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Edited Transcript of FN.TO earnings conference call or presentation 31-Jul-19 3:30pm GMT

Q2 2019 First National Financial Corp Earnings Call

Toronto Aug 22, 2019 (Thomson StreetEvents) -- Edited Transcript of First National Financial Corp earnings conference call or presentation Wednesday, July 31, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Moray Tawse

First National Financial Corporation - Co-Founder, Executive VP, Secretary & Director

* Robert A. Inglis

First National Financial Corporation - CFO

* Stephen J. R. Smith

First National Financial Corporation - Co-Founder, Chairman, President & CEO

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Conference Call Participants

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* Graham Ryding

TD Securities Equity Research - Research Analyst of Financial Services

* Nikolaus Priebe

BMO Capital Markets Equity Research - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to First National Second Quarter 2019 Analyst Call. (Operator Instructions) This call is being recorded for replay purposes on July 31, 2019, at 11:30 a.m. Eastern Time.

It's now my pleasure turn the call over to Stephen Smith, Chairman and Chief Executive Officer of First National. Please go ahead, Mr. Smith.

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [2]

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Thank you, operator. Good morning, everyone. Welcome to our call, and thank you for participating. I'm joined by Rob Inglis, our Chief Financial Officer; and Moray Tawse, Executive Vice President. I will remind you that our remarks and answers may contain forward-looking information about future events or the company's future performance. This information is subject to risk and uncertainties and should be considered in conjunction with the risk factors detailed in our MD&A.

First National delivered strong performance in the second quarter. Mortgages under administration, as significant source of the company's earnings, grew to a new record of $109.6 billion, a 6% increase over last year and a 10% annualized increase since March. After a slow start to the year, we're pleased with this pace of growth, which reflects the continued successful execution of our business model against the backdrop of the solid economy and a low interest rate environment. While we had anticipated growth, mortgage originations surpassed our expectations in both single-family and commercial segments. In single-family new originations were $500 million or 13% above Q2 last year as the team did a great job in responding to opportunity income in a competitive marketplace. Regionally, First National experienced origination growth of about 25% on Ontario and the Maritimes compared to last year. We believe that this is a result of our strong position in the broker market, which we have built over many years. In the case of Ontario, growth was supported by Excalibur, our alternative lending platform, which continued to be in traction among brokers.

This quarter, BC was the employer with originations down about 2% from last year. Nationally, single-family renewals were about $400 million or about 23% below last year, which partly reflects smaller pool of renewal opportunities for us and partly the competitive environment.

Our commercial division also had a record quarter. Commercial segment originations were 50% or $900 million higher than a year ago, reflecting strong demand in the company's leading national market position. Commercial mortgage renewals were $365 million or 222% higher than last year on the same fundamentals. Company took advantage on increased demand, which is risen with the recent decline in interest rates. This is the commercial team's most productive quarter on record. The approach to the market and steps to differentiate itself from competitors is clearly delivering great results.

Based on the expansion of MUA, operating earnings, measured by pre-fair market value EBITDA, increased 22%. At 72% -- at $0.72, rather, per share net income was also solid, but about $0.04 below last year due to changing capital market conditions and the accounting impact from financial instruments.

Turning to dividends. We continue to pay monthly at an annualized rate of $1.90 per common share, up from $1.85 last year at this time. Even so, the common share payout ratio was relatively modest 66% compared to 61% a year ago. Had we eliminated the impact of fair value gains and losses on financial instruments to Q2, the payout ratio was 58% versus 70% last year. We believe this is a worthwhile way to think about the payout ratio because generally fair value accounting is just an income recognition timing issue.

I'll now ask Rob to provide details on our most recent performance before Moray comments on our outlook. Rob?

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Robert A. Inglis, First National Financial Corporation - CFO [3]

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Thanks, Stephen, and good morning, everyone. As you may recall, we were somewhat disappointed with the first quarter due to lower single-family originations to affect the profitability. For the second quarter, we're pleased with our activity levels in both single-family and commercial and their impacts on operating results. Due to growth in MUA along with the change in funding mix from materialization to institutional placement, we experienced a 15% revenue growth in Q2. Our placement fees, they grew faster than other components of revenue. These were up $29.4 million or 95% above last year, largely reflecting the change of funding mix and wider mortgage spreads which are the results of market interest rates, which declined notably in the first 6 months of the year.

More specifically, we placed about $5.9 billion of volume with institutions compared to about $3.7 billion last year. And although single-family renewals were lower than last year, as Stephen mentioned, the value of renewals increased with the spread widening. With both volume and the value of placements increasing, the company was able to take advantage of new originations and renewals in the current environment to achieve this growth. As a reminder, while we attempt to mitigate the impact of changing interest rates on our new single-family commitment pipeline, this activity does not qualify for hedge accounting. As a result, gains and losses, if any, on this program are recorded in current period income.

Bond yields dropped significantly in the first half of the year. Large losses on financial instruments were created in both Q1 and Q2. Related commitments that subsequently may became funded mortgages in Q2 would have had generally higher rates than newly originated mortgages. By placing these mortgages, the company has immediately crystallized the value inherent in them.

Moving on. Mortgage servicing income was up $1.9 million or 5% from Q2 last year. This was driven by higher MUA. Net interest revenue earned on securitized mortgages was down 3% or about $900,000 due to the impact of accounting for financial instruments prior to the adoption of IFRS 9 and the tighter weighted average mortgage spread on the portfolio overall. I think I've described the impact of this accounting in our previous calls, so I won't go into detail again except to say that we estimate that the impact of this accounting treatment decreased net interest on securitized mortgages this quarter by about $2.1 million. As I mentioned, 2019 securitization spreads have widened with the decrease in the risk-free interest rates. As these securitized mortgages perform, there will be wider margins in future periods.

Mortgage investment income was lower down 2% or about $4,000 primarily due to a lower commercial segment's mortgage and loan investments held in the period. Gains on deferred placement fees were up $500,000 or about 21% from last year, due to higher volumes in mortgages originated and sold to institutional investors.

Moving now to expenses. Brokerage fees increased about 131% year-over-year largely due to higher single-family mortgage originations for institutional investors. On per unit basis, broker fees was slightly higher and company spent more on portfolio insurance. Result of wider mortgage spread, pre-fair market value EBITDA was up 22%. As Stephen said, we're very pleased with this outcome, particularly after a slow start in Q1.

Now here's Moray with our closing comments.

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Moray Tawse, First National Financial Corporation - Co-Founder, Executive VP, Secretary & Director [4]

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Good morning, everyone. As you recall, on our last call, we said we felt more positive heading in the Q2. That's because the single-family mortgage commitments in March were ahead of 2018 levels by about 10% and mortgages were with wider spreads, which were originated during the first quarter were due to be placed on securitized and securitized in the second quarter. Those factors did, in fact, help Q2, as you just heard.

Going forward, we remain optimistic for the balance of the year. Although not the same degree as we experienced at the end of the first quarter of 2019, single-family mortgage commitments continue to outpace 2018. Similarly, our commercial segment continues to meet its growth initiatives and strengthens its presence across the country. While commercial origination is unlikely to rest for another quarter of 50% year-over-year growth, the forecast is for double-digit rate to continue this year. With slightly favorable factors, First National continued to be faced with tight securitization margins. This is a result of mortgage rates which narrowed towards the end of the quarter and the fair value accounting conventions used prior to 2018, which will continue to have a negative impact on income for the balance of the year.

Stepping back and thinking about the bigger picture, we continue to enjoy strong relationship with mortgage brokers, great access to diverse funding sources and a solid foundation for which to generate income and cash flow in the form of our $31 billion portfolio of mortgages pledged under securitization and our $76 billion servicing portfolio.

Going forward, we will continue to focus on realizing the value inherent in our significant single-family renewables. These factors and purposeful execution of our business model will be instrumental in sustaining First National's market leadership this year and for the future. That concludes our prepared remarks. Now we will be pleased to take your questions.

Operator, please open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Nik Priebe from BMO Capital Markets.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [2]

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I just wanted to start with a few questions on the alternative product. I understand you took a step to diversify funding sources for the product in the quarter with the bank-sponsored securitization program. I just want to know what the capacity of that client might be. Or how it might affect the pace of the ramp in that new product category?

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [3]

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I don't think we're prepared to share the size of the capacity of that facility.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [4]

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Okay. Okay. I'll move on. You did also allude to the strong contribution of that product being a factor in the year-over-year growth of new single-family origination in the quarter. I don't know if you have this offhand, but if you were to strip out that product from new single-family origination, do you know what the growth rate would've been on originations for just solely the -- like the prime conventional product?

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [5]

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No, we don't have that offhand. It was -- I would say it was strong. I think it was strong, but I don't know what that number is offhand. Do you -- or do and -- we generally -- do we split those numbers out?

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Robert A. Inglis, First National Financial Corporation - CFO [6]

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We don't split it out. No, we don't. Certainly both were positive and I think the current program grew more than 13%, but single-family prime book increased probably double-digit.

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [7]

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Yes. Probably double-digit.

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Nikolaus Priebe, BMO Capital Markets Equity Research - Analyst [8]

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Okay. Okay. Got it. And then I also wanted to ask, obviously, a very strong quarter for new commercial origination. Just wanted to ask for a little bit of insight there as to what the big drivers were? Whether there is a particular property type or any geographic concentration or whether it was driven more by institutional demand, or just more opportunities that you saw in the marketplace in the quarter? Just any sort of color would be helpful there.

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Moray Tawse, First National Financial Corporation - Co-Founder, Executive VP, Secretary & Director [9]

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We've really been expanding our staff base and our coverage across the country. And we've added a lot of new advisory services that we're just becoming the people that if you going to get a commercial mortgage in Canada, you have to at least speak with First National. I think we've been doing that for the last couple of years, and that's really starting to increase the opportunities that we're seeing. And the commercial market is still strong. There's always a big refinance market in the CMHC part of the business. I just think we're just getting bigger. We're getting a bigger and bigger sales force, and we're getting more and more market share.

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Operator [10]

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(Operator Instructions) And our next question comes from the line of Graham Ryding from TD Securities.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [11]

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Maybe I could just start on the commentary around your margins on the securitized portfolio. It sounds like it -- or it did benefit a little bit this quarter from higher mortgage spreads earlier in the year, but it sounds like those would come in. So what is your outlook for the remainder of the year? Is it further compression from here in terms of net interest margin? Or can you maintain this level?

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [12]

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Well, if we knew where mortgage spreads were going, we wouldn't have to run the business. We -- I think we were -- we certainly did benefited from wider mortgage spreads in the earlier part of the year. They have tightened in. I don't think -- I guess our -- we had a view -- we don't think things are going to tighten in. I don't know what that means. Rob, do you have off the top for forecast for what NIMs are going to do perhaps?

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Robert A. Inglis, First National Financial Corporation - CFO [13]

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Well, I think that towards the end of 2018 or as time has been for the last 10 years, it's something with all the problems we have with, I guess, equity markets kind of pull off side. Some of these spreads were really wide in January. And it's going to come back toward to where they were before in November 2018, I think. So I think, there's pretty good place there, we'll get some value out of that as those mortgages perform, but going forward, back to sort of 2018 levels, I think.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [14]

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Okay. Because your net interest margin today is still down year-over-year, although it did increase quarter-over-quarter. So are you actually calling for your margin to expand back to 2018 levels?

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Robert A. Inglis, First National Financial Corporation - CFO [15]

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Well, I think there are a couple of things there. There's the fair market value from 2018 that we're still kind of working through with amortizing through income. I cannot disclose that number. That has an impact. That gets lower and lower as we go forward. I think by 2021, it's almost gone, so that's good. And there's also the commercial stuff in there as well the res stuff, the growth stuff, I think it's been pretty steady. So I think this is more of a -- I don't think we're going to see too much decline. It's kind of steady now.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [16]

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Okay. Okay. That's helpful. There was a big jump in your salaries expense line. Is that a reflection of just a strong commercial origination activity this quarter?

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [17]

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Yes. That would be correct.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [18]

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Okay. And then the -- just on the commercial side. Can you maybe elaborate -- are there any sort of specific market verticals or anything in particular that you're benefiting from? I know you talked about how you're increasing staff across the geographies. But is there any particular sort of macro factors to what's driving this multiyear growth?

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Moray Tawse, First National Financial Corporation - Co-Founder, Executive VP, Secretary & Director [19]

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I think as we put a plan in place, the 5-year plan, probably 4 years ago, we had a lot of our perceptual product being CMHC. And that is the limited market and we decided that we really had to focus on more conventional products. And I think a lot of that growth that you're seeing coming on our numbers is because we've really expanded our commercial offerings, conventional commercial offerings, where now it's sort of almost 50-50, where at one time it was probably 80% CMHC and 20% commercial. So we're really focused on the conventional commercial financing, and that's where we're seeing a lot of the increase in volumes.

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Graham Ryding, TD Securities Equity Research - Research Analyst of Financial Services [20]

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So with that being said, I'd suggest that there is probably a fair amount of runway, given that, that conventional commercial market is fairly big?

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [21]

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As long as the market continues to be attractive for real estate investments, which it appears from our clients that there seems to be almost unlimited funds to go into real estate, we're anticipating that the market should stay strong.

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Operator [22]

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And there are no further questions at this time. I will turn the call back over to Mr. Smith for closing remarks.

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Stephen J. R. Smith, First National Financial Corporation - Co-Founder, Chairman, President & CEO [23]

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Thanks, operator. That concludes today's event. We look forward to reporting our third quarter results this fall. Thanks for taking part in our call today, and have a good evening -- have a good day.

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Operator [24]

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This concludes today's conference call. You may now disconnect.