint ventures and associates when the entity prepares separate financial statements.  Management is currently evaluating the potential impact that the adoption of the reissued IAS 27 will have on the financial statements of the Company's subsidiaries

Controls over Financial Reporting

Management is responsible for the design and effectiveness of internal controls over financial reporting in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements that are free of material errors.  During the Company's transition period to IFRS, management identified and subsequently implemented certain changes to accounting processes and procedures in order to comply with IFRS.  The material changes in processes and procedures relate to the following;

  • Accounting for securitized mortgages on the Company's balance sheet.
  • Accounting for the secured borrowing liability.
  • Accounting for securitized mortgages interest income and secured borrowing interest expense.
  • Application of hedge accounting for hedges of interest rate risk.
  • Conversion of historical Canadian GAAP financial information to IFRS for comparative purposes.

As a result of these changes to accounting process and procedures, management revised existing internal controls and designed and implemented new internal controls over financial reporting to provide reasonable assurance that the risk of material misstatements in the Company's financial reporting has been mitigated.

During the third quarter, the Company began capturing, summarizing and reporting mortgage, deposit and expense transactions using a new financial system.  The new system involved revisions to accounting processes.  The Company's internal controls over financial reporting were modified as a result of the changes to these processes.  Development of this system will continue into the fourth quarter and additional control modifications will be made as required.

There were no other changes that have or could be reasonably expected to materially affect internal control over financial reporting.

Comparative Consolidated Financial Statements

The comparative interim unaudited consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2011 unaudited interim consolidated financial statements.

UPDATED SHARE INFORMATION

As at September 30, 2011, the Company had issued 34,649,240 Common Shares. In addition, outstanding employee stock options amounted to 942,250 (Note 9(B)) (748,750 - Q3 2010) of which 475,625 were exercisable as of the quarter-end (434,100 - Q3 2010) for proceeds to the Company upon exercise of $15.8 million ($14.4 million - Q3 2010).

Subsequent to the end of the third quarter, the Board of Directors declared a quarterly cash dividend of $0.20 per common share payable on December 1, 2011 to shareholders of record at the close of business on November 15, 2011.

QUARTERLY FINANCIAL HIGHLIGHTS

Table 16: Summary of Quarterly Results

                                   
(000s, except per share and %)           IFRS               IFRS   CGAAP
              2011                2010    2009 
      Q3   Q2   Q1   Q4   Q3   Q2   Q1   Q4
Net interest income (TEB) $ 89,478  $ 83,121  $ 78,232  $ 74,238  $ 70,104  $ 64,234  $ 63,354  $ 48,178 
Less TEB adjustment   1,866    1,799    1,626    1,779    1,993    2,032    2,096    2,842 
Net interest income per financial statements   87,612    81,322    76,606    72,459    68,111    62,202    61,258    45,336 
Non-interest income   5,661    12,454    7,109    1,891    24,004    20,221    8,052    28,015 
Non-interest expense   26,036    26,643    25,216    26,610    24,756    24,357    19,753    19,856 
Total revenues   200,288    198,568    184,613    176,044    187,195    170,407    153,603    121,381 
Net income   48,417    48,206    43,178    30,108    47,621    41,316    35,707    40,481 
Return on common shareholders' equity   27.0%   28.2%   26.7%   19.5%   32.7%   30.4%   27.6%   28.4%
Return on average total assets   1.2%   1.2%   1.1%   0.8%   1.4%   1.3%   1.2%   2.4%
Earnings per common share                                
  Basic $ 1.40  $ 1.39  $ 1.24  $ 0.87  $ 1.37  $ 1.19  $ 1.03  $ 1.17 
  Diluted $ 1.39  $ 1.38  $ 1.24  $ 0.87  $ 1.37  $ 1.19  $ 1.03  $ 1.16 
Book value per common share $ 21.10  $ 20.24  $ 19.14  $ 18.14  $ 17.44  $ 16.06  $ 15.26  $ 17.00 
Efficiency ratio (TEB)   27.4%   27.9%   29.6%   35.0%   24.6%   28.8%   27.7%   26.1%
Efficiency ratio   27.9%   28.4%   30.1%   35.8%   25.1%   29.6%   28.5%   27.1%
Tier 1 capital ratio   17.7%   18.4%   19.0%   18.1%   16.9%   16.7%   16.5%   16.4%
Total capital ratio   21.0%   22.1%   20.3%   19.4%   18.1%   17.9%   17.9%   18.0%
Non-performing loans as a % of gross loans   0.32%   0.23%   0.29%   0.24%   0.26%   0.34%   0.47%   0.85%
Annualized provision as a % of gross loans   0.06%   0.03%   0.03%   0.17%   0.07%   0.02%   0.04%   0.17%

1 TEB - Taxable Equivalent Basis, see definition on page 7

2 These figures relate to the Company's operating subsidiary, Home Trust Company

The Company's key financial measures for each of the last eight quarters are summarized in the table above.  Figures prior to Q1 2010 are presented on the previous Canadian GAAP basis. Readers are cautioned to consider the differences between IFRS and previous Canadian GAAP when making comparisons between IFRS and previous Canadian GAAP operating results and financial position.  These highlights illustrate the Company's profitability, return on equity, as well as efficiency measures and capital ratios. The quarterly results are modestly affected by seasonal factors, with first quarter mortgage advances typically impacted by winter weather conditions, and the fourth quarter normally experiencing increased credit card activity over the holiday period.

The Company continues to achieve positive financial results driven by revenue growth in mortgage lending, and continued low efficiency ratios.  Tier 1 and Total capital ratios through 2010 and into 2011 reflect the Company's prudent capital management strategies and the proactive approach to maintain a strong capital base.

OUTLOOK

The Company will continue to focus on its core mortgage lending business, including its traditional mortgage lending programs which have successfully operated for nearly 25 years, as well as developing new products in this suite of offerings. These products serve selected segments of the Canadian financial services marketplace which are generally not the focus of the major financial institutions. Additionally, the Company will continue to offer insured mortgage products which are competitive and well-serviced and will continue to participate in the CMB and National Housing Authority MBS securitization programs when market conditions are favourable.  Growth of the overall loans portfolio will continue through cautious and strategic geographic penetration combined with ongoing measured growth of the consumer portfolio, while maintaining the Company's prudent credit policies. The Company will continue to explore solutions that will allow the Company to profitably grow its originations in the insured mortgage market segment.

The Company is committed to maintaining its financial strength through a strong capital base and conservative liquidity and believes it is in a strong position to deal with any economic uncertainty that may spill over into the Canadian economy and positions it to continue generating above-average returns and capitalize on market opportunities where they arise, at controlled, acceptable levels of risk.  The Company is well positioned to continue to grow its assets, revenue and net income within its current objectives for 2011 and into 2012.

Consistent with the first nine months of 2011 the Company expects that the rate of growth in the total mortgage loans portfolio will be moderate unless solutions that encourage growth of insured mortgage lending become available. Net income and net interest income will continue to grow as the portfolio shifts to higher yielding loans while maintaining credit quality. Securitization volumes will continue to reflect declines in Accelerator originations as the Company focuses its origination processes on its traditional mortgage products which are more profitable. Spreads earned on Accelerator and traditional mortgages are anticipated to remain relatively stable for the rest of 2011 and into 2012.

The Company continues to observe healthy and stable real estate conditions throughout most of the country, with stable to modest increases in new and resale home sale volumes and stable to moderate price appreciation in most markets. The Company believes that the Canadian housing market will be stable throughout the remainder of 2011 and into 2012.

Despite a reduction in Accelerator and multi-unit residential mortgage originations, the Company has maintained growth in its profitability by adapting its strategies to deal with changing capital allocation requirements and market changes. Stable housing markets allow for increased focus on the Company's traditional mortgage portfolio, Equityline Visa and modest geographic diversification. The Company continues focusing on superior customer and broker service, expansion of broker networks and increased market penetration. Home Capital expects origination volume increases in the traditional mortgage portfolio, modest increases in originations outside Ontario and continued growth in consumer lending, which includes Equityline Visa, for the remainder of 2011 and into 2012.

The credit performance of the loan portfolio remains strong, with arrears, non-performing loans and write-offs within expected levels. The Company expects the level of write-offs and non-performing loans to remain consistent on a relative basis for the remainder of 2011 and into 2012.

The investment in and implementation of SAP Solutions for Banking provides the foundation for the Company's future growth, and product development leading to increased future revenue, and profits. The new platform expands current capacity, improves customer service and will lead to future operational efficiencies, resulting in improved cost efficiency and growth.  The Company will commence the amortization of the capitalized SAP costs, beginning in the fourth quarter, over a 10 year period. It is expected that savings on the pre-implementation costs, which will not reoccur, combined with savings from increased operational efficiencies will mitigate the amortization expenses over time.

Looking ahead, the Board of Directors and management are confident that Home Capital will continue generating strong earnings and growth throughout 2011 and into 2012. This Outlook section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements on page 6 of this quarterly report.

Consolidated Statements of Income

        For the three months ended   For the nine months ended
        September 30   September 30   September 30   September 30
        2011    2010    2011    2010 
thousands of Canadian dollars, except per share amounts (Unaudited)       (restated to IFRS)       (restated to IFRS)
Net Interest Income Non-Securitized Assets                
Interest from loans $ 104,418  $ 89,872  $ 291,733  $ 263,584 
Dividends from securities   4,887    4,592    13,858    14,106 
Other interest   1,127    2,472    4,039    6,530 
        110,432    96,936    309,630    284,220 
Interest on deposits   49,387    47,846    141,374    140,382 
Interest on senior debt   2,011      3,279   
Net interest income non-securitized assets   59,034    49,090    164,977    143,838 
                     
Net Interest Income Securitized Loans and Assets (note 6)                
Interest from securitized loans and assets   84,195    66,255    248,615    174,708 
Interest on securitization liabilities   55,617    47,234    168,052    126,975 
Net interest income securitized loans and assets   28,578    19,021    80,563    47,733 
                     
Total Net Interest Income   87,612    68,111    245,540    191,571 
Provision for credit losses (note 5(D))   2,349    2,167    4,540    3,615 
        85,263    65,944    241,000    187,956 
Non-Interest Income                
Fees and other income   9,697    7,127    26,703    22,069 
Gain on sale of loan portfolio     3,917      3,917 
Realized net gains and unrealized losses on securities   1,224    1,347    5,394    10,725 
Net realized and unrealized gain (loss) on derivatives (note 14)   (5,260)   11,613    (6,873)   15,566 
        5,661    24,004    25,224    52,277 
        90,924    89,948    266,224    240,233 
Non-Interest Expenses                 
Salaries and benefits   13,509    11,847    39,339    34,334 
Premises   1,997    1,732    5,769    5,074 
Other operating expenses   10,530    11,177    32,787    29,459 
        26,036    24,756    77,895    68,867 
                     
Income Before Income Taxes    64,888    65,192    188,329    171,366 
Income taxes (note 12(A))                
  Current   18,249    10,548    50,414    25,284 
  Deferred   (1,778)   7,023    (1,832)   21,439 
        16,471    17,571    48,582    46,723 
NET INCOME $ 48,417  $ 47,621  $ 139,747  $ 124,643 
                     
NET INCOME PER COMMON SHARE                
Basic $ 1.40  $ 1.37  $ 4.03  $ 3.59 
Diluted $ 1.39  $ 1.37  $ 4.02  $ 3.58 
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING                 
Basic   34,682    34,717    34,691    34,708 
Diluted   34,804    34,781    34,804    34,814 
                     
Total number of outstanding common shares (note 9(A))   34,649    34,679    34,649    34,679 
Book value per common share $ 21.10  $ 17.44  $ 21.10  $ 17.44 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

Consolidated Statements of Comprehensive Income

    For the three months ended   For the nine months ended
      September 30   September 30   September 30   September 30
      2011    2010    2011    2010 
thousands of Canadian dollars (Unaudited)       (restated to IFRS)       (restated to IFRS)
                   
NET INCOME $ 48,417  $ 47,621  $ 139,747  $ 124,643 
                   
OTHER COMPREHENSIVE LOSS                
                   
Available for Sale Securities                
Net unrealized (losses) gains on securities available for sale   (9,221)   8,760    (9,302)   2,480 
Net gains reclassified to net income   (1,499)   (1,651)   (5,989)   (9,268)
      (10,720)   7,109    (15,291)   (6,788)
Income tax (recovery) expense   (2,707)   2,070    (3,875)   (659)
      (8,013)   5,039    (11,416)   (6,129)
                   
Cash Flow Hedges                
Net unrealized losses on cash flow hedges (note 14)   (3,430)     (6,747)  
Net losses reclassified to net income   189      280   
      (3,241)     (6,467)  
Income tax recovery   (843)     (1,682)  
      (2,398)     (4,785)  
                   
Total other comprehensive (loss) income   (10,411)   5,039    (16,201)   (6,129)
                   
COMPREHENSIVE INCOME $ 38,006  $ 52,660  $ 123,546  $ 118,514 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

Consolidated Balance Sheets

                 
        September 30   December 31   January 1
      2011    2010    2010 
thousands of Canadian dollars (Unaudited)       (restated to IFRS)   (restated to IFRS)
ASSETS             
Cash Resources (note 4(A)) $ 417,701  $ 846,824  $ 930,134 
Securities (note 4(B))            
Held for trading       99,938 
Available for sale   440,458    424,168    494,602 
Pledged securities (note 6(B))   208,18   2,954   
        648,641    427,122    594,540 
Loans (note 5)            
Residential mortgages   5,782,855    4,683,527    4,473,255 
Securitized residential mortgages (notes 5 and 6)   8,502,466    8,116,636    4,126,707 
Non-residential mortgages   951,203    838,253    708,425 
Personal and credit card loans   546,122    453,339    342,918 
        15,782,646    14,091,755    9,651,305 
Collective allowance for credit losses (note 5(D))   (29,390)   (29,153)   (27,793)
        15,753,256    14,062,602    9,623,512 
Other            
Income taxes receivable     9,451    6,466 
Derivative assets (note 14)   71,656    24,157    13,186 
Other assets (note 7)   99,581    80,099    75,322 
Capital assets   4,487    4,894    4,863 
Intangible assets   61,051    47,917    26,811 
Goodwill   15,752    15,752    15,752 
        252,527    182,270    142,400 
      $ 17,072,125  $ 15,518,818  $ 11,290,586 
LIABILITIES AND SHAREHOLDERS' EQUITY            
Liabilities            
Deposits and Senior Debt            
  Deposits payable on demand $ 27,000  $ 50,359  $ 38,223 
  Deposits payable on a fixed date   7,193,517    6,545,620    6,433,533 
  Senior debt(note 13)   153,998     
        7,374,515    6,595,979    6,471,756 
Securitization Liabilities (note 6(C))            
  Mortgage-backed security liabilities   2,604,521    2,826,105    1,191,552 
  Canada Mortgage Bond liabilities   6,148,605    5,278,473    2,964,904 
        8,753,126    8,104,578    4,156,456 
Other            
Derivative liabilities (note 14)   3,800    9,009    11,099 
Income taxes payable   10,413     
Other liabilities (note 8)   160,774    140,554    130,823 
Deferred tax liabilities (note 12(C))   38,281    40,113    16,829 
        213,268    189,676    158,751 
        16,340,909    14,890,233    10,786,963 
Shareholders' Equity            
Capital stock (note 9)   54,489    50,427    45,396 
Contributed surplus   5,453    4,571    3,606 
Retained earnings   681,569    567,681    444,416 
Accumulated other comprehensive (loss) income (note 11)   (10,295)   5,906    10,205 
        731,216    628,585    503,623 
      $ 17,072,125  $ 15,518,818  $ 11,290,586 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

Consolidated Statements of Changes in Shareholders' Equity

 
        Net Unrealized Net Unrealized Total  
        Gains (Losses) Losses on Accumulated  
        on Securities Cash Flow Other Total
thousands of Canadian dollars, Capital Contributed Retained Available for Hedges, Comprehensive Shareholders'
except per share amounts (Unaudited) Stock Surplus Earnings Sale, after Tax after Tax Income Equity
Balance at December 31, 2010                            
(restated to IFRS) $ 50,427  $ 4,571  $ 567,681  $ 5,906  $ $ 5,906  $ 628,585 
Comprehensive income       139,747    (11,416)   (4,785)   (16,201)   123,546 
Stock options settled (note 9(A))   4,237    (933)           3,304 
Amortization of fair value of
employee stock options (note 10(A))
    1,815            1,815 
Repurchase of shares (note 9(A))   (175)     (5,724)         (5,899)
Dividends paid or declared                            
($0.56 per share)       (20,135)         (20,135)
Balance at September 30, 2011 $ 54,489  $ 5,453  $ 681,569  $ (5,510) $ (4,785) $ (10,295) $ 731,216 
                             
Balance at January 1, 2010 $ 45,396  $ 3,606  $ 444,416  $ 10,205  $ $ 10,205  $ 503,623 
Comprehensive income       124,643    (6,129)     (6,129)   118,514 
Exercise of stock appreciation rights     (186)           (186)
Stock options settled (note 9(A))   5,309    (880)           4,429 
Amortization of fair value of
employee stock options (note 10(A))
    1,655            1,655 
Repurchase of shares (note 9(A))   (230)     (6,745)         (6,975)
Dividends paid or declared                            
($0.48 per share)       (16,311)         (16,311)
Balance at September 30, 2010                            
(restated to IFRS) $ 50,475  $ 4,195  $ 546,003  $ 4,076  $ $ 4,076  $ 604,749 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

Consolidated Statements of Cash Flows

        For the nine months ended
          September 30   September 30
          2011    2010 
thousands of Canadian dollars (Unaudited)       (restated to IFRS)
CASH FLOWS FROM OPERATING ACTIVITIES        
Net income for the period $ 139,747  $ 124,643 
Adjustments to determine cash flows relating to operating activities:        
  Deferred income taxes   (1,832)   21,439 
  Amortization of capital assets   2,181    1,829 
  Amortization of intangible assets    65    192 
  Amortization of premium/discount on securities   33    2,113 
  Amortization of securitization and senior debt transaction costs   6,736    6,731 
  Provision for credit losses (note 5(D))   4,540    3,615 
  Change in accrued interest payable   21,581    18,384 
  Change in accrued interest receivable   (3,647)   (4,181)
  Realized net gains and unrealized losses on securities   (5,394)   (10,725)
  Loss (gain) on derivatives   6,265    (32,083)
  Net increase in mortgages   (1,602,452)   (3,081,068)
  Net increase in personal and credit card loans   (92,742)   (82,008)
  Net increase in deposits   624,538    315,774 
  Activity in securitization liabilities        
    Proceeds from securitization of mortgage-backed security liabilities   1,044,863    2,941,789 
    Settlement and repayment of securitization liabilities   (456,891)   (509,483)
  Amortization of fair value of employee stock options (note 10)   1,815    1,655 
  Other   1,973    1,183 
Cash flows used in operating activities   (308,621)   (280,201)
CASH FLOWS FROM FINANCING ACTIVITIES        
Repurchase of shares   (5,899)   (6,975)
Exercise of employee stock options and stock appreciation rights   3,304    4,243 
Issuance of senior debt   149,072   
Dividends paid   (19,440)   (16,664)
Cash flows from (used in) financing activities   127,037    (19,396)
CASH FLOWS FROM INVESTING ACTIVITIES        
Activity in available for sale and held for trading securities        
  Purchases   (592,802)   (317,312)
  Proceeds from sales   273,078    272,194 
  Proceeds from maturities   87,158    146,989 
Purchases of capital assets   (1,774)   (2,216)
Purchases of intangible assets   (13,199)   (17,605)
Cash flows (used in) from investing activities   (247,539)   82,050 
Net decrease in cash and cash equivalents during the period   (429,123)   (217,547)
Cash and cash equivalents at beginning of the period   846,824    930,134 
Cash and Cash Equivalents at End of the Period (note 4(A)) $ 417,701  $ 712,587 
Supplementary Disclosure of Cash Flow Information        
Dividends received $ 13,034  $ 11,863 
Interest received   536,701    452,277 
Interest paid   291,124    262,399 
Income taxes paid   27,952    31,793 

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

 

Notes to the Interim Consolidated Financial Statements
(unless otherwise stated, all amounts are in Canadian dollars, Unaudited)

1. CORPORATE INFORMATION

Home Capital Group Inc. (the "Company") is a public limited liability holding company traded on the Toronto Stock Exchange.  The Company is incorporated and domiciled in Canada with its registered and principal business offices located at 145 King Street West, Suite 2300, Toronto, Ontario.  The Company operates primarily through its federally regulated subsidiary, Home Trust Company (Home Trust), which offers deposits, residential and non-residential mortgage lending, securitization of insured residential first mortgage products, consumer lending, Visa products and payment card services.  Licensed to conduct business across Canada, Home Trust has branch offices in Ontario, Alberta, British Columbia, Nova Scotia and Quebec.  The Company is the ultimate parent of the group.

These unaudited interim consolidated financial statements for the period ended September 30, 2011 were authorized for issuance by the Board of Directors of the Company on November 2, 2011.  The Board of Directors have the power to amend the financial statements after their issuance only in the case of discovery of an error.

Subsequent to the end of the third quarter and before the date these financial statements were authorized for issuance, the Board of Directors declared a quarterly cash dividend of $6.9 million or $0.20 per common share payable December 1, 2011 to shareholders of record at the close of business on November 15, 2011.

2. ACCOUNTING POLICIES USED TO PREPARE THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

These unaudited interim consolidated financial statements of the Company have been prepared in accordance with International Accounting Standard 34 Interim Financial Reporting (IAS 34) as issued by the International Accounting Standards Board (IASB) and using the accounting policies and methods of application that the Company expects to adopt in its consolidated financial statements as at and for the year ending December 31, 2011.  Those accounting policies and methods of application are based on the International Financial Reporting Standards (IFRS) that the Company expects to be applicable as at December 31, 2011.  The accounting policies were consistently applied to all periods presented unless otherwise noted.

These unaudited interim consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements as at and for the year ended December 31, 2010 as set out in the 2010 Annual Report, on pages 59 through 88 and the Company's unaudited interim consolidated financial statements as at and for the three months ended March 31, 2011 as set out in the 2011 First Quarter Report, on pages 33 through 74.  The effect of transitioning from the previous Canadian GAAP is explained in Note 17 to the first quarter financial statements included in the 2011 First Quarter Report and Note 18 to these unaudited interim consolidated financial statements.

The significant accounting policies used in the preparation of these unaudited interim consolidated financial statements are summarized on pages 38 through 43 of the 2011 First Quarter Report.  During the second quarter of 2011, the Company issued $150 million in 5 year fixed senior debentures to the market as discussed in Note 13.  The accounting policy applied in respect of these debentures is described below under senior debt.

Use of judgement and estimates

Management has exercised judgement in the process of applying the Company's accounting policies.  In particular, the Company's accounting policy regarding loans and liabilities under current securitization programs, where such loans are not derecognized and securitization liabilities are recognized is based on management's judgement that substantially all of the risks and rewards of ownership of the securitized loans are retained.

The preparation of consolidated financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet date and the reported amounts of revenue and expenses during the reporting period.  Key areas where management has made estimates include allowance for credit losses, fair values and impairment of financial instruments, goodwill and intangible assets, income taxes, fair value of stock options and useful lives of capital assets and intangible assets. Actual results could differ from those estimates.

Senior debt

Senior debt is carried at amortized cost, including the principal amount received on issue, plus accrued interest and costs incurred on issue, less repayments of principal and interest and amortization of issue costs and any premium or discount to the face amount of the debt.  Issue costs and premium or discount are amortized to income using the effective interest rate method.

3. FUTURE CHANGES IN ACCOUNTING POLICIES

The following accounting pronouncements issued by the IASB were not effective as at September 30, 2011 and therefore have not been applied in preparing these consolidated financial statements.

IFRS 7 Financial Instruments: Disclosures

In October 2010, the IASB issued amendments to IFRS 7 regarding Disclosures - Transfers of Financial Assets, which are effective for annual periods beginning on or after July 1, 2011 with earlier application permitted.  The amendments comprise additional disclosures on financial asset transfer transactions. These amendments will not have an impact on the results of operations or financial position of the Company as they are disclosure requirements only.

IFRS 9 Financial Instruments

In November 2009, the IASB issued, and subsequently revised in October 2010, IFRS 9 Financial Instruments (IFRS 9) as a first phase in its ongoing project to replace IAS 39.  IFRS 9, which is to be applied retrospectively, is effective for annual periods beginning on or after January 1, 2013, with earlier application permitted.  In August 2011, the IASB issued an exposure draft proposing to change this effective date to January 1, 2015 (a final decision is still pending).  IFRS 9 provides new requirements as to how an entity should classify and measure financial assets and liabilities that are in the scope of IAS 39.  The standard requires all financial assets to be classified on the basis of the entity's business model for managing such financial assets and the contractual cash flow characteristics of the financial assets.

A financial asset is measured at amortized cost if the objective of the business model is to hold the financial asset for the collection of the contractual cash flows and the contractual cash flows under the instrument solely represent payments of principal and interest.  A financial asset that meets the criteria to be measured at amortized cost can be designated at fair value through profit or loss under the fair value option, if doing so would significantly reduce or eliminate an accounting mismatch.  If a financial asset does not meet the criteria to be measured at amortized cost, it is measured at fair value.

IFRS 9 requires all equity investments to be measured at fair value with an option to present unrealized and realized fair value gains and losses in other comprehensive income for equity investments not held for trading.  This irrevocable designation to present in other comprehensive income must be made on initial recognition on an instrument-by-instrument basis.  There is no subsequent transfer of fair value gains and losses to profit or loss.  Dividends from such investments will continue to be recognized in profit or loss. Management is currently evaluating the potential impact that the adoption of IFRS 9 will have on the Company's consolidated financial statements.

IFRS 10 Consolidated Financial Statements

In May 2011, the IASB issued IFRS 10 Consolidated Financial Statements (IFRS 10) which is effective for annual periods beginning on or after January 1, 2013 with earlier adoption permitted.  IFRS 10 will replace portions of IAS 27 Consolidated and Separate Financial Statements and interpretation SIC-12 Consolidation - Special Purpose Entities.  Under IFRS 10, consolidated financial statements will include all controlled entities under a single control model.  Management is currently evaluating the potential impact that the adoption of IFRS 10 will have on the Company's consolidated financial statements.

IFRS 12 Disclosure of Interests in Other Entities

In May 2011, the IASB issued IFRS 12 Disclosure of Interests in Other Entities (IFRS 12) which is effective for annual periods beginning on or after January 1, 2013 with earlier adoption permitted.  IFRS 12 provides disclosure requirements about subsidiaries, joint ventures and associates, as well as unconsolidated structured entities and replaces existing disclosure requirements.  The requirements of IFRS 12 will not have an impact on the results of operations or financial position of the Company as they are disclosure requirements only.

IFRS 13 Fair Value Measurement

In May 2011, the IASB issued IFRS 13 Fair Value Measurement (IFRS 13) which is effective for annual periods beginning on or after January 1, 2013 with earlier adoption permitted.  IFRS 13 establishes a single source of guidance for fair value measurements when fair value is required or permitted by IFRS and provides for enhanced disclosures when fair value is applied.  Management is currently evaluating the potential impact that the adoption of IFRS 13 will have on the Company's consolidated financial statements.

IAS 27 Separate Financial Statements

In May 2011, the IASB reissued IAS 27 Separate Financial Statements (IAS 27) which is effective for annual periods beginning on or after January 1, 2013 with earlier adoption permitted.  As the consolidation guidance will now be included in IFRS 10, IAS 27 will only prescribe the accounting and disclosure requirements for investments in subsidiaries, joint ventures and associates when the entity prepares separate financial statements.  Management is currently evaluating the potential impact that the adoption of the reissued IAS 27 will have on the financial statements of the Company's subsidiaries.

4. CASH RESOURCES AND SECURITIES

(A) Cash Resources            
             
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
    2011    2010    2010 
Deposits with regulated financial institutions $ 320,507  $ 347,631  $ 866,069 
Treasury bills guaranteed by government   178    406,938   
Cash and cash equivalents   320,685    754,569    866,069 
Restricted cash - Canada Mortgage Bond program   70,600    70,000    46,100 
Restricted cash - interest rate swaps   26,416    22,255    17,965 
  $ 417,701  $ 846,824  $ 930,134 

Restricted cash - Canada Mortgage Bond program represents deposits held as collateral by CMHC in connection with the Company's securitization activities. To participate in the National Housing Authority mortgage-backed security programs, the Company is required to maintain an amount of cash in a trust account to cover deposits of unscheduled principal prepayments (UPP). The amount represents a percentage of UPP, which is based on the Company's average monthly UPP rate for the last year and calculated on the basis of the end of year principal balance. The Company is allowed to invest the above amount in eligible securities. The funds must be invested on behalf of the Principal & Interest Custodial/Trust Account.  Currently, these funds are deposits held by a Canadian Schedule A Bank.

Restricted cash - interest rate swaps are deposits held by swap counterparties as collateral for the Company's interest rate swap transactions.  The Company is required to provide collateral against its interest rate swap transactions as part of the agreements with the counterparties. The terms and conditions for these collaterals are governed by International Swaps Dealers Associations (ISDA) agreements.

(B) Available for Sale Securities - Net Unrealized Gains and Losses
               
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
Gains (losses)   2011    2010    2010 
Securities issued or guaranteed by:            
  Canada $ $ $ 237 
  Corporations   49    130    (35)
Equity securities            
  Common   786    1,584    2,369 
  Fixed rate preferred   (7,925)   6,282    8,105 
Income trusts   (835)   (458)   2,317 
Mutual funds   287    115    (55)
    $ (7,638) $ 7,653  $ 12,938 

Net unrealized gains and losses are included in accumulated other comprehensive income except for impairment losses which are transferred to net income. Accumulated other comprehensive income is disclosed in Note 11.

The unrealized losses included above represent differences between the cost of a security and its current fair value. The Company regularly monitors its investments and market conditions for indications of permanent impairment.

For the three months ended September 30, 2011, the Company recognized $0.8 million with a year-to-date total of $1.9 million ($nil - Q3 2010 and $nil - nine months of 2010) of impairment losses on available for sale securities.  These losses were transferred into net income. These unrealized losses are not included in the above table.

5. LOANS

(A) Loans by Geographic Region and Type (net of individual allowances for credit losses)
                       
thousands of Canadian dollars, except % (Unaudited)         As at September 30, 2011
    Securitized        
  Residential Residential Non-residential Personal and   Percentage
  Mortgages Mortgages Mortgages Credit Card Loans Total of Portfolio
British Columbia $ 320,801  $ 905,244  $ 5,156  $ 13,514  $ 1,244,715  7.9%
Alberta   329,193    714,534    33,640    33,679    1,111,046  7.1%
Ontario   4,830,157    5,753,245    840,218    491,638    11,915,258  75.5%
Quebec   201,827    715,059    47,114    1,705    965,705  6.1%
Atlantic provinces   90,752    216,848    25,075    4,414    337,089  2.1%
Other   10,125    197,536      1,172    208,833  1.3%
  $ 5,782,855  $ 8,502,466  $ 951,203  $ 546,122  $ 15,782,646  100.0%
As a % of portfolio   36.6%   53.9%   6.0%   3.5%   100.0%  
                       
thousands of Canadian dollars, except % (Unaudited)         As at December 31, 2010
    Securitized        
  Residential Residential Non-residential Personal and   Percentage
  Mortgages Mortgages Mortgages Credit Card Loans Total of Portfolio
British Columbia $ 313,225  $ 897,890  $ 9,580  $ 15,921  $ 1,236,616  8.8%
Alberta   302,113    719,726    31,813    39,090    1,092,742  7.8%
Ontario   3,686,264    5,411,314    736,310    391,976    10,225,864  72.5%
Quebec   157,098    665,942    34,710    1,482    859,232  6.1%
Atlantic provinces   128,328    224,695    25,840    3,661    382,524  2.7%
Other   96,499    197,069      1,209    294,777  2.1%
  $ 4,683,527  $ 8,116,636  $ 838,253  $ 453,339  $ 14,091,755  100.0%
As a % of portfolio   33.3%   57.6%   5.9%   3.2%   100.0%  
                       
thousands of Canadian dollars, except % (Unaudited)           As at January 1, 2010
    Securitized        
  Residential Residential Non-residential Personal and   Percentage
  Mortgages Mortgages Mortgages Credit Card Loans Total of Portfolio
British Columbia $ 480,004  $ 494,867  $ 9,270  $ 22,617  $ 1,006,758  10.4%
Alberta   368,201    494,736    76,424    54,209    993,570  10.3%
Ontario   3,326,976    2,414,112    570,339    258,952    6,570,379  68.1%
Quebec   133,798    453,652    31,660    1,594    620,704  6.4%
Atlantic provinces   93,139    122,826    11,399    4,095    231,459  2.4%
Other   71,137    146,514    9,333    1,451    228,435  2.4%
  $ 4,473,255  $ 4,126,707  $ 708,425  $ 342,918  $ 9,651,305  100.0%
As a % of portfolio   46.3%   42.8%   7.3%   3.6%   100.0%  


(B) Past Due Loans that are not Impaired

A loan is recognized as being impaired (non-performing) when the Company is no longer reasonably assured of the timely collection of the full amount of principal and interest. As a matter of practice, a loan is deemed to be impaired at the earlier of the date it has been individually provided for or when it has been in arrears for 90 days.  Residential mortgages (including securitized residential mortgages) guaranteed by the Government of Canada are not considered impaired until payment is contractually 365 days past due.  As securitized residential mortgages are insured, credit losses are not anticipated on this portfolio. Secured and unsecured credit card balances that have a payment that is contractually 120 days in arrears are individually provided for and those that have a payment that is contractually 180 days in arrears are written off. Equityline Visa credit card balances are measured on a basis consistent with mortgage loans.

             
thousands of Canadian dollars (Unaudited)       As at September 30, 2011
      Securitized        
  Residential   Residential   Non-residential Personal and  
  Mortgages   Mortgages   Mortgages Credit Card Loans Total
1 - 30 days $ 134,967    $ 54,491    $ 3,828  $ 4,313  $ 197,599 
31 - 60 days   35,920      11,921      126    1,628    49,595 
61 - 90 days   6,715      2,376      414    2,269    11,774 
Over 90 days   9,282    17,955      1,256    28,493 
  $ 186,884    $ 86,743    $ 4,368  $ 9,466  $ 287,461 
                         
thousands of Canadian dollars (Unaudited)       As at December 31, 2010
      Securitized        
  Residential   Residential   Non-residential Personal and  
  Mortgages   Mortgages   Mortgages Credit Card Loans Total
1 - 30 days $ 108,842    $ 39,981    $ 4,671  $ 4,706  $ 158,200 
31 - 60 days   26,027      5,836      1,022    1,922    34,807 
61 - 90 days   6,038      3,055        1,857    10,950 
Over 90 days   7,080    10,909      1,384    19,373 
  $ 147,987    $ 59,781    $ 5,693  $ 9,869  $ 223,330 
                         
thousands of Canadian dollars (Unaudited)             As at January 1, 2010
      Securitized        
  Residential   Residential   Non-residential Personal and  
  Mortgages   Mortgages   Mortgages Credit Card Loans Total
1 - 30 days $ 134,925    $ 50,396    $ 4,058  $ 5,204  $ 194,583 
31 - 60 days   36,149      10,450      1,910    1,428    49,937 
61 - 90 days   3,080      3,386        2,162    8,628 
Over 90 days   8,911    24,005      749    33,665 
  $ 183,065    $ 88,237    $ 5,968  $ 9,543  $ 286,813 

1Insured residential mortgages are considered impaired when they are 365 days past due.

(C) Impaired Loans

Residential mortgages guaranteed by the Government of Canada are not considered impaired until payment is contractually 365 days past due.  As securitized residential mortgages are all fully insured, credit losses are not anticipated.

               
thousands of Canadian dollars (Unaudited)             As at September 30, 2011
    Securitized      
  Residential Residential Non-residential Personal and  
  Mortgages Mortgages Mortgages Credit Card Loans Total
Gross amount of impaired loans $ 43,819  $ $ 2,732  $ 6,443  $ 52,994 
Individual allowances on principal   (1,312)     (33)   (1,854)   (3,199)
Net $ 42,507  $ $ 2,699  $ 4,589  $ 49,795 
                     
thousands of Canadian dollars (Unaudited)             As at December 31, 2010
    Securitized      
  Residential Residential Non-residential Personal and  
  Mortgages Mortgages Mortgages Credit Card Loans Total
Gross amount of impaired loans $ 29,586  $ $ 2,295  $ 7,241  $ 39,122 
Individual allowances on principal   (1,757)       (3,140)   (4,897)
Net $ 27,829  $ $ 2,295  $ 4,101  $ 34,225 
                     
thousands of Canadian dollars (Unaudited)               As at January 1, 2010
    Securitized      
  Residential Residential Non-residential Personal and  
  Mortgages Mortgages Mortgages Credit Card Loans Total
Gross amount of impaired loans $ 41,621  $ $ 2,417  $ 4,847  $ 48,885 
Individual allowances on principal   (1,483)     (135)   (961)   (2,579)
Net $ 40,138  $ $ 2,282  $ 3,886  $ 46,306 

(D) Allowance for Credit Losses

 
thousands of Canadian dollars (Unaudited)   For the three months ended September 30, 2011
    Residential Non-residential Personal and  
    Mortgages Mortgages Credit Card Loans Total
Individual allowances                
Allowance on loan principal                
  Balance at the beginning of the period $ 1,168  $ $ 1,983  $ 3,151 
  Provision for credit losses   1,765    33    420    2,218 
  Write-offs   (1,701)     (582)   (2,283)
  Recoveries   8     33    113 
      1,312    33    1,854    3,199 
Allowance on accrued interest receivable                
  Balance at the beginning of the period   443        443 
  Provision for credit losses   131        131 
      574        574 
Total individual allowance   1,886    33    1,854    3,773 
Collective allowance                
  Balance at the beginning of the period   16,919    8,334    4,137    29,390 
  Provision for credit losses   -       
      16,919    8,334    4,137    29,390 
Total allowance $ 18,805  $ 8,367  $ 5,991  $ 33,163 
Total provision $ 1,89 $ 33  $ 420  $ 2,349 
                   
thousands of Canadian dollars (Unaudited)   For the three months ended September 30, 2010
    Residential Non-residential Personal and  
    Mortgages Mortgages Credit Card Loans Total
Individual allowances                
Allowance on loan principal                
  Balance at the beginning of the period $ 725  $ 145  $ 699  $ 1,569 
  Provision for credit losses   1,636    (85)   360    1,911 
  Write-offs   (1,359)     (649)   (2,008)
  Recoveries   181      61    242 
      1,183    60    471    1,714 
Allowance on accrued interest receivable                
  Balance at the beginning of the period   294        294 
  Provision for credit losses   54        54 
      348        348 
Total individual allowance   1,531    60    471    2,062 
Collective allowance                
  Balance at the beginning of the period   21,464    4,100    3,380    28,944 
  Provision for credit losses   (2)   84    120    202 
      21,462    4,184    3,500    29,146 
Total allowance $ 22,993  $ 4,244  $ 3,971  $ 31,208 
Total provision $ 1,688  $ (1) $ 480  $ 2,167 

                   
thousands of Canadian dollars (Unaudited) For the nine months ended September 30, 2011
    Residential Non-residential Personal and  
    Mortgages Mortgages Credit Card Loans Total
Individual allowances                
Allowance on loan principal                
  Balance at the beginning of the period $ 1,757  $ $ 3,140  $ 4,897 
  Provision for credit losses   4,140    33    (41)   4,132 
  Write-offs   (4,880)     (1,351)   (6,231)
  Recoveries   295      106    401 
      1,312    33    1,854    3,199 
Allowance on accrued interest receivable                
  Balance at the beginning of the period   403        403 
  Provision for credit losses   171        171 
      574        574 
Total individual allowance   1,886    33    1,854    3,773 
Collective allowance                
  Balance at the beginning of the period   16,299    9,357    3,497    29,153 
  Provision for credit losses   620    (1,023)   640    237 
      16,919    8,334    4,137    29,390 
Total allowance $ 18,805  $ 8,367  $ 5,991  $ 33,163 
Total provision $ 4,931  $ (990) $ 599  $ 4,540 
                   
thousands of Canadian dollars (Unaudited) For the nine months ended September 30, 2010
    Residential Non-residential Personal and  
    Mortgages Mortgages Credit Card Loans Total
Individual allowances                
Allowance on loan principal                
  Balance at the beginning of the period $ 1,483  $ 135  $ 961  $ 2,579 
  Provision for credit losses   1,739    (75)   635    2,299 
  Write-offs   (4,376)     (1,315)   (5,691)
  Recoveries   2,337      190    2,527 
      1,183    60    471    1,714 
Allowance on accrued interest receivable                
  Balance at the beginning of the period   385        385 
  Provision for credit losses   (37)       (37)
      348        348 
Total individual allowance   1,531    60    471    2,062 
Collective allowance                
  Balance at the beginning of the period   19,948    4,398    3,447    27,793 
  Provision for credit losses   1,514    (214)   53    1,353 
      21,462    4,184    3,500    29,146 
Total allowance $ 22,993  $ 4,244  $ 3,971  $ 31,208 
Total provision $ 3,216  $ (289) $ 688  $ 3,615 

There were no provisions, allowances or net write-offs on securitized residential mortgages, which are insured.

6. SECURITIZATION ACTIVITY

(A) Securitized Assets

The Company's wholly owned subsidiary, Home Trust, securitizes insured residential mortgage loans by participating in the National Housing Authority (NHA) mortgage-backed securities (MBS) program. Through the program the Company issues securities backed by residential mortgage loans that are insured against borrowers' default. Once the mortgage loans are securitized, the Company assigns underlying mortgages and/or related securities to CMHC.  As an issuer of the MBS, Home Trust is responsible for advancing all scheduled principal and interest payments to CMHC, irrespective of whether or not the amounts have been collected on the underlying transferred mortgages.  The securitization activity includes the Company's participation in the Canada Mortgage Bond (CMB) program. Under the CMB program, CMHC guarantees the bonds of a special purpose trust, Canada Housing Trust (CHT). CHT uses the proceeds of its bond issuance to finance the purchase of NHA MBS.

In these securitizations, the Company retains certain prepayment risk and interest rate risk related to the transferred mortgages. Due to retention of these risks, transferred mortgages are not derecognized and the securitization proceeds are accounted for as secured borrowing transactions. There are no expected credit losses on the securitized mortgage assets as the mortgages are insured against default. Further, the investors and CMHC have no recourse to other assets of either the Company or Home Trust in the event of failure of debtors to pay when due.

The carrying amounts of the mortgages transferred during the quarter amounted to $396.8 million, including replacement assets of $161.6 million, for a total of $1.60 billion, including replacement assets of $548.1 million for the nine months ended September 30, 2011 ($1.13 billion including replacement assets of $211.8 million - Q3 2010 and $3.31 billion including replacement assets of $477.1 million for the nine months ended September 30, 2010).  The transferred mortgages are recorded on the consolidated balance sheets as securitized residential mortgages.  Associated new securitization liabilities of $235.4 million were added during the quarter for a total of $1.05 billion for the nine months ended September 30, 2011 ($964.8 million - Q3 2010 and a total of $2.89 billion for the nine months ended September 30, 2010) and are secured by the mortgages and other pledged assets.

(B) Assets Pledged as Collateral

Mortgage loans and other assets used in securitization activities are pledged against the associated secured borrowings (securitization liabilities). As a requirement of the NHA MBS program, the Company assigns, transfers, and sets over to CMHC, all of its rights, title, and interest in existing mortgage pools. If the Company fails to make timely payment under an NHA MBS security, CMHC may enforce the assignment to CMHC of the mortgages included in all the mortgage pools backing the securities issued. If CMHC enforces the assignments, all authority and power of the Company under the terms of NHA MBS guide, whether with respect to securities issued or mortgages pooled in the contract, shall pass to and be vested in CMHC.

As at September 30, 2011 the principal value of the Company's mortgage loans securitized and pledged as collateral for associated liabilities was $8.45 billion ($8.06 billion - December 31, 2010; $4.10 billion - January 1, 2010). These mortgages are recorded as securitized residential mortgages on the consolidated balance sheets. The Company has also pledged $208.2 million as at September 30, 2011 ($3.0 million - December 31, 2010; $nil - January 1, 2010) in non-Home Trust MBS and treasury bills as collateral in the CMB program, which are recorded as pledged securities on the consolidated balance sheets.

(C) Securitization Liabilities

Securitization liabilities represent the funding secured by insured mortgages assigned under NHA MBS programs, which include both MBS securities directly sold to third party investors and participation in the CMB program.  As the securitization of mortgages does not lead to derecognition of the mortgages under accounting standards, proceeds received through securitization of these mortgages are recorded as CMB and MBS liabilities on the consolidated balance sheets of the Company.  The total amount of MBS and CMB liabilities outstanding as at September 30, 2011 amounted to $8.75 billion ($8.10 billion - December 31, 2010; $4.16 billion - January 1, 2010).  Accrued interest on these liabilities is classified in other liabilities as accrued interest payable on securitized liabilities.

MBS securitization liabilities are reduced on a monthly basis based on principal payments collected from securitized assets during the month. CMB liabilities are bullet bond liabilities with fixed maturities. Any principal collected against securitized assets underlying CMB liabilities is transferred to CMHC under the program on a monthly basis. The funds are received back from CMHC once the Company provides replacement assets monthly.

Interest accrued on MBS liabilities is based on MBS coupon and is paid monthly to MBS investors. Interest accrued on CMB liabilities is based on the CMB coupon related to the series in which the Company participated. Accrued interest on underlying MBS and replacement assets provided over the course of CMB liabilities is passed to counterparties on a monthly basis and is shown as MBS interest receivable in other assets. At the coupon settlement date, the Company pays/receives the difference between the amount already paid to counterparties and accrued interest based on the CMB coupon through an interest rate swap. Because the underlying cash flows associated with this interest rate swap are captured through the on-balance sheet recognition of the underlying mortgages and the associated CMB secured borrowing, these interest rate swaps are not recognized at fair value on the consolidated balance sheets and fair value changes are not recognized in the consolidated statements of income. The underlying cash flows of the interest rate swap are recognized on an accrual basis as described above. As at September 30, 2011, the notional amount of these swaps, which represents the CMB secured borrowing, was $6.12 billion compared to $5.31 billion at December 31, 2010 and $4.58 billion at September 30, 2010.

7. OTHER ASSETS

             
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
    2011    2010    2010 
Accrued interest receivable $ 53,567  $ 49,920  $ 43,269 
MBS interest receivable   19,840    9,449    5,521 
Other prepaid assets and deferred items   26,174    20,730    26,532 
  $ 99,581  $ 80,099  $ 75,322 

8. OTHER LIABILITIES

             
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
    2011    2010    2010 
Accrued interest payable on deposits $ 80,014  $ 72,630  $ 76,564 
Accrued interest payable on securitization liabilities   36,506    22,309    13,417 
Dividends payable   6,931    6,236    5,901 
Other, including accounts payable and accrued liabilities   37,323    39,379    34,941 
  $ 160,774  $ 140,554  $ 130,823 

9. CAPITAL

(A) Common Shares Issued and Outstanding

 
thousands (Unaudited) For the three months ended   For the nine months ended
  September 30, 2011 September 30, 2010 September 30, 2011 September 30, 2010
  Number of     Number of     Number of     Number of    
  Shares   Amount Shares   Amount Shares   Amount Shares   Amount
Outstanding at beginning of period 34,684  $ 54,543  34,670  $ 48,771  34,646  $ 50,427  34,713  $ 45,396 
Options exercised   43    1,751  116    4,237  131    5,309 
Repurchase of shares (35)   (54) (34)   (47) (113)   (175) (165)   (230)
Outstanding at end of period 34,649  $ 54,489  34,679  $ 50,475  34,649  $ 54,489  34,679  $ 50,475 

The purchase cost of shares acquired through the repurchase of shares is allocated between capital stock and retained earnings.

(B) Share Purchase Options

                         
thousands, except per share amounts                      
(Unaudited) For the three months ended   For the nine months ended
  September 30, 2011 September 30, 2010 September 30, 2011 September 30, 2010
      Weighted-     Weighted-     Weighted-     Weighted-
      Average     Average     Average     Average
  Number of   Exercise Number of   Exercise Number of   Exercise Number of   Exercise
  Shares   Price Shares   Price Shares   Price Shares   Price
Outstanding at beginning of period 949  $ 36.99  797  $ 30.81  1,066  $ 36.07  925  $ 31.32 
Granted   10    44.63    10    44.63 
Exercised   (43)   34.96  (116)   28.43  (131)   33.94 
Forfeited (6)   47.92  (15)   29.06  (7)   47.92  (55)   34.66 
Outstanding at end of period 943  $ 36.92  749  $ 30.80  943  $ 36.92  749  $ 30.80 
Exercisable, end of period 47 $ 33.19  434  $ 33.26  476  $ 33.19  434  $ 33.26 

(C) Capital Management 

The Company has a capital management policy which governs the quantity and quality of capital held. The objective of the policy is to meet regulatory capital requirements, while also providing a sufficient return to investors. The Risk and Capital Committee and the Board of Directors annually review the policy and monitor compliance with the policy on a quarterly basis.

The Company's subsidiary, Home Trust, is subject to the regulatory capital requirements governed by the Office of the Superintendent of Financial Institutions Canada (OSFI).  These requirements are consistent with international standards (Basel II) set by the Bank for International Settlements.  Home Trust follows the Standardized Approach for calculating credit risk and the Basic Indicator Approach for operational risk.

The regulatory capital position of Home Trust was as follows:

     
thousands of Canadian dollars, except ratios and multiple (Unaudited) September 30 December 31
      2011    2010 
        (Canadian GAAP)
Tier 1 capital        
  Capital stock $ 23,497  $ 23,497 
  Contributed surplus   951    951 
  Retained earnings   674,314    658,530 
  Accumulated other comprehensive loss   (6,039)   -
  IFRS transition adjustment   61,486    -
  Total   754,209    682,978 
Tier 2 capital        
  Collective allowance for credit losses   29,390    29,153 
  Accumulated other comprehensive income     4,545 
  Subordinated debentures   115,000    15,000 
  Total   144,390    48,698 
Total regulatory capital $ 898,599  $ 731,676 
Risk-weighted assets for        
  Credit risk $ 3,831,000  $ 3,423,017 
  Operational risk   438,175    354,250 
Total risk-weighted assets $ 4,269,175  $ 3,777,267 
Regulated capital to risk-weighted assets        
  Tier 1 capital   17.7%   18.1%
  Tier 2 capital   3.4%   1.3%
Total regulatory capital ratio   21.0%   19.4%
Assets to regulatory capital multiple   14.0    10.5 

1 Accumulated other comprehensive loss relates to unrealized losses on certain available for sale equity securities, net of tax, which decrease Tier 1 capital.
2 The Company is allowed to include its collective allowance for credit losses up to a prescribed percentage of risk-weighted assets in Tier 2 capital.  At September 30, 2011, the Company's collective allowance represented 0.69% of risk-weighted assets.
3 Accumulated other comprehensive income relates to unrealized gains on certain available for sale equity securities, net of tax, which increase Tier 2 capital.
4 Regulatory capital and calculations as at December 31, 2010 are based on previous Canadian GAAP balances.

Under Basel II, OSFI considers a financial institution to be well-capitalized if it maintains a Tier 1 capital ratio of 7% and a Total capital ratio of 10%. Home Trust Company is in compliance with the OSFI capital guidelines.

Under IFRS transition relief permitted by OSFI, the Company has elected to amortize the December 31, 2010 IFRS retained earnings transition adjustment over eight quarters beginning March 31, 2011. The IFRS retained earnings transition adjustment for regulatory capital calculation purposes is the difference between retained earnings under Canadian GAAP and IFRS at December 31, 2010. In the absence of this election, the Company's Tier 1 and Total capital would be $692.7 million and $837.1 million, respectively, at September 30, 2011.

10. STOCK-BASED COMPENSATION

(A) Common Shares Issued and Outstanding

During the third quarter of 2011, $584 thousand was recorded as an expense for a year-to-date total of $1,815 thousand ($475  thousand - Q3 2010 and $1,655 thousand - nine months of 2010) for stock option awards in the consolidated statements of income, with an offsetting credit to contributed surplus. During the third quarter of 2011, no options were granted for a year-to-date total of nil (10 thousand - Q3 2010 and 10 thousand - nine months of 2010).

(B) Deferred Share Unit Plan

Effective January 1, 2009 the Board of Directors approved a deferred share unit (DSU) plan. The plan is only available to non-employee Directors of the Company who elect to accept remuneration in the form of cash, cash and DSUs or DSUs.  At September 30, 2011, 10,889 DSUs remain issued with an associated liability of $445 thousand recorded in other liabilities on the consolidated balance sheet.

11. ACCUMULATED OTHER COMPREHENSIVE INCOME

               
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
      2011    2010    2010 
Unrealized (losses) gains on            
  Available for sale securities $ (7,638) $ 7,653  $ 12,938 
  Income tax (recovery) expense   (2,128)   1,747    2,733 
      (5,510)   5,906    10,205 
               
Unrealized losses on            
  Cash flow hedges   (6,467)    
  Income tax expense   (1,682)    
      (4,785)    
Accumulated other comprehensive (loss) income $ (10,295) $ 5,906  $ 10,205 

12. INCOME TAXES

(A) Reconciliation of Income Taxes

 
thousands of Canadian dollars (Unaudited) For the three months ended For the nine months ended
    September 30 September 30 September 30 September 30
      2011    2010    2011    2010 
Income before income taxes $ 64,888  $ 65,192  $ 188,329  $ 171,366 
Income taxes at statutory combined federal and provincial income tax rates $ 18,373  $ 20,403  $ 53,122  $ 53,162 
Increase (decrease) in income taxes at statutory income tax rates resulting from                
  Tax-exempt income   (1,341)   (1,408)   (3,802)   (4,262)
  Non-deductible expenses   189    (138)   568    69 
  Future tax rate changes   (82)   (154)   (197)   (214)
  Other   (668)   (1,132)   (1,109)   (2,032)
Income tax $ 16,471  $ 17,571  $ 48,582  $ 46,723 

(B) Reconciliation of Income Tax Rates

 
(Unaudited) For the three months ended For the nine months ended
    September 30 September 30 September 30 September 30
    2011  2010  2011  2010 
Statutory income tax rate   28.31%   31.30%   28.21%   31.02%
Increase (reduction) in income tax rate resulting from                
  Tax-exempt income   (2.06)%   (2.16)%   (2.02)%   (2.49)%
  Non-deductible expenses   0.29%   (0.21)%   0.30%   0.04%
  Future tax rate changes   (0.13)%   (0.24)%   (0.10)%   (0.12)%
  Other   (1.03)%   (1.74)%   (0.59)%   (1.18)%
Effective income tax   25.38%   26.95%   25.80%   27.27%

(C) Sources of Deferred Tax Balances

 
thousands of Canadian dollars (Unaudited) September 30 December 31 January 1
      2011    2010    2010 
Deferred tax liabilities            
  Commissions $ 5,675  $ 5,904  $ 6,754 
  Finders fees, net of commitment fees   12,712    14,750    9,962 
  Securitization transaction costs   9,210    10,652    4,064 
  Swaps   3,683    5,183    567 
  Development costs   14,220    11,060    7,232 
  Other   429    344   
      45,929    47,893    28,579 
               
Deferred tax assets            
  Allowance for credit losses   7,545    7,780    7,549 
  Other   103      4,201 
      7,648    7,780    11,750 
    $ 38,281  $ 40,113  $ 16,829 

Capital losses totalling $2.8 million are available to reduce capital gains in future years.  The future tax benefits arising from application of these losses have not been reflected in the consolidated statements of income and changes in shareholders' equity.

13. SENIOR DEBT

The company issued $150.0 million principal amount of 5.20% debentures on May 4, 2011 in denominations of $1,000 and authorized multiples of thereof.  The debenture pays interest semi-annually on November 4 and May 4 in each year commencing on November 4, 2011.  The debentures mature on May 4, 2016 and are redeemable at the option of the company upon 30 days written notice to the registered holder at a redemption price equal to the greater of the Canada Yield Price and par, together in each case with accrued and unpaid interest up to but excluding the date fixed for redemption.

14. DERIVATIVE FINANCIAL INSTRUMENTS

The Company utilizes interest rate swaps and forward contracts to hedge exposures to interest rate risk. The Company generally uses its derivative instruments in hedge accounting relationships to minimize volatility in earnings caused by changes in interest rates. When a hedging derivative functions effectively, gains, losses, revenues or expenses of the hedging derivative will offset the gains, losses, revenues or expenses of the hedged item. To qualify for hedge accounting treatment, the hedging relationship is formally designated and documented at its inception. The documentation describes the particular risk management objective and strategy for the hedge and the specific asset, liability or cash flow being hedged and how effectiveness of the hedge is assessed. Changes in the fair value of the derivative instruments must be highly effective at offsetting either the changes in the fair value of the risk on the on-balance sheet asset or liability being hedged or the changes in the amount of future cash flows.

Hedge effectiveness is assessed at the inception of the hedge and on an ongoing basis, retrospectively and prospectively, over the life of the hedge. Any ineffectiveness in the hedging relationship is recognized immediately through non-interest expense.

Cash Flow Hedging Relationships

The Company uses bond forward contracts to hedge the economic value exposure of movements in interest rates between the time that the Company is committed to its liabilities pursuant to asset securitization, and the time the mortgages are legally sold and the liabilities are incurred. The intent of the bond forward is to manage the change in cash flows of the future interest payments on the anticipated secured borrowings through asset securitization.

The following table presents gains or (losses) related to cash flow hedges on the Company's financial results:

     
thousands of Canadian dollars (Unaudited) For the three months ended For the nine months ended
  September 30 September 30 September 30 September 30
    2011    2010    2011    2010 
Fair value changes recorded in other comprehensive income $ (3,430) $ $ (6,747) $
Fair value changes recorded in non-interest income       (545)  
Amounts reclassified from other comprehensive income
to net interest income
  (189)     (280)  

Fair Value Hedging Relationships

The Company uses interest rate swaps to hedge changes in the fair value of long term fixed rate liabilities associated with changes in market interest rates.

The following table presents gains or (losses) related to fair value hedges on the Company's financial results:

     
thousands of Canadian dollars (Unaudited) For the three months ended For the nine months ended
  September 30 September 30 September 30 September 30
    2011    2010    2011    2010 
Fair value changes recorded on interest rate swaps $ 54,218  $ 3,895  $ 59,204  $ 3,895 
Fair value changes of hedged CMB liabilities for interest rate risk   (55,333)   (3,951)   (58,826)   (3,951)
Hedge ineffectiveness recognized in non-interest income $ (1,115) $ (56) $ 378  $ (56)

1 Unrealized gains and losses on hedging derivatives (interest rate swaps) are recorded as derivative assets or liabilities, as appropriate, on the consolidated balance sheets.
2 Unrealized gains and losses on hedged items (fixed rate liabilities) for the risk being hedged are recorded as part of the associated fixed rate liability on the consolidated balance sheets.

Other Derivative Gains and Losses

From time to time, the Company enters into derivative positions which are not designated as hedges for accounting purposes.  The changes in fair value of such hedges flow directly to the income statement.  The Company recorded losses of $4.1 million in the quarter.

As at September 30, 2011, December 31, 2010 and January 1, 2010, the outstanding interest rate and bond forward contracts (bonds) positions were as follows:

           
           
thousands of Canadian dollars (Unaudited)         As at September 30, 2011
Term (years) Notional Amount Derivative Asset Derivative Liability Net Fair Value
                 
Hedging swaps                
1 to 5 $ 1,612,214  $ 64,875  $ $ 64,875 
6 to 10   109,600    6,769    (171)   6,598 
  $ 1,721,814  $ 71,644  $ (171) $ 71,473 
                 
Non-hedging swaps                
1 to 5 $ 118,100  $ 12  $ (3,629) $ (3,617)
                 
Hedging bond forwards                
1 to 5 $ $ $ $
                 
Total $ 1,839,914  $ 71,656  $ (3,800) $ 67,856 
                 
thousands of Canadian dollars (Unaudited)         As at December 31, 2010
Term (years) Notional Amount Derivative Asset Derivative Liability Net Fair Value
                 
Hedging swaps                
1 to 5 $ 705,964  $ 1,292  $ (4,408) $ (3,116)
                 
Non-hedging swaps                
1 to 5 $ 507,796  $ 21,111  $ (2,883) $ 18,228 
6 to 10   13,108    1,421    (656)   765 
  $ 520,904  $ 22,532  $ (3,539) $ 18,993 
                 
Non-hedging bond forwards                
1 to 5 $ 36,300  $ 44  $ (92) $ (48)
6 to 10   215,900    289    (970)   (681)
  $ 252,200  $ 333  $ (1,062) $ (729)
                 
Total $ 1,479,068  $ 24,157  $ (9,009) $ 15,148 

           
thousands of Canadian dollars (Unaudited)         As at January 1, 2010
Term (years) Notional Amount Derivative Asset Derivative Liability Net Fair Value
                 
Non-hedging swaps                
1 to 5 $ 226,988  $ 10,734  $ (7,345) $ 3,389 
6 to 10   3,042      (3,739)   (3,739)
  $ 230,030  $ 10,734  $ (11,084) $ (350)
                 
Non-hedging bond forwards                
1 to 5 $ 17,200  $ 307  $ $ 307 
6 to 10   166,600    2,145    (15)   2,130 
  $ 183,800  $ 2,452  $ (15) $ 2,437 
                 
Total $ 413,830  $ 13,186  $ (11,099) $ 2,087 

1Non-hedging swaps include swaps that were not in hedging relationships in 2010 or do not meet hedging criteria in 2011.
2The term of the bond forward contracts is based on the term of the underlying bonds.

The notional amount represents the amount to which the rate or price is applied in order to calculate the amount of cash exchanged under the contract.  Notional amounts do not represent an asset or liability recorded on the consolidated balance sheets.

15. INTEREST RATE SENSITIVITY

The Company's exposure to interest rate risk results from the difference, or gap between earliest of the maturity or re-pricing dates of interest sensitive assets and liabilities, including off-balance sheet items. The following table shows the gap positions at September 30, 2011, December 31, 2010 and January 1, 2010 for selected period intervals. Figures in brackets represent an excess of liabilities over assets or a negative gap position.

                             
thousands of Canadian dollars, except % (Unaudited)           As at September 30, 2011
    Floating   0 to 3   3 Months       Over   Non-interest    
    Rate   Months   to 1 Year   1 to 3 Years   3 Years   Sensitive   Total
Total assets $ 128,931  $ 4,724,886  $ 2,890,270  $ 5,706,488  $ 3,440,663  $ 180,887  $ 17,072,125 
Total liabilities and equity   (6)   (3,638,203)   (3,103,205)   (5,881,552)   (3,314,586)   (1,134,573)   (17,072,125)
Off-balance sheet items     (416,954)       416,954     
Interest rate sensitive gap $ 128,925  $ 669,729  $ (212,935) $ (175,064) $ 543,031  $ (953,686) $
Cumulative gap $ 128,925  $ 798,654  $ 585,719  $ 410,655  $ 953,686  $ $
Cumulative gap as a percentage of total assets   0.8%   4.7%   3.4%   2.4%   5.6%    
                             
thousands of Canadian dollars, except % (Unaudited)           As at December 31, 2010
    Floating   0 to 3   3 Months       Over   Non-interest    
    Rate   Months   to 1 Year   1 to 3 Years   3 Years   Sensitive   Total
Total assets $ 82,211  $ 3,850,355  $ 2,434,387  $ 4,470,999  $ 4,492,797  $ 188,069  $ 15,518,818 
Total liabilities and equity   (6)   (2,529,328)   (3,224,469)   (4,716,434)   (4,103,708)   (944,873)   (15,518,818)
Off-balance sheet items     (411,111)   16,408    179,836    214,867     
Interest rate sensitive gap $ 82,205  $ 909,916  $ (773,674) $ (65,599) $ 603,956  $ (756,804) $
Cumulative gap $ 82,205  $ 992,121  $ 218,447  $ 152,848  $ 756,804  $ $
Cumulative gap as a percentage of total assets   0.5%   6.4%   1.4%   1.0%   4.9%    
                             
thousands of Canadian dollars, except % (Unaudited)     As at January 1, 2010
    Floating   0 to 3   3 Months       Over   Non-interest    
    Rate   Months   to 1 Year   1 to 3 Years   3 Years   Sensitive   Total
Total assets $ 68,941  $ 2,443,513  $ 1,590,908  $ 2,864,679  $ 4,142,369  $ 180,176  $ 11,290,586 
Total liabilities and equity   (6)   (663,651)   (3,001,431)   (3,060,937)   (3,801,226)   (763,335)   (11,290,586)
Off-balance sheet items     (307,364)   100,114    207,266    (16)    
Interest rate sensitive gap $ 68,935  $ 1,472,498  $ (1,310,409) $ 11,008  $ 341,127  $ (583,159) $
Cumulative gap $ 68,935  $ 1,541,433  $ 231,024  $ 242,032  $ 583,159  $ $
Cumulative gap as a percentage of total assets   0.6%   13.7%   2.0%   2.1%   5.2%    

Based on the current interest rate gap position at September 30, 2011, the Company estimates that a 100 basis point decrease in interest rates would decrease net interest income and other comprehensive income after tax over the next twelve months by $8.7 million and $2.0 million, respectively. A 100 basis point increase in interest rates would increase net interest income and other comprehensive income after tax over the next twelve months by $8.7 million and $2.0 million, respectively.

16. EARNINGS BY BUSINESS SEGMENT

The Company operates principally through two segments - mortgage lending and consumer lending. The mortgage lending operation consists of mortgage lending, securitization of insured mortgage loans and secured loans. The consumer lending operation consists of credit cards, PSiGate and individual loans to customers of retail businesses. These operating segments are supported by other activities including treasury and security investments and general corporate activities.

               
              For the three months ended
thousands of Canadian dollars                        
(Unaudited) Mortgage Lending Consumer Lending Other Total
    September 30 September 30 September 30 September 30 September 30 September 30 September 30 September 30
      2011    2010    2011    2010    2011    2010    2011    2010 
Net interest income $ 72,203  $ 51,971  $ 10,974  $ 8,692  $ 4,435  $ 7,448  $ 87,612  $ 68,111 
Provision for credit losses   (1,929)   (1,687)   (420)   (480)       (2,349)   (2,167)
Fees and other income   5,283    3,283    4,292    3,815    122    29    9,697    7,127 
Net (loss) gain on securities and others   (1,288)   11,457      3,917    (2,748)   1,503    (4,036)   16,877 
Non-interest expenses   (16,690)   (16,180)   (4,270)   (3,498)   (5,076)   (5,078)   (26,036)   (24,756)
Income before income taxes   57,579    48,844    10,576    12,446    (3,267)   3,902    64,888    65,192 
Income taxes   (15,462)   (13,800)   (2,991)   (3,848)   1,982    77    (16,471)   (17,571)
Net income $ 42,117  $ 35,044  $ 7,585  $ 8,598  $ (1,285) $ 3,979  $ 48,417  $ 47,621 
Goodwill $ 2,324  $ 2,324  $ 13,428  $ 13,428  $ $ $ 15,752  $ 15,752 
Total assets $ 15,613,159  $ 12,463,168  $ 580,999  $ 487,704  $ 877,967  $ 1,243,588  $ 17,072,125  $ 14,194,460 
                                   
                  For the nine months ended
thousands of Canadian dollars                        
(Unaudited) Mortgage Lending Consumer Lending Other Total
    September 30 September 30 September 30 September 30 September 30 September 30 September 30 September 30
      2011    2010    2011    2010    2011    2010    2011    2010 
Net interest income $ 199,574  $ 145,692  $ 31,143  $ 26,771  $ 14,823  $ 19,108  $ 245,540  $ 191,571 
Provision for credit losses   (3,941)   (2,927)   (599)   (688)       (4,540)   (3,615)
Fees and other income   12,628    10,619    13,708    11,301    367    149    26,703    22,069 
Net (loss) gain on securities and others   (3,726)   16,305      3,917    2,247    9,986    (1,479)   30,208 
Non-interest expenses   (49,027)   (44,166)   (12,838)   (11,092)   (16,030)   (13,609)   (77,895)   (68,867)
Income before income taxes   155,508    125,523    31,414    30,209    1,407    15,634    188,329    171,366 
Income taxes   (43,014)   (36,574)   (8,885)   (9,349)   3,317    (800)   (48,582)   (46,723)
Net income $ 112,494  $ 88,949  $ 22,529  $ 20,860  $ 4,724  $ 14,834  $ 139,747  $ 124,643 
Goodwill $ 2,324  $ 2,324  $ 13,428  $ 13,428  $ $ $ 15,752  $ 15,752 
Total assets $ 15,613,159  $ 12,463,168  $ 580,999  $ 487,704  $ 877,967  $ 1,243,588  $ 17,072,125  $ 14,194,460 

17. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS

The comparative interim unaudited consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2011 unaudited interim consolidated financial statements.

18. TRANSITION TO IFRS

The Company has adopted IFRS effective January 1, 2011.  Prior to the adoption of IFRS, the Company prepared its consolidated financial statements in accordance with previous Canadian GAAP.  The Company's consolidated financial statements for the year ended December 31, 2011 will be the first annual financial statements that comply with IFRS.  Accordingly, the Company will make an explicit and unreserved statement of compliance with IFRS beginning with its 2011 annual consolidated financial statements.  The Company's transition date is January 1, 2010 (the "transition date") and the Company has prepared its opening consolidated balance sheet at that date.  These consolidated financial statements have been prepared in accordance with the accounting policies described or referred to in Note 2.  The Company will ultimately prepare its opening consolidated balance sheet and consolidated financial statements for 2010 and 2011 by applying existing IFRS with an effective date of December 31, 2011 or prior.  Accordingly, the opening consolidated balance sheet and consolidated financial statements for 2010 and 2011 may differ from these financial statements.

In preparing these consolidated financial statements, the Company has applied the requirements of IFRS 1 First-time Adoption of International Financial Reporting Standards (IFRS 1).  IFRS 1 requires first-time adopters to retrospectively apply all effective IFRS as of the first annual reporting date which, for the Company, will be December 31, 2011.  However, IFRS 1 provides for certain optional exemptions and certain mandatory exemptions from full retrospective application of IFRS.  The optional exemptions and mandatory exemptions applied by the Company are described below.

(A) Elected Exemptions from Full Retrospective Application

(i) Business combinations

The Company elected to apply the business combinations exemption in IFRS 1 and did not apply IFRS 3 Business Combinations retrospectively to past business combinations.  Accordingly, the Company has not restated business combinations that took place prior to the transition date to IFRS and the carrying amount of goodwill under IFRS at transition date is equal to the carrying amount under Canadian GAAP at that date.

(ii) Share-based payment transactions

The Company elected to apply IFRS 2 Share-based Payment (IFRS 2) to equity instruments granted after November 7, 2002, that have not vested by the transition date.  Accordingly, the Company has only applied IFRS 2 to grants of employee stock options that were granted after November 7, 2002 that remain unvested as at January 1, 2010.

(iii) Borrowing costs

The Company elected to apply IAS 23 Borrowing Costs to borrowing costs relating to qualifying assets for which the commencement date for capitalization is on or after the transition date to IFRS.

(iv) Leases

The Company elected to determine whether an arrangement existing at the date of transition contains a lease on the basis of facts and circumstances existing at the transition date.

(B) Mandatory Exemptions from Full Retrospective Application

(i) Derecognition of financial assets and financial liabilities

Although recent amendments to IFRS 1 permit the Company to apply the derecognition requirements of IAS 39 Financial Instruments: Recognition and Measurement prospectively from January 1, 2010, the Company chose to apply the standards retroactively as directed by OSFI.

(ii) Hedge accounting

Hedge accounting cannot be reflected in the opening IFRS balance sheet if it does not qualify for hedge accounting under IFRS nor be applied retrospectively to transactions entered into prior to the transition to IFRS.  Accordingly, the Company only applied hedge accounting to transactions that qualified for hedge accounting after the date of transition to IFRS.  The Company did not apply hedge accounting under Canadian GAAP.

(iii) Estimates

Hindsight cannot be used to create or revise estimates and accordingly the estimates previously made by the Company under Canadian GAAP were not revised for application of IFRS except where necessary to reflect any difference in accounting policies.

(C) Reconciliations of Canadian GAAP to IFRS

The Company is required under IFRS 1 to provide the following reconciliations from previous Canadian GAAP to IFRS for its shareholders' equity and comprehensive income.

 
 
Reconciliation of Shareholders' Equity
thousands of Canadian dollars (Unaudited) Note   As at September 30, 2010
             
Shareholders' equity reported under previous Canadian GAAP       $ 695,848 
Differences increasing (decreasing) reported shareholders' equity:          
  Securitization of mortgages (i)       (138,894)
  Hedge ineffectiveness (ii)       56 
  Interest on non-performing loans (iv)       1,455 
  Provision for accrued interest on non-performing loans (v)       (348)
  Deferred income taxes (vii)       46,632 
Shareholders' equity reported under IFRS       $ 604,749 
             
Reconciliation of Net Income   Three Months Ended Nine Months Ended
thousands of Canadian dollars (Unaudited) Note September 30, 2010 September 30, 2010
             
Net income reported under previous Canadian GAAP   $ 45,450  $ 130,562 
Differences increasing (decreasing) reported net income:          
  Securitization of mortgages (i)   5,121    (6,621)
  Hedge ineffectiveness (ii)   56    56 
  Impairment of AFS securities (iii)   (5)   739 
  Interest on non-performing loans (iv)   (9)   (191)
  Provision for accrued interest on non-performing loans (v)   (54)   37 
  Share-based compensation expense (vi)   (176)   (743)
  Deferred income taxes (vii)   (2,762)   804 
Net income reported under IFRS   $ 47,621  $ 124,643 
             
Reconciliation of Comprehensive Income   Three Months Ended Nine Months Ended
thousands of Canadian dollars (Unaudited) Note September 30, 2010 September 30, 2010
             
Comprehensive income reported under previous Canadian GAAP   $ 49,699  $ 123,691 
Differences increasing (decreasing) reported comprehensive income:          
  Differences in net income     2,171    (5,919)
  Securitization of mortgages (i)   1,167    2,829 
  Impairment of AFS securities (iii)     (739)
  Deferred income taxes (vii)   (382)   (1,348)
Comprehensive income reported under IFRS   $ 52,660  $ 118,514 

Notes to Above Reconciliations

(i) Securitization of mortgages

The Company periodically transfers pools of mortgages to CMHC-sponsored special purpose entities or trusts which, in turn, issue securities to investors.

Under previous Canadian GAAP, these transfers were accounted for as sales when the Company surrendered control of the transferred assets and received consideration other than the beneficial interest in the transferred assets.  When such sales occur, the Company retained interest-only strips and servicing responsibilities for the assets sold.  Gains or losses on these transactions were recognized as income. The gains or losses recorded were dependent in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of transfer, net of transaction costs.  Retained interests were classified as available for sale assets and were stated at their fair value at the date of transfer with unrealized gains and losses reported in accumulated other comprehensive income.  The servicing liabilities were included with other liabilities and stated originally at their fair value and amortized into income over the period of the mortgage pool.  As part of the securitization program, the Company entered into certain interest rate swaps.  These transactions did not qualify for hedge accounting and therefore were accounted for on a mark-to-market basis, with changes in the fair value of the swap being recognized in income.

Under IFRS, the above securitization transactions do not qualify for treatment as sales of mortgages and instead are treated as secured borrowing transactions.  Consequently, the securitized mortgages are accounted for in the same manner as non-securitized mortgages, remaining on the consolidated balance sheets with interest income recognized in the consolidated statements of income.  In addition, an obligation to repay the funding received in the securitization transaction is recognized on the consolidated balance sheets as secured borrowing (securitization liabilities) and related interest expense is recognized in the consolidated statements of income.

The difference in accounting treatment between previous Canadian GAAP and IFRS for these securitization transactions has resulted in the following adjustments to the Company's consolidated financial statements:

  • Securitized mortgages that were off-balance sheet under previous Canadian GAAP have been recognized in the consolidated balance sheets under IFRS
  • Securitization liabilities not previously recognized under previous Canadian GAAP have been recognized in the consolidated balance sheets under IFRS
  • Securitization receivables related to retained interests recognized on the consolidated balance sheets under previous Canadian GAAP have been removed from the consolidated balance sheets under IFRS
  • Securitization servicing liability included in other liabilities on the consolidated balance sheets under previous Canadian GAAP has been removed from the consolidated balance sheets under IFRS
  • Home Trust MBS held by the Company but not yet sold to third parties or used as replacement assets in the CMB program were reclassified to securitized mortgages from available for sale securities. Unrealized fair value gains or losses recognized in accumulated other comprehensive income were reversed under IFRS
  • Gains and losses on securitization previously recognized in net income under previous Canadian GAAP have been reversed under IFRS
  • Interest income earned on the securitized mortgages not previously recognized under previous Canadian GAAP has been recognized in net income under IFRS
  • Interest expense on the securitization liabilities not previously recognized under previous Canadian GAAP has been recognized in net income under IFRS
  • Unrealized gains and losses on retained interests recognized in other comprehensive income under previous Canadian GAAP has been reversed under IFRS
  • Amortization of servicing liability recognized in net income under previous Canadian GAAP has been reversed under IFRS
  • Certain transaction costs that formed part of the gain or loss on securitization under previous Canadian GAAP have been capitalized and recognized in interest income and expense under IFRS through the use of the effective interest rate method
  • Gains and losses on the interest rate swaps (seller swaps) that were recognized in net income under previous Canadian GAAP were reversed under IFRS as the cash flows associated with these swaps are captured in the interest income recognized on the securitized mortgages and the interest expense recognized on the secured debt under IFRS

The above adjustments related to securitization transactions occurring before the date of transition have been adjusted through retained earnings or accumulated other comprehensive income in the consolidated balance sheet as at January 1, 2010.  The adjustments related to securitization transactions occurring on or after the date of transition and up to September 30, 2010 have been reflected in the consolidated statements of comprehensive income for the periods ending September 30, 2010 and through retained earnings and accumulated other comprehensive income on the consolidated balance sheet as at September 30, 2010 and December 31, 2010.

The overall impact of the difference in accounting treatment between previous Canadian GAAP and IFRS for these securitization transactions results in differences as to the timing of the recognition of the cash flows in total comprehensive income.  Ultimately, at the end of the life of each securitization pool, the same cumulative total amount of income will have been recognized in shareholders' equity under both previous Canadian GAAP and IFRS.

(ii) Hedging

In the latter part of 2010, the Company designated certain derivative instruments used to hedge interest rate risk in hedge accounting relationships under IFRS that did not qualify for hedge accounting under previous Canadian GAAP.   Accordingly, certain gains and losses recognized in net income under previous Canadian GAAP have been accounted for as fair value hedges under IFRS, where only the ineffective portion of the hedges are recorded in net income.

(iii) Impairment of equity investments

Under IFRS, a significant or prolonged decline in the fair value of an investment in an equity investment below its cost is considered objective evidence of impairment resulting in the recognition of an impairment loss.  Under previous Canadian GAAP, such significant or prolonged declines were considered as an indicator of impairment, but not a definitive factor.  The Company has recognized impairment losses as at January 1, 2010 and during 2010 under IFRS on certain equity investments with significant or prolonged declines in fair value below cost that were not considered impaired under previous Canadian GAAP.  Additionally, impairment losses on certain equity investments were recognized under previous Canadian GAAP during 2010 that would have been recognized prior to 2010 under IFRS and consequently recognized as at January 1, 2010 under IFRS.  Accordingly, adjustments from previous Canadian GAAP to IFRS were made between retained earnings and accumulated other comprehensive income as at January 1, 2010 and between net income and other comprehensive income during 2010.  These adjustments did not affect total shareholders' equity.

(iv) Accrued interest on non-performing loans

Under previous Canadian GAAP, when a loan becomes non-performing the accrual of interest ceases. Interest that is subsequently recovered is recognized at the time of recovery. Under IFRS, interest on non-performing loans continues to be accrued.  Accordingly, an adjustment from previous Canadian GAAP to IFRS has been made to retained earnings as at January 1, 2010 to reflect accrued interest on non-performing loans up to the date of transition.  Interest on non-performing loans subsequent to the date of transition has been recognized in net income in the relevant period.

(v) Allowance for accrued interest on non-performing loans

As a result of recognizing accrued interest on non-performing loans under IFRS as describe above, the carrying amount of accrued interest receivable related to these non-performing loans recognized in the consolidated balance sheets has increased.  Consequently, an allowance against the accrued interest receivable on these non-performing loans has been established where the Company does not expect to recover all of the accrued interest.  Changes to this allowance are recognized in the provision for credit losses in the consolidated statements of income.

(vi) Share-based compensation

Under previous Canadian GAAP, the Company accounted for stock option grants with graded vesting as one award, recognizing as expense the total fair value on a straight-line basis over the vesting period.  Under IFRS, the Company is required to account for each tranche in an award with graded vesting as a separate grant with a different vesting period and fair value.  As a result, the Company adjusted its expense for these share-based awards to reflect this difference in recognition.

Under previous Canadian GAAP, the Company had the option of recognizing forfeitures as they occur or making an estimate of forfeitures.  The Company utilized both options under previous Canadian GAAP based on when the award was granted.  Under IFRS, the Company makes an estimate of forfeitures for all awards.  As a result, the Company adjusted its expense for these share-based awards to reflect this difference in recognition.

The above adjustments resulted in differences between previous Canadian GAAP and IFRS for the amount of expense recognized in net income.  However, as these differences only result in a reclassification between retained earnings and contributed surplus on the consolidated balance sheets, there was no resulting difference in total shareholders' equity.

(vii) Income taxes

The adjustments for income taxes reflect the impact of the other IFRS adjustments described above.  The portion of the adjustments to income taxes payable or recoverable that is related to items recorded through other comprehensive income does not affect net income.

Financial Statement Reconciliations

The following reconciliations demonstrate the impact of the above noted IFRS transition adjustments to the consolidated balance sheet and the consolidated statements of income, comprehensive income and cash flows.

 
 
Reconciliation of Consolidated Balance Sheet
thousands of Canadian dollars (Unaudited)     As at September 30, 2010
  Canadian GAAP IFRS IFRS IFRS    
Previous Canadian GAAP Line Items Balance Adjustments Reclassification Balance   IFRS Line Items
ASSETS                   ASSETS
Cash Resources $ 712,587  $ $ $ 712,587    Cash Resources
Securities                   Securities
Held for trading   49,651        49,651    Held for trading
Available for sale   776,065    (330,255)     445,810    Available for sale
      1,039      1,039    Pledged securities
    825,716    (330,255)     496,500     
Loans                   Loans
Residential mortgages   4,709,360    329,282      5,038,642    Residential mortgages
      6,574,568      6,574,568    Securitized residential mortgages
Non-residential mortgages   774,580        774,580    Non-residential mortgages
Personal and credit card loans   428,207        428,207    Personal and credit card loans
    5,912,147    6,903,850      12,815,997     
General allowance for credit losses   (29,146)       (29,146)   Collective allowance for credit losses
    5,883,001    6,903,850      12,786,851     
Other                   Other
Securitization receivable   315,203    (315,203)        
        10,002    10,002    Income taxes receivable
      38,290      38,290    Derivative assets
Other assets   129,662    25,320    (69,978)   85,004    Other assets
Capital assets   5,250        5,250    Capital assets
        44,224    44,224    Intangible assets
        15,752    15,752    Goodwill
    450,115    (251,593)     198,522     
  $ 7,871,419  $ 6,322,002  $ $ 14,194,460     
LIABILITIES AND SHAREHOLDERS' EQUITY                   LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities                   Liabilities
Deposits                   Deposits
Payable on demand $ 20,827  $ $ $ 20,827    Payable on demand
Payable on a fixed date   6,766,703        6,766,703    Payable on a fixed date
    6,787,530        6,787,530     
                    Securitization Liabilities
      2,031,320      2,031,320    Mortgage-backed security liabilities
      4,564,365      4,564,365    Canada Mortgage Bond liability
      6,595,685      6,595,685     
Other                   Other
      5,418      5,418    Derivative liabilities
Other liabilities   388,041    (140,813)   (84,393)   162,835    Other liabilities
      (46,150)   84,393    38,243    Deferred tax liabilities
    388,041    (181,545)     206,496     
    7,175,571    6,414,140      13,589,711     
Shareholders' Equity                   Shareholders' Equity
Capital stock   50,475        50,475    Capital stock
Contributed surplus   3,452    743      4,195    Contributed surplus
Retained earnings   627,524    (81,521)     546,003    Retained earnings
Accumulated other comprehensive income   14,397    (10,321)     4,076    Accumulated other comprehensive loss
    695,848    (91,099)     604,749     
  $ 7,871,419  $ 6,323,041  $ $ 14,194,460     

1 Other liabilities under the previous Canadian GAAP balance includes cheques and other items in transit of $9,908 which was disclosed separately on the face of the consolidated balance sheet as presented in the 2010 third quarter report.  This change in presentation is not part of the transition to IFRS.

 
 
Reconciliation of Consolidated Statement of Income
thousands of Canadian dollars, except per share amounts (Unaudited)   For the Three Months Ended September 30, 2010
  Canadian GAAP IFRS IFRS    
Previous Canadian GAAP Line Items Balance Adjustments Balance   IFRS Line Items
Income               Net Interest Income Non-Securitized Assets
Interest from loans $ 89,881  $ (9) $ 89,872    Interest from loans
Dividends from securities   4,592      4,592    Dividends from securities
Other interest   2,472      2,472    Other interest
    96,945    (9)   96,936     
Interest on deposits   47,846      47,846    Interest on deposits
Net interest income   49,099    (9)   49,090    Net interest income non-securitized assets
                Net Interest Income Securitized Loans and Assets
      66,255    66,255    Interest from securitized loans and assets
      47,234    47,234    Interest on securitization liabilities
      19,021    19,021    Net interest income securitized loans and assets
                 
    49,099    19,012    68,111    Total Net Interest Income
Provision for credit losses   2,113    54    2,167    Provision for credit losses
    46,986    18,958    65,944     
Non-Interest Income               Non-Interest Income
Fees and other income   7,127      7,127    Fees and other income
Securitization income   21,320    (21,320)      
Gain on sale of loan portfolio   3,917      3,917    Gain on sale of loan portfolio
Realized net gains and unrealized losses on securities   1,503    (156)   1,347    Realized net gains and unrealized losses on securities
Net realized and unrealized gain on derivatives   2,941    8,672    11,613    Net realized and unrealized gain on derivatives
    36,808    (12,804)   24,004     
    83,794    6,154    89,948     
Non-Interest Expenses               Non-Interest Expense
Salaries and benefits   11,847      11,847    Salaries and benefits
Premises   1,732      1,732    Premises
General and administrative   9,956    1,221    11,177    Other operating expenses
    23,535    1,221    24,756     
                 
Income Before Income Taxes   60,259    4,933    65,192    Income Before Income Taxes
                 
Income Taxes               Income Taxes
Current   10,548      10,548    Current
Future   4,261    2,762    7,023    Deferred
    14,809    2,762    17,571     
NET INCOME $ 45,450  $ 2,171  $ 47,621    NET INCOME
                 
NET INCOME PER COMMON SHARE               NET INCOME PER COMMON SHARE
Basic $ 1.31  $ 0.06  $ 1.37    Basic
Diluted $ 1.31  $ 0.06  $ 1.37    Diluted
AVERGAGE NUMBER OF COMMON SHARES OUTSTANDING         AVERGAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic   34,717      34,717    Basic
Diluted   34,781      34,781    Diluted
                 
Total number of outstanding common shares   34,679      34,679    Total number of outstanding common shares
Book value per common share $ 20.07  $ (2.63) $ 17.44    Book value per common share

 
Reconciliation of Consolidated Statement of Comprehensive Income
thousands of Canadian dollars (Unaudited)   For the Three Months Ended September 30, 2010
  Canadian GAAP IFRS IFRS    
Previous Canadian GAAP Line Items Balance Adjustments Balance   IFRS Line Items
                 
NET INCOME $ 45,450  $ 2,171  $ 47,621    NET INCOME
                 
OTHER COMPREHENSIVE LOSS               OTHER COMPREHENSIVE LOSS
                 
Available for sale securities               Available for sale securities
Net unrealized losses on securities available for sale   7,308    1,452    8,760    Net unrealized losses on securities available for sale
Net gains reclassified to net income   (1,371)   (280)   (1,651)   Net gains reclassified to net income
    5,937    1,172    7,109     
Income tax expense   1,688    382    2,070    Income tax recovery
Total other comprehensive loss   4,249    790    5,039    Total other comprehensive loss
                 
COMPREHENSIVE INCOME $ 49,699  $ 2,961  $ 52,660    COMPREHENSIVE INCOME

 
Reconciliation of Consolidated Statement of Income
thousands of Canadian dollars, except per share amounts (Unaudited)   For the Nine Months Ended September 30, 2010
  Canadian GAAP IFRS IFRS    
Previous Canadian GAAP Line Items Balance Adjustments Balance   IFRS Line Items
Income               Net Interest Income Non-Securitized Assets
Interest from loans $ 263,775  $ (191) $ 263,584    Interest from loans
Dividends from securities   14,106      14,106    Dividends from securities
Other interest   6,530      6,530    Other interest
    284,411    (191)   284,220     
Interest on deposits   140,382      140,382    Interest on deposits
Net interest income   144,029    (191)   143,838    Net interest income non-securitized assets
                Net Interest Income Securitized Loans and Assets
      174,708    174,708    Interest from securitized loans and assets
      126,975    126,975    Interest on securitization liabilities
      47,733    47,733    Net interest income securitized loans and assets
                 
    144,029    47,542    191,571    Total Net Interest Income
Provision for credit losses   3,652    (37)   3,615    Provision for credit losses
    140,377    47,579    187,956     
Non-Interest Income               Non-Interest Income
Fees and other income   22,069      22,069    Fees and other income
Securitization income   70,309    (70,309)      
Gain on sale of loan portfolio   3,917      3,917    Gain on sale of loan portfolio
Realized net gains and unrealized losses on securities   9,986    739    10,725    Realized net gains and unrealized losses on securities
Net realized and unrealized loss on derivatives   (1,498)   17,064    15,566    Net realized and unrealized gain on derivatives
    104,783    (52,506)   52,277     
    245,160    (4,927)   240,233     
Non-Interest Expenses               Non-Interest Expense
Salaries and benefits   34,334      34,334    Salaries and benefits
Premises   5,074      5,074    Premises
General and administrative   27,663    1,796    29,459    Other operating expenses
    67,071    1,796    68,867     
                 
Income Before Income Taxes   178,089    (6,723)   171,366    Income Before Income Taxes
                 
Income Taxes               Income Taxes
Current   25,284      25,284    Current
Future   22,243    (804)   21,439    Deferred
    47,527    (804)   46,723     
NET INCOME $ 130,562  $ (5,919) $ 124,643    NET INCOME
                 
NET INCOME PER COMMON SHARE               NET INCOME PER COMMON SHARE
Basic $ 3.76  $ (0.17) $ 3.59    Basic
Diluted $ 3.75  $ (0.17) $ 3.58    Diluted
AVERGAGE NUMBER OF COMMON SHARES OUTSTANDING         AVERGAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic   34,708      34,708    Basic
Diluted   34,814      34,814    Diluted
                 
Total number of outstanding common shares   34,679      34,679    Total number of outstanding common shares
Book value per common share $ 20.07  $ (2.63) $ 17.44    Book value per common share

 
Reconciliation of Consolidated Statement of Comprehensive Income
thousands of Canadian dollars (Unaudited)   For the Nine Months Ended September 30, 2010
  Canadian GAAP IFRS IFRS    
Previous Canadian GAAP Line Items Balance Adjustments Balance   IFRS Line Items
                 
NET INCOME $ 130,562  $ (5,919) $ 124,643    NET INCOME
                 
OTHER COMPREHENSIVE LOSS               OTHER COMPREHENSIVE LOSS
                 
Available for sale securities               Available for sale securities
Net unrealized losses on securities available for sale   (382)   2,862    2,480    Net unrealized losses on securities available for sale
Net gains  reclassified to net income   (8,496)   (772)   (9,268)   Net gains reclassified to net income
    (8,878)   2,090    (6,788)    
Income tax recovery   (2,007)   1,348    (659)   Income tax recovery
Total other comprehensive loss   (6,871)   742    (6,129)   Total other comprehensive loss
                 
COMPREHENSIVE INCOME $ 123,691  $ (5,177) $ 118,514    COMPREHENSIVE INCOME

Adjustments to the Consolidated Statement of Cash Flows

The transition from previous Canadian GAAP to IFRS resulted in certain cash flows included in financing and investing activities under previous Canadian GAAP to be reclassified to operating activities under IFRS.  Specifically, net changes in deposits were reclassified from financing activities to operating activities and net changes in mortgages and personal and credit card loans were reclassified from investing activities to operating activities.  In addition, certain cash flows related to the Company's securitization activities that were included in investing activities under previous Canadian GAAP are reflected in operating activities under IFRS.

Home Capital Group Inc. is a public company, traded on the Toronto Stock Exchange (HCG), operating through its principal subsidiary, Home Trust Company. Home Trust is a federally regulated trust company offering deposit, residential and non-residential mortgage lending, securitization of insured residential first mortgage products, consumer lending, Visa and payment card services. Licensed to conduct business across Canada, Home Trust has offices in Ontario, Alberta, British Columbia, Nova Scotia and Quebec.

 

 

 

For further information:

Gerald M. Soloway, CEO, or
Martin Reid, President
416-360-4663
www.homecapital.com


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