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Press release from CNW Group

Home Capital Reports Record Results for Second Quarter of 2010: Net Income Rises 26.3%; Return on Equity Strong at 27.1%; Basic Earnings per Share Increase to $1.25

Wednesday, August 04, 2010

Home Capital Reports Record Results for Second Quarter of 2010: Net Income Rises 26.3%; Return on Equity Strong at 27.1%; Basic Earnings per Share Increase to $1.2518:00 EDT Wednesday, August 04, 2010TORONTO, Aug. 4 /CNW/ - Home Capital (TSX: HCG) today announced another quarter of record earnings and continued growth for the three month and six months ended June 30, 2010. The Company's continued focus on growth and service in all lines of business combined with an improving Canadian economy have resulted in record mortgage originations and profitability, and increased assets under administration.Key results for the second quarter of 2010 included: << - Net income, driven by growth in net interest income and strong securitization income, grew to $43.4 million in the second quarter and to $85.1 million for the first six months of 2010, representing increases of 26.3% and 29.4% respectively over the same periods last year. - Basic and diluted earnings per share were $1.25 for the quarter and $2.45 for the first six months of 2010, up 25.0% and 26.3%, respectively from $1.00 and $0.99 per basic and diluted earnings per share reported in the second quarter of 2009, and up 28.3% and 29.0% from the basic and diluted earnings per share of $1.91 and $1.90 reported for the first six months of 2009. - Net interest income after the provision for credit losses was $46.9 million in the second quarter and $93.4 million for the first six months of 2010, representing an increase of 25.3% and 32.8% respectively over the $37.4 million and $70.3 million recorded in the same periods of 2009. - Return on equity was 27.1% in the quarter and 27.4% year-to-date, compared to 27.9% and 27.7% respectively return on equity recorded in the comparable periods of 2009. - Total assets under administration, which included securitized off- balance sheet mortgages, increased 40.8% to $13.30 billion at June 30, 2010 from $9.44 billion at June 30, 2009 and rose 10.4% from the $12.04 billion recorded at the end of first quarter of 2010. - Total on-balance sheet assets were $7.57 billion as at June 30, 2010 compared to $6.15 billion at June 30, 2009 and $7.05 billion at March 31, 2010. - The total value of mortgages originated in the second quarter of 2010 reached a record $2.01 billion, an increase of 56.9% over the $1.28 billion originated in the second quarter of 2009 and an increase of 51.6% over the $1.33 billion originated in the first quarter of 2010. - Residential mortgage originations reached a record $1.92 billion, an increase of 52.8% over the $1.26 billion advanced in the second quarter in 2009 and an increase of 55.8% over the $1.23 billion originated in the first quarter of 2010. - The Accelerator mortgage program continues to generate strong originations with $805.8 million of residential mortgage originations in the second quarter of 2010 compared to $433.4 million in the same period last year and $561.1 million in the first quarter of 2010. The Company's continued focus on its traditional uninsured portfolio has increased originations to $903.4 million in the second quarter of 2010, up from $407.9 million in the comparable quarter of 2009 and $537.9 million in the first quarter of 2010. Residential originations also include multi-unit residential originations of $212.8 million compared to $381.6 million in the second quarter of 2009 and $134.8 million in the first quarter of 2010. - Non-residential mortgage advances were $45.1 million in the second quarter of 2010 compared to $16.3 million and $61.2 million in the comparable quarter in 2009 and the first quarter of 2010, respectively. Store and apartment advances were $27.9 million and warehouse commercial mortgages were $14.5 million in the second quarter of 2009 compared to $4.0 million and $3.0 million in the second quarter of 2009. - The Company's securitization program maintained robust volumes as securitizations in the three and six months ended June 30, 2010 reached $1.16 billion and $2.18 billion respectively compared to $655.1 million and $1.12 billion respectively for the same periods of 2009. Securitization income was $26.8 million in the second quarter of 2010 and $49.0 million year-to-date compared to $26.7 million and $54.4 million for the same comparable periods of 2009. Gains on securitization have moderated compared to last year, despite record volumes, as the spreads earned on these transactions have normalized towards historical levels due to improvement in economic and credit conditions. - The Company's focus on growing its Equityline Visa program continued successfully in the quarter as 1,515 new accounts were added compared to 1,008 in the first quarter of 2010 and 617 in the comparable quarter of 2009. Increases in Equityline Visa and water-heater loans begun in the first quarter of 2010 has increased the personal loans and credit cards receivable balance to $424.4 million at June 30, 2010, an increase of 21.1% from one year ago and 23.8% since the end of 2009. - The performance of the loans portfolio has shown marked improvement as net impaired loans showed a return to historic norms at 0.67% of the total loans portfolio at June 30, 2010, a decrease from 1.26% in net impaired loans at June 30, 2009 and a decrease from 0.91% at the end of the first quarter of 2010. - The Company's capital ratios remain strong at 16.7% for Tier 1 capital and 17.9% for Total capital at June 30, 2010 compared to 16.4% and 18.0% at December 31, 2009 and 15.2% and 16.7% at June 30, 2009. >> For the second quarter of 2010, the Company observed marked stabilization in the residential real estate markets across Canada, consistent with the first quarter of the year. The reintroduction of its higher margin traditional uninsured lending programs across the country has proven successful and management is pleased by the strong response to this initiative. The Company is experiencing increased market penetration through innovative marketing programs, an expanded broker network, superior customer service and the Company's ability to offer a one-stop shop to the mortgage broker community.Following the end of the quarter, the Company announced it had selected Gemalto, a world leader in digital security, to manage Home Trust Company's migration from magnetic stripe credit cards to Chip and PIN smart payment cards. This is an important step in supporting the continuous growth of the Company's Visa products.Starting on January 1, 2011, the Company will change over to financial reporting under International Financial Reporting Standards (IFRS). The Company has completed a preliminary high-level calculation of the potential IFRS securitization impacts for the first and second quarters of 2010. The preliminary analysis suggests that if the income statement for Home Capital's first and second quarters of 2010 were presented on an IFRS basis, net income and earnings per share would not be materially impacted. The transition to IFRS in 2011 will not impact the Company's ability to continue with its current growth strategies. The IFRS calculations are preliminary, assume currently applicable IFRS, and contain certain management assumptions and, therefore, are subject to change as the information is further refined and audited.Subsequent to the end of the quarter the Board of Directors declared a quarterly cash dividend of $0.16 per Common share, payable on September 1, 2010 to shareholders of record at the close of business on August 16, 2010.With the improving economy in Canada and the strong increase in mortgage originations during the first half of 2010 over the same period in 2009, management is confident that the momentum generated through the first six months of the year will continue through the remainder of 2010, enabling Home Capital to once again meet or exceed all of its annual financial and operating targets. << (signed) (signed) GERALD M. SOLOWAY NORMAN F. ANGUS Chief Executive Officer Chairman of the Board August 4, 2010 >> Additional information concerning the Company's targets and related expectations for 2010, including the risks and assumptions underlying these expectations, may be found in Management's Discussion and Analysis in the 2009 Annual Report.Second Quarter Results Conference CallThe conference call will take place on Thursday, August 5, 2010 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 ArchiveA telephone replay of the call will be available between 1:30 p.m. Thursday, August 5, 2010 and midnight Thursday, August 12, 2010 by calling 416-849-0833 or 1-800-642-1687 (enter passcode 87341073). The archived audio web cast 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 << For the Period Ended June 30 (Unaudited) Three Months Ended Six Months Ended ------------------------------------------------------------------------- (000s, except Per Share and Percentage Amounts) 2010 2009 2010 2009 ------------------------------------------------------------------------- OPERATING RESULTS Net Income $ 43,393 $ 34,351 $ 85,112 $ 65,769 Total Revenue 132,768 121,778 255,441 242,499 Earnings per Share - Basic $ 1.25 $ 1.00 $ 2.45 $ 1.91 Earnings per Share - Diluted 1.25 0.99 2.45 1.90 Return on Shareholders' Equity 27.1% 27.9% 27.4% 27.7% Return on Average Assets 2.4% 2.3% 2.3% 2.2% Net Interest Margin 2.6% 2.8% 2.7% 2.6% Spread of Loans over Deposits 2.9% 3.2% 3.1% 3.1% Efficiency Ratio 27.4% 25.7% 26.7% 26.6% Efficiency Ratio (TEB(1)) 26.7% 25.1% 26.1% 26.1% (Non-interest Expense/Net Interest Income Plus Fee Income) ------------------------------------------------------------------------- BALANCE SHEET HIGHLIGHTS Total Assets $7,574,170 $6,152,730 Loans 6,159,707 4,801,321 Deposits 6,486,556 5,241,377 Shareholders' Equity 651,198 515,740 Mortgage-Backed Security Assets Under Administration 5,723,890 3,289,231 ------------------------------------------------------------------------- FINANCIAL STRENGTH Capital Measures(2) Risk Weighted Assets $3,585,039 $3,053,453 Tier 1 Capital Ratio 16.7% 15.2% Total Capital Ratio 17.9% 16.7% Credit Quality Net Impaired Loans as a Percentage of Gross Loans 0.7% 1.3% Allowance as a Percentage of Gross Impaired Loans 70.8% 47.1% Annualized Provision as a Percentage of Gross Loans 0.1% 0.3% Share Information Book Value per Common Share $ 18.78 $ 14.99 Common Share Price - Close $ 42.17 $ 30.21 Market Capitalization $1,462,034 $1,039,164 Number of Common Shares Outstanding 34,670 34,398 ------------------------------------------------------------------------- (1) See definition of Taxable Equivalent Basis (TEB) under Non-GAAP Measures of this unaudited interim consolidated financial report. (2) These figures relate to the Company's operating subsidiary, Home Trust Company. ------------------------------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS ------------------------------------------------------------------------- >> Caution Regarding Forward-Looking StatementsFrom 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 32 through 41 of the Company's 2009 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 Message 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 us 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 2010 and how it will affect Home Capital's business are material factors the Company considers when setting its objectives. 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 performance target ranges for 2010, management's expectations assume: << - The Canadian economy will continue a slow recovery, with fragmented growth prospects across the country, and inflation will remain low; - Unemployment levels will remain elevated by historical norms through much of 2010. The Company expects the employment rate to show slower growth for the remainder of 2010; - Housing demand will remain healthy in 2010 but the rate of increase in demand may begin to slow as interest rates begin to increase in the second half of 2010. The Company has observed that nationally home sales have slowed compared to the growth observed in the first quarter of 2010 and the latter half of 2009; - A slowly increasing interest rate environment in the second half of 2010, supported by stable inflation, driven by lower demand for commodity and energy goods. The Company has already observed increased Bank of Canada overnight lending rates; - Sound credit quality with actual losses within Home Capital's historical range of acceptable levels; and - A stable net interest margin and comparatively lower investment returns, reflecting the Company's shift to higher quality assets held in the security and liquidity portfolios and prudent levels of liquid assets being held in response to continuing uncertainty in the capital markets. In the first half of 2010 the Company observed improvements in the economy and capital markets and began reducing excess liquidity. >> Non-GAAP MeasuresThe Company uses a number of financial measures to assess its performance. Some of these measures are not calculated in accordance with Generally Accepted Accounting Principles (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 Discussion and Analysis (MD&A) are defined as follows:Return on Shareholders' EquityReturn 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 AssetsReturn on assets is a profitability measure that presents the net income as a percentage of the average total assets deployed to earn the income.Efficiency or Productivity RatioManagement 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.Net Interest MarginNet interest margin is calculated by taking net interest income, on a taxable equivalent basis, divided by average total assets.Tier 1 and Total Capital RatiosThe 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 8 of the Unaudited Interim Consolidated Financial Statements.Taxable Equivalent Basis (TEB)Most banks and trust companies analyze and report 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 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 $2.0 million for the second quarter and $4.1 million for the first six months of 2010 ($1.5 million for the second quarter and $2.8 million for the first six months of 2009) increased reported interest income. TEB does not have a standard meaning prescribed by Canadian 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 FilingsThe 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 PerformanceThis MD&A should be read in conjunction with the unaudited interim consolidated financial statements for the period ended June 30, 2010 included herein, and the audited consolidated financial statements and MD&A for the year ended December 31, 2009. These are available on the Canadian Securities Administrators' website at www.sedar.com and on pages 10 through 76 of the Company's 2009 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 2009 remain substantially unchanged. These unaudited interim consolidated financial statements and MD&A have been prepared based on information available as at August 3, 2010. 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.2010 Objectives and PerformanceHome Capital published its financial objectives for 2010 on page 13 of the Company's 2009 Annual Report. The following table compares actual performance to date against each of these objectives.Table 1: 2010 Objectives and Performance << ------------------------------------------------------------------------- Six-month Period Ended June 30, 2010 2010 Objectives(1) Actual Results(1) ------------------------------------------------------------------------- Net Income 15%-20% $85.1 million, or ($75.6 million - 29.4% increase over the $78.9 million) same period last year Diluted Earnings per 15%-20% $2.45 per share, or Share ($2.19 per share - 29.0% increase $2.28 per share) over the same period last year Total Assets and Assets 15%-20% $13.30 billion, or Under Administration ($10.86 billion - 40.8% increase over the $11.33 billion) same period last year Return on Shareholders' Equity 20.0% 27.4% Efficiency Ratio (TEB) 28.0% to 34.0% 26.1% Capital Ratios(2) Tier 1 Minimum of 10% 16.7% Total Minimum of 12% 17.9% Provision for Loan Losses as a Percentage of Total Loans 0.2% to 0.5% 0.05% ------------------------------------------------------------------------- (1) Objectives and results for net income and diluted earnings per share are for the current year. (2) Based on the Company's wholly owned subsidiary, Home Trust Company. ------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS ------------------------------------------------------------------------- >> In the second quarter of 2010, the Company's originations reached a record $2.01 billion. Combined with strong net income and improvements in the credit performance of the loan portfolio, the Company continues to provide superior shareholder returns. The Company continued to maintain a prudent risk profile in the loan portfolio and a strong capital base. The Company's key financial highlights for the first quarter of 2010 are summarized below.Income Statement Highlights << - Net income grew to $43.4 million, an increase of 26.3% and 29.4% over the comparable three and six months of 2009, driven by a 25.3% and 32.8% increase in net interest income over the comparable periods of 2009. - Diluted earnings per share for the quarter increased 26.3% to $1.25 compared to $0.99 in the second quarter of 2009 and increased 29.0% to $2.45 for the six months ended June 30, 2010 compared to $1.90 in the same period of 2009. - Provisions for credit losses decreased to $0.6 million compared to $3.1 million the second quarter of 2009 and declined to $1.5 million for the first six months of 2010, compared to $6.4 million for the same period last year due to improved recoveries and a reduction in overall arrears. - Securitization income was $26.8 million in the quarter and $49.0 million year-to-date compared to $26.7 million in the second quarter of 2009 and $54.4 million for the first six months of 2009. The Company securitized $1.16 billion in mortgages in the second quarter of 2010 for a year-to-date total of $2.18 billion compared to $655.1 million and $1.12 billion for same periods in 2009. Market spreads earned on securitization transactions reflected normalized levels in this quarter compared to 2009 as the economy and credit markets improved. - Fees and other income was $7.1 million for the quarter and $14.9 million year-to-date, down marginally from the $7.5 million recorded in the second quarter of 2009 and consistent with the $14.8 million recorded for the first six months of 2009. Fees and other income has been impacted from a relative increase in originations of lower fee products. - The Company took advantage of the improvement in securities markets and realized $5.3 million in net gains on the sale of certain securities during the first quarter compared to realized gains of $2.3 million in the second quarter of 2009. - The efficiency ratio (TEB) remained low at 26.7% for the quarter and 26.1% year-to-date compared to 25.1% and 26.1% in the comparable 2009 periods; reflecting the Company's continued diligence in managing expenses. - Return on average shareholders' equity remained strong at 27.1% for the quarter and 27.4% year-to-date compared to 27.9% and 27.7% for the same periods last year. >> Balance Sheet Highlights << - Total assets under administration, including the off-balance sheet securitized mortgages, grew to $13.30 billion in the first quarter. This represents a 40.8% increase from the $9.44 billion recorded one year ago and an increase of 15.6% over the $11.51 billion recorded at December 31, 2009. Driving this increase is robust growth in residential mortgage originations spanning across both the traditional and Accelerator mortgage products. - Total on-balance sheet assets ended the quarter at $7.57 billion compared to $7.36 billion at December 31, 2009 and $6.15 billion one year ago. The increase is attributed to strong loan originations offset by a decline in the liquidity portfolio. - Liquid assets at June 30, 2010 were $580.2 million, down from $1.20 billion at December 31, 2009 and $777.7 million at June 30, 2009. The Company reduced this level toward normalized levels during the quarter while maintaining a conservative liquidity position. Liquidity levels were high at the end of 2009 due to the timing of receipt of securitization funding close to the end of the year. - The Company's capital position remains strong with Tier 1 and Total capital ratios of 16.7% and 17.9%, respectively, at the end of the quarter compared to 16.4% and 18.0% at December 31, 2009 and 15.2% and 16.7% at June 30, 2009, respectively. - Deposit liabilities as at June 30, 2010 were $6.49 billion, an increase of $76.7 million from December 31, 2009 and an increase of $1.25 billion from June 30, 2009. The modest increase in deposits compared to origination volumes over the first six months of the year is due to the drawdown of the liquidity portfolio and increased funding through securitization which reduced the need to raise deposits. ------------------------------------------------------------------------- EARNINGS REVIEW ------------------------------------------------------------------------- Net Interest Income Table 2: Net Interest Income For the three months ended ------------------------------------------------------------------------- June 30, 2010 June 30, 2009 Income/ Average Income/ Average (000s, except %) Expense Rate(1) Expense Rate(1) ------------------------------------------------------------------------- Assets Cash and cash resources $ 991 1.1% $ 365 0.3% Securities 5,491 3.2% 6,690 5.4% Loans 88,137 5.9% 84,286 7.2% Taxable equivalent adjustment 2,032 - 1,535 - ------------------------------------------------------------------------- Total interest earning assets 96,651 5.5% 92,876 6.6% Other assets - - - - ------------------------------------------------------------------------- Total Assets $ 96,651 5.2% $ 92,876 6.3% ------------------------------------------------------------------------- Liabilities and Shareholders' Equity Deposits $ 47,184 3.0% $ 50,852 4.0% Other liabilities - - - - Shareholders' equity - - - - ------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $ 47,184 2.6% $ 50,852 3.5% ------------------------------------------------------------------------- Net Interest Income $ 49,467 $ 42,024 Tax Equivalent Adjustment (2,032) (1,535) ------------------------------------------------------------------------- Net Interest Income per Financial Statements $ 47,435 $ 40,489 ------------------------------------------------------------------------- Net Interest Margin(2) 2.6% 2.8% Spread of Loans over Deposits Only 2.9% 3.2% ------------------------------------------------------------------------- For the six months ended ------------------------------------------------------------------------- June 30, 2010 June 30, 2009 Income/ Average Income/ Average (000s, except %) Expense Rate(1) Expense Rate(1) ------------------------------------------------------------------------- Assets Cash and cash resources $ 2,372 1.0% $ 1,631 0.6% Securities 11,200 3.2% 12,784 5.3% Loans 173,894 6.0% 165,613 7.1% Taxable equivalent adjustment 4,128 - 2,808 - ------------------------------------------------------------------------- Total interest earning assets 191,594 5.5% 182,836 6.4% Other assets - - - - ------------------------------------------------------------------------- Total Assets $ 191,594 5.2% $ 182,836 6.1% ------------------------------------------------------------------------- Liabilities and Shareholders' Equity Deposits $ 92,536 2.9% $ 103,307 4.0% Other liabilities - - - - Shareholders' equity - - - - ------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $ 92,536 2.5% $ 103,307 3.5% ------------------------------------------------------------------------- Net Interest Income $ 99,058 $ 79,529 Tax Equivalent Adjustment (4,128) (2,808) ------------------------------------------------------------------------- Net Interest Income per Financial Statements $ 94,930 $ 76,721 ------------------------------------------------------------------------- Net Interest Margin(2) 2.7% 2.6% Spread of Loans over Deposits Only 3.1% 3.1% ------------------------------------------------------------------------- (1) The average rate is a simple average calculated with reference to opening and closing monthly balances and as such may not be as precise if daily balances were used. (2) Net interest margin is calculated on a tax equivalent basis. >> As noted in Table 2 above, net interest income was $47.4 million in the second quarter of 2010, an increase of 17.1% over the $40.5 million recorded in the second quarter of 2009. The increase in net interest income over the comparable quarter is due to a significant increase in the on-balance sheet loans portfolio of 28.3%, dampened marginally by a slight decline in the net interest margin.Net interest margin and spread of loans over deposits of 2.6% and 2.9%, respectively declined from the 2.8% and 3.2% in the comparable quarter of 2009. The average rate on the loans portfolio continues to decline as new mortgages are originated in a lower rate environment and higher rate mortgages are renewed at lower rates. Deposit rates have also declined but the deposit portfolio re-prices at a slower rate overall. The Company's Accelerator mortgages, which carry lower interest rates then the traditional portfolio and are predominately earmarked for securitization, do remain on the balance sheet for a period of time. The Company originated a record volume of Accelerator mortgages in the quarter and significant volumes have not yet been securitized. The on-balance sheet Accelerator mortgages lower the overall net interest margin. Year-to-date net interest margin is consistent with the prior year.The average rate on cash resources has increased over the comparable quarter in 2009 due to increased purchases of longer duration instruments which carry higher yields and the overall timing of the reduction of the portfolio during the quarter resulted in a decrease in the average outstanding asset balance used in the calculation of the average rate.Non-Interest IncomeTotal non-interest income was $38.1 million for the second quarter compared to $30.4 million in the second quarter of 2009 and $29.8 million in the first quarter of 2010. The largest component of non-interest income is securitization income which is discussed in the section below. The other main components of non-interest income are fees and other income and gains and losses on securities and derivatives.Fees and other income was $7.1 million for the quarter and $14.9 million for the six months ended June 30, 2010 compared to $7.5 million and $14.8 million recorded in the comparable periods of 2009. The increased relative volumes of products with lower and more competitive fee structures, such as Accelerator mortgage products, do not provide the same level of growth in this income stream.The Company recognized a net gain of $5.3 million on the sale of certain securities during the quarter, compared to net gains of $2.3 million and $3.1 million in the comparable quarter of 2009 and first quarter of 2010, respectively. The Company takes advantage of improvements in securities markets when appropriate.Also included in non-interest income are unrealized gains (losses) due to the changes in the fair value of the derivatives used to hedge risk in the securitization program. Unrealized losses of $1.1 million were recognized in the quarter compared to $6.1 million and $3.3 million in unrealized losses in the comparable quarter of 2009 and first quarter of 2010, respectively. Please see the Derivatives and the Off-Balance Sheet Arrangements sections of this MD&A for additional information.Table 3: Securitization ActivityThe following table summarizes the securitization activities during the second quarter of 2010 compared to first quarter of 2010 and the comparable quarter of 2009: << For the three months ended June 30, 2010 ------------------------------------------------------------------------- Single Single Family Family Residential Residential Multi-Unit MBS Under MBS Over Residential (000s, except %) 1 year 1 year MBS Total ------------------------------------------------------------------------- Book value of mortgages securitized $ 109,501 $ 928,007 $ 118,208 $1,155,716 Net gain on sale of mortgages(1) 1,945 12,982 939 15,866 Average Prepayment rate 19.9% 15.2% 0.0% 14.1% Average Excess spread(2) 3.5% 1.9% 0.7% 1.9% Average Discount rate 1.3% 2.0% 3.1% 2.0% ------------------------------------------------------------------------- For the three months ended March 31, 2010 ------------------------------------------------------------------------- Single Single Family Family Residential Residential Multi-Unit MBS Under MBS Over Residential (000s, except %) 1 year 1 year MBS Total ------------------------------------------------------------------------- Book value of mortgages securitized $ 62,253 $ 773,441 $ 189,010 $1,024,704 Net gain on sale of mortgages(1) 1,390 16,654 2,856 20,900 Average Prepayment rate 5.1% 18.9% 0.0% 14.6% Average Excess spread(2) 3.5% 1.5% 0.9% 1.5% Average Discount rate 1.0% 1.3% 3.6% 1.7% ------------------------------------------------------------------------- For the three months ended June 30, 2009 ------------------------------------------------------------------------- Single Single Family Family Residential Residential Multi-Unit MBS Under MBS Over Residential (000s, except %) 1 year 1 year MBS Total ------------------------------------------------------------------------- Book value of mortgages securitized $ 47,263 $ 324,019 $ 283,812 $ 655,094 Net gain on sale of mortgages(1) 1,884 12,173 8,790 22,847 Average Prepayment rate 4.0% 12.8% 0.0% 6.6% Average Excess spread(2) 5.7% 1.1% 1.2% 1.5% Average Discount rate 1.0% 2.9% 2.7% 2.7% ------------------------------------------------------------------------- (1) The gain on sales of mortgages is net of gains and losses realized on hedging activities. (2) The excess spread is gross of hedging activity. >> The Company sold $1.16 billion Mortgage Backed Securities (MBS) pools during the first quarter of 2010, an increase of $500.6 million or 76.4% over the same period last year and an increase of $131.0 million or 12.8% over the first quarter of this year.The growth in volumes was focused in the single family residential MBS during the quarter and is indicative of strong origination volumes. There was a slight decline in multi-unit residential securitization as fewer mortgages have been available.The overall average prepayment rate assumption of 14.1% is slightly lower than last quarter and has increased over the same period last year. Compared to first quarter and last year, the Company increased its prepayment assumption on MBS under 1 year as market data and the Company's current experience indicated a higher prepayment rate was likely for these pools. For MBS over one year the Company has experienced and observed market prepayments below the assumptions in the first quarter of 2010. The average prepayment rate in the second quarter of 2009 was impacted by the relatively higher proportion of non-residential MBS which have no prepayment privileges and assume a 0.0% prepayment rate. Prepayment rates are also impacted by the volume of variable rate mortgages that are securitized, as management has estimated relatively higher prepayment for variable rate mortgages. In the second quarter $252.8 million of variable rate mortgages were securitized compared to $538.6 million in the first quarter of this year. No variable rate mortgages were securitized prior to 2010.The Company has observed an average excess spread for securitization transactions in line with historical levels compared to spreads in 2008 and 2009 and expects this to continue. Average excess spreads on securitizations, gross of hedging activity for the quarter were 1.9% compared to 1.5% in the first quarter of 2010 and 1.5% in the comparable quarter of 2009. Spreads in the second quarter of 2009 were impacted by increasing bond yields in that quarter which caused spreads to narrow compared to the overall higher spreads experienced in 2009.The average discount rate is based on the coupon rate of the underlying MBS or CMB sold.Table 4: Reconciliation of Securitization ActivityThe table below provides a summary reconciling the gains recorded during the respective quarter and the excess spread earned from the Company's continued servicing of these portfolios. << For the three For the six months ended months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Securitization gains $ 21,314 $ 9,314 $ 44,622 $ 34,936 Securitization hedging activity (5,448) 13,533 (7,856) 12,173 ------------------------------------------------------------------------- Securitization gains, net of hedge costs 15,866 22,847 36,766 47,109 Recurring securitization income 10,956 3,896 12,223 7,289 ------------------------------------------------------------------------- Net securitization income $ 26,822 $ 26,743 $ 48,989 $ 54,398 ------------------------------------------------------------------------- ------------------------------------------------------------------------- >> Net securitization income of $26.8 million for the quarter is consistent with the $26.7 million earned in the comparable quarter of 2009. Year-to-date securitization income is $5.4 million or 9.9% lower than the comparable period of 2009.Securitization gains, gross of hedging activity, for the second quarter are up $12.0 million or 128.8% over the comparable quarter of 2009, and up $9.7 million or 27.7% on a year-to-date basis. The increase in securitization gains, gross of hedging activity, is primarily reflective of increased volumes and relatively consistent gross spreads. Also impacting the gross securitization gains is the overall duration of the mortgages being securitized, where shorter duration leads to a lower securitization gain. For the three and six months ended June 30, 2010 the average duration of mortgages securitized was 3.6 years and 4.3 years respectively, compared to 5.2 years and 5.1 years in the comparable periods of 2009.As described in the Derivatives and Off-Balance Sheet Arrangements sections of this MD&A, the Company utilizes forward bond contracts to manage exposure to movements in interest rates prior to the sale of securitized mortgage pools. Forward bond contracts are settled at the time of securitization and any realized gain or loss is then included in the securitization gain as shown above. During the second quarter of 2009, the Canadian capital markets experienced a strong upward movement in bond yields such that if the Company had not economically hedged its mortgage originations that were to be securitized, the Company's net securitization gains would have been reduced. In the second quarter of 2010 bond yields declined over the period that the hedges were in place and therefore reduced the net securitization gains.Recurring securitization income represents servicing income, net of servicing fees, excess spread, and also includes the impact of any changes in management's estimation of prepayments. In the second quarter, recurring income was impacted by changes in management's estimation of prepayments. Recent actual prepayment experience indicates a lower prepayment estimation is a more reflective estimate based on the current portfolio mix, which now includes a significantly higher percentage of Accelerator products. Past prepayment estimates were based on the Company's experience with securitizations of traditional products which maintained higher prepayments compared to the Accelerator product. The lowering of the prepayment estimate increased recurring securitization income compared to the comparable period in 2009.The Company's securitization activities include participation in Canada Mortgage Housing Corporation's (CMHC) Canada Mortgage Bond (CMB) program, administered through the Canada Housing Trust (CHT). This program provides the Company with an additional channel to diversify its funding stream for MBS pools. Of the total MBS pools issued during the second quarter, pools with a book value of $649.3 million were securitized through the CMB program, including replacement assets, compared to $607.8 million and $617.9 million in the comparable period of 2009 and first quarter of 2010, respectively. This resulted in net securitization gains of $6.8 million compared to $20.3 million in the comparable quarter of 2009 and $13.9 million in the first quarter of 2010.The Company also holds longer term derivative contracts to hedge its obligations for pools previously sold to CHT under the CMB program. These hedging instruments do not qualify for hedge accounting treatment under current GAAP and must therefore be marked-to-market through net income. (Refer to Note 12 of these unaudited interim consolidated financial statements and the Derivatives and Off-Balance Sheet Arrangements sections of this MD&A.)Non-Interest ExpensesTotal non-interest expenses incurred in the second quarter were $23.4 million and $43.5 million year-to-date compared to $18.2 million and $37.1 million for the comparable periods of 2009.The increase over the comparable periods of 2009 is consistent with the overall growth of the Company and plans for continued growth and diversification. The growth accomplished to date, along with the Company's strategies looking forward, has resulted in the need for additional staff, space and an increase in general and administration expenditures. The Company expects increases in non-interest expenses to continue in a measured and efficient manner in order to align with its growth strategy through strategic investments in infrastructure, accommodation, technology and people.During the second quarter, salaries and staff benefits were $11.7 million and $22.5 million year-to-date compared to $10.1 million and $20.2 million in the comparable periods of 2009. The Company continues to anticipate increases in staff levels during the year to accommodate business growth. On June 30, 2010 the Company employed 536 full-time staff, compared to 505 employees at March 31, 2010 and 446 staff one year ago. The Company also employs part-time students during the summer months. This summer the Company hired 44 summer students.Premises expenses were $1.7 million during the quarter, consistent with the $1.6 million last quarter and slightly increased from the $1.4 million in the second quarter of 2009 due to lease renewals and increased space in Toronto as compared to last year. There were no changes to premises during the quarter.General and administration expenses were $10.0 million during the quarter, and $17.7 million year-to-date compared to $6.7 million and $14.1 million in the comparable periods of 2009. These expenses are expected to increase in order to support managed growth. In particular, the Company has experienced increased information technology costs reflective of additional employees and additional costs associated with the implementation of a new core banking system that are not eligible for capitalization.The efficiency ratio (TEB) for the three and six months ended June 30, 2010 was 26.7% and 26.1%, respectively, compared to 25.1% and 26.1% for the comparable period of 2009. The ratio continues to reflect the Company's consistent and prudent cost management leadership within the industry.Provision for Credit LossesTable 5: Provision for Credit Losses << ------------------------------------------------------------------------- (000s except %) For the three months ended For the six months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 2010 2009 % Change 2010 2009 % Change ------------------------------------------------------------------------- Specific provision $ 142 $ 2,418 (94.1)% $ 388 $ 5,076 (92.4)% General provision 430 681 (36.9)% 1,151 1,306 (11.9)% ------------------------------------------------------------------------- Total provision 572 3,099 (81.5)% 1,539 6,382 (75.9)% ------------------------------------------------------------------------- Average loans 5,818,597 $4,653,999 25.0% 5,800,227 $4,653,856 24.6% Provision as % of average loans (annualized) 0.01% 0.07% 0.03% 0.14% Net write-offs 1,319 $ 2,211 (40.3)% 1,398 $ 3,663 (61.8)% Net write-offs as % of average loans (annualized) 0.02% 0.05% 0.02% 0.08% ------------------------------------------------------------------------- Table 6: Net impaired Loans & Allowances (000s except %) As at ------------------------------------------------------------------------- June 30 December 31 June 30 2010 2009 2009 ------------------------------------------------------------------------- Net impaired loans $ 41,535 $ 46,306 $ 61,062 Gross loans 6,190,220 5,471,119 4,832,143 ------------------------------------------------------------------------- Net impaired as % of gross loans 0.67% 0.85% 1.26% ------------------------------------------------------------------------- General allowance $ 28,944 $ 27,793 $ 26,483 Specific allowance 1,569 2,579 4,339 ------------------------------------------------------------------------- Total allowance 30,513 30,372 30,822 ------------------------------------------------------------------------- ------------------------------------------------------------------------- >> The provisions for credit losses are charged to the income statement by an amount that brings the specific and general allowances for credit losses to the level determined by management to be adequate. Factors that 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 general and specific allowances required based on available data including external economic factors, the composition of the portfolio, and the overall growth in the loans portfolio.The total provision for credit losses for the second quarter has declined 81.5% over the comparable quarter in 2009 and has declined 75.9% on a year-to-date basis over 2009. The decline is due to the following factors: << - A decline in net impaired loans. Net impaired loans as a percentage of gross loans ended the quarter at 0.67% which is at a low point compared to 2009 and 2008. The overall trend in net impaired loans has been downward since a peak in mid-2009. The Company is optimistic that credit losses and impaired loans will normalize towards the Company's historical averages. Proactive strategies employed by the Company to tighten underwriting standards and to take into account local market conditions in the early days of the economic and credit crisis have lead to manageable arrears and credit losses during the economic challenges. Further, the Company continues to employ prudent strategies to maintain the credit quality of the loans portfolio. - An overall decline in the level of net write-offs over 2009. This reflects an improvement in recoveries due to improving real estate markets, lower overall net write-offs and a continued focused effort at working out non-performing loans. Write-offs in the residential mortgage portfolio have improved over comparable periods and have returned to more normalized level. Personal and credit card loans and secured loans net write-offs are within expected levels. The non- residential mortgage portfolio continues the trend of zero write- offs. 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 under the Credit Risk section of this MD&A and in the 2009 Annual Report under the heading Risk Management. - An improvement in the overall risk profile of the loan portfolio and Canadian economic factors that influence management's assessment of the level of general allowance (please see the Credit Risk section of this MD&A for more information). >> The general allowance balance at June 30, 2010 increased $1.2 million over the fourth quarter of 2009 and $2.5 million over June 30, 2009. The general allowance was 80.7 basis points of the Company's risk-weighted assets at June 30, 2010 compared to 86.1 basis points at December 31, 2009 and 86.7 basis points at June 30, 2009. The change in the level of the general allowance reflects the overall growth in the Company's loan portfolio, the current economic conditions, as well as changes in the overall risk profile of portfolio, including an overall reduction of non-residential loans and continued prudent lending practises.The specific allowances balance at June 30, 2010 declined $1.0 million and $2.8 million over December 31, 2009 and June 30, 2009, respectively. The decrease in specific allowances is the result of an overall improvement in the performance of the portfolio.Income TaxesThe income tax expense amounted to $18.2 million (effective tax rate of 29.5%) for the second quarter of 2010 and $32.7 million (effective tax rate of 27.8%) for 2010, compared to $15.3 million (effective tax rate of 30.8%) for the second quarter and $30.0 million (effective tax rate of 31.3%) for 2009. The lower effective tax rate during the quarter is attributed to Canadian dividend income which is non-taxable to financial institutions, which results in a lower effective income tax rate. In the absence of tax-free dividends, the tax rates would have been 31.8% for the second quarter and 30.1% for the six months of 2010, compared to 32.8% for the second quarter and 33.3% for the first six months of 2009.During the fourth quarter of 2009, the Ontario Provincial Government announced that it intended to reduce the Provincial Corporate Tax rates from 14% to 12% effective July 1, 2010 and further reductions which will result in a eventual Provincial tax rate of 10% effective July 1, 2013. These rate reductions have been accounted for in the Company's future tax provision.Comprehensive IncomeComprehensive income is the aggregate of net income and other comprehensive income (OCI). Comprehensive income was $31.2 million for the quarter and $74.0 million year-to-date compared to $52.2 million and $93.2 million in the comparable periods of 2009. OCI was a loss of $12.2 million for the quarter and a loss of $11.1 million year-to-date compared to income of $17.8 million and $27.5 million for the comparable periods in 2009.OCI includes changes in unrealized income on available for sale securities, valuation changes on the securitization receivables, transfers of previously unrealized net gains and losses to net income once they have been realized, and transfers of unrealized losses on investments considered other than temporarily impaired to net income.The Company recognized a net transfer of a $2.3 million realized gain from OCI to net income related to a gain on sale of securities in the quarter for a total of $4.9 million year-to-date. This compares to a net transfer of a $7.1 million loss to net income in the comparable quarter of 2009 and $13.1 million loss for the first six months of 2009.There was a net decrease in market value on securities available for sale, including fixed income, preferred and equity securities of $9.9 million for the quarter and $6.2 million year-to-date compared to a net increase of $10.7 million and $14.4 million for the comparable periods of 2009. This net decrease in market value is predominately a result of market value declines in the preferred share portfolio. << ------------------------------------------------------------------------- BALANCE SHEET REVIEW ------------------------------------------------------------------------- >> AssetsTable 7: AssetsThe table below presents the asset position of the Company at June 30, 2010, December 31, 2009 and June 30, 2009 along with percentage changes. << As at % Change ------------------------------------------------------------------------- June 30, 2010 June 30, Decem- - Decem 2010 - June 30 ber 31 June 30 -ber 31, June 30, (000s, except %) 2010 2009 2009 2009 2009 ------------------------------------------------------------------------- Cash resources $ 358,532 $ 930,134 $ 412,186 (61.5)% (13.0)% Securities 634,400 650,597 650,810 (2.5)% (2.5)% Residential mortgages 4,995,261 4,369,458 3,639,986 14.3% 37.2% Non- Residential mortgages 729,172 708,425 774,077 2.9% (5.8)% Personal and credit card loans 424,375 342,918 350,550 23.8% 21.1% Secured loans 39,843 47,739 63,191 (16.5)% (36.9)% General allowance (28,944) (27,793) (26,483) 4.1% 9.3% ------------------------------------------------------------------------- Total loans 6,159,707 5,440,747 4,801,321 13.2% 28.3% ------------------------------------------------------------------------- Other assets 421,531 339,396 288,413 24.2% 46.2% ------------------------------------------------------------------------- Total on-balance sheet assets 7,574,170 7,360,874 6,152,730 2.9% 23.1% ------------------------------------------------------------------------- Mortgage- backed security assets under administr- ation 5,723,890 4,147,711 3,289,231 38.0% 74.0% ------------------------------------------------------------------------- ------------------------------------------------------------------------- >> The Company reduced liquidity levels to more normalized levels in the second quarter of 2010 leading to lower cash resources compared to the end of 2009 and one year ago, The Company had been maintaining higher liquidity levels in response to market uncertainty and liquidity was higher at March 31, 2010 due to the timing of securitization transactions. Excess liquidity was used partially to fund mortgage origination activity.The securities portfolio has declined marginally from the end of 2009 and one year ago. The decline is due to securities sales and a decline in the market value of certain securities. The Company continues to invest in conservative assets while balancing appropriate returns. In the second quarter the Company took advantage of market opportunities and sold certain securities for a net before tax gain of $5.3 million.Record residential mortgage originations of $2.01 billion offset by securitization volumes of $1.16 billion in the second quarter of 2010 have lead to the increase in the residential mortgage balance compared to December 31, 2009 and June 30, 2009. Additionally, strong originations in Equityline Visa and consumer lending have driven personal and credit card loan balances higher compared to the same dates. Please see the results by business segment section of this MD&A for further discussion.Non-residential mortgages are up marginally as the Company has maintained the level of this portfolio in the second quarter after reducing the portfolio in late 2008 and early 2009 in response to market uncertainty.Secured loans, which are second mortgages, continue to decline as discharges outpace new originations. The Company is not currently actively growing this portfolio.Other assets include the Company's securitization receivable, capital assets and other assets. Growth in the securitization receivable of $106.2 million over June 30, 2009 and $66.7 million over December 31, 2009 is the primary driver of the increase in other assets. The securitization receivable balance, which represents the Company's right to the future cash flows of securitizations transactions, increases with new securitization volumes and reduces as the actual cash flows are collected over time.Additionally, other assets increased due to an increase in intangible assets of $11.6 million and $24.2 million over December 31, 2009 and June 30, 2009, respectively, related to the development of the Company's new core banking system offset by a decline in other prepaid assets and deferred items.Gross loans under administration, which include the mortgage-backed security assets under administration, reached $11.88 billion at the end of the quarter, an increase of 23.9% or $2.30 billion from the $9.59 billion recorded at the end of 2009 and a 46.8% or $3.79 billion increase over the $8.09 billion recorded one year ago. This increase is due to strong origination and securitization volumes.Table 8: Liabilities & Shareholders' Equity << As at % Change ------------------------------------------------------------------------- June 30, 2010 June 30, Decem- - Decem 2010 - June 30 ber 31 June 30 -ber 31, June 30, (000s, except %) 2010 2009 2009 2009 2009 ------------------------------------------------------------------------- Deposits $6,486,556 $6,409,822 $5,241,377 1.2% 23.8% Other liabilities 436,416 360,764 395,613 21.0% 10.3% Shareholders' equity 651,198 590,288 515,740 10.3% 26.3% ------------------------------------------------------------------------- Total liabilities and shareholders' equity 7,574,170 7,360,874 6,152,730 2.9% 23.1% ------------------------------------------------------------------------- ------------------------------------------------------------------------- >> Deposit liabilities increased marginally from December 31, 2009 as the Company utilized excess liquidity and securitization proceeds to fund originations rather than deposits in the first six months of 2010. Deposit liabilities increased compared one year ago as relatively more deposits were used to fund originations in the second half of 2009.Growth in other liabilities was principally driven by general increases in the business that increase liability balances in accrued interest, servicing liabilities, future tax liabilities and other accrued liabilities.The increase in total shareholders' equity since December 31, 2009 was internally generated from net income over the six months of $85.1 million, $3.0 million in proceeds from the exercise of stock options less $11.1 million for dividends paid and payable to shareholders. This was offset by a reduction in accumulated other comprehensive income of $11.1 million from unrealized losses on available for sale securities and the repurchase of shares of $5.5 million.The increase in shareholders' equity over June 30, 2009 was internally generated from net income for the twelve-month period ended June 30, 2010 of $163.8 million, $7.6 million in proceeds from the exercise of stock options, less $22.9 million in shareholder dividends. Additional movements resulted from amortization of the fair value of stock options,, reduction of capital stock through the Company's Normal Course Issuer Bid and changes in accumulated other comprehensive income.At June 30, 2010 the book value per common share was $18.78, compared to $17.00 at December 31, 2009 and $14.99 at June 30, 2009.DerivativesFrom time to time, the Company enters into hedging transactions to manage interest rate exposure on outstanding loan commitments. The Company uses forward contracts to sell Government of Canada bonds to hedge the impact of movements in interest rates between the time that mortgages are committed to be securitized and the time those mortgages are actually securitized. The intent of the forward bond contracts is to have the fair value movements of the forward bond contracts offset, within a reasonable range, the fair value changes due to interest rate fluctuations of the pool of fixed rate mortgages. This period of time is generally 60 to 150 days. For this purpose, during the second quarter of 2010, the Company entered into $516.8 million of forward bond contracts.The forward bond contracts are settled at the time of securitization of the underlying mortgages. For the second quarter of 2010, a net realized loss of $5.4 million was recognized in the income statement through securitization income compared to a net gain of $13.5 million in the second quarter of 2009. The gain or loss realized on settlement of these contracts is dependant upon interest rate movements on the underlying bonds while the Company holds the forward bond contracts. If interest rates increase the Company will realize a gain which will be offset by a reduction in the securitization gain.At June 30, 2010 the Company continued to hold notional forward bond contracts of $47.7 million in anticipation of future securitizations compared to $183.8 million and $310.4 million at December 31, 2009 and June 30, 2009, respectively. These contracts had a negative fair value of $0.9 million at June 30, 2010 compared to a positive fair value of $2.4 million at the end of 2009 and a negative fair value of $1.4 million at June 30, 2009. The fair value changes in these contracts create unrealized gains or losses which are included in income statement through loss on derivatives.The Company participates in the CMB program sponsored by CMHC, and administered by CHT. Through this program, the Company must manage the cash flow mismatch between the Canada Mortgage Bond (CMB) interest rate payments and the amortizing MBS pools interest payments. To accomplish this, the Company enters into interest rate swaps (seller swap) in which, for fixed rate MBS, the Company pays the fixed interest payments on the CMB and receives the total return on the MBS. For variable rate MBS, the Company enters into interest rate swaps (seller swap), where the Company pays the variable rate interest rate payments on the CMB and receives the variable rate total return on the MBS. As well, for fixed rate MBS the Company enters into accreting interest rate swaps (hedge swaps) to manage the reinvestment risk between the amortizing fixed rate MBS and the bullet fixed rate CMB.The total notional value of the seller swaps and hedge swaps at June 30, 2010 was $4.31 billion ($3.20 billion - Q4 2009; $2.25 billion - Q2 2009). These swaps, including both the seller and hedge swaps, had a negative fair value of $8.1 billion at June 30, 2010 ($10.7 million - Q4 2009; $7.8 million - Q2 2009). Unrealized gains (losses) due to changes in fair value are recorded in the consolidated statements of income through loss on derivatives. Unrealized gains (losses) from the fair value changes of these swaps are impacted by the total notional amount outstanding, changes in interest rates and changes in prepayment rates. Each of these factors creates some volatility in the fair value, which, over time, should stabilize.The Company may also from time to time enter into interest rate swaps to manage the duration risk between the seller and the hedge swaps described above. At the time of entering into the hedge swap management must estimate the expected rate of prepayment of the underlying securitized pool. Where actual prepayments differ from the original expectation, an un-hedged reinvestment risk exposure will emerge. These interest rate swaps are entered into to hedge this exposure. At June 30, 2010 the total notional value of these interest rate swaps was $75.0 million. The interest rate swap had a negative fair value of $1.9 million at June 30, 2010. There were no similar positions at June 30, 2009 or December 31, 2009.For additional information refer to Note 12 of these unaudited interim consolidated financial statements.Off-Balance Sheet ArrangementsThe Company originates, securitizes and sells insured residential mortgage loans through MBS and CMB programs into special purpose entities for funding. When these mortgages are sold, the Company retains rights to certain excess interest spreads less servicing liabilities, which constitute retained interests classified as securitization receivable on the consolidated balance sheet. The Company periodically reviews the value of retained interests, and any other than temporary impairment in value is charged to income. The Company continues to administer a large majority of securitized assets that the Company originates after the sale and, upon maturity of the mortgage, will renew or refinance these mortgage loans whenever possible.As at June 30, 2010 outstanding securitized mortgage loans under administration amounted to $5.72 billion ($4.15 billion - Q4 2009; $3.29 billion - Q2 2009) with retained interest of $296.1 million ($229.4 million - Q4 2009; $189.9 million - Q2 2009). The off-balance sheet portfolio continues to perform well, with 99.0% of the portfolio current and 0.4% greater than 60 days in arrears compared to 97.9% current and 0.9% over 60 days at December 31, 2009 and 97.2% current and 1.0% over 60 days at June 30, 2009.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 $536.8 million at June 30, 2010 ($380.8 million - Q4 2009; $384.8 million Q2- 2009). Included within the outstanding commitments are unutilized non-residential loan advances of $89.0 million at June 30, 2010 ($48.6 million - Q4 2009; $99.2 million - Q2 2009). Commitments for the loans remain open for various dates through March 2011. As at June 30, 2010 un-utilized credit card balances amounted to $65.1 million ($52.8 million - Q4 2009; $49.6 million - Q2 2009). Outstanding commitments for future advances for the Equityline Visa portfolio were $5.5 million at June 30, 2010 ($2.9 million - Q4 2009; $2.4 million - Q2 2009). << ------------------------------------------------------------------------- CAPITAL MANAGEMENT ------------------------------------------------------------------------- >> Home Trust's capital ratios are calculated using the guidance of OSFI. Regulatory capital is calculated 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 for Home Trust, risk-weighted assets are calculated for each of credit and operational risk. Home Trust's capital structure and risk-weighted assets were as follows:Table 9: Regulatory Capital << As at ------------------------------------------------------------------------- June 30 December 31 June 30 (000s, except %) 2010 2009 2009 ------------------------------------------------------------------------- Capital Stock $ 23,497 23,497 23,497 ------------------------------------------------------------------------- Retained earnings 577,228 505,808 439,932 ------------------------------------------------------------------------- Contributed surplus 951 951 951 Accumulated (net after tax) unrealized losses on available for sale equity securities (2,655) - - ------------------------------------------------------------------------- Net tier 1 capital $ 599,021 530,256 464,380 ------------------------------------------------------------------------- Subordinated debt 15,000 15,000 15,000 Accumulated (net after tax) unrealized gains on available for sale equity securities - 7,987 2,788 Eligible general allowance for credit losses 28,944 27,793 26,483 ------------------------------------------------------------------------- Total Capital $ 642,965 581,036 508,651 ------------------------------------------------------------------------- Risk-weighted assets for: Credit risk $3,251,251 $2,913,092 2,740,828 Operational risk 333,788 314,063 312,625 ------------------------------------------------------------------------- Total Risk-weighted Assets(1) $3,585,039 $3,227,155 3,053,453 ------------------------------------------------------------------------- Tier 1 Capital Ratio 16.7% 16.4% 15.2% ------------------------------------------------------------------------- Total Capital Ratio 17.9% 18.0% 16.7% ------------------------------------------------------------------------- Asset to Capital Multiple 11.79 12.66 12.09 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) Based on the Company's wholly owned subsidiary, Home Trust Company. >> The capital base of Home Trust continues to be strong. The 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.The Company continues to maintain its conservative approach to capital and to build capital through the growth of retained earnings. The strong capital position affords the Company the flexibility to maintain and grow operations, both organically and, if the opportunity should arise, through strategic acquisitions. Additionally, given the uncertainty in international rule-making activities that may potentially impact capital requirements in Canada, the Company believes a continued prudent capital management approach is warranted. << ------------------------------------------------------------------------- RISK MANAGEMENT ------------------------------------------------------------------------- >> The Company is exposed to various types of risks owing 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 discipline for managing all sources of risks. The Company's ERM structure is supported by a governance framework which 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 policies are reviewed and approved annually by the Board of Directors. The Company's key risk management practices remain in place and continue to be reviewed and enhanced from those outlined on pages 32 through 41 in the MD&A section of the Company's 2009 Annual Report.Credit RiskThis 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. The Company's exposure to credit risk is monitored by senior management, the ERM function, the Audit Committee and the Risk and Capital Committee of the Board of Directors who undertake reviews of credit policies, lending practices, the adequacy of loan loss reserves and credit risk based capital. The Company's policy is that credit is approved by different levels of senior management, 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 table below.Table 10: Mortgage Portfolio << ------------------------------------------------------------------------- As at ------------------------------------------------------------------------- June 30 December 31 June 30 (000s, except %) 2010 2009 2009 ------------------------------------------------------------------------- Total mortgage portfolio balance $5,724,433 $5,077,883 $4,414,063 Percentage of residential mortgages 87.3% 86.0% 82.5% Percentage of non-residential mortgages 12.7% 14.0% 17.5% Percentage of insured residential mortgages 26.7% 31.0% 21.8% Percentage of new residential originations insured (for the three months ended) 60.3% 60.7% 67.7% Percentage of first mortgages 99.7% 99.7% 99.6% Percentage of mortgages current 96.8% 95.5% 94.3% Percentage of mortgages over 60 days past due 0.9% 1.1% 1.7% ------------------------------------------------------------------------- >> The composition of the mortgage portfolio is well within the internal policy limits approved by the Company's Risk and Capital Committee. The proportion of non-residential has declined over the past twelve months due to the Company's prudent approach in the non-residential sector and the significant growth in the residential portfolio. Refer to Note 4 of these unaudited interim consolidated financial statements for a further breakdown by geographic region.Insured mortgages reduce the credit risk to the Company. The insured on-balance sheet mortgage balance has declined from December 31, 2009 due to the securitization of a high volume of insured mortgages securitized but has increased over one year ago as insured mortgage origination volumes have increased over the 12 months. With the success of the Accelerator program the Company continues a trend of originating high volumes of insured mortgages, but the increased focus on growing the traditional portfolio resulted in a lower percentage of mortgages insured at origination compared to the three months ended December 31, 2009 and June 30, 2009.The Company also 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. The average loan to value on origination of the Company's traditional residential mortgage loans portfolio was 69.7%, compared to 68.8% at December 31, 2009 and 67.7% one year ago.The performance of the mortgage loans portfolio is closely monitored by senior management and ERM. The mortgage portfolio continues to perform well with arrears returning to historical norms and showing signs of stability. The total mortgage loans portfolio under administration, which includes the off-balance sheet securitized mortgages, is also performing well with 97.8% of the portfolio current and 0.9% over 60 days in arrears.At June 30, 2010 the gross credit card receivable balance totalled $311.1 million, of which 99.9% was 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 $301.9 million or 97.0% of the total credit card receivable balance as at June 30, 2010 compared to 97.6% at December 31, 2009. Cash deposits securing credit card accounts amounted to $7.3 million, and are included in the Company's deposits. Additionally, the Equityline Visa portfolio has a loan to value of 69.5 % at June 30, 2010 consistent with a loan to value of 69.3% at both December 31, 2009 and June 30, 2009. At June 30, 2010, $6.8 million or 2.2% of the credit card portfolio was over 60 days in arrears compared to $7.5 million or 2.5% at December 31, 2009 and $11.0 million or 3.3% at June 30, 2009.The secured loan portfolio of $39.8 million decreased by $7.9 million from December 31, 2009 and decreased $23.3 million from June 30, 2009. These loans are secured by second mortgages on residential properties. At June 30, 2010, 97.9% of the secured loan portfolio was current while $0.4 million or 0.9% was over 60 days in arrears. This compares to 96.6% of the secured loan portfolio being current while $0.5 million or 0.9% was over 60 days in arrears at December 31, 2009. As at June 30, 2009, 95.5% of the secured loan portfolio was current while $1.4 million or 2.1% was over 60 days in arrears.Table 11: Total Net Impaired Loans << As at ------------------------------------------------------------------------- (000s, except %) June 30 December 31 June 30 2010 2009 2009 ------------------------------------------------------------------------- Net impaired loans $ 41,535 $ 46,306 $ 61,062 Gross loans 6,190,220 5,471,119 4,832,143 ------------------------------------------------------------------------- Net impaired as % of gross loans 0.67% 0.85% 1.26% ------------------------------------------------------------------------- >> Total net impaired loans continue to improve after a slight seasonal increase to $50.1 million in the first quarter of 2010. The Company benefited from its early implementation of strategies to minimize loss exposure during the economic challenges. These strategies included the tightening of its underwriting criteria taking into account local market conditions. While the Company has begun prudently re-entering certain markets including markets outside Ontario, its ongoing business strategy ensures that experienced employees of the Company 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 going forward. 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 totalled $1.3 million, up from $0.1 million last quarter and down from $2.2 million for the comparable quarter of 2009. The first quarter of this year benefited from higher than normal recoveries. The Company continually monitors arrears and write-offs very carefully, and deals prudently and effectively with impaired loans.The Company maintains a general allowance that, in management's judgement, is sufficient to absorb probable losses in its loans portfolio. At June 30, 2010 the Company held a general allowance of $28.9 million compared to $27.8 million at December 31, 2009 and $26.5 million at June 30, 2009. The Company routinely monitors the adequacy of the general allowance. The Company has security in the form of real property or cash deposits against loans totalling 99.9% of the total loans portfolio. The Company's evaluation of the adequacy of the general allowance takes into account asset quality, borrowers' creditworthiness, property location and past loss experience. The Company periodically reviews the methods utilized in assessing the general allowance, giving due consideration to changes in economic conditions, interest rates and local housing market conditions.The total general allowance was 80.7 basis points of the Company's risk-weighted assets at June 30, 2010 compared to 86.1 basis points at December 31, 2009 and 86.7 basis points at June 30, 2009. The decrease reflects the overall improvement in the performance of the portfolio and improving economic conditions.Liquidity RiskThis is the risk whereby 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, such as the minimum levels of liquid assets to be held at all times, the composition of types of liquid assets to be maintained, the daily monitoring of the liquidity position by senior management and the ERM function, 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 and debentures, and Canadian bank bonds to comply with its liquidity policy. At June 30, 2010 liquid assets amounted to $580.2 million, compared to $1.2 billion recorded at December 31, 2009 and $777.7 million at June 30, 2009. The decline in overall liquidity levels from the fourth quarter is a result of higher liquidity levels at December 31, 2009 due to the timing of securitization activities. The Company has drawn down some excess liquidity during the quarter but continues to maintain conservative levels. The Company's policy is to maintain a minimum 20% of 100-day obligations in liquid assets and at June 30, 2010, the Company had 29.6% of 100 day liabilities in liquid assets. For the twelve months ended June 30, 2010 the Company maintained a monthly average of $643.7 million or 44.2% of 100-day obligations in liquid assets compared to $646.5 million or 44.8% for the twelve months ended December 31, 2009 and $603.5 million or 44.0% for the twelve months ended June 30, 2009.As another tool used in managing liquidity, the Company runs a model which 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 June 30, 2010 liquid assets amounted to 147% under the immediate scenario and 128% under the ongoing scenario compared to 165% and 139%, respectively, at December 31, 2009 and 168% and 143%, respectively, as at June 30, 2009. The Company continues to monitor these scenarios and will take appropriate actions should the need arise.Structural Interest Rate RiskStructural interest rate risk is the risk of lost earnings or capital due to sudden changes in interest rates. The objective of 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 Asset Liability Management Committee (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 June 30, 2010 is presented under Note 13 in these 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 13 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, by way of prepayments. Similarly, some contractual off-balance sheet mortgage commitments may be extended 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 history.To assist in matching assets and liabilities, the Company utilizes 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 << June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Increase in Decrease in interest rates interest rates ------------------------------------------------------------------------- 100 basis point shift Impact on net interest income, after tax (for the next 12 months) $ 4,611 $ 3,798 $ (4,611) $ (3,798) Impact on net present value of shareholders' equity (8,474) (6,478) 9,224 6,830 200 basis point shift Impact on net interest income, after tax (for the next 12 months) $ 9,222 $ 7,596 $ (9,222) $ (7,596) Impact on net present value of shareholders' equity (16,277) (12,626) 19,290 14,036 ------------------------------------------------------------------------- >> As described in the Derivatives section of this MD&A, the Company may enter into derivative contracts for the purpose of hedging the interest rate risk on loan commitments. The purpose is to manage interest rate exposures during the period between when a mortgage commitment is made and when this mortgage loan is securitized. At June 30, 2010, the Company held notional $47.7 million ($183.8 million - Q4 2009; $310.4 million - Q2 2009) in bond forward contracts for the sale of Government of Canada bond positions to hedge this risk. Through the Company's participation in CMHC's CMB program, the Company is also required to enter into specific interest rate swap contracts to hedge interest rate risk and the reinvestment risk between the amortizing MBS pool and the CMB. Refer to Derivatives section of this MD&A and Note 12 of these unaudited interim consolidated financial statements for additional information.RESULTS BY BUSINESS SEGMENTThe following section discusses the mortgage lending, consumer lending and other segments for the three and six-month period ended June 30, 2010 (refer to Note 14 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 LendingTable 13: Summary of Mortgage Lending Results << For the three months ended For the six months ended ------------------------------------------------------------------------- (000s, June 30 June 30 % June 30 June 30 % except %) 2010 2009 Change 2010 2009 Change ------------------------------------------------------------------------- Net interest income $ 33,054 $ 24,669 34.0% $ 64,792 $ 45,126 43.6% Net income 31,741 25,367 25.1% 61,629 50,035 23.2% ------------------------------------------------------------------------- Total assets 6,089,927 4,865,588 25.2% 6,089,927 4,865,588 25.2% ------------------------------------------------------------------------- >> The Company's principal line of business continues to experience growth in net interest income driven through increased mortgage originations driving higher mortgage loan balances. The rise in net income on a quarter over comparable quarter of 2009 is due to the increased net interest income, lower provisions for credit losses, decreased unrealized losses on derivatives, offset by decreases in fee income and increases in expenses and taxes.The table below provides a breakdown of specific residential and non-residential advances made during the quarter compared to the previous quarter.Table 14: Mortgage Production << For the three For the six months ended months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Traditional single family residential mortgages(1) $ 903,369 $ 407,852 $1,441,311 $ 714,204 Accelerator single family residential mortgages(1) 805,767 433,378 1,366,883 633,065 Multi-unit residential mortages(1) 212,762 381,586 347,586 550,384 Warehouse residential mortgages(1) - 34,611 - 49,951 Non-residential mortgages 45,058 16,316 106,288 38,615 Store and apartments 27,869 4,014 51,651 14,389 Warehouse commercial mortgages 14,500 3,000 20,750 6,000 ------------------------------------------------------------------------- Total Mortgage Advances $2,009,325 $1,280,757 $3,334,469 $2,006,608 ------------------------------------------------------------------------- (1) As defined by OSFI >> The mortgage lending segment advanced a record $2.01 billion in the second quarter of 2010 despite the slowing growth in the real estate markets in the quarter. The Company's success is based on its focus on customer service and broker relationships, as well as the breadth of mortgage product offerings and this is leading to expanded market penetration. The Company began offering Equityline Visa products along with mortgages as a packaged product to qualified customers. Through this, and other initiatives, the Company has been able to offer a "one stop" lending solution to brokers and customers driving both increased mortgage originations and new Equityline Visa accounts, which are included in the consumer lending line of business.The fully insured Accelerator mortgage program remains a key contributor to growth and the cautious expansion in the traditional portfolio is also providing increased origination volumes. The Company has increased its presence in markets outside the Ontario region and has grown originations outside of Ontario on a volume basis by 16.4% compared to the first quarter of 2010.The non-residential product advances of $45.1 million have increased over the comparable quarter and over the comparable year-to-date. The Company began a focused effort in early 2009 to reduce the level of exposure to non-residential mortgages and this is reflected in the lower volumes in 2009. The Company is currently maintaining the overall balance in this portfolio.The Company securitized $1.16 billion of insured residential mortgage loans through the creation of MBS securities during the quarter. Strong Accelerator mortgage originations drove this record level of securitization. Securitization income was $26.8 million for the quarter compared to $26.7 million in the comparable quarter last year. Please see the Securitization Activity section of this MD&A and Note 5 of the unaudited interim consolidated financial statements for additional information.Through Regency Finance Corp. (Regency), the Company acts as Regency's agent in offering residential second mortgage loans. These mortgage loans are securitized and the investments are purchased by the Company. At the end of the second quarter of 2010 the Company held $39.8 million in Secured Loans as Notes Receivable issued by Regency, compared to $47.7 million at December 31, 2009 and $63.2 million at June 30, 2009. These Notes yield 5.6% with an average duration of 2.2 years. The Company also receives fee income for servicing and administering these mortgages for Regency. This income amounted to 0.3% of the portfolio value, on an annualized basis. The underlying credit quality of the mortgage loans securing the Notes Receivable remains high, with only 0.9% of the portfolio in arrears over 60 days. This program has experienced minimal losses since inception.Consumer Lending - Credit Cards and Retail ServicesTable 15: Summary of Consumer Lending Results << For the three months ended For the six months ended ------------------------------------------------------------------------- (000s, June 30 June 30 % June 30 June 30 % except %) 2010 2009 Change 2010 2009 Change ------------------------------------------------------------------------- Net interest income $ 8,746 $ 9,642 (9.3)% $ 18,079 $ 18,066 0.1% Net income 6,056 5,797 4.5% 12,262 10,614 15.5% ------------------------------------------------------------------------- Total assets 486,707 388,463 25.3% 486,707 388,463 25.3% ------------------------------------------------------------------------- >> Consumer lending, which includes Visa and retail lending, continues to generate positive returns for the Company. Net interest income for the second quarter of 2010 declined compared to the second quarter of 2009 due to a reduction in the yield on the portfolio as the Company began to issue lower rate Equityline Visa cards to high quality borrowers.During the second quarter of 2010, 1,515 Equityline Visa accounts with $44.9 million in authorized credit limits were issued, up from 1,008 Equityline Visa accounts with $37.8 million in authorized credit limits issued in the first quarter of 2010 and up from 617 Equityline Visa accounts with $23.2 million in authorized credit limits issued for the three months ended June 30, 2009.The balance in the Equityline Visa loans portfolio amounted to $301.9 million at June 30, 2010 ($297.3 million - Q4 2009: $320.9 million - Q2 2009).Equityline Visa comprises 97.0% (97.6% - Q4 2009; 97.5% - Q2 2009) of the total gross credit card receivable balance of $311.1 million, and bearing an average interest rate of 9.86% (10.8% - Q4 2009; 10.8% - Q2 2009) on outstanding balances. The Company had scaled back lending in the Equityline Visa product last year as a proactive measure to manage credit risk in during the economic downturn. The Company has resumed its strategy to prudently increase this business line through new marketing and product initiatives, including packaging with the traditional mortgage product, has seen increased volumes, and expects this trend to continue.The Company added 11,265 new water heater accounts during the second quarter for a net increase in receivables over the first quarter of 2010 of $8.6 million.OtherTable 16: Summary of Other Results << For the three months ended For the six months ended ------------------------------------------------------------------------- (000s, June 30 June 30 % June 30 June 30 % except %) 2010 2009 Change 2010 2009 Change ------------------------------------------------------------------------- Net interest income $ 5,635 $ 6,178 (8.8)% $ 12,059 $ 13,529 (10.9)% Net income 5,596 3,187 75.6% 11,221 5,120 119.2% ------------------------------------------------------------------------- Total assets 997,536 898,679 11.0% 997,536 898,679 11.0% ------------------------------------------------------------------------- >> The Other segment is comprised of the operating results from the Company's securities portfolio and corporate activities. Net income has increased over comparable periods as the Company sold certain securities during the first six months to take advantage of market opportunities. The decline in net interest income is reflective of a smaller liquidity portfolio offset by an increase in dividend income compared to comparable periods in 2009.ACCOUNTING STANDARDS AND POLICIESCritical accounting estimates which require management to make significant judgements, some of which are inherently uncertain, are outlined on pages 44 through 45 of the 2009 Annual Report. These estimates are critical since they involve material amounts and require management to make estimates 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, securitization of residential mortgages, financial instruments measured at fair value, other than temporary impairment of available for sale securities, goodwill and future income tax liabilities. Further information can be found under Notes 3, 4, 5, 11, and 12 of these unaudited interim consolidated financial statements. There have been no subsequent changes to the critical accounting estimates disclosed on pages 44 through 45 of the 2009 Annual Report.Controls over Financial ReportingNo changes were made in the Company's internal controls over financial reporting during the interim period ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)Preliminary Impact of Securitization Accounting Changes on Net Income in 2010The Company has completed a preliminary calculation of what the possible material IFRS securitization impacts would be for the first and second quarters of 2010. This analysis has not been audited by the Company's external auditors. The analysis suggests that if the income statement for the first and second quarters of 2010 were presented on an IFRS basis, net income and earnings per share would not be materially impacted compared to current net income and earnings per share.The reason for this result is that in the quarters analyzed, when the mortgages currently off-balance are included on the Company's balance sheet under IFRS, they earn net interest income that is not materially different from the securitization gains that were otherwise recognized in the quarters under current Canadian GAAP. While this result would be expected to at least continue for the remaining quarters of 2010, changes in interest rates, securitization spreads or securitization volumes could affect this conclusion.The IFRS calculations are preliminary and contain certain management assumptions and, therefore, are subject to change as the information is further refined and audited. The calculations assume the application of currently applicable IFRS and the expected interpretation that all securitized assets are accounted for on-balance sheet. This interpretation could change as more information becomes available or if certain IFRS are amended before the Company's conversion date. Please see discussion below. This section contains forward-looking statements. (Please see the Caution Regarding Forward-Looking Statements on page 5 of these unaudited interim consolidated financial statements.)The Company utilized existing disclosure controls and internal controls over financial reporting to develop and conduct the preliminary impact of securitization changes on net income.Transition Adjustment at January 1, 2010Adjustments on the transition to IFRS are made against the Company's opening retained earnings on January 1, 2010, the Company's transition date. The Company is in the process calculating the IFRS transition adjustment and expects to disclose this amount in the third quarter report.For regulatory calculations, Home Capital will be able to exclude mortgages securitized prior to March 31, 2010 from the asset to capital multiple (measure of leverage) and transition the IFRS opening retained earnings adjustment for securitization transactions over eight quarters. Please see the discussion below for more information.IFRS ProjectThe Company will change over to IFRS starting with interim and annual financial statements relating to fiscal periods beginning on or after January 1, 2011. The transition date will require the restatement for comparative purposes of amounts reported by the Company for the interim periods and the year ended December 31, 2010. The Company is in the process of transition from current Canadian GAAP to IFRS. A project team that includes representatives from various areas of the organization is working towards a smooth transition to IFRS. The IFRS project team provides regular progress reports to the Audit Committee of the Board of Directors on the status of the IFRS implementation project.Most adjustments required on transition to IFRS will be made retrospectively, against opening retained earnings as of the date of the first comparative balance sheet presentation based on standards applicable at that time. Transitional adjustments relating to those standards where comparative figures are not required to be restated will only be made as of the first day of the year of adoption.The Company's analysis of IFRS and comparison with currently applied accounting principles has identified a number of differences. Many of the differences identified are not expected to have a material impact on the reporting results and financial positions. However, there may be significant accounting changes following from the IFRS accounting principles and provisions for first-time adoption of IFRS standards on certain areas as described below.IFRS 1 "First-Time Adoption of International Financial Reporting Standards", provides entities adopting IFRS for the first time with a number of optional exemptions and mandatory exceptions, in certain areas, to the general requirement for full retrospective application of IFRS. The Company has analyzed the various accounting policy choices available and has made preliminary conclusions on the accounting policy choices, but these elections are subject to change during the transition year. None of the preliminary elections made by management under IFRS 1 are expected to have a material impact on the financial statements.The Company is currently in the process of implementing solutions to capture IFRS based accounting for the 2010 comparative periods and calculating the IFRS opening balance sheet adjustments as at January 1, 2010.Key project milestones in 2010 include: << - quantification of the opening retained earnings adjustment - Q3 2010; - production of 2010 comparative IFRS financial information - Q3 and Q4 2010; and - design and testing of revised disclosure controls and internal controls over financial reporting - Q3 and Q4 2010. >> Summary of IFRS ImpactsThe table below provides a preliminary high-level summary of the more significant IFRS impacts identified by the Company. The table below is based on current IFRS and is subject to change based on potential IFRS changes prior to January 1, 2011. << ------------------------------------------------------------------------- IFRS Area Identified Impact on Home ------------------------------------------------------------------------- Securitization The most significant IFRS implication for the Company Accounting is the accounting for the securitization and sale of mortgages under the CMHC sponsored CMB and MBS programs. Based on the current structure of these programs, the IFRS in effect at transition and the current IFRS 1, the Company expects that it will no longer account for these transactions as sales of mortgages. As such, at the transition date to IFRS (January 1, 2010), all previously recognized securitization gains will be reversed through opening retained earnings offset by the income that would have been recognized if the mortgages had not been securitized and sold, less the cost of the securitization funding. The Company's balance sheet at transition will include the mortgages previously securitized and sold ($4.12 billion at December 31, 2009) and the associated liability to the security holders. Future securitization transactions undertaken through the current CMHC CMB and MBS structures, using the current IFRS, will not be accounted for as sales of mortgages. As such, upfront securitization gains will no longer be recognized and instead will be replaced by the interest income on the mortgages less the interest expense on the funding. ------------------------------------------------------------------------- Accounting for The Company anticipates that the loans portfolio will Loans continue to be accounted for at amortized cost. However, non-performing loans will continue to accrue interest. This will be offset by an increase in provisions for credit losses. ------------------------------------------------------------------------- Accounting for The Company's preliminary decision is to continue to Investments account for securities portfolio as Available for Sale under IFRS where fair value changes are recorded through OCI. ------------------------------------------------------------------------- First-time The Company's preliminary elections under IFRS 1 are Adoption of not expected to have a material financial impact on IFRS (IFRS 1) the Company. The Company will need to provide the additional reconciliations and disclosures required by IFRS 1 throughout 2011. ------------------------------------------------------------------------- Stock-based The Company has identified differences in the way the Compensation vesting of options are treated under IFRS. This may lead to acceleration in the recognition of the expense under IFRS. The Company has not yet quantified the potential impact, but it is not expected to be material to the results. ------------------------------------------------------------------------- Income Tax Impact Any financial statement adjustment under IFRS will of IFRS have a related income tax accounting impact. The Company has identified tax accounting differences between Canadian GAAP and IFRS. The Company has not quantified the IFRS income tax accounting differences but does not expect the impact to be material. ------------------------------------------------------------------------- Additional There are a number of IFRS that require additional Disclosure disclosures compared to Canadian GAAP. Additionally, any changes to the financial statement balances will change the related financial statement note disclosure on a comparative basis. ------------------------------------------------------------------------- >> Information Technology ImpactsThe Company has completed a comprehensive assessment of its existing financial information technology platforms and has determined that there are no significant changes required due to its transition to IFRS. The company has developed controls and procedures to capture all required IFRS based financial information in order to produce its comparative year financial information. In addition, the company is in the process of a major system conversion and expects to have it operational and IFRS compliant during 2011.Disclosure Controls and Internal Controls over Financial Reporting ImpactsManagement has determined that the Company's internal controls over financial reporting and its disclosure controls and procedures will largely be unaffected by the transition to IFRS. Effects will be limited primarily to the development of internal controls and procedures over the accounting and communicating of IFRS financial and non-financial information. In the comparative year, potential changes in the accounting treatment for securitization activities and additional disclosures to the Company's financial statements. Management has identified potential changes to its control environment and has incorporated them into its IFRS implementation plan.IFRS Education and Corporate GovernanceIn 2009 the Company began developing its IFRS education program. The program was established to ensure that an appropriate level of expertise and governance is in place upon the Company's transition to IFRS. The training program consists of presentations, technical work shops and exercises. This program is being provided to the Board of Directors, senior management, accounting and finance staff, and other affected members of the Company.Regulatory ConsiderationsIn March 2010 OSFI released a Final Advisory on the conversion to IFRS by Federally Regulated Entities (FREs) that among other items provided guidance on the capital treatment under IFRS of securitization activities under the CMHC-sponsored CMB and National Housing Authority (NHA) MBS programs. These activities, as off-balance sheet items, were previously excluded from the calculation of the assets to capital multiple (ACM) prescribed by OSFI. The Final Advisory requires that these activities be included in the calculation of ACM when these activities are accounted for on-balance sheet under IFRS. CMHC-sponsored securitizations entered into on or before March 31, 2010 would be grandfathered for purposes of the ACM calculation and will not impact the ACM. The Company believes that the proposed ACM rules for securitization will not materially impact participation in the CMB and NHA MBS programs, nor affect the Company's ability to continue offering these competitive mortgage products which utilize these programs to provide additional funding sources. Additionally, OSFI's Final Advisory provided transitional relief for the opening IFRS capital adjustment for certain adjustments including the impact of mortgages securitized through CMHC programs. Based on the regulatory relief, the Company will be permitted to transition the opening retained earnings adjustment over eight quarters beginning March 31, 2011. The transition to IFRS will not materially impact the strong capital position of the Company.UPDATED SHARE INFORMATIONAs at June 30, 2010 the Company had issued 34,669,840 Common Shares. In addition, outstanding director and employee stock options amounted to 797,250 (814,250 - Q1 2010, and 1,374,250 - Q2 2009) of which 406,000 were exercisable as of the quarter-end (381,750 - Q1 2010, and 653,000 - Q2 2009) for proceeds to the Company upon exercise of $13.1 million ($12.5 million - Q1 2010, and $13.9 million - Q2 2009).Subsequent to the end of the second quarter, the Board of Directors declared a quarterly cash dividend of $0.16 per common share payable on September 1, 2010 to shareholders of record at the close of business on August 16, 2010.QUARTERLY FINANCIAL HIGHLIGHTSTable 17: Summary of Quarterly Results << ------------------------------------------------------------------------- (000s, except 2010 2009 per share and %) ------------------------------------------------------------------------- Q2 Q1 Q4 Q3 Net interest income (TEB(1)) $ 49,467 $ 49,591 $ 48,178 $ 45,254 Less TEB adjustment 2,032 2,096 2,842 2,300 ------------------------------------------------------------------------- Net interest income per financial statements 47,435 47,495 45,336 42,954 Non-interest income 38,149 29,826 28,015 33,589 Non-interest expense 23,435 20,101 19,856 21,674 Total revenues 132,768 122,673 121,381 125,299 Net income 43,393 41,719 40,481 38,243 Return on common shareholders' equity 27.1% 27.4% 28.4% 28.7% Return on average total assets 2.4% 2.3% 2.4% 2.5% Earnings per common share Basic $ 1.25 $ 1.20 $ 1.17 $ 1.11 Diluted $ 1.25 $ 1.20 $ 1.16 $ 1.10 Book value per common share $ 18.78 $ 18.08 $ 17.00 $ 15.99 Efficiency ratio (TEB)(1) 26.7% 25.3% 26.1% 27.5% Efficiency ratio 27.4% 26.0% 27.1% 28.3% Tier 1 capital ratio(2) 16.7% 16.5% 16.4% 16.6% Total capital ratio(2) 17.9% 17.9% 18.0% 18.2% Net impaired loans as a % of gross loans 0.7% 0.9% 0.8% 1.2% Annualized provision as a % of gross loans 0.1% 0.1% 0.2% 0.2% ------------------------------------------------------------------------- ------------------------------------------------------------------------- (000s, except 2009 2008 per share and %) ------------------------------------------------------------------------- Q2 Q1 Q4 Q3 Net interest income (TEB(1)) $ 42,024 $ 37,505 $ 36,399 $ 39,478 Less TEB adjustment 1,535 1,273 1,162 1,130 ------------------------------------------------------------------------- Net interest income per financial statements 40,489 36,232 35,237 38,348 Non-interest income 30,437 32,034 26,023 23,013 Non-interest expense 18,222 18,849 16,852 16,953 Total revenues 121,778 120,721 117,996 116,950 Net income 34,351 31,418 29,039 27,939 Return on common shareholders' equity 27.9% 27.9% 27.4% 27.6% Return on average total assets 2.3% 2.2% 2.0% 2.0% Earnings per common share Basic $ 1.00 $ 0.91 $ 0.84 $ 0.81 Diluted $ 0.99 $ 0.91 $ 0.84 $ 0.81 Book value per common share $ 14.99 $ 13.62 $ 12.57 $ 12.07 Efficiency ratio (TEB)(1) 25.1% 27.1% 27.0% 27.1% Efficiency ratio 25.7% 27.6% 27.5% 27.6% Tier 1 capital ratio(2) 15.2% 13.8% 12.9% 12.7% Total capital ratio(2) 16.7% 15.2% 14.2% 14.0% Net impaired loans as a % of gross loans 1.3% 1.2% 0.9% 0.7% Annualized provision as a % of gross loans 0.3% 0.3% 0.2% 0.3% ------------------------------------------------------------------------- (1) TEB - Taxable Equivalent Basis, see definition on page 6 (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. 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 all business segments, and continued low efficiency ratios. Tier 1 and total capital ratios throughout 2009 and into 2010 reflect the Company's prudent capital management strategies and the proactive approach to increase the capital base during the economic downturn.Net impaired loans as a percentage of gross loans trended upwards over the last half of 2008 and into 2009; however, improvement began in the fourth quarter of 2009 and continued through the first half of 2010 and currently reflect historical norms. The Company expects the relative level of net impaired loans to remain relatively stable.OUTLOOKThe Company will continue to increase focus on its core business consisting of the classic traditional mortgage lending programs that have successfully operated for over 20 years. These products focus on serving selected segments of the Canadian financial services marketplace that are not the focus of the major financial institutions. Additionally, the Company will maintain growth in the insured mortgage portfolio by offering competitive, well-serviced mortgage products. The focus on growth of the loans portfolio will continue through cautious and strategic geographical growth combined with ongoing measured growth of the consumer portfolio, while maintaining the Company's prudent credit policies.The Company is committed to maintaining its financial strength through a strong capital base, conservative liquidity and no external debt is needed for organic growth. The Company believes that this positions the Company to continue generating above-average returns and capitalize on market opportunities where they arise.Real estate markets showed robust growth in the first quarter of 2010 and began to slow in the second quarter. Despite a slowing real estate market in Ontario in the second quarter of 2010, The Company was able to capitalize on the momentum of the first quarter and continue its growth pattern. The Company has observed healthier and more stable real estate conditions across the country. The Company expects the relative increase in new and resale home sales and price appreciation will continue to slow to more sustainable levels into the second half of 2010. Much of the pent up demand that was leading the robust real estate growth in late 2009 and the first part of 2010 has been satisfied. However, the Company still believes the housing market will remain healthy in 2010.A modest slowing of the growth rate in the housing markets is not expected to impact the Company's ability to achieve its stated objectives for 2010 as the strategies it employs to generate growth and robust returns have been developed with these market expectations in mind. The Company intends to keep focusing on superior customer and broker service, diverse product offerings and expansion of broker networks and market penetration. The stabilization of housing markets has allowed for renewed focus on growth in the Company's traditional mortgage portfolio, Equityline Visa and geographic growth strategies. The Company expects further origination volume increases in the traditional mortgage portfolio, increased originations outside Ontario and continued growth in consumer lending, which includes Equityline Visa.Arrears in the Company's mortgage portfolio reached a high water mark in the second quarter of 2009 when the total arrears over 30 days reached $71.3 million and $56.3 million non-performing at June 30, 2009. At June 30, 2010 arrears over 30 days was $39.0 million and $39.1 million non-performing. Non-performing loans as a percentage of gross loans was 0.67% at June 30, 2010 compared to 1.26% one year ago. Management believes these levels are at a low point and the Company expects arrears and non-performing loans to remain stable on a relative basis for the remainder of the year.The Company expects securitization volumes to remain robust for the remainder of the year, reflective of strong Accelerator originations and spreads earned on securitization are expected to remain relatively stable over the last half of the year.As a result of the transition to the Harmonized Sales Tax ("HST") regime, the Company anticipates certain expenses to increase due to the additional tax being introduced. Most notably, the Company forecasts higher rent, consulting fees, legal and audit fees as they are currently subject to GST at a rate of 5%. Effective July 1, 2010, these expenditures will increase by 8% for a total of 13% HST.Looking ahead, the Board of Directors and management are confident that Home Capital is well positioned to continue generating strong earnings and growth in 2010, and continue to believe the following objectives are achievable for 2010: 15-20% growth in each of total earnings, diluted earnings per share and total assets (including off-balance sheet securitized assets), as well as 20% return on equity.This Outlook section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements on page 5 of these unaudited interim consolidated financial statements. << Consolidated Statements of Income For the three For the six months ended months ended ------------------------------------------------------------------------- 000s except per share June 30 June 30 June 30 June 30 amounts (Unaudited) 2010 2009 2010 2009 ------------------------------------------------------------------------- Income Interest from loans $ 88,137 $ 84,286 $ 173,894 $ 165,613 Dividends from equity securities 4,682 3,427 9,514 6,267 Other interest 1,800 3,628 4,058 8,148 ------------------------------------------------------------------------- 94,619 91,341 187,466 180,028 Interest Expense Interest on deposits 47,184 50,852 92,536 103,307 ------------------------------------------------------------------------- Net interest income 47,435 40,489 94,930 76,721 Provision for credit losses (note 4(E)) 572 3,099 1,539 6,382 ------------------------------------------------------------------------- 46,863 37,390 93,391 70,339 ------------------------------------------------------------------------- Non-interest Income Fees and other income 7,126 7,462 14,942 14,784 Securitization income on mortgage-backed securities (note 5) 26,822 26,743 48,989 54,398 Net gain realized and unrealized on securities 5,337 2,325 8,483 1,382 Loss on derivatives (1,136) (6,093) (4,439) (8,093) ------------------------------------------------------------------------- 38,149 30,437 67,975 62,471 ------------------------------------------------------------------------- 85,012 67,827 161,366 132,810 ------------------------------------------------------------------------- Non-interest Expenses Salaries and staff benefits 11,712 10,096 22,487 20,180 Premises 1,701 1,449 3,342 2,805 General and admin- istration 10,022 6,677 17,707 14,086 ------------------------------------------------------------------------- 23,435 18,222 43,536 37,071 ------------------------------------------------------------------------- Income Before Income Taxes 61,577 49,605 117,830 95,739 Provision for income taxes (note 11(A)) 18,184 15,254 32,718 29,970 ------------------------------------------------------------------------- NET INCOME $ 43,393 $ 34,351 $ 85,112 $ 65,769 ------------------------------------------------------------------------- NET INCOME PER COMMON SHARE Basic $ 1.25 $ 1.00 $ 2.45 $ 1.91 Diluted $ 1.25 $ 0.99 $ 2.45 $ 1.90 ------------------------------------------------------------------------- AVERAGE NUMBER OF COMMON SHARES OUT- STANDING Basic 34,769 34,459 34,722 34,501 Diluted 34,745 34,662 34,739 34,724 ------------------------------------------------------------------------- Total number of out- standing common shares 34,670 34,398 34,670 34,398 Book value per common share $ 18.78 $ 14.99 $ 18.78 $ 14.99 ------------------------------------------------------------------------- The accompanying notes are an integral part of these unaudited interim consolidated financial statements. Consolidated Statements of Comprehensive Income For the three For the six months ended months ended ------------------------------------------------------------------------- 000s (Unaudited) June 30 June 30 June 30 June 30 2010 2009 2010 2009 ------------------------------------------------------------------------- NET INCOME $ 43,393 $ 34,351 $ 85,112 $ 65,769 ------------------------------------------------------------------------- OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX Unrealized income on available for sale securities Net unrealized (loss) income on securities available for sale, net of $(3,919) tax (($4,753) - three months ended June 30, 2009; $(1,480) - six months ended June 30, 2010; $7,185 - six months ended June 30, 2009) (9,919) 10,702 (6,210) 14,355 Reclassification of losses (gain) in respect of available for sale securities, net of $1,049 tax ($1,538 - three months ended June 30, 2009; $2,215 - six months ended June 30, 2010; $1,716 - six months ended June 30, 2009) (2,288) 7,129 (4,910) 13,115 ------------------------------------------------------------------------- Total other comprehensive (loss) income (12,207) 17,831 (11,120) 27,470 ------------------------------------------------------------------------- COMPREHENSIVE INCOME $ 31,186 $ 52,182 $ 73,992 $ 93,239 ------------------------------------------------------------------------- The accompanying notes are an integral part of these unaudited interim consolidated financial statements. Consolidated Balance Sheets ------------------------------------------------------------------------- June 30 December June 30 000s (Unaudited) 2010 31 2009 2009 ------------------------------------------------------------------------- ASSETS Cash Resources (note 3) Deposits with regulated financial institutions $ 333,277 $ 912,169 $ 399,451 Restricted cash 25,255 17,965 12,735 ------------------------------------------------------------------------- 358,532 930,134 412,186 ------------------------------------------------------------------------- Securities (note 3) Held for trading 49,976 99,938 199,817 Available for sale 584,424 550,659 450,993 ------------------------------------------------------------------------- 634,400 650,597 650,810 ------------------------------------------------------------------------- Loans (note 4) Residential mortgages 4,995,261 4,369,458 3,639,986 Non-residential mortgages 729,172 708,425 774,077 Personal and credit card loans 424,375 342,918 350,550 Secured loans 39,843 47,739 63,191 General allowance for credit losses (28,944) (27,793) (26,483) ------------------------------------------------------------------------- 6,159,707 5,440,747 4,801,321 ------------------------------------------------------------------------- Other Securitization receivable (note 5) 296,130 229,418 189,936 Capital assets 5,474 4,863 5,396 Other assets (note 6) 119,927 105,115 93,081 ------------------------------------------------------------------------- 421,531 339,396 288,413 ------------------------------------------------------------------------- $7,574,170 $7,360,874 $6,152,730 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Payable on demand $ 25,020 $ 38,223 $ 20,920 Payable on a fixed date 6,461,536 6,371,599 5,220,457 ------------------------------------------------------------------------- 6,486,556 6,409,822 5,241,377 ------------------------------------------------------------------------- Other Cheques and other items in transit 7,366 4,617 5,637 Other liabilities (note 7) 429,050 356,147 389,976 ------------------------------------------------------------------------- 436,416 360,764 395,613 ------------------------------------------------------------------------- 6,922,972 6,770,586 5,636,990 ------------------------------------------------------------------------- Shareholders' Equity Capital stock (note 8) 48,771 45,396 39,757 Contributed surplus 3,615 3,606 3,941 Retained earnings 588,664 520,018 455,625 Accumulated other comprehensive income (note 10) 10,148 21,268 16,417 ------------------------------------------------------------------------- 651,198 590,288 515,740 ------------------------------------------------------------------------- $7,574,170 $7,360,874 $6,152,730 ------------------------------------------------------------------------- The accompanying notes are an integral part of these unaudited interim consolidated financial statements. Consolidated Statements of Changes in Shareholders' Equity For the three For the six months ended months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 000s (Unaudited) 2010 2009 2010 2009 ------------------------------------------------------------------------- CAPITAL STOCK (note 8) Balance at beginning of the period $ 48,348 $ 39,006 $ 45,396 $ 39,094 Proceeds of options exercised 529 774 3,558 774 Normal course issuer bid (106) (23) (183) (111) ------------------------------------------------------------------------- BALANCE AT END OF THE PERIOD $ 48,771 $ 39,757 $ 48,771 $ 39,757 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONTRIBUTED SURPLUS Balance at beginning of the period $ 3,366 $ 3,670 $ 3,606 $ 3,283 Amortization of fair value of employee stock options (note 9) 334 385 613 772 Employee stock options exercised (85) (114) (604) (114) ------------------------------------------------------------------------- BALANCE AT END OF THE PERIOD $ 3,615 $ 3,941 $ 3,615 $ 3,941 ------------------------------------------------------------------------- ------------------------------------------------------------------------- RETAINED EARNINGS Balance at beginning of the period $ 553,918 $ 426,677 $ 520,018 $ 401,429 Normal course issuer bid (3,099) (580) (5,358) (1,941) Net income for the period 43,393 34,351 85,112 65,769 Dividends paid or declared during the period (5,548) (4,823) (11,108) (9,632) ------------------------------------------------------------------------- BALANCE AT END OF THE PERIOD $ 588,664 $ 455,625 $ 588,664 $ 455,625 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ACCUMULATED OTHER COMP- REHENSIVE INCOME (LOSS) Balance at beginning of the period $ 22,355 $ (1,414) $ 21,268 $ (11,053) Other comprehensive (loss) income, net of $(2,870) tax; ($6,291 - three months ended June 30, 2009; $735 - six months ended June 30, 2010; $8,901 - six months ended June 30, 2009) (12,207) 17,831 (11,120) 27,470 ------------------------------------------------------------------------- BALANCE AT END OF THE PERIOD $ 10,148 $ 16,417 $ 10,148 $ 16,417 ------------------------------------------------------------------------- The accompanying notes are an integral part of these unaudited interim consolidated financial statements. Consolidated Statements of Cash Flows For the three For the six months ended months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 000s (Unaudited) 2010 2009 2010 2009 ------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income for the period $ 43,393 $ 34,351 $ 85,112 $ 65,769 Adjustments to determine cash flows relating to operating activities: Future income taxes 10,562 3,390 17,956 12,968 Amortization of securities 1,291 9,447 1,941 1,746 Provision for credit losses (note 4 (E)) 572 3,099 1,539 6,382 Change in accrued interest payable 5,173 4,286 14,441 1,911 Change in accrued interest receivable (536) 438 (423) 1,580 Net gain realized and unrealized on invest- ment securities (5,337) (2,325) (8,483) (1,382) Loss on derivatives 1,136 6,093 4,439 8,093 Securitization income on mortgage-backed securities (26,822) (26,743) (48,989) (54,398) Amortization of fair value of employee stock options (note 9) 334 385 613 772 Change in payments received for securitized pools 32,044 36,225 25,445 79,299 Other (1,518) (2,646) 13,254 12,841 ------------------------------------------------------------------------- Cash flows from operating activities 60,292 66,000 106,845 135,581 ------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 450,964 417,745 76,734 138,596 Issuance of capital stock 529 774 3,557 774 Normal course issuer bid (3,205) (603) (5,541) (2,052) Exercise of employee stock options (85) (114) (604) (114) Dividends paid (5,548) (4,816) (11,108) (9,292) ------------------------------------------------------------------------- Cash flows from financing activities 442,655 412,986 63,038 127,912 ------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Activity in available for sale and held for trading securities Purchases (300,383) (302,372) (488,657) (548,852) Proceeds from sales 253,936 203,800 370,468 439,137 Proceeds from maturities 118,887 7,917 129,179 13,261 Activity in mortgages Net increase (1,831,728) (968,757) (2,826,832) (1,442,834) Proceeds from secur- itization of mortgage- backed securities 1,137,303 641,140 2,148,560 1,091,973 Change in mortgage- backed securities receivable 17,226 25,646 13,168 29,680 Net (increase) decrease in personal and credit card loans (10,155) 9,637 (81,732) 16,708 Net increase in re- stricted cash (5,690) (10,355) (7,290) (12,735) Net decrease in secured loans 3,350 6,284 7,643 9,097 Purchases of capital assets (899) (788) (1,718) (1,116) Purchases of intangible assets (3,832) (3,859) (11,564) (12,783) ------------------------------------------------------------------------- Cash flows used in investing activities (621,985) (391,707) (748,775) (418,464) ------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents during the period (119,038) 87,279 (578,892) (154,971) Cash and cash equivalents at beginning of the period 452,315 312,172 912,169 554,422 ------------------------------------------------------------------------- Cash and cash equivalents at end of the period $ 333,277 $ 399,451 $ 333,277 $ 399,451 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Supplementary Disclosure of Cash Flow Information Interest paid $ 42,011 $ 46,562 $ 78,096 $ 101,396 Income taxes paid 9,563 8,547 21,470 20,393 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The accompanying notes are an integral part of these unaudited interim consolidated financial statements. Notes to the Unaudited Interim Consolidated Financial Statements 1. ACCOUNTING POLICIES USED TO PREPARE THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2009 as set out in the 2009 Annual Report, on pages 50 through 76. These unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles. The accounting policies and methods of application used in the preparation of these unaudited interim consolidated financial statements are consistent with the accounting policies used in Home Capital Group Inc.'s (the "Company") most recent annual audited financial statements. These unaudited interim consolidated financial statements reflect amounts which must, of necessity, be based on the best estimates and judgement of management with appropriate consideration as to materiality. Actual results may differ from these estimates. The comparative interim unaudited consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2010 interim unaudited consolidated financial statements. 2. FUTURE CHANGES IN ACCOUNTING POLICIES International Financial Reporting Standards The Canadian Institute of Chartered Accountants will transition financial reporting for Canadian public entities to International Financial Reporting Standards (IFRS) effective for fiscal years beginning on or after January 1, 2011. Please see the discussion regarding IFRS on pages 26 - 28 of the MD&A and pages 46 - 48 of the 2009 Annual Report for additional information on the Company's transition to IFRS. 3. CASH RESOURCES AND SECURITIES (A) Cash Resources ------------------------------------------------------------------------- (000s) June 30 December 31 June 30 ------------------------------------------------------------------------- 2010 2009 2009 ------------------------------------------------------------------------- Deposits with regulated financial institutions(1) $ 333,277 $ 912,169 $ 399,451 Restricted cash(2) 25,255 17,965 12,735 ------------------------------------------------------------------------- $ 358,532 $ 930,134 $ 412,186 ------------------------------------------------------------------------- (1) This includes a deposit of $46.1 million (December 31, 2009 - $46.1 million, June 30, 2009 - $21.6 million) held as collateral for the Company's securitization activities. (2) Restricted cash is held as collateral by a third party for the Company's interest rate swap transactions. (B) Available for Sale Securities - Net Unrealized Gains and Losses Net unrealized gains and losses are included in accumulated other comprehensive income except unrealized losses which are other than temporary in nature which are transferred to net income. Accumulated other comprehensive income is disclosed in Note 10. ------------------------------------------------------------------------- June 30 December 31 June 30 ------------------------------------------------------------------------- (000s) 2010 2009 2009 ------------------------------------------------------------------------- Securities issued or guaranteed by: Canada $ 56 $ 3 $ (3) Corporations 618 (35) (84) Equity securities Common (185) 360 (164) Fixed rate preferred (1,670) 8,105 146 Floating rate preferred - - 360 Income trusts (904) 2,317 520 Mutual funds (82) (55) (246) ------------------------------------------------------------------------- $ (2,167) $ 10,695 $ 529 ------------------------------------------------------------------------- The above unrealized gains and (losses) represent differences between the carrying value of a security and its current fair value. The Company does not consider these losses to be other than temporary based on market conditions at the reporting date, and continues to regularly monitor these investments and market conditions. For the three months ended June 30, 2010, the Company determined $nil with a year-to-date total of $0.3 million ($4.3 million - Q2 2009 and $9.0 million - six months of 2009) of unrealized losses on available for sale securities were other than temporary in nature, and transferred that amount into net income. These unrealized losses are not included in the previous table. 4. LOANS (A) Loans by Geographic Region and Type As at June 30, 2010 ------------------------------------------------------------------------- Non- Personal Percentage (000s, Residential residential and Credit Secured of except %) Mortgages Mortgages Card Loans Loans Total Portfolio ------------------------------------------------------------------------- British Columbia $ 391,764 $ 9,675 $ 17,858 $ - $ 419,297 6.8% Alberta 337,233 27,954 44,463 4,491 414,141 6.7% Ontario 3,859,283 636,240 355,533 34,070 4,885,126 78.9% Quebec 205,288 35,188 1,497 - 241,973 3.9% Maritimes 100,846 10,772 3,732 1,282 116,632 1.9% Manitoba and Saskatchewan 100,847 9,343 1,292 - 111,482 1.8% ------------------------------------------------------------------------- $4,995,261 $ 729,172 $ 424,375 $ 39,843 $6,188,651 100.0% ------------------------------------------------------------------------- As a % of portfolio 80.7% 11.8% 6.9% 0.6% 100.0% ------------------------------------------------------------------------- As at December 31, 2009 ------------------------------------------------------------------------- Non- Personal Percentage (000s, Residential residential and Credit Secured of except %) Mortgages Mortgages Card Loans Loans Total Portfolio ------------------------------------------------------------------------- British Columbia $ 476,418 $ 9,270 $ 22,617 $ 7 $ 508,312 9.3% Alberta 358,683 76,424 54,209 5,367 494,683 9.1% Ontario 3,241,147 570,339 258,952 40,749 4,111,187 75.2% Quebec 131,776 31,660 1,594 - 165,030 3.0% Maritimes 90,505 11,399 4,095 1,616 107,615 1.9% Manitoba and Saskatchewan 70,929 9,333 1,451 - 81,713 1.5% ------------------------------------------------------------------------- $4,369,458 $ 708,425 $ 342,918 $ 47,739 $5,468,540 100.0% ------------------------------------------------------------------------- As a % of portfolio 79.9% 12.9% 6.3% 0.9% 100.0% ------------------------------------------------------------------------- As at June 30, 2009 ------------------------------------------------------------------------- Non- Personal Percentage (000s, Residential residential and Credit Secured of except %) Mortgages Mortgages Card Loans Loans Total Portfolio ------------------------------------------------------------------------- British Columbia $ 364,955 $ 9,796 $ 28,870 $ 11 $ 403,632 8.4% Alberta 374,253 105,240 68,366 6,990 554,849 11.5% Ontario 2,595,703 593,005 245,077 54,172 3,487,957 72.3% Quebec 154,293 39,213 1,786 - 195,292 4.0% Maritimes 83,200 11,961 4,927 2,018 102,106 2.1% Manitoba and Saskatchewan 67,582 14,862 1,524 - 83,968 1.7% ------------------------------------------------------------------------- $3,639,986 $ 774,077 $ 350,550 $ 63,191 $4,827,804 100.0% ------------------------------------------------------------------------- As a % of portfolio 75.4% 16.0% 7.3% 1.3% 100.0% ------------------------------------------------------------------------- (B) Past Due Loans that are not Impaired A loan is recognized as being impaired 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 specifically provided for or when it has been in arrears for 90 days. Residential mortgages guaranteed by the Government of Canada where payment is contractually past due 365 days are automatically placed on a non-accrual basis. Secured and unsecured credit card balances 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. As at June 30, 2010 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- 1 - 30 days $ 99,562 $ 5,385 $ 3,917 $ 492 $ 109,356 31 - 60 days 26,418 - 1,670 30 28,118 61 - 90 days 3,857 - 792 - 4,649 91 - 120 days 8,703 - 1,058 - 9,761 ------------------------------------------------------------------------- $ 138,540 $ 5,385 $ 7,437 $ 522 $ 151,884 ------------------------------------------------------------------------- As at December 31, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- 1 - 30 days $ 133,967 $ 4,058 $ 5,204 $ 958 $ 144,187 31 - 60 days 35,922 1,910 1,428 227 39,487 61 - 90 days 3,080 - 2,162 - 5,242 91 - 120 days 8,911 - 749 - 9,660 ------------------------------------------------------------------------- $ 181,880 $ 5,968 $ 9,543 $ 1,185 $ 198,576 ------------------------------------------------------------------------- As at June 30, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- 1 - 30 days $ 124,353 $ 3,263 $ 4,498 $ 1,020 $ 133,134 31 - 60 days 49,528 385 1,971 449 52,333 61 - 90 days 6,447 88 2,803 53 9,391 91 - 120 days 14,841 - 508 - 15,349 ------------------------------------------------------------------------- $ 195,169 $ 3,736 $ 9,780 $ 1,522 $ 210,207 ------------------------------------------------------------------------- (C) Impaired Loans and Specific Allowances for Credit Losses As at June 30, 2010 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Gross amount of impaired loans $ 37,552 $ 1,577 $ 3,606 $ 369 $ 43,104 Specific allowances (635) (145) (699) (90) (1,569) ------------------------------------------------------------------------- Net $ 36,917 $ 1,432 $ 2,907 $ 279 $ 41,535 ------------------------------------------------------------------------- As at December 31, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Gross amount of impaired loans $ 41,149 $ 2,417 $ 4,847 $ 472 $ 48,885 Specific allowances (1,346) (135) (961) (137) (2,579) ------------------------------------------------------------------------- Net $ 39,803 $ 2,282 $ 3,886 $ 335 $ 46,306 ------------------------------------------------------------------------- As at June 30, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Gross amount of impaired loans $ 50,272 $ 6,073 $ 7,754 $ 1,302 $ 65,401 Specific allowances (2,139) (475) (1,328) (397) (4,339) ------------------------------------------------------------------------- Net $ 48,133 $ 5,598 $ 6,426 $ 905 $ 61,062 ------------------------------------------------------------------------- (D) Collateral The fair value of collateral held against mortgages is based on appraisals at the time a loan is originated. Appraisals are only updated should circumstances warrant it or if a mortgage becomes impaired. At June 30, 2010, the total appraised value of the collateral for mortgages past due that are not impaired, as determined when the mortgages were originated, was $368.8 million. For impaired mortgages, the total appraised value of collateral at June 30, 2010 was $65.6 million. (E) Allowance for Credit Losses For the three months ended June 30, 2010 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Specific allowances Balance at the beginning of the period $ 1,198 $ 295 $ 1,034 $ 219 $ 2,746 Provisions for credit losses 269 (150) (30) 53 142 Write-offs (1,877) - (377) (187) (2,441) Recoveries 1,045 - 72 5 1,122 ------------------------------------------------------------------------- 635 145 699 90 1,569 ------------------------------------------------------------------------- General allowance Balance at the beginning of the period 20,592 4,105 3,366 451 28,514 Provisions for credit losses 453 (5) 14 (32) 430 ------------------------------------------------------------------------- 21,045 4,100 3,380 419 28,944 ------------------------------------------------------------------------- Total allowance $ 21,680 $ 4,245 $ 4,079 $ 509 $ 30,513 ------------------------------------------------------------------------- For the three months ended December 31, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Specific allowances Balance at the beginning of the period $ 2,783 $ 418 $ 1,332 $ 437 $ 4,970 Provisions for credit losses 1,258 (283) 15 19 1,009 Write-offs (3,461) - (467) (329) (4,257) Recoveries 766 - 81 10 857 ------------------------------------------------------------------------- 1,346 135 961 137 2,579 ------------------------------------------------------------------------- General allowance Balance at the beginning of the period 18,377 4,156 3,446 541 26,520 Provisions for credit losses 1,084 242 1 (54) 1,273 ------------------------------------------------------------------------- 19,461 4,398 3,447 487 27,793 ------------------------------------------------------------------------- Total allowance $ 20,807 $ 4,533 $ 4,408 $ 624 $ 30,372 ------------------------------------------------------------------------- For the three months ended June 30, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Specific allowances Balance at the beginning of the period $ 2,439 $ 430 $ 776 $ 487 $ 4,132 Provisions for credit losses 1,063 45 1,161 149 2,418 Write-offs (1,453) - (673) (274) (2,400) Recoveries 90 - 64 35 189 ------------------------------------------------------------------------- 2,139 475 1,328 397 4,339 ------------------------------------------------------------------------- General allowance Balance at the beginning of the period 16,816 4,654 3,625 707 25,802 Provisions for credit losses 1,001 (138) (99) (83) 681 ------------------------------------------------------------------------- 17,817 4,516 3,526 624 26,483 ------------------------------------------------------------------------- Total allowance $ 19,956 $ 4,991 $ 4,854 $ 1,021 $ 30,822 ------------------------------------------------------------------------- For the six months ended June 30, 2010 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Specific allowances Balance at the beginning of the period $ 1,346 $ 135 $ 961 $ 137 $ 2,579 Provisions for credit losses (150) 10 275 253 388 Write-offs (2,699) - (666) (318) (3,683) Recoveries 2,138 - 129 18 2,285 ------------------------------------------------------------------------- 635 145 699 90 1,569 ------------------------------------------------------------------------- General allowance Balance at the beginning of the period 19,461 4,398 3,447 487 27,793 Provisions for credit losses 1,584 (298) (67) (68) 1,151 ------------------------------------------------------------------------- 21,045 4,100 3,380 419 28,944 ------------------------------------------------------------------------- Total allowance $ 21,680 $ 4,245 $ 4,079 $ 509 $ 30,513 ------------------------------------------------------------------------- For the six months ended June 30, 2009 ------------------------------------------------------------------------- Non- Personal Residential residential and Credit Secured (000s) Mortgages Mortgages Card Loans Loans Total ------------------------------------------------------------------------- Specific allowances Balance at the beginning of the period $ 1,680 $ - $ 547 $ 699 $ 2,926 Provisions for credit losses 2,667 475 1,704 230 5,076 Write-offs (2,298) - (1,008) (567) (3,873) Recoveries 90 - 85 35 210 ------------------------------------------------------------------------- 2,139 475 1,328 397 4,339 ------------------------------------------------------------------------- General allowance Balance at the beginning of the period 16,136 4,580 3,700 761 25,177 Provisions for credit losses 1,681 (64) (174) (137) 1,306 ------------------------------------------------------------------------- 17,817 4,516 3,526 624 26,483 ------------------------------------------------------------------------- Total allowance $ 19,956 $ 4,991 $ 4,854 $ 1,021 $ 30,822 ------------------------------------------------------------------------- 5. LOAN SECURITIZATION The following table summarizes the Company's new securitization activities. For the three months ended For six months ended ------------------------------------------------------------------------- (000s, except % June 30 June 30 June 30 June 30 and number of years) 2010 2009 2010 2009 ------------------------------------------------------------------------- Book value of mortgages securitized $1,155,716 $ 655,094 $2,180,420 $1,115,718 Securitization receivable $ 44,070 $ 31,240 $ 87,693 $ 74,150 Servicing liability $ 3,239 $ 6,756 $ 8,684 $ 11,323 Net proceeds received on securitized mortgages $1,137,303 $ 641,141 $2,148,560 $1,091,974 Net gain on sale of mortgages(1) $ 15,866 $ 22,847 $ 36,766 $ 47,109 Prepayment rate 14.1% 6.6% 14.3% 7.2% Excess spread 1.9% 1.5% 1.7% 2.2% Weighted average life in years 3.6 5.2 4.3 5.1 Discount rate 2.0% 2.7% 1.9% 2.5% ------------------------------------------------------------------------- (1) The gain on sale of mortgages is net of hedging activities; see Table 4 in the MD&A. During the second quarter of 2010, the Company securitized insured residential mortgages through CMHC's CMB program with a book value of $649.3 million for a total of $1.27 billion for the six months ended June 30, 2010 ($607.8 million in Q2 2009 for a total of $938.5 million for the six months ended June 30, 2009). The net gain on sale was $6.8 million during the second quarter and $20.7 million for the six months ended June 30, 2010 ($20.3 million in Q2 2009 and $38.6 million for the six months ended June 30, 2009). These figures are included in the table above. 6. OTHER ASSETS ------------------------------------------------------------------------- June 30 December 31 June 30 (000s) 2010 2009 2009 ------------------------------------------------------------------------- Accrued interest receivable $ 26,576 $ 26,153 $ 26,281 Income taxes receivable 9,357 - 4,432 Goodwill 15,752 15,752 15,752 Intangible assets(1) 38,375 26,811 14,170 Other prepaid assets and deferred items 29,867 36,399 32,446 ------------------------------------------------------------------------- $ 119,927 $ 105,115 $ 93,081 ------------------------------------------------------------------------- (1) Intangible assets are primarily comprised of deferred costs capitalized for the development of the Company's new core banking system. 7. OTHER LIABILITIES ------------------------------------------------------------------------- June 30 December 31 June 30 (000s) 2010 2009 2009 ------------------------------------------------------------------------- Accrued interest payable $ 152,939 $ 138,498 $ 161,526 Dividends payable 5,894 5,901 4,816 Future income tax liability (note 11) 75,515 57,559 50,564 Income taxes payable - 3 - Securitization servicing liability 36,134 30,389 20,414 Payable to MBS and CMB holders 97,390 92,896 121,312 Other, including accounts payable and accrued liabilities 61,178 30,901 31,344 ------------------------------------------------------------------------- $ 429,050 $ 356,147 $ 389,976 ------------------------------------------------------------------------- 8. CAPITAL (A) Common Shares Issued and Outstanding For the three months ended ------------------------------------------------------------------------- (000s) June 30, 2010 June 30, 2009 ------------------------------------------------------------------------- Number of Number of Shares Amount Shares Amount ------------------------------------------------------------------------- Outstanding at beginning of period 34,732 $ 48,348 34,355 $ 39,006 Options exercised 13 529 63 774 Normal course issuer bid (75) (106) (20) (23) ------------------------------------------------------------------------- Outstanding at end of period 34,670 $ 48,771 34,398 $ 39,757 ------------------------------------------------------------------------- For the six months ended ------------------------------------------------------------------------- (000s) June 30, 2010 June 30, 2009 ------------------------------------------------------------------------- Number of Number of Shares Amount Shares Amount ------------------------------------------------------------------------- Outstanding at beginning of period 34,713 $ 45,396 34,434 $ 39,094 Options exercised 88 3,558 63 774 Normal course issuer bid (131) (183) (99) (111) ------------------------------------------------------------------------- Outstanding at end of period 34,670 $ 48,771 34,398 $ 39,757 ------------------------------------------------------------------------- The purchase price of shares acquired through the normal course issuer bid is allocated between capital stock and retained earnings. (B) Share Purchase Options For the three months ended ------------------------------------------------------------------------- (000s, except per share amounts) June 30, 2010 June 30, 2009 ------------------------------------------------------------------------- Weighted- Weighted- average average Number of Exercise Number of Exercise Shares Price Shares Price ------------------------------------------------------------------------- Outstanding at beginning of period 814 $ 30.78 1,447 $ 24.60 Granted - - 40 31.87 Exercised (13) 33.46 (63) 10.56 Forfeited (4) 16.27 (50) 23.71 ------------------------------------------------------------------------- Outstanding at end of period 797 $ 30.81 1,374 $ 25.47 ------------------------------------------------------------------------- Exercisable, end of period 406 $ 32.25 653 $ 21.32 ------------------------------------------------------------------------- For the six months ended ------------------------------------------------------------------------- (000s, except per share amounts) June 30, 2010 June 30, 2009 ------------------------------------------------------------------------- Weighted- Weighted- average average Number of Exercise Number of Exercise Shares Price Shares Price ------------------------------------------------------------------------- Outstanding at beginning of period 925 $ 31.32 1,407 $ 25.08 Granted - - 100 23.41 Exercised (89) 33.46 (63) 10.56 Forfeited (39) 37.01 (70) 28.08 ------------------------------------------------------------------------- Outstanding at end of period 797 $ 30.81 1,374 $ 25.47 ------------------------------------------------------------------------- Exercisable, end of period 406 $ 32.25 653 $ 21.32 ------------------------------------------------------------------------- (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 ensure that regulatory capital requirements are met, 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 Company is subject to the regulatory capital requirements governed by OSFI. ------------------------------------------------------------------------- June 30 December 31 June 30 (000s, except ratios and multiple) 2010 2009 2009 ------------------------------------------------------------------------- Regulatory capital Tier 1 $ 599,021 $ 530,256 $ 464,380 Total 642,965 581,036 508,651 Regulatory ratios Tier 1 16.7% 16.4% 15.2% Total 17.9% 18.0% 16.7% Assets to capital multiple 11.8 12.7 12.1 ------------------------------------------------------------------------- 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. 9. STOCK-BASED COMPENSATION (A) Common Shares Issued and Outstanding During the second quarter of 2010, $334,000 was recorded as an expense for a year-to-date total of $613,000 ($385,000 - Q2 2009 and $772,000 - six months of 2009) for stock option awards in the consolidated statements of income, with an offsetting credit to contributed surplus. During the second quarter of 2010, no options were granted for a year-to- date total of nil. During the second quarter of 2009, 40,000 options were granted for a total of 100,000 for the first six months of 2009. (B) Deferred Share Unit Plan Effective January 1, 2009 the Board of Directors approved a deferred share unit plan (DSU). The plan is open to Directors of the Company who elect to accept remuneration in the form of cash, cash and DSUs or DSUs. At June 30, 2010 there were 8,154 deferred share units issued with the associated liability of $0.34 million recorded in other liabilities on the consolidated balance sheet. 10. ACCUMULATED OTHER COMPREHENSIVE INCOME ------------------------------------------------------------------------- June 30 December 31 June 30 (000s) 2010 2009 2009 ------------------------------------------------------------------------- Unrealized (losses) and gains on Available for sale securities $ (2,167) $ 10,695 $ 529 Income taxes (expense) recovery (22) (2,733) 2,194 ------------------------------------------------------------------------- (2,189) 7,962 2,723 ------------------------------------------------------------------------- Unrealized gains on Securitization receivables 17,819 19,772 20,307 Income tax expense (5,482) (6,466) (6,613) ------------------------------------------------------------------------- 12,337 13,306 13,694 ------------------------------------------------------------------------- Accumulated other comprehensive income $ 10,148 $ 21,268 $ 16,417 ------------------------------------------------------------------------- 11. INCOME TAXES (A) Reconciliation of Income Taxes For the three For the six months ended months ended ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Income before income taxes $ 61,577 $ 49,605 $ 117,830 $ 95,739 ------------------------------------------------------------------------- Income taxes at statutory combined federal and provincial income tax rates $ 18,944 $ 16,162 $ 36,270 $ 31,195 Increase (decrease) in income taxes at statutory income tax rates resulting from Tax-exempt income (1,404) (1,035) (2,854) (1,891) Non-deductible expenses 37 1,380 208 2,592 Future tax rate changes 809 (648) (7) (2,132) Other (202) (605) (899) 206 ------------------------------------------------------------------------- Income tax $ 18,184 $ 15,254 $ 32,718 $ 29,970 ------------------------------------------------------------------------- (B) Sources of Future Income Tax Balances ------------------------------------------------------------------------- June 30 December 31 June 30 (000s) 2010 2009 2009 ------------------------------------------------------------------------- Future income tax liabilities Deferred agent commissions and other charges $ 22,324 $ 18,761 $ 12,149 Mortgage-backed securities receivable 67,161 49,560 52,302 ------------------------------------------------------------------------- 89,485 68,321 64,451 ------------------------------------------------------------------------- Future income tax assets Allowance for credit losses 7,571 7,549 8,347 Deferred commitment fees and other charges 6,399 3,213 5,540 ------------------------------------------------------------------------- 13,970 10,762 13,887 ------------------------------------------------------------------------- $ 75,515 $ 57,559 $ 50,564 ------------------------------------------------------------------------- 12. DERIVATIVE FINANCIAL INSTRUMENTS The Company utilizes derivative financial instruments to hedge economic exposures. For example, the Company uses bond forward contracts to hedge the economic value exposure of movements in interest rates between the time that the mortgages are committed to be funded under asset securitization, and the time the mortgages are actually sold (these mortgages qualify for government insurance). The intent of the bond forward contract is to have fair value movements offset the fair value movements in the pool of mortgages over the period in which the fixed rate pool may be exposed to movements in interest rates, generally 60 to 150 days. During the quarter, the Company unwound $587.7 million in bond forward contracts realizing a loss of $5.4 million. This realized loss is included in the consolidated income statement through securitization income. Additionally, the Company participates in the Canada Mortgage Bond program sponsored by CMHC. Under this program, the Company sells amortizing MBS pools to Canada Housing Trust which finances the purchase by issuing a bullet Canada Mortgage Bond. Under this program, for fixed rate mortgage pools the Company manages the cash flow mismatch and reinvestment risk between the amortizing MBS pool and the bullet Canada Mortgage Bond. To hedge the cash flow mismatch on fixed rate mortgage pools, the Company enters into seller swaps where the Company pays the fixed interest payments on the Canada Mortgage Bond, and receives the total return on the amortizing MBS pool. As well, the Company enters into accreting hedge swaps to manage the reinvestment risk between providing additional amortizing MBS pools and the bullet Canada Mortgage Bond. The Company also enters into seller swap for variable rate Canada Mortgage Bonds, where Company pays the variable rate Canada Mortgage Bond rate and receives the variable rate total return on the amortizing variable rate MBS. The Company does not enter into hedge swaps for the variable rate Canada Mortgage Bond. The Company may also from time to time enter into interest rate swaps to manage the rebalance of the interest rate risk between the seller and the accreting hedge swaps described above. At June 30, 2010 the total notional value of these interest rate swaps was $75.0 million. The interest swap had a negative fair value of $1.9 million at June 30, 2010. There were no similar positions at June 30, 2009 or December 31, 2009. As at June 30, 2010, December 31, 2009 and June 30, 2009, the outstanding interest rate, seller and hedge swap contracts (swaps) and bond forward contracts (bonds) positions were as follows: ------------------------------------------------------------------------- (000s) June 30, 2010 December 31, 2009 June 30, 2009 ------------------------------------------------------------------------- Term Notional Fair Notional Fair Notional Fair (years) Amount Value Amount Value Amount Value ------------------------------------------------------------------------- Swaps 1 to 5 $3,494,604 $ 3,113 $2,710,744 $ 1,332 $2,020,032 $ (9,337) 6 to 10 819,390 (13,151) 491,498 (11,989) 233,239 1,568 ------------------------------------------------------------------------- $4,313,994 $ (10,038) $3,202,242 $ (10,657) $2,253,271 $ (7,769) ------------------------------------------------------------------------- Bonds(1) 1 to 5 $ 7,800 $ (61) $ 17,200 $ 307 $ 265,900 $ (1,687) 6 to 10 39,900 (844) 166,600 2,130 44,500 325 ------------------------------------------------------------------------- $ 47,700 $ (905) $ 183,800 $ 2,437 $ 310,400 $ (1,362) ------------------------------------------------------------------------- (1) The term of the bond forward contracts is based on the term of the underlying bonds. The fair value of the swap and bond forward contracts are included in other assets or other liabilities in the consolidated balance sheet with changes in fair value included in loss on derivatives in the consolidated statement of income. 13. 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 June 30, 2010, December 31, 2009 and June 30, 2009 for selected period intervals. Figures in brackets represent an excess of liabilities over assets or a negative gap position. As at June 30, 2010 ------------------------------------------------------------------------- (000s, Floating 0 to 3 3 Months 1 to 3 except %) Rate Months to 1 Year Years ------------------------------------------------------------------------- Total assets $ 33,288 $ 2,026,469 $ 1,387,743 $ 2,417,560 Total liabilities and equity (6) (863,620) (2,668,819) (2,104,758) Off-balance sheet items - (801,105) 13,392 345,075 ------------------------------------------------------------------------- Interest rate sensitive gap $ 33,282 $ 361,744 $(1,267,684) $ 657,877 ------------------------------------------------------------------------- Cumulative gap $ 33,282 $ 395,026 $ (872,658) $ (214,781) ------------------------------------------------------------------------- Cumulative gap as a percentage of total assets 0.4% 5.2% (11.5%) (2.8%) ------------------------------------------------------------------------- As at June 30, 2010 ------------------------------------------------------------ Non- (000s, Over 3 interest except %) Years Sensitive Total ------------------------------------------------------------ Total assets $ 1,238,482 $ 470,628 $ 7,574,170 Total liabilities and equity (812,802) (1,124,165) (7,574,170) Off-balance sheet items 442,638 - - ------------------------------------------------------------ Interest rate sensitive gap $ 868,318 $ (653,537) $ - ------------------------------------------------------------ Cumulative gap $ 653,537 $ - $ - ------------------------------------------------------------ Cumulative gap as a percentage of total assets 8.6% - - ------------------------------------------------------------ As at December 31, 2009 ------------------------------------------------------------------------- (000s, Floating 0 to 3 3 Months 1 to 3 except %) Rate Months to 1 Year Years ------------------------------------------------------------------------- Total assets $ 68,941 $ 2,346,017 $ 1,313,090 $ 2,076,689 Total liabilities and equity (6) (568,242) (2,765,144) (2,240,214) Off-balance sheet items - (537,393) 100,114 262,865 ------------------------------------------------------------------------- Interest rate sensitive gap $ 68,935 $ 1,240,382 $(1,351,940) $ 99,340 ------------------------------------------------------------------------- Cumulative gap $ 68,935 $ 1,309,317 $ (42,623) $ 56,717 ------------------------------------------------------------------------- Cumulative gap as a percentage of total assets 0.9% 17.8% (0.6%) 0.8% ------------------------------------------------------------------------- As at December 31, 2009 ------------------------------------------------------------ Non- (000s, Over 3 interest except %) Years Sensitive Total ------------------------------------------------------------ Total assets $ 1,165,781 $ 390,356 $ 7,360,874 Total liabilities and equity (786,090) (1,001,178) (7,360,874) Off-balance sheet items 174,414 - - ------------------------------------------------------------ Interest rate sensitive gap $ 554,105 $ (610,822) $ - ------------------------------------------------------------ Cumulative gap $ 610,822 $ - $ - ------------------------------------------------------------ Cumulative gap as a percentage of total assets 8.3% - - ------------------------------------------------------------ As at June 30, 2009 ------------------------------------------------------------------------- (000s, Floating 0 to 3 3 Months 1 to 3 except %) Rate Months to 1 Year Years ------------------------------------------------------------------------- Total assets $ 30,511 $ 1,710,532 $ 1,309,211 $ 1,380,718 Total liabilities and equity (6) (902,074) (2,081,439) (1,773,658) Off-balance sheet items - (299,180) 53,717 228,781 ------------------------------------------------------------------------- Interest rate sensitive gap $ 30,505 $ 509,278 $ (718,511) $ (164,159) ------------------------------------------------------------------------- Cumulative gap $ 30,505 $ 539,783 $ (178,728) $ (342,887) ------------------------------------------------------------------------- Cumulative gap as a percentage of total assets 0.5% 8.8% (2.9%) (5.6%) ------------------------------------------------------------------------- As at June 30, 2009 ------------------------------------------------------------ Non- (000s, Over 3 interest except %) Years Sensitive Total ------------------------------------------------------------ Total assets $ 1,361,389 $ 360,369 $ 6,152,730 Total liabilities and equity (450,149) (945,404) (6,152,730) Off-balance sheet items 16,682 - - ------------------------------------------------------------ Interest rate sensitive gap $ 927,922 $ (585,035) $ - ------------------------------------------------------------ Cumulative gap $ 585,035 $ - $ - ------------------------------------------------------------ Cumulative gap as a percentage of total assets 9.5% - - ------------------------------------------------------------ Based on the current interest rate gap position at June 30, 2010, 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 $4.6 million and $2.6 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 $4.6 million and $2.6 million, respectively. 14. EARNINGS BY BUSINESS SEGMENT The Company operates principally through two business segments - mortgage lending and consumer lending. The mortgage lending operation consists of core residential mortgage lending, securitization of government-insured mortgage loans, commercial real estate lending, and the administration of Regency Finance Corp. second mortgage loans (secured loans). The consumer lending operation consists of credit card services, instalment lending to customers of retail businesses and PSiGate operations. The Other category includes the Company's treasury and securities investment activities. For the three months ended ------------------------------------------------------------------------- Mortgage Lending Consumer Lending ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Net interest income $ 33,054 $ 24,669 $ 8,746 $ 9,642 Provision for credit losses (588) (2,037) 16 (1,062) Fees and other income 3,061 4,452 4,014 2,692 Securitization income 26,822 26,743 - - Net gain on securities and others (1,136) (6,093) - - Non-interest expenses (14,414) (11,502) (4,000) (2,554) ------------------------------------------------------------------------- Income before income taxes 46,799 36,232 8,776 8,718 Income taxes (15,058) (10,865) (2,720) (2,921) ------------------------------------------------------------------------- Net income $ 31,741 $ 25,367 $ 6,056 $ 5,797 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill $ 2,324 $ 2,324 $ 13,428 $ 13,428 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $6,089,927 $4,865,588 $ 486,707 $ 388,463 ------------------------------------------------------------------------- ------------------------------------------------------------------------- For the three months ended ------------------------------------------------------------------------- Other Total ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Net interest income $ 5,635 $ 6,178 $ 47,435 $ 40,489 Provision for credit losses - - (572) (3,099) Fees and other income 51 318 7,126 7,462 Securitization income - - 26,822 26,743 Net gain on securities and others 5,337 2,325 4,201 (3,768) Non-interest expenses (5,021) (4,166) (23,435) (18,222) ------------------------------------------------------------------------- Income before income taxes 6,002 4,655 61,577 49,605 Income taxes (406) (1,468) (18,184) (15,254) ------------------------------------------------------------------------- Net income $ 5,596 $ 3,187 $ 43,393 $ 34,351 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill $ - $ - $ 15,752 $ 15,752 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 997,536 $ 898,679 $7,574,170 $6,152,730 ------------------------------------------------------------------------- ------------------------------------------------------------------------- For the six months ended ------------------------------------------------------------------------- Mortgage Lending Consumer Lending ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Net interest income $ 64,792 $ 45,126 $ 18,079 $ 18,066 Provision for credit losses (1,331) (4,852) (208) (1,530) Fees and other income 7,336 9,202 7,486 5,154 Securitization income 48,989 54,398 - - Net gain on securities and others (4,439) (8,093) - - Non-interest expenses (27,411) (23,177) (7,594) (5,711) ------------------------------------------------------------------------- Income before income taxes 87,936 72,604 17,763 15,979 Income taxes (26,307) (22,569) (5,501) (5,365) ------------------------------------------------------------------------- Net income $ 61,629 $ 50,035 $ 12,262 $ 10,614 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill $ 2,324 $ 2,324 $ 13,428 $ 13,428 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $6,089,927 $4,865,588 $ 486,707 $ 388,463 ------------------------------------------------------------------------- ------------------------------------------------------------------------- For the six months ended ------------------------------------------------------------------------- Other Total ------------------------------------------------------------------------- June 30 June 30 June 30 June 30 (000s) 2010 2009 2010 2009 ------------------------------------------------------------------------- Net interest income $ 12,059 $ 13,529 $ 94,930 $ 76,721 Provision for credit losses - - (1,539) (6,382) Fees and other income 120 428 14,942 14,784 Securitization income - - 48,989 54,398 Net gain on securities and others 8,483 1,382 4,044 (6,711) Non-interest expenses (8,531) (8,183) (43,536) (37,071) ------------------------------------------------------------------------- Income before income taxes 12,131 7,156 117,830 95,739 Income taxes (910) (2,036) (32,718) (29,970) ------------------------------------------------------------------------- Net income $ 11,221 $ 5,120 $ 85,112 $ 65,769 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Goodwill $ - $ - $ 15,752 $ 15,752 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 997,536 $ 898,679 $7,574,170 $6,152,730 ------------------------------------------------------------------------- ------------------------------------------------------------------------- >> 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 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.For further information: Gerald M. Soloway, CEO, or Martin Reid, President, 416-360-4663