Gateway Mortgage Investment Corp. Financial Statements December 31, 2011

Transcription

1 Financial Statements December 31, 2011

2 Management's Responsibility To the Shareholders of Gateway Mortgage Investment Corp.: Management is responsible for the preparation and presentation of the accompanying financial statements, including responsibility for significant accounting judgments and estimates in accordance with Canadian generally accepted accounting principles. This responsibility includes selecting appropriate accounting principles and methods, and making decisions affecting the measurement of transactions in which objective judgment is required. In discharging its responsibilities for the integrity and fairness of the financial statements, management designs and maintains the necessary accounting systems and related internal controls to provide reasonable assurance that transactions are authorized, assets are safeguarded and financial records are properly maintained to provide reliable information for the preparation of financial statements. The Board of Directors is composed of management of the Company, as well as Directors who are neither management nor employees of the Company. The Board is responsible for overseeing management in the performance of its financial reporting responsibilities. The Board fulfils these responsibilities by reviewing the financial information prepared by management and discussing relevant matters with management and external auditors. The Board is also responsible for recommending the appointment of the Company's external auditors. MNP LLP, an independent firm of Chartered Accountants, is appointed by the shareholders to audit the financial statements and report directly to them; their report follows. The external auditors have full and free access to, and meet periodically and separately with, both the Board and management to discuss their audit findings. April 23, 2012 signed "Stan Galbraith" Stan Galbraith, Secretary/Treasurer signed "David Paruk" David Paruk, Administration Manager

3 Independent Auditors Report To the Shareholders of Gateway Mortgage Investment Corp.: We have audited the accompanying financial statements of Gateway Mortgage Investment Corp., which comprise the balance sheets as at December 31, 2011 and 2010, and the statements of earnings, comprehensive income and retained earnings and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management s Responsibility for Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditors' Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of Gateway Mortgage Investment Corp. as at December 31, 2011 and 2010 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Edmonton, Alberta April 23, 2012 Chartered Accountants Suite 400, Avenue NW, Edmonton, Alberta, T5J 0H8, Phone: (780) , 1 (800)

4 Balance Sheet As at December 31, Assets Current Cash and cash equivalents 2, ,681 Rental income receivable 5,700 - Interest receivable (Note 3) 286, , , ,710 Mortgages (Note 3), (Note 7) 12,134,467 15,006,270 Property held for resale (Note 4) 6,503,057 1,385,354 Due from related parties (Note 7) 1,912,421-20,844,647 16,750,334 Liabilities Current Bank indebtedness (Note 5) 2,145,000 2,095,000 Accounts payable and accruals 1, Dividends payable 38,849 33,834 Prepaid interest 47,573 45,780 2,232,530 2,174,875 Shareholders' Equity Share capital (Note 6) 18,324,550 14,536,870 Retained earnings 287,567 38,589 Approved on behalf of the Board signed "Stan Galbraith" Stan Galbraith, Secretary/Treasurer 18,612,117 14,575,459 20,844,647 16,750,334 The accompanying notes are an integral part of these financial statements 1

5 Statement of Earnings, Comprehensive Income and Retained Earnings Revenue (Note 3) 2,041,384 1,604,313 Expenses Investor relation fees (Note 7) 332, ,994 Interest and bank charges 83,979 31,059 Property management 48,321 19,630 Professional fees 23,408 19,845 Bad debts 17, ,012 Legal fees 14,967 14,405 Securities compliance 13,284 16,068 Software 91 3, , ,050 Net earnings and comprehensive income 1,507, ,263 Retained earnings, beginning of year 38, Dividends (Note 9) (1,258,762) (958,672) Retained earnings, end of year 287,567 38,589 The accompanying notes are an integral part of these financial statements 2

6 Statement of Cash Flows Cash provided by (used for) the following activities Operating activities Cash received from customers 1,742,926 1,239,420 Cash paid to suppliers (99,222) (72,726) Cash paid for investor relation fees (Note 7) (332,443) (246,994) Interest paid (83,979) (31,059) 1,227, ,641 Financing activities Issue of common shares (Note 6) 4,516,397 5,915,787 Redemption of common shares (Note 6) (728,717) (801,076) Dividends (1,253,751) (940,413) Advances to related parties (Note 7) (1,717,463) - Advances from related parties (Note 7) 2,500,000-3,316,466 4,174,298 Investing activities Purchases related to property held for resale (3,372,239) (931,521) Proceeds on disposition of property held for resale - 1,036,682 Funding of mortgages (Note 3) (2,727,008) (10,316,691) Repayment of mortgages (Note 3) 1,407,224 2,032,951 (4,692,023) (8,178,579) Decrease in cash resources (deficiency) (148,275) (3,115,640) Cash resources (deficiency), beginning of year (1,994,319) 1,121,321 Cash deficiency, end of year (2,142,594) (1,994,319) Cash deficiency is composed of: Cash and cash equivalents 2, ,681 Bank indebtedness (2,145,000) (2,095,000) (2,142,594) (1,994,319) The accompanying notes are an integral part of these financial statements 3

7 1. Nature of operations Gateway Mortgage Investment Corp. (the "Company") was incorporated under the laws of the Business Corporations Act of the Province of Alberta on May 10, The Company's principal business activity is mortgage lending for residential and commercial properties. The Company is a mortgage investment corporation and is deemed to be a public corporation under the Income Tax Act. The investment objective of the Company is, with a primary focus on capital preservation, to acquire and maintain a diversified portfolio of mortgage loan investments, which generate income allowing the Company to pay monthly distributions to shareholders at the highest possible return. 2. Significant accounting policies The financial statements have been prepared in accordance with Canadian generally accepted accounting principles and include the following significant accounting policies: Basis of presentation The Company is an investment company as defined in Accounting Guideline 18, Investment Companies. As a result, mortgage investments, investments and property held for resale are recorded at fair value, except where a controlling interest in another investment company exists and the Company is involved in the day-to-day management of the investee. Any changes in the fair value are recorded in the statement of earnings, comprehensive income, and retained earnings. Revenue recognition Interest on investments is recorded on the accrual basis except when a loan is considered to be non-performing. Interest income on non-performing loans is recognized on a cash basis but only after any specific provision for impairment has been recovered, and provided there is no further doubt as to the collectability of the principal amount. Revenue from the sale of foreclosed properties is recorded when title has transferred and collectibility is reasonably assured. Cash and cash equivalents Cash and cash equivalents include balances with banks. Mortgages Mortgages are recorded at estimated fair value with changes in fair value reflected in net earnings and comprehensive income in accordance with Accounting Guideline 18 and CICA Section 3855 Financial Instruments - Recognition and Measurement. When in management's opinion collection of principal on a particular mortgage is no longer reasonable assured, the fair value of the mortgage is reduced to the estimated net realizable recovery from the collateral securing the mortgage loan. A realized change in the fair value of a mortgage as a result of a disposition or repayment is recorded as a realized fair value adjustment. Property held for resale The Company hold title to property acquired through the foreclosure process and these properties are measured at fair value in accordance with Accounting Guideline 18, Investment Companies, where fair value is estimated as the net realizable value of the properties. 4

8 2. Significant accounting policies (Continued from previous page) Financial instruments Held for trading: The Company has designated cash and cash equivalents, interest receivable, rental income receivable, and mortgages on initial recognition as held for trading in accordance with its risk management strategy, as doing so allows the Company to eliminate or significantly reduce a measurement or recognition inconsistency; as the instruments are evaluated on a fair value basis in accordance with the Company s documented risk management strategy and reported to key management personnel on that basis; etc. The Company's held for trading instruments are initially recognized at their fair value. Transactions to purchase or sell these items are recorded on the settlement date., and transaction costs are immediately recognized in earnings. Net gains and losses arising from changes in fair value are recognized immediately in net earnings and comprehensive income. Other financial liabilities: The Company has classified the following financial liabilities as other financial liabilities: bank indebtedness, accounts payable and accruals, and dividends payable. These liabilities are initially recognized at their fair value. Transactions to purchase or sell these items are recorded on the settlement date, and transaction costs directly attributable to their issue are included in the fair value cost of these liabilities, while transaction costs arising from their disposal are immediately recognized in income. Total interest expense, calculated using the effective interest rate method, is recognized in net earnings and comprehensive income. Comprehensive income Comprehensive income includes all changes in equity of the Company, except those resulting from investments by owners and distributions to owners. Comprehensive income is the total of net earnings and other comprehensive income. Other comprehensive income comprises revenues, expenses, gains and losses that, in accordance with Canadian generally accepted accounting principles, require recognition, but are excluded from net earnings. The Company does not have any items giving rise to other comprehensive income, nor is there any accumulated balance of other comprehensive income. All gains and losses, including those arising from measurement of all financial instruments have been recognized in net earnings for the year. Fair value measurements The Company classifies fair value measurements recognized in the balance sheet using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1: Quoted prices (unadjusted) are available in active markets for identical assets or liabilities; Level 2: Inputs other than quoted prices in active markets that are observable for the asset or liability, either directly or indirectly; and Level 3: Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions. Fair value measurements are classified in the fair value hierarchy based on the lowest level input that is significant to that fair value measurement. This assessment requires judgment, considering factors specific to an asset or a liability and may affect placement within the fair value hierarchy. 5

9 2. Significant accounting policies (Continued from previous page) Mortgage Investment Corporation ("MIC") eligibility criteria To qualify as a MIC for Canadian income tax purposes the Company must comply with the following: i) At least 50% of the Company's assets must consist of residentially oriented mortgages and/or cash; ii) The Company's only business activity is investing funds of the corporation and not managing or developing any real property; iii) The Company must not hold any investments secured by real property situated outside Canada; iv) The Company must be a Canadian corporation; v) The cost of real property, except real property assumed through foreclosure, cannot exceed 25% of the cost of its property; and vi) No shareholder may own more than 25% of the issued shares of any class and the Company must have at least 20 shareholders. In the opinion of management, these requirements have been met. Income taxes The Company is a MIC under the Income Tax Act and as such, is permitted to deduct from income for tax purposes dividends paid to shareholders during the year and within 90 days thereafter. The Company intends to continue conducting its affairs in such a manner as to continue qualifying as a MIC and pay dividends to its shareholders to ensure that it will not be subject to income taxes. Accordingly, for financial statement reporting purposes, the tax deductibility of the Company's distributions results in the Company being effectively exempt from taxation and no provision for current or future income taxes is required for the Company. Measurement uncertainty (use of estimates) The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Interest receivable and mortgages are stated after evaluation as to their collectability and are recorded at their estimated fair value. The estimation of fair value is made at a specific point, given current relevant market information and expected cash flows. Property held for resale is stated at fair value which is estimated by its net realizable value. The estimate of net realizable value is made at a specific point in time, given current relevant market information. These estimates are subjective and involve uncertainties and judgments. These estimates and assumptions are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Changes to the underlying assumptions and estimates or legislative changes in the near term could have a material impact on the provision recognized. 6

10 2. Significant accounting policies (Continued from previous page) Recent accounting pronouncements Adoption of International Financial Reporting Standards The Accounting Standards Board of the Canadian Institute of Chartered Accountants has confirmed that International Financial Reporting Standards ( IFRS ) will replace current Canadian GAAP for fiscal years beginning on or after January 1, 2011, for publicly accountable enterprises, such as investment funds and other reporting issuers. In December 2011, the AcSB announced amendments which will provide investment companies with the option to defer adoption of IFRS until fiscal years beginning on or after January 1, As a result of the amendments, the Company will adopt IFRS at the earliest beginning January 1, 2014, and will issue its first annual financial statements in accordance with IFRS, including comparative IFRS information for the previous fiscal year, for the year ending December 31, The Company is evaluating the potential impact of adopting IFRS on its financial statements and is developing a changeover plan to adopt the standards. The key elements of the plan include assessing the impact of adopting IFRS on: Accounting policies; IT and data systems; Internal controls over financial reporting; Disclosure controls and procedures; and Business activities as well as matters that may be influenced by GAAP measures (such as debt covenants and capital requirements). The changeover plan is still in the early stages and, as such, the impact of adopting IFRS on the Company s financial reporting is not reasonably determinable. 3. Mortgages and interest receivable Investment risk management Risk management relates to the understanding and active management of risks associated with all areas of the operations and the associated operating environment. Investments are primarily exposed to market, interest rate, and credit risk. Market risk is the risk that the value of an investment will fluctuate as a result of changes in market prices whether those changes are caused by factors specific to the investment, or factors affecting all securities traded in the market. The Company mitigates this risk by charging interest rates which are significantly above normal banking rates. There is also market risk in the event of a default on a mortgage. The Company secures its investments through holding first, second, and occasionally third mortgages. The risk is that the property could drop in value. The Company protects itself from this risk by ensuring that the assessed value of the property is 20-50% higher than the amounts loaned, unless otherwise approved by the Directors. Interest rate risk refers to the effect on interest income from investments due to fluctuations of interest rates. The Company mitigates interest rate risk by entering into fixed interest investments and committing to only one year terms. Credit risk is the risk that a party to a mortgage will fail to fully honour its financial obligation. The Company is subject to significant concentration of credit risk. Investments consist of first, second and third mortgages with fixed interest rates ranging from 5-18%. The Company manages credit risk through risk management policies and procedures that emphasize the quality and diversification of its investments. The Company protects itself from credit risk by securing the investment against real property. The Company will not lend out more than 75% on mortgages, unless otherwise approved by the Directors. In the event that a loan is considered impaired, the accrual of interest is discontinued. In the event that the carrying amount of the loan exceeds the estimated realizable value, the loan is written down to the realizable valuable. During the year, $17,151 of mortgages were written off ( $257,012) as they are no longer collectible. At year end, there was interest receivable of $286,596 ( $258,029), all of which is considered collectible. The collection of interest receivable is included in the cash receipts from customers on the cash flow statement. 7

11 3. Mortgages and interest receivable (Continued from previous page) A reconciliation of mortgages is as follows: Mortgages, beginning of year 15,006,270 6,722,530 Funding of mortgages 2,727,008 10,316,691 Unrealized interest income adjustment on mortgages 248,835 - Repayment of mortgages (1,407,224) (2,032,951) Transfers to property held for resale (2,541,464) - Transfer to due from related parties (1,898,958) - 12,134,467 15,006,270 Presently there are 45 ( ) mortgages, all fixed rate. The weighted average interest rate of the portfolio is 10.02% ( %). 4. Property held for resale Property held for resale consists of 11 (2010-3) foreclosed properties, which consist of residential and condominium complexes. The Company capitalizes all maintenance, foreclosure, pre-development costs, borrowing costs, occupancy costs, and property taxes with the intention of recovering the costs upon subsequent sale of the property. When a specific property's fair value is less than the carrying value, a fair market value adjustment is made. A property's fair value is estimated by net realizable value based on current listings, appraisals, and other relevant market information less selling costs. The estimates of net realizable value of real estate assets are made at a specific point in time, given current relevant market information. These estimates are subjective and involve uncertainties and judgment. 5. Bank indebtedness Bank indebtedness consists of an interest only repayment, overdraft facility with a maximum limit of $3,000,000 ( $3,000,000) and bears interest at Toronto-Dominion Bank prime plus 1.25% ( prime plus 1.25%). The Toronto- Dominion bank overdraft facility is secured by a general security agreement ("GSA") representing a first charge on all the borrower's assets and undertaking, registered in British Columbia and Alberta, as well as a general hypothecation of collaterals. Covenants have been disclosed in Note 10. 8

12 6. Share capital Authorized Issued Common shares Unlimited number of Class A voting shares Unlimited number of Class B non-voting shares Redeemable preferred shares Unlimited number of Class C non-voting shares Common shares 4,000 Class A voting shares ,324,150 Class B non-voting shares ( ,536,870) 18,324,150 14,536,470 18,324,550 14,536,870 During the year, the Company issued 4,516,397 (2010-5,915,787) Class B shares for cash consideration of $4,516,397 ( $5,915,787). Of the shares issued, $821,116 ( $629,399) of the cash consideration came from reinvested dividends from shareholders. The Company also redeemed 728,717 ( ,076) Class B shares in the year for cash consideration of $728,717 ( $801,076). 7. Related party transactions The Company has an agreement with Gateway Capital Inc., a company under control of directors of the Company to provide investor relation services. Based on this agreement, Gateway Capital Inc. can charge the Company up to 3% annually based on the value of the assets of the Company. Investor relation fees of $332,443 ( $246,994) were paid to Gateway Capital Inc. during the year. As at December 31, 2011, $4,415,875 ( $3,579,547) of mortgages were receivable from Cypress Hills Management Company ( Cypress Hills ) and Alberta Ltd. ( ), wholly owned subsidiaries of Gateway Capital Inc. These amounts are secured by the properties held by Cypress Hills and , bear interest at 5.70% ( %) and have no specified terms of repayment. Cypress Hills and have each entered into separate trust agreements with the Company by which Cypress Hills and hold the properties in trust for the Company, with all of the costs and profits of Cypress Hills and to be distributed to the Company. As at December 31, 2011, $1,912,421 ( $nil) was due from Cypress Hills and for additional costs incurred on the properties held by Cypress Hills and These amounts are secured by the assets under the trust agreements, non-interest bearing and have no specified terms of repayment. Included in this amount was $796,000 in property transferred from the Company to the Cypress Hills and in the current year. The transfer was recorded as an increase in the due from related parties balance and consequently the non-cash transaction was not recorded in the statement of cash flows. As at December 31, 2011 the carrying value of the properties held in Cypress Hills and is $8,828,296 ( $3,579,547). Aside from the amounts owing to the Company, Cypress Hills and also have a demand loan from a third party for $2,500,000 ( $nil) which is secured by specific properties held by Cypress Hills and These transactions are incurred in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. 9

13 8. Financial instruments The Company as part of its operations carries a number of financial instruments. It is management's opinion that the Company is not exposed to significant interest, currency, credit, liquidity, market or other price risk arising from these financial instruments except as otherwise disclosed. Interest rate risk Interest rate risk is the risk that the value of a financial instrument might be adversely affected by a change in the interest rates. Changes in market interest rates may have an effect on the cash flows associated with some financial assets and liabilities, known as cash flow risk, and on the fair value of other financial assets or liabilities, known as price risk. The Company is exposed to interest rate risk with respect to bank indebtedness, which is expected to be realized within one year, and which is subject to floating interest rates of prime plus 1.25% (2010 prime plus 1.25%). The interest rate risk on bank indebtedness is not considered significant. A 1% change in interest rates relating to bank indebtedness could increase interest expense by approximately $21,450 ( $20,950) if the operating loan was fully drawn upon. Liquidity risk Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities. The Company has drawn on its line of credit in order to fund investments, for which repayment is required. Liquidity risk is measured by reviewing the Company s future net cash flows for the possibility of a negative net cash flow. The Company manages the liquidity risk resulting from bank indebtedness by ensuring cash from operations is sufficient to meet operating needs as well as raising equity for investing purposes instead of relying on bank indebtedness for investing activities. Mortgages typically are relatively illiquid, where liquidity is dictated by the market economics of supply and demand and desirability of the investment. This could limit the Company's ability to liquidate its mortgages and property held for resale, or result in proceeds to the Company being less than the total value of the investments. The result may be that the Company would face risks associated with debt financing, including the risk that the mortgages secured by properties held for resale of the Company will not be able to be refinanced or that the terms of re-financing will not be as favourable as the terms of the existing mortgages. Fair value of financial instruments The carrying amount of cash, rental income receivable, interest receivable, mortgages, due from related parties, bank indebtedness, accounts payable and accruals and dividends payable is approximated by their fair value due to their shortterm nature or the underlying interest rates approximating the prevailing market rates. Cash is recorded using level 1 fair value techniques and mortgages, rental income receivable, interest receivable and due from related parties are recorded using level 3 fair value techniques. There was no transfer between levels 1 and 3 from December 31, 2010 to December 31, Income taxes During the year, the Company deducted the following dividends for tax purposes: Net earnings 1,507, ,263 Dividends declared in the year (1,258,762) (958,672) Dividends declared in the current year, deducted for tax purposes in prior year 38, Dividends declared after year end, deducted for tax purposes in the current year (38,849) (38,589) Unrealized interest income adjustment on mortgages (248,835) - Net income for tax purposes, after deduction of dividends (117) - 10

14 10. Capital risk management The Company manages its capital to ensure that it will be able to continue as a going concern while maximizing the return to shareholders through a suitable debt and equity balance appropriate for an entity of the Company's size and status. The Company's overall strategy remains unchanged from the prior year. The capital structure of the Company consists of equity attributable to common shareholders, comprised of issued capital, retained earnings as well as bank indebtedness from a financial institution. A capital restriction on the Company is a limit on the bank indebtedness for the lesser of $3,000,000 and the total of 75% of the accepted first and second mortgages on residential property and 50% of first mortgages on eligible commercial properties. The Company must also maintain a debt to tangible net worth ratio of no greater than 0.5 to 1.0 and interest coverage of not less than 300% based on a rolling four quarter basis for the most recent four quarters. The Company's investment portfolio is also restricted to no less then 75% residential properties along with maximum amounts on commercial property and residential serviced land, 25% and 15% of the authorized credit limit respectively. The Company must not be in second or lower position on more than 40% of their total portfolio, and second mortgage financing is subject to a maximum of $750,000,000 in total mortgages, including prior charges. Mortgages on commercial properties must be a minimum of 85% leased. The Company is in compliance with all such covenants at December 31, 2011 with the exception of the portfolio restriction that mortgages held on commercial property must not be in excess of 25% of the authorized credit limit. The lender has subsequently provided a written waiver stating that it has waived the Company's requirement for compliance with this covenant for the period ending December 31, It is management's opinion that the Company is likely to become in compliance with all such covenants throughout the next 12 months subsequent to December 31, Correction of an error During the prior year, the Company categorized its mortgages as loans and receivables under CICA 3862 and its property held for resale at amortized cost and did not follow Accounting Guideline 18, Investment Companies, which dictates these assets should be valued at fair value. The Company qualifies as an investment company under Accounting Guideline 18 and therefore should have recorded mortgages and property held for resale at fair value. In the current year, mortgages have been reclassified as held for trading and both mortgages and property held for resale have been recorded at fair value. The retroactive application of this correction of an error did not have a material impact on the financial position, results of operations or the statement of cash flows of the Company. The change only impacted the disclosure of the accounting policies in Note 2 and specific disclosures related to mortgages and property held for resale in Notes 3 and Comparative figures Certain comparative figures have been reclassified to conform with current year presentation. 11