First National Financial Corp

TSX:FN

Good morning, and welcome to First National's First Quarter Earnings Call. This call is being recorded on Wednesday, April 30, 2025. [Operator Instructions]

Now, it is my pleasure to turn the call over to Jason Ellis, President and Chief Executive Officer of First National. Please go ahead, sir.

Thank you, and good morning. Welcome to our call, and thank you for participating.

Robert Inglis, our Chief Financial Officer, joins me and will provide his commentary shortly. Also with us today is Jeremy Wedgbury, our Executive Vice President of Commercial Mortgages, who will be on hand during the Q&A portion of the call.

I remind you that our remarks and answers may contain forward-looking information about future events or the company's future performance. This information is subject to risk and uncertainties and should be considered in conjunction with the risk factors detailed in our management's discussion and analysis.

Pre-fair market value income was $52.6 million, or 16% below last year's first quarter, despite substantial growth in our long-term drivers of profitability, originations and MUA. Consistent with our forecast and indicative of a strong commitment pipeline heading into 2025, total single-family funding increased 34% on a year-over-year basis.

In our Commercial business, our focus and expertise in the insured multi-unit residential housing market drove first quarter originations up 18%, reflecting both new funding growth as well as renewals. Activity in both markets was supported by 7 Bank of Canada rate reductions between June of last year and March of this year, as well as a variety of government incentives. These include the recent purchase price cap increase and the reintroduction of a 30-year amortization for qualifying insured residential mortgages. Both changes are proving to be popular, particularly in high-cost cities like Toronto and Vancouver. Similarly, multi-unit property developers and owners continue to take advantage of CMHC's affordable loan programs alongside time-bound GST rebates for construction.

Moving to our outlook. We've recently seen a downgrade in the housing market forecast from CREA, a result of uncertainty caused by the imposition of cross-border tariffs and heightened risk of recession and job loss. While this backdrop can't be ignored, First National's near-term reality is different. Based on single-family mortgage commitments issued and outstanding at the end of the first quarter, up significantly from last year, we expect to see year-over-year growth in originations continue into Q2.

To be clear, we have not made any adjustments in our approach to pricing or credit quality to generate higher commitment levels. We are simply continuing to focus on providing good products and responsive service to our broker partners and borrowers. In terms of credit performance, the arrears profile in our prime mortgage portfolio is relatively unchanged and remains below levels observed prior to the pandemic. Alt-A arrears, however, remain elevated relative to the prime portfolio and are higher than the same time last year, but have fallen month-over-month in each of February and March.

Alt-A mortgages are characterized by shorter terms and as a result, borrowers renewed more quickly into the higher rate environment of 2022 and 2023, without the benefit of 5 years of household income and home equity growth enjoyed by the typical prime borrower. Virtually, all of the Alt-A mortgages originated during the period of lowest mortgage rates between 2020 and 2022 have already renewed and have been servicing their mortgages at higher rates for several quarters now and are looking ahead to their next renewal, which will come at lower rates.

For commercial mortgages, we expect multi-unit residential to be a resilient market given the need for rental apartments, particularly affordable units. For context, however, originations and renewals amounted to a record $5 billion in Q2 last year, which sets a high bar for comparison. Also factoring into our outlook is the fact that CMHC has also taken a more cautious view to underwriting. So, while there is still good fundamental support for the market, the environment for new CMHC originations is evolving.

To summarize, the quarter featured strong growth in new and renewed mortgage production, in line with our expectations. And with that growth, First National added to its foundation of recurring revenue that will benefit shareholders in future periods.

Now over to you, Rob.

Thanks, Jason, and good morning, everyone.

Starting at the top line, MUA increased 7% year-over-year or by $10.3 billion, a very positive outcome considering the broader market dynamics and in the first quarter, housing market seasonality. Annualized MUA growth in the first quarter itself was a healthy 4%. While higher production and strong retention are the ingredients that drive MUA, it's worth noting that new originations do not immediately contribute to earnings, which is one reason why measures of profitability did not rise with higher volumes.

I'll discuss the other factors, beginning with revenue. Revenue increased 2% year-over-year, despite a 2% decline in net interest revenue earned on securitized mortgages. This reflected a NIM compression of about 7 basis points year-over-year as high-margin pandemic era mortgages amortized down and asset-backed commercial paper funding costs did not immediately fall with the overnight rate cuts. As a reminder, the bank-sponsored conduits generally sell longer-term paper in a declining rate market, such that our cost of funds is temporarily higher. This has been accentuated with the recent Bank of Canada rate cuts.

Origination for direct securitization into NHA-MBS, CMB and ABCP programs remained a large part of our strategy, with about $3.2 billion of volume in the first quarter. Funding with securitization rather than placing mortgages with investors has the effect of deferring-related revenue to future periods. As a result of lower third-party underwriting revenues and lower interest earned on escrow deposits in a declining interest rate environment, mortgage servicing income was lower by about 3% from the last year.

Gains in deferred placement fees were also lower as volumes related primarily to multi-unit residential mortgages originated and sold to institutional investors for this program decreased by 6%. Associated margins were also much tighter in 2025 compared to 2024. On the plus side, placement fees were up 2% on a 20% increase in placement activity. The delta reflected a shift in mix, favoring renewed mortgages where per-unit placement fees are lower than a new residential origination. As a reminder, on renewal with an investor client, we earn an additional placement fee and continue to earn servicing revenue over the term of the renewed mortgage. So even though the renewal fees paid by investors are lower than the initial fee without a broker fee to net against it, it is still accretive to First National's earnings.

Mortgage investment income increased 15%, primarily reflecting a larger balance of mortgages accumulated for securitization even though rates were lower year-over-year due to the interest rate environment. This increase was somewhat offset by a reduction in our commercial bridge loan program as we placed more of this product with institutional customers. This decision reduced the mortgage loan investment portfolio for commercial by about $50 million.

Turning to expenses now. The year-over-year headcount growth of 7% was the primary reason for a 7%, or $3.9 million increase in salaries and benefits expense. Some of this is related to staffing in our third-party underwriting business in advance of anticipated volumes, which acted as a drag on operating leverage in the quarter. Brokerage fee expense declined by 12% or $2.4 million compared to last year despite an increase in new volumes placed with institutional investors.

On a per-unit basis, fees are about 9% lower, a function of prevailing market conditions in 2024 when higher incentives were required to match some of our competitors. Interest expense increased 20% or $6.5 million because of higher use of short-term funding sources to fund the larger balances of mortgages accumulated for securitization. Interest expense also includes the cost of carry for the company's economic hedging program. Other operating expenses increased by 7% or $1.4 million. This relates to significant technology replatforming activity discussed on our previous calls. We expect IT expenses to remain elevated in the next few quarters as we upgrade our systems and migrate to the cloud from on-site servers. We do expect to generate efficiency advantages from this higher spending in future years.

Turning now to profitability. As Jason said, Q1 pre-fair market value income was 16%, or $10.1 million lower than last year. The decline was due to lower revenues in various segments of the business against the backdrop of higher cost of operating the business. Lower revenues were recorded in mortgage servicing, particularly third-party underwriting and residential securitization income with some NIM compression. The higher costs include about $1.4 million of other operating costs, largely IT related and growing headcount in place to fund the larger residential segment volumes expected in Q2 and Q3.

Looking at the bottom line for shareholders. Ongoing profitability supported ongoing dividend payments at an annualized rate of $2.50 per share. As is often the case, in the first quarter, our dividend payout ratio against after-tax pre-fair market value income was elevated this time at about 98%.

To sum up, the first quarter unfolded as we expected with strong funding volumes, which allowed us to add to our portfolio of mortgages pledged under securitization and our servicing portfolio. This will benefit First National and our shareholders in the form of income and cash flow in future years. Based on our single-family commitment pipeline at the end of the quarter, we can also look forward to year-over-year growth in originations in the second quarter.

Now, we'll be pleased to answer your questions. Operator, please open the lines. Thank you.

[Operator Instructions] Your first question comes from the line of Etienne Ricard from BMO Capital Markets.

It's interesting to see the origination numbers in single-family, part of which seems driven by better renewal volumes. Yet when we look at resale activity in large urban markets, it has not meaningfully picked up this year. So why is First National seeing higher volumes in a still relatively slow housing market?

It's a good question. I think that there are 2 factors leading to our perhaps relative outperformance of the broader market. One is a higher level of engagement with some of our third-party investors who have empowered us with compelling rate offerings, which has made us perhaps relatively more competitive in the conventional origination space than we were relative to the previous year. And as a business that perhaps has a disproportionate share of the new purchase and specifically high-ratio business, we've benefited perhaps disproportionately from the changes in CMHC's rules around the $1.5 million purchase price cap and the reintroduction of 30-year amortizations for first-time homebuyers.

So, part of the growth in year-over-year originations in dollar terms is a larger average insured mortgage size. Mortgage units are up year-over-year as well. However, much of the single-family increase is a function of higher average mortgage size. And for what it's worth, when I speak to the mortgage default insurance providers, their experience has also been very constructive this quarter relative to the same quarter last year. So, I think that there is something of a disconnect between what we see the media reporting in terms of housing activity and what we're actually seeing on the ground from an originations perspective.

Okay. Interesting. On servicing income, you raised in the financials that the third-party underwriting volumes were down in the quarter. So, maybe to tie it back to your comments, Jason, how do you reconcile this with the increase in single-family volumes that we're seeing at First National? Is it driven by the same drivers that you just mentioned?

Well, I can speak to First National's performance. And again, I think that we may have outperformed the market marginally just with our focus on high-ratio insured mortgages and the increase in the average size of those. Our third-party underwriting clients are Schedule I banks who have, I think, a more particular strength on the conventional side. So, I don't think they've seen the same growth in average mortgage size. So that tailwind, I don't think was in play as much for them as it was for us. I would say that as we look ahead on our third-party underwriting platform, it has a lot of operational leverage and the first quarter is traditionally from a seasonal perspective, fairly small. So in combination of seasonality and what we've seen recently in their own origination activity as a lot of, I would say, good traction, their pipeline heading into the second quarter is relatively strong compared to the first. So, we're actually looking forward to seeing that third-party underwriting revenue line restore itself as we move into the second and third quarter.

Your next question comes from the line of Graham Ryding from TD Securities.

Just on the -- I guess, Rob, this question is for you, just on the securitization NIM in the quarter. It sounds like there was a few pieces that weighed on -- it was a pretty material drop sort of quarter-over-quarter and year-over-year. Can you just elaborate on what you think is going to be a recurring theme in terms of NIM compression and what was maybe not expected to recur? It sounds like maybe the mortgage prepayment charges and the asset-backed commercial paper funding cost that may alleviate, but the first component may be an ongoing sort of headwind. Is that the right way to think about it?

It's Jason, Graham. I'll take that one. So one -- there's 3 -- I would say there were 3 specific components that contributed to the compression that we saw in the first quarter. One was, as Rob mentioned and you highlight, some of the pools that were originated in the beginning of 2020 were originated at wider average gross margins than were typical of, say, the entire portfolio. And those are beginning to run off. So, we may see that as a theme, though you've got to remember that the maturities during any given quarter are relatively small in comparison to the $45 billion portfolio at large. So, NIM will change relatively slowly as a function of that. I took the opportunity to do a bit of a roll forward of the NHA-MBS portfolio for several quarters. Absent any new originations, the average NIM on the single-family MBS portfolio only ticks along a couple of basis points over the next few quarters. So, I don't think that's going to be a major story. I think more significant is the transient impact of the compression in the ABCP program. I'd say year-over-year, I think NIM or net interest income, I should say, was about $1 million compared to $1 million lower compared to the same quarter last year.

The ABCP cost of funds compression probably was at least $3 million in the quarter, and this is not going to be recurring. As the old ABCP paper reaches maturity and is replaced with new, we will see the margins in that conduit restore themselves. So, I don't think that's going to be a recurring issue. And the other, I think, idiosyncratic event during the quarter was the net rate differential indemnities that we did pay on the 975 type single-family pools was negative in the quarter for the first time in a number of quarters. And I don't think that is actually going to be a persistent phenomenon. I think that probably reverses itself again in the second quarter based on where we see rates now. So I think, generally speaking, NIM should not be a concern going forward the way it was in the first quarter.

Sorry, that was a lot. Did that answer the question?

That did help. Maybe I can just follow on. So, my math suggests you had 48 bps in NIM for your securitized portfolio in this quarter, which is down from 52 bps quarter-over-quarter and 54 bps year-over-year. So, what would you sort of roughly guide to for 2025? Is 48 bps the run rate? Or it sounds like is there a couple of pieces that could maybe bring that 48 bps up a little bit higher?

Yes. I would say, obviously, I can't predict the future, but I do believe there is a chance to repatriate a couple of basis points, largely on the normalization of the spreads in our ABCP conduits. And I would say, a normalization of those net indemnity payments on the single-family MBS pools. So, I think there's a couple of bps that we could catch up on. And then the only contrary to that would be, again, over the next couple of quarters, we do have some legacy pools rolling off that had sort of early pandemic era wider spreads. So, we'll see how well we can replace those with new issues.

Right. Okay. And then my next question would be on the placement fee side. I realize that there was a mix impact this quarter. You had higher sort of volumes of renewals relative to sort of new residential volumes. But when you look at sort of your per unit fees on those renewals and your per unit fees on your new originations, were those lower year-over-year?

I think what you guys don't get the benefit of is, I guess, some of the separation of placement fees and the like. I think there's a really good outcome this quarter that gets lost in the mix, and it kind of goes to your question. When I look at our single-family residential placement fees, relative to our broker residential broker fees in the quarter, that net -- the net of our residential placement, net of the residential broker fees actually expanded by 30% in the quarter versus the same quarter last year or was about a couple of million dollars wider. And that's a function of a couple of things.

One, our per-unit broker fee on new originations was lower in the quarter compared to the same quarter last year, and that was specifically attributable to the fact that we were not paying as much bonus compensation to mortgage brokers for high-ratio insured mortgages. And it's a function of the fact that on the placement side, a slightly higher percentage of the mortgages placed relative to the same quarter last year were renewed mortgages, where the placement fee, the per unit placement fee is, in fact, lower, but the broker fee is 0. So a combination of things, better year-over-year per-unit broker costs and a slightly higher percentage of the residential mortgages placed were renewed mortgages. So the per-unit placement was lower, but the net between those 2 things was wider. And structurally, that's a thing that we're going to enjoy going forward for the rest of the year.

Okay. That's great. If I could sneak in one more. Just I feel like I'm getting a little bit of a mixed message from you on the multi-unit side. So on the one hand, the CMHC has increased funding from $40 billion to $60 billion. But then on the other hand, they sound like they're tightening up their underwriting a little bit. So pulling those 2 pieces together, what is your outlook for sort of steady volumes at this level? Or does one outweigh the other?

Yes. I'll turn it over to Jeremy to answer that one. But just before I do that, I do want to highlight the fact that, again, as we look at -- as we deconstruct placement fees and deferred placement fees in the first quarter, a couple of large 10-year deals that were slated to be part of our 10-year securitization in Q1 did move into the second quarter. So, I think a little bit of, again, an anomaly there in terms of period-over-period deferred placement fees.

But as far as CMHC's stance on credit, I'll turn it over to Jeremy.

Yes. Thank you. In November of last year, CMHC made some changes to their program. They had a very strong performance, I guess, you could say, over the last couple of years with their select product that they created to add to supply in Canada. They pulled back. They went essentially more risk off, I would say. And so that is likely the comment that you kind of heard us talk about and talk about with our customers. It's had more of an impact on the construction side of the business where they've limited some of their loan to cost, and they've added a few other sort of guardrails to it like the bonding of subtrades.

So, we would say that certainly on the term side, we don't really see CMHC's changes as having too much impact on our term business and our outlook for 2025. We do think it will have an impact on our construction book, which has been really strong. But we think that there will still continue to be an appetite. There is still a lot of supply that is being considered in Canada, and we're going to have to just work really hard to make sure we're in front of the right borrowers that will continue to go forward. So as much as, yes, CMHC has gone a little bit risk off, we don't think it's going to have a huge impact on us.

Probably worth also just tying into the tail end of that, the fact that we have such a large CMHC insured construction book that even if new term transactions were to moderate, we have a natural pipeline of constructions that -- construction deals that as they come online will transition into new term mortgages for sale into the CMB. So, a nice built-in pipeline there.

What would your mix be between construction lending and term multi?

So in the quarter, we did $2.7 billion of new business and of new business, the construction component of it would represent advances in the quarter of about $0.5 billion. So that's -- we're on average, I think we're putting out new advances in the range of $2 billion. But overall -- so obviously, more business going towards the term. I think that I would say term would typically be about 75% overall versus the construction side of it. That would be the way I think about our advances, but I don't always sort of put it in that -- in those terms.

[Operator Instructions] Your next question comes from the line of Jaeme Gloyn from National Bank Financial.

Just wanted to follow up on the net placement fee discussion, and it's something I like to track and just sort of benchmark the performance because it's obviously difficult to guess the mix of funding. What I've noticed is that Q1 tends to have a higher net placement fee margin, if I'm taking the revenue versus the expense. Is that something that you would expect to be consistent this year since we're digging into those details a little bit more?

Sorry, I'm not aware of a sort of a correlation between the quarter and net placement fees. If there is, I think it's coincidental.

It definitely be a mix of renewal versus new, I guess. The new is typically, I guess, lower in Q1.

Yes. But if originations are lower, renewals should be -- yes, I'm not -- so what is it you're seeing in particular? Or over how many Q1s have you seen this, Jaeme?

Let's say going back to '21 at least.

If there's anything that jumps to mind, Rob, have you -- in Q1, do you ever perhaps -- do we benefit from the over -- overallocation or accretion of any kind of expected broker expenses that you then release back in Q1 if they didn't materialize, like annual volume bonuses that we may have accrued for, that maybe we didn't pay out and do those?

Yes. Typically, we like to over accrue, I guess, or be conservative in the year. And then Q1, we take back any positives where volume bonuses aren't as high as we budgeted in the previous year. So, there's a little bit of that. But I mean, it's not like a big, big number. I don't think because we know what we're doing.

Yes. I would say, though, if there were to be a theme as we roll through the rest of this year and the cohort of 2020 originations, especially as we move into the second part of the second quarter and beyond, that cohort of originations was so strong in 2020 that all else being equal, the mix of mortgages being placed with our institutional investors will be relative to history, perhaps a higher concentration of renewed mortgages, which means there won't be broker fees. So, that net of placement against broker fees should have a fairly strong trend to it as we move through the year because of that change of mix.

Yes, no, I agree with that point. And yes, it's a fair -- I think it's a fair assumption. We'll see how it plays out. I'll take -- maybe I'll take a little bit of that offline then and just sort of like dig in a little bit to make sure we're on the same page. The other question I just wanted to clarify as well was just going back to the securitization discussion and around the mix shift. So the 2020 mortgages coming off and then some narrower spread mortgages from, let's say, like '22, '23 where rates were moving higher. Your commentary was that's going to be a couple of bps of drag on the NIM. Is that like for the year or for sort of each quarter going forward for the next few?

I look at it -- so what I did was I took all of the outstanding all the outstanding 975-type NHA-MBS and I looked at the gross margins at origination for each of our pools outstanding. So the weighted average mortgage coupon less the MBS coupon. And I just rolled that whole portfolio forward. And what I found was that the sort of average gross margin is around 100 basis points, and it didn't move significantly over the next couple of quarters. And again, I think it's just because it's a part of a much larger portfolio. Now, of course, a big question is what kind of gross margin will we be replacing those maturing pools with in the coming quarters? I noticed that you used some colorful language, Jaeme, in your quick take to describe our mortgage spreads as off the lease this quarter. I think that you were probably referring to -- what's that?

I don't know my language.

Okay. Well, it was in -- at least it was in the National Bank quick take. But anyway, I think it might have been referring to the table that Rob produces in the MD&A, which simply captures on the last day of the quarter, the insured mortgage coupon versus the prevailing 5-year Government of Canada bond. And certainly, that was lower when it was measured than it was at the same time in the last quarter. But for what it's worth, over the entire quarter, the day-to-day-to-day average mortgage coupon versus the prevailing exit strategy of a fully priced NHA-MBS yield was actually right on target. So the last 5 years, that spread of insured mortgage coupon to MBS yield has been 98 basis points. And in Q1, all of our insured mortgage originations day-over-day-over-day compared to the daily MBS yields was 97 basis points. So, I don't think the new origination spreads are quite as dire as they were perhaps thought to be.

Understood on that point. I guess there's still also a factor from the hedging and when the mortgages are actually placed. So is that fair?

That is absolutely right. Yes. So it makes it difficult to know with great precision because there's the accretion of new issue discounts on the MBS pool price when they were issued. There's the outstanding gains and losses that have been amortizing. There's the idea that, yes, there were hedge and losses incurred at the time of origination 5 years ago that were incurred during the commitment period that were expensed at the time. It did not form part of the capitalized amounts being amortized into NIM. So it is difficult to predict with perfect precision what's going to happen as those old pools run off. But from what I can see with full transparency and clarity in terms of that gross margin, I'm not expecting anything significant.

I'll take an opportunity maybe just to address -- I'm just going to address one other thing. And Jaeme, I'm not dumping it on you, but you did comment on how servicing missed big in the quarter. I would say this about servicing because, again, I don't think you guys get the benefit of the details in our reporting. But when I think about our servicing, not just residential, but commercial, there's really 2 parts to it or 3 parts. There's core servicing, which is core business activities, the fees we receive from both the borrowers and from our investors who purchase mortgages from us. And those core servicing activities were up 7% in the quarter compared to the same quarter last year.

As Rob mentioned, we do include our third-party underwriting fees as part of that servicing line. Those were the most significant piece of the year-over-year change, combined with the fact that prevailing interest rates are so much lower that the passive float interest we earn on those collections in the servicing book were lower as well. So, I mean, again, that will persist for a couple of quarters while rates are lower. But the core business of servicing has certainly grown as expected with MUA. And while we're -- overall, we would have liked to have seen better bottom line numbers this quarter, this business continues to be a function of growth in originations, renewals and growth of MUA, which will drive a persistent growth in servicing revenue and net interest income going forward. So generally speaking, I think we feel much more positive about the quarter than may have otherwise been perceived out there. And that's it.

There are no further questions at this time. I'd like to turn the call over to Mr. Jason Ellis for closing comments. Sir, please go ahead.

All right. Thank you, operator. We look forward to hosting our Virtual Annual Meeting of Shareholders on May 13 and reporting our second quarter results in July. Thank you for participating, and have a good day.

This concludes today's conference call. Thank you very much for your participation. You may now disconnect.