First National Financial : Quarter 2024 - National Financial Corporation Shareholder Report

Report to Shareholders

Period Ended March 31, 2024

16 York Street, Suite 1900, Toronto, Ontario M5J 0E6

www.firstnational.ca

Fellow Shareholders:

First National reported its first quarter 2024 results on April 30th, which we summarize below.

• Mortgages Under Administration ("MUA") increased 9% to a record $145.1 billion compared to $133.0 billion at March 31, 2023
• Revenue increased 20% to $518.0 from $432.1 million a year ago
• Pre-FMVIncome, a non-GAAP Measure, increased 5% to $62.7 from $59.7 million a year ago
• Net income was $49.9 million ($0.82 cents per share) compared to $35.7 million ($0.58 cents per share) a year ago
• Common share dividends paid or declared were $36.7 million compared to $36.0 million a year ago, reflecting an increase in the regular monthly dividend to an annualized rate of $2.45 per common share from $2.40 per share effective in December 2023
• The common share payout ratio in the first quarter was 75% compared to 103% a year ago or 81% and 84% respectively if gains and losses on financial instruments are excluded

As these results show, First National translated its business model advantages into positive results for shareholders. On the strength of mortgage servicing and our securitization strategy, we generated solid profitability. The presence of these income sources and the diversified nature of our lending activities once again proved to be important as we experienced intense competition for new mortgage business. Residential originations including renewals were 20% below last year as two large lenders in the mortgage broker channel discounted rates as part of their market share strategies. This decline was offset by a 39% increase in multi-unit originations including renewals largely on growth in insured mortgages. While the lower single-family volumes affected operational leverage, First National continued to benefit from historically slow prepayment speeds and the impact of higher interest rates on revenue.

Looking Forward

We expect competition to remain elevated this spring resulting in lower single-family origination. Although we do not see weakness in the housing market, the acceleration of activity from expected Bank of Canada rate cuts has been delayed, leaving some prospective buyers on the sidelines. For our commercial segment, we anticipate steady origination volumes as government announcements support the creation of multi-unit housing. However, other lenders have become more aggressive and mortgage spreads in the multi-unit sector are narrowing from the levels experienced in 2023 and the first quarter of 2024. In both business segments, management is confident that First National will remain a competitive leader in the marketplace and will approach opportunities as we always have: with discipline and a focus on service and technology.

Yours sincerely,

Stephen Smith	Jason Ellis
Executive Chairman	President and Chief Executive Officer

MANAGEMENT'S DISCUSSION AND ANALYSIS

The following management's discussion and analysis ("MD&A") of financial condition and results of operations is prepared as of April 30, 2024. This discussion should be read in conjunction with the unaudited interim condensed consolidated financial statements and accompanying notes of First National Financial Corporation (the "Company" or "Corporation" or "First National") as at and for the three months ended March 31, 2024. The unaudited interim condensed consolidated financial statements of the Company have been prepared in accordance with International Financial Reporting Standards ("IFRS").

This MD&A contains forward-looking information. Please see "Forward-Looking Information" for a discussion of the risks, uncertainties and assumptions relating to these statements. The selected financial information and discussion below also refer to certain measures to assist in assessing financial performance. These other measures, such as "Pre-FMV Income" and "After-taxPre-FMV Dividend Payout Ratio", should not be construed as alternatives to net income or loss or other comparable measures determined in accordance with IFRS as an indicator of performance or as a measure of liquidity and cash flow. These measures do not have standard meanings prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers.

Unless otherwise noted, tabular amounts are in thousands of Canadian dollars.

Additional information relating to the Company is available in First National Financial Corporation's profile on the System for Electronic Data Analysis and Retrieval ("SEDAR") website at www.sedar.com.

General Description of the Company

First National Financial Corporation is the parent company of First National Financial LP ("FNFLP"), a Canadian-based originator, underwriter and servicer of predominantly prime residential (single-family and multi-unit) and commercial mortgages. With more than $145 billion in mortgages under administration ("MUA"), First National is one of Canada's largest non-bank originators and underwriters of mortgages and is among the top three lenders in market share in the mortgage broker distribution channel.

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First Quarter 2024 Results Summary

First National's performance in the first quarter of 2024 met management's expectations to start the year. With a highly competitive mortgage market, the Company's residential mortgage originations were lower by 20%. Commercial origination offset the residential segment decrease with growth of 39%, such that together the Company's total origination was comparable to last year's opening quarter. . Core operating profitability, measured by Pre-FMV Income(1), grew by 5% from the first quarter of 2023 reflecting the effectiveness of the Company's long term securitization strategy that made up for lower origination volumes. Solid growth in Mortgages Under Administration (MUA) in the year together with strong relationships with institutional investors continued to benefit First National.

The following summarizes performance of the Company's significant metrics:

• MUA grew to $145.1 billion at March 31, 2024 from $133.0 billion at March 31, 2023, an increase of 9%; the growth from December 31, 2023, when MUA was $143.5 billion, was 4% on an annualized basis.
• Total single-family mortgage origination, including renewals, was $3.5 billion in the first quarter of 2024 compared to $4.4 billion in 2023, a decrease of 20%. The Company attributes the decrease to increased competition in the mortgage broker distribution channel. In the past two quarters two large lenders in the channel offered discounted rates and larger broker incentives to attract more market share. Commercial segment origination, including renewals, of $3.0 billion was 39% higher than the $2.2 billion originated in the 2023 first quarter. Growth in commercial mortgage origination continued to be fueled by demand for high-quality insured multi-unit mortgage products. Total origination was materially the same in the 2024 quarter as the 2023 quarter.
• Revenue for the first quarter of 2024 increased by 20% to $518.0 million from $432.1 million in the first quarter of 2023. This change was largely the result of higher interest rates. Since early 2022, mortgage rates increased in tandem with the interest rate environment as monetary policy tightened to counteract inflation risks. These changes led to comparatively higher interest revenue earned on the securitization portfolio as newer mortgages with higher rates replaced older lower-rate mortgages which matured or renewed.
• Income before income taxes was $67.9 million in the first quarter of 2024 compared to $48.6 million in the first quarter of 2023. The increase included the effect of changing capital market conditions in both years. Excluding gains and losses related to financial instruments, earnings before income taxes and gains and losses on financial instruments ("Pre-FMV Income" (1)) for the first quarter 2024 increased by 5% to $62.7 million from $59.7 million in the 2023 comparative quarter. This change was largely the result of the Company's success in growing MUA over time. Higher MUA creates higher servicing revenues, and the larger portfolio of securitized mortgages provides five- and ten-year streams of income which are reflected in higher net interest income.

1. This non-IFRS measure adjusts income before income taxes by eliminating the impact of changes in fair value by adding back losses on the valuation of financial instruments (except those on mortgage investments) and deducting gains on the valuation of financial instruments (except those on mortgage investments). See Key Performance Indicators section in this MD&A.

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Selected Quarterly Information

Quarterly Results of First National Financial Corporation

($000s, except per share amounts)

		Net Income for	Pre-FMV	Net Income
		Income for the	per Common
	Revenue	the Period	Period (1)	Share	Total Assets
2024
First quarter	$518,045	$49,892	$62,745	$0.82	$45,765,958
2023
Fourth quarter	$503,441	$44,245	$77,125	$0.72	$45,957,399
Third quarter	$562,861	$83,630	$95,456	$1.38	$45,176,543
Second quarter	$525,897	$89,194	$89,854	$1.47	$46,417,841
First quarter	$432,086	$35,738	$59,748	$0.58	$44,268,705
2022
Fourth quarter	$414,785	$42,669	$59,492	$0.70	$43,763,672
Third quarter	$392,413	$40,145	$48,219	$0.66	$42,392,225
Second quarter	$416,774	$61,281	$55,864	$1.01	$42,927,449

Reconciliation of Quarterly Determination of Pre-FMV Income

($000s, except per share amounts)

	Income	Add/ deduct	Deduct (losses), add
	before	Realized and	gains related to	Pre-FMV
	income tax	unrealized	mortgage investments	Income for
	for the Period	losses (gains)		the Period (1)
2024
First quarter	$67,892	($5,147)	$-	$62,745
2023
Fourth quarter	$59,895	$16,894	$336	$77,125
Third quarter	$113,830	($18,435)	$61	$95,456
Second quarter	$121,544	($31,690)	$-	$89,854
First quarter	$48,638	$11,110	$-	$59,748
2022
Fourth quarter	$58,269	$1,353	($130)	$59,492
Third quarter	$54,645	($5,846)	($580)	$48,219
Second quarter	$83,081	($27,217)	$-	$55,864

1. This non-IFRS measure adjusts income before income taxes by eliminating the impact of changes in fair value by adding back losses on the valuation of financial instruments (except those on mortgage investments) and deducting gains on the valuation of financial instruments (except those on mortgage investments). See Key Performance Indicators section in this MD&A.

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With First National's large portfolio of mortgages under administration, quarterly revenue is driven primarily by servicing income and the gross interest earned on mortgages pledged under securitization. The gross interest on the mortgage portfolio is dependent both on the size of the portfolio of mortgages pledged under securitization, as well as mortgage rates. Recently MUA has increased, and revenue followed. Net income is partially dependent on conditions in bond markets, which affect the value of gains and losses on financial instruments arising from the Company's interest rate hedging program. Accordingly, the movement of this measurement between quarters is related to factors external to the Company's core business. By removing this volatility and analyzing Pre-FMV Income, management believes a more appropriate measurement of the Company's performance can be assessed.

In the past eight quarters, the Company experienced a relatively volatile economic environment. 2022 began with a positive economic outlook: there was a surplus of liquidity for investment in financial assets and origination volumes remained strong. However, late in the 2022 first quarter, risks associated with inflation became evident as wages and prices increased and companies competed for employees. The Bank of Canada moved quickly and continuously beginning on March 2, 2022, in an attempt to stem inflation. Short-term interest rates rose by 425 basis points between March 2022 and January 2023 to their highest level since 2011. While spreads on new mortgage originations widened somewhat, the Company faced the headwinds of a slowing housing market, and strong competition for customers such that it earned comparatively lower Pre- FMV Income (1). 2023 featured a return to a more stable housing environment: mortgage rates stabilized, and consumer confidence returned. In general, despite two more increases from the Bank of Canada, there was a sequential improvement in mortgage origination volumes between the first and third quarters of 2023. The fourth quarter was softer as economic indicators turned more negative. Throughout 2023 lower prepayment rates also added to performance. The resulting operational efficiency from solid origination levels and the record MUA, translated to higher Pre-FMV Income (1). 2024 began with increased competition in the mortgage broker distribution channel which negatively affected origination and reduced the Company's operational leverage in the first quarter.

Outstanding Securities of the Corporation

At March 31, 2024, the Corporation had outstanding: 59,967,429 common shares; 2,984,835 Class A preference shares, Series 1; 1,015,165 Class A preference shares, Series 2; 200,000 November 2024 senior unsecured notes; 200,000 November 2025 senior unsecured notes; and 200,000 September 2026 unsecured notes. On April 1, 2024, the Company issued 200,000 new senior unsecured bonds to mature on November 1, 2027. There were no other changes in the Company's outstanding securities to April 30, 2024.

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Selected Annual Financial Information and Reconciliation to Pre-FMV Income(1)

($000s, except per share amounts)

	2023	2022	2021
For the Year Ended December 31,
Income Statement Highlights
Revenue	2,024,285	1,574,293	1,394,606
Interest expense - securitized mortgages	(1,119,475)	(739,295)	(630,279)
Brokerage fees	(139,199)	(173,290)	(201,786)
Salaries, interest and other operating expenses	(421,704)	(392,626)	(298,720)
Add (deduct): realized and unrealized losses (gains) on
financial instruments	(22,121)	(59,610)	(5,815)
Add (deduct): unrealized gains (losses) regarding
mortgage investments	397	(710)	(730)
Pre-FMV Income(1)	322,183	208,762	257,276
Add (deduct): realized and unrealized gains (losses) on
financial instruments excluding those on mortgage
investments	21,785	60,320	6,545
Provision for income taxes	(91,100)	(71,350)	(69,260)
Net income	252,807	197,732	194,561
Common share dividends declared	189,397	141,423	210,885
Per Share Highlights
Net income per common share	4.15	3.25	3.20
Dividends per common share	3.16	2.36	3.52
At Year End
Balance Sheet Highlights
Total assets	45,957,399	43,763,672	42,274,158
Total long-term financial liabilities	598,745	399,222	398,888

Note:

1. Pre-FMVIncome is not a recognized earnings measure under IFRS and does not have a standardized meaning prescribed by IFRS. Therefore, Pre-FMV Income may not be comparable to similar measures presented by other issuers. Investors are cautioned that Pre- FMV Income should not be construed as an alternative to net income or loss determined in accordance with IFRS as an indicator of the Company's performance or as an alternative to cash flows from operating, investing and financing activities as a measure of liquidity and cash flows.

Vision and Strategy

The Company provides mortgage financing solutions to the residential and commercial mortgage markets in Canada. By offering a full range of mortgage products, with a focus on customer service and superior technology, the Company believes that it is a leading non-bank mortgage lender. The Company intends to continue leveraging these strengths to lead the non-bank mortgage lending industry in Canada, while appropriately managing risk. The Company's strategy is built on four cornerstones: providing a full range of mortgage solutions for Canadian single-family and commercial customers; growing assets under administration; employing technology to enhance business processes and service to mortgage brokers and borrowers; and maintaining a conservative risk profile. An important element of the Company's strategy is its direct relationship with mortgage borrowers. The Company is considered by most of its borrowers as the mortgage lender. This is a critical distinction. It allows the Company to communicate with each borrower directly throughout the term of the related mortgage. Through this relationship, the Company can negotiate new transactions and pursue marketing initiatives. Management believes this strategy will provide long-term profitability and sustainable brand recognition for the Company.

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Key Performance Drivers

The Company's success is driven by the following factors:

• Growth in the portfolio of mortgages under administration;
• Growth in the origination of mortgages;
• Raising capital for operations; and
• Employing innovative securitization transactions to minimize funding costs.

Growth in Portfolio of Mortgages under Administration

Management considers the growth in MUA to be a key element of the Company's performance. The portfolio grows in two ways: through mortgages originated by the Company and through third-party mortgage servicing contracts. Mortgage originations not only drive revenues from placement and interest from securitized mortgages, but perhaps more importantly, create longer-term value from servicing rights, renewals and growth in the customer base for marketing initiatives. As at March 31, 2024, MUA totalled $145.1 billion, up from $133.0 billion at March 31, 2023, an increase of 9%. The growth of MUA in the first quarter of 2024 was 4% on an annualized basis.

Growth in Origination of Mortgages

Direct Origination by the Company

The origination of mortgages not only drives the growth of MUA as described above, but leverages the Company's origination platform, which has a large fixed-cost component. As more mortgages are originated, the marginal costs of underwriting decrease. Increased origination satisfies demand from institutional customers and produces volume for the Company's own securitization programs. In the first quarter of 2024, the Company's single-family origination decreased by 20% compared to 2023's first quarter. The Company believes this is the result of increased competition as lenders look to deploy capital in a slower market. The commercial segment continued to perform well despite changing market conditions. Total commercial volumes were $3.0 billion in the quarter compared to $2.2 billion in the first quarter of 2023, an increase of 39%. On a combined basis, overall origination in first quarter 2024 was materially the same year over year.

Third-Party Mortgage Underwriting and Fulfilment Processing Services

In 2015, the Company launched its third-party underwriting and fulfilment processing services business with a large Canadian Schedule I bank ("Bank"). This business is designed to adjudicate mortgages originated by the Bank through the single-family residential mortgage broker channel. First National employs a customized software solution based on its industry-leading MERLIN technology to accept mortgage applications from the Bank in the mortgage broker channel and underwrite these mortgages in accordance with the Bank's underwriting guidelines. The Bank funds all the mortgages underwritten under the agreement and retains full responsibility for mortgage servicing and the client relationship. Management considers the agreement a way to leverage the capabilities and strengths of First National in the mortgage broker channel and add some diversity to the Company's service offerings. In late 2019 and 2023, the Company entered into similar agreements with two other Canadian banks.

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Excalibur Mortgage Products

The Company originates alternative single-family ("Excalibur") mortgage products. Alternative lending describes single-family residential mortgages that are originated using broader underwriting criteria than those applied in originating prime mortgages. These mortgages generally have higher interest rates than prime mortgages. First National's relationships with mortgage brokers and its underwriting systems allow for cost effective origination of significant volumes. The product is originated primarily for placement with institutional investors, but beginning in April 2019, the Company finalized an agreement with a bank- sponsored securitization conduit to fund a portion of Excalibur origination. In early 2020, an agreement was reached with another bank-sponsored conduit to provide additional funding for this product. Excalibur was rolled out gradually, beginning in Ontario. Currently the program originates the majority of its mortgages in Ontario with growing volumes in Western Canada.

Raising Capital for Operations

Bank Credit Facility

The Company has a $1.5 billion revolving line of credit with a syndicate of banks. This facility enables the Company to fund the large amounts of mortgages accumulated for securitization. Subsequent to March 31, 2024, the Company extended the term of the facility by another year to mature in March 2029. The facility bears interest at floating rates. The Company has elected to undertake this debt for a number of reasons: (1) the facility provides the amount of debt required to fund mortgages originated for securitization purposes; (2) the debt is revolving and can be used and repaid as the Company requires, providing more flexibility than senior unsecured notes, which are fully drawn during their term; (3) the five-year remaining term gives the Company a committed facility for the medium term; and (4) the cost of borrowing reflects the Company's BBB issuer rating.

Note Issuance

In the first quarter of 2024, the Company successfully launched a new unsecured $200 million note transaction pursuant to a private placement under an offering memorandum. On April 1, 2024, 200,000 new Series 5 notes were issued at a coupon of 6.261% for a three-year7-month term maturing November 1, 2027. These notes add to the Company's 2023 issuance of 200,000 7.293% Series 4 senior unsecured notes, 2020's issuance of 200,000 2.961% Series 3 senior unsecured notes and 2019's issuance of 200,000 3.582% Series 2 senior unsecured notes. The net proceeds of these issuances, after broker commissions, were invested in FNFLP. On settlement, the proceeds were used to pay down a portion of the indebtedness under the bank credit facility. The Company's medium-term debt capital now stands at approximately $800 million. The notes issued in April 2024 provide the Company with liquidity to fund the 2019 issued notes which mature on November 25, 2024

Preferred Share Issuance

Effective April 1, 2021, pursuant to the original prospectus, the Company reset the annual dividend rate on the outstanding Class A Series 1 preference shares to 2.895% for a five-year term to March 31, 2026. After the exercise of shareholder conversion rights in March 2021, there were 2,984,835 Class A Series 1 shares outstanding and 1,015,165 Class A Series 2 outstanding. The Series 2 shares bear a floating rate dividend calculated quarterly based on the 90-dayT-Bill rate. Both the Series 1 and Series 2 shares pay quarterly dividends, subject to Board of Directors approval, and are redeemable at the discretion of the Company such that after each five-year term ending on March 31, the Company can choose to extend the shares for another five-year term at a fixed spread (2.07%) over the relevant index (five-year Government of Canada bond yield for any Series 1 shares or the 90-dayT-Bill rate for any Series 2 shares). While investors in these shares have an option on each five-year anniversary to convert their Series 1 preference shares into Series 2 preference shares (and vice versa), there is no provision of redemption rights to these shareholders. As such, the Company considers these shares to represent a permanent source of capital.

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Employing Securitization Transactions to Minimize Funding Costs

Approval as Both an Issuer of NHA-MBS and Seller to the Canada Mortgage Bonds Program

In December 2007, the Company was approved by Canada Mortgage and Housing Corporation ("CMHC") as an issuer of NHA-MBS and as a seller into the Canada Mortgage Bonds ("CMB") program. Issuer status provides the Company with direct and independent access to reliable and low-cost funding. Insured mortgage spreads can be illustrated by comparing insured posted five-year fixed single-family mortgage rates to a similar term five-year Government of Canada bond as listed in the table below.

Period	Period end Five-Year Insured Mortgage Spread by Quarter
Q1 2022	1.38%
Q2 2022	1.98%
Q3 2022	1.51%
Q4 2022	1.48%
Q1 2023	1.62%
Q2 2023	1.65%
Q3 2023	1.59%
Q4 2023	2.07%
Q1 2024	1.46%

Generally, when this spread is wider, the Company can earn higher returns from its securitization activities, although credit spreads and program fees observed in mortgage securitization markets also affect profitability. In 2022 and through 2023, spreads widened in response to the Bank of Canada's interest rate policy announcements and an increase in general economic uncertainty. To start 2024, spreads tightened as renewed competition in the mortgage broker market brought mortgage rates lower. In the first quarter of 2024, the Company originated and renewed approximately $2.4 billion of single-family and multi-unit residential mortgages for securitization purposes.

The Company is subject to various regulations put in place by CMHC. These rules include the amount of CMHC guarantees issued which are required to issue a pool. Currently there is a tiered NHA-MBS guarantee fee pricing structure, such that any guarantees issued to one issuer over $9.0 billion of issuance have a higher price. The tiered limit of $9.0 billion remains unchanged for 2024. In July 2022, CMHC issued new rules related to the allocation of NHA-MBS guarantee fees between "lenders" and "aggregators". These rules commenced in the latter part of 2023 through a transition period. CMHC indicated in 2023 that these rules may be subject to further clarification. While these rules have not yet impacted the Company's ability to place mortgages with its existing institutional customers, the rules will have an ongoing impact on the amount of NHA MBS that issuers can create.

Canada Mortgage Bonds Program

The CMB program is an initiative where Canada Housing Trust ("CHT") issues securities to investors in the form of semi-annualinterest-yielding 5 and 10-year bonds. As a seller into the CMB, the Company is able to make direct sales of NHA MBS into the program. The ability to sell into the CMB has given the Company access to lower costs of funds on both single-family and multi-family mortgage securitizations. Because of the effectiveness of the CMB, many institutions have indicated their desire to participate. As a result, CHT has created guidelines through CMHC that limit the amount that can be sold by each seller into the CMB each quarter. The Company is subject to these limitations. CMHC has indicated there may be modifications as early as 2024 which may reduce the amounts which the Company's can sell into 10-year CMB. The 2023 federal budget suggested that there could be changes to this program. Subsequently, the government consulted with industry participants including First National. At the end of September 2023, the federal government through the Ministry of Finance, announced that the annual limit for Canada Mortgage Bonds was increased to $60 billion from $40 billion. The additional CMB capacity will be allocated exclusively for the funding of CMHC

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