In the ever-evolving world of Canadian finance, First National Financial’s second-quarter results for 2024 offer a fascinating glimpse into the current state of the mortgage industry. Despite facing headwinds in single-family originations, the company has shown resilience and adaptability, particularly in its commercial lending sector. Let’s dive deep into the numbers, trends, and insights that define First National’s performance in Q2 2024 and explore the broader implications for Canada’s mortgage market.

The Big Picture: A Mixed Bag of Results

First National’s Q2 2024 results paint a picture of a company navigating through changing market dynamics. Here’s a quick overview of the key metrics:

These numbers tell a story of contrasts. While single-family originations saw a significant drop, commercial lending experienced robust growth. The overall growth in mortgages under administration suggests that First National is successfully navigating the challenges of the current market.

Single-Family Originations: A Challenging Landscape

The 17% year-over-year decline in single-family originations is one of the most striking aspects of First National’s Q2 results. Several factors contributed to this downturn:

1. Increased market competition: The return of major players like Scotiabank to more aggressive lending practices has intensified competition in the mortgage space. This shift has led to a redistribution of market share among lenders.
2. Comparison to an exceptional Q2 2023: Last year’s second quarter saw “surprisingly strong” activity due to unique market conditions, including a temporary reduction in rates and the absence of a significant competitor. This made the year-over-year comparison particularly challenging.
3. Interest rate environment: While the Bank of Canada initiated a quarter-point rate cut in June, its impact on stimulating the housing market was limited in Q2. The psychological effect of higher rates continued to influence borrower behavior.
4. Borrower psychology: The uncertainty surrounding interest rates and the broader economy has made some potential homebuyers more cautious, potentially delaying their decisions to enter the market or take on new mortgages.

Despite these challenges, it’s worth noting that Q2’s single-family originations were still up 74% from Q1 2024, indicating a seasonal uptick in activity. This suggests that while the market faces headwinds, there’s still underlying demand for mortgages.

Strategies for Addressing Single-Family Challenges

To address the challenges in the single-family sector, First National and other lenders might consider:

• Enhancing product offerings: Developing innovative mortgage products that cater to the current market conditions and borrower needs.
• Improving customer experience: Investing in technology and processes to streamline the mortgage application and approval process.
• Targeted marketing: Focusing on segments of the market that may be underserved or have unique needs in the current environment.
• Strengthening broker relationships: As competition intensifies, maintaining strong relationships with mortgage brokers becomes even more crucial.

Commercial Lending: A Bright Spot in the Portfolio

In contrast to the single-family sector, First National’s commercial lending business shone brightly in Q2 2024:

• 35% year-over-year growth in commercial originations, including renewals
• Total commercial originations reached $5 billion for the quarter
• Driven by increasing demand for insured multi-family financing

This strong performance in commercial lending helped offset the challenges in the single-family sector and contributed significantly to the overall growth in mortgages under administration.

Factors Driving Commercial Lending Growth

Several factors have contributed to the robust growth in First National’s commercial lending portfolio:

1. CMHC Program Refinements: In June 2024, CMHC made refinements to some of its programs, leading to an increase in application volumes for commercial mortgages.
2. Canada Mortgage Bond Program: An increase in funding available from this program has provided additional support for commercial lending activities.
3. GST Removal for New Construction: This change has stimulated activity in the new construction sector, particularly for multi-family projects.
4. Demand for Multi-Family Housing: Ongoing urbanization trends and housing affordability issues have maintained strong demand for multi-family properties, driving financing needs.
5. First National’s Market Position: The company has maintained its position as a profitable market leader in the multi-unit space, despite increased competition.

Outlook for Commercial Lending

First National expects commercial originations in Q3 2024 to surpass the $3.3 billion seen in Q3 2023. This optimistic outlook is based on:

• Continued strong demand for multi-family properties
• Ongoing support from government programs and policies
• First National’s established reputation and expertise in the commercial lending space

However, the company also notes that increased competition in the multi-unit space has impacted available spreads, highlighting the need for continued efficiency and strategic pricing.

Mortgages Under Administration: Steady Growth Continues

Despite the headwinds in single-family originations, First National’s total mortgages under administration grew by 8% compared to Q2 2023, reaching $148.2 billion. This growth demonstrates the company’s ability to expand its portfolio even in challenging market conditions.

The increase in mortgages under administration is particularly noteworthy because it:

1. Provides a stable base for ongoing servicing revenue
2. Demonstrates the company’s ability to retain existing customers
3. Reflects the cumulative impact of strong originations in both single-family and commercial sectors over time

Looking Ahead: Cautious Optimism for H2 2024

First National’s leadership, including President Jason Ellis, expressed cautious optimism for the second half of 2024. Here are some key points to consider:

• Potential market stimulation: Subsequent interest rate cuts by the Bank of Canada could lead to increased activity in the housing market. The psychological impact of lower rates might encourage more borrowers to enter the market or refinance existing mortgages.
• Positive early indicators: New single-family commitments in July were higher than the same month last year, though it’s too early to call this a definitive trend. This uptick could signal a potential recovery in the single-family sector.
• Continued strength in commercial lending: The company expects commercial originations in Q3 2024 to surpass the $3.3 billion seen in Q3 2023, building on the strong performance in Q2.
• Seasonal factors: The typically busier fall season for real estate could provide a boost to mortgage activity in both single-family and commercial sectors.

Challenges and Opportunities in the Current Market

Market Competition and Pricing Pressures

The return of major players to aggressive lending practices has intensified competition in the mortgage market. This has led to:

• Pressure on spreads for residential mortgages
• Increased incentives being paid to mortgage brokers
• Potential moderation of these aggressive practices in the near future

First National noted that while spreads on residential mortgages are under pressure, the most significant source of this pressure has been the additional incentives being paid to mortgage brokers. This suggests that lenders are competing not just on rates, but also on their relationships with the broker community.

Alternative Lending: Excalibur Portfolio

First National’s alternative lending portfolio, Excalibur, has also faced challenges:

• Volumes decreased similarly to prime products
• Higher interest rates have made it more difficult for borrowers to qualify in the non-prime space

The performance of the Excalibur portfolio highlights the broader challenges facing the alternative lending sector in Canada. As interest rates have risen, the affordability challenges for non-prime borrowers have become more acute, leading to reduced demand for these products.

Mortgage Arrears: A Sign of Financial Health

Despite economic pressures, First National’s borrowers are showing resilience:

• 90-day arrears represent just 8 basis points of the prime book (up slightly from 7 basis points in Q1 2024 and 5 basis points a year ago)
• The historical tendency toward five-year mortgage terms has benefited prime borrowers
• Alt-A products (Excalibur) show higher arrears rates due to shorter terms, but virtually no realized loan losses in Q2

These low arrears rates are a positive sign for First National and the broader Canadian mortgage market. They suggest that despite higher interest rates and economic uncertainties, most borrowers are still able to meet their mortgage obligations.

However, First National is taking a prudent approach by continuing to accumulate provisions for credit losses, which have not been released into income. This conservative stance reflects an awareness of potential future risks in the market.

Diversification and Growth Strategies

Third-Party Underwriting Services

First National has been expanding its services beyond direct lending:

• New underwriting partnership with BMO, which re-entered the broker channel in January 2024
• Growing underwriting and fulfillment platform for third-party lenders

This diversification into third-party services represents an important strategic move for First National. By leveraging its expertise in underwriting and fulfillment, the company can generate additional revenue streams and strengthen its position in the mortgage ecosystem.

The partnership with BMO, in particular, demonstrates First National’s ability to work with major financial institutions and adapt to changing market dynamics. As more lenders potentially enter or re-enter the broker channel, First National’s third-party services could become an increasingly important part of its business model.

Focus on Commercial Lending

The company’s strong performance in commercial lending is supported by several factors:

• Refinements to CMHC programs in June 2024 led to increased application volumes
• Increased funding available from the Canada Mortgage Bond Program
• Removal of GST for new construction
• First National remains a profitable market leader in the multi-unit space despite increased competition

The success in commercial lending highlights the importance of diversification in First National’s business model. By maintaining a strong presence in both single-family and commercial lending, the company can better weather fluctuations in different segments of the market.

The Broader Economic Context

To fully understand First National’s performance, it’s crucial to consider the broader economic environment:

1. Interest Rate Trajectory: The Bank of Canada’s decisions on interest rates will continue to play a significant role in shaping the mortgage market. While a quarter-point cut was implemented in June, the impact of future rate decisions will be closely watched.
2. Housing Market Dynamics: Factors such as housing supply, affordability, and regional variations will impact demand for mortgages. The ongoing challenges in housing affordability in major urban centers could continue to influence borrower behavior and lending patterns.
3. Regulatory Environment: Any changes to mortgage rules or lending guidelines could affect First National’s operations and the broader market. Policymakers’ responses to housing market challenges and economic conditions will be important to monitor.
4. Economic Recovery: The pace and nature of Canada’s economic recovery from recent challenges will influence borrower behavior and lending patterns. Factors such as employment rates, wage growth, and overall economic stability will play crucial roles.
5. Global Economic Factors: International economic conditions, trade relationships, and global financial markets can indirectly impact Canada’s mortgage market through their effects on the broader economy and interest rates.
6. Demographic Trends: Factors such as population growth, immigration patterns, and the aging of the population will continue to shape long-term demand for housing and mortgages.

Strategies for Success in a Changing Market

Given the current landscape, here are some strategies that mortgage lenders like First National might consider:

1. Diversification: Continuing to balance single-family and commercial lending can help mitigate risks associated with market fluctuations. Exploring new market segments or geographical areas could also provide growth opportunities.
2. Technology Investment: Enhancing digital capabilities to streamline processes and improve customer experience. This could include advanced analytics for risk assessment, automated underwriting systems, and improved customer-facing platforms.
3. Risk Management: Maintaining robust credit assessment practices while adapting to changing market conditions. This includes staying vigilant about potential economic risks and adjusting lending criteria as needed.
4. Partnership Development: Exploring new partnerships, like the BMO underwriting agreement, to expand service offerings. This could include collaborations with fintech companies, other financial institutions, or real estate services providers.
5. Product Innovation: Developing new mortgage products that cater to evolving borrower needs and market conditions. This might include products designed for specific demographics, such as first-time homebuyers or retirees, or products that address unique market challenges.
6. Talent Development: Investing in employee training and development to ensure the workforce is equipped to handle evolving market conditions and technological advancements.
7. Sustainability Focus: Incorporating environmental, social, and governance (ESG) considerations into lending practices and corporate strategy to align with growing investor and consumer preferences.
8. Customer Education: Providing resources and tools to help borrowers navigate the complexities of the mortgage market, particularly in a changing interest rate environment.

Conclusion: Resilience in the Face of Change

First National’s Q2 2024 results demonstrate the company’s ability to navigate a complex and challenging mortgage landscape. While single-family originations have faced headwinds, the strong performance in commercial lending and overall growth in mortgages under administration highlight the benefits of a diversified approach.

The company’s cautious optimism for the second half of 2024 reflects a realistic assessment of both the challenges and opportunities in the current market. The potential for increased activity due to interest rate cuts, combined with the ongoing strength in commercial lending, provides a foundation for potential growth.

However, First National and other lenders in the Canadian mortgage market will need to remain agile and responsive to changing conditions. The interplay of interest rates, housing market dynamics, regulatory changes, and broader economic factors will continue to shape the industry landscape.

For borrowers, the evolving market conditions may present both challenges and opportunities. While higher interest rates have impacted affordability, potential rate cuts and innovative mortgage products could open new possibilities for homeownership or refinancing.

As the Canadian mortgage market continues to evolve, companies like First National will need to leverage their strengths while adapting to new realities. The ability to balance risk management with growth opportunities, invest in technology and talent, and respond to changing customer needs will be key to success in this dynamic environment.

For industry observers, policymakers, and market participants, First National’s Q2 2024 results provide valuable insights into the current state of Canada’s mortgage market. As we move into the second half of the year, all eyes will be on how these trends develop and how they shape the future of housing finance in Canada.

In this complex and ever-changing landscape, staying informed, adaptable, and focused on long-term sustainability will be crucial for success. The coming months promise to be an interesting and potentially transformative period in Canada’s mortgage market, with implications that extend far beyond the financial sector to impact the broader economy and society as a whole.

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