Financial Highlights 2010

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1 Board Report Sandy Shaw Chair, Board of Directors Through the efforts of our dedicated FirstOntario employees, and your Board of Directors, the planned growth for our credit union is well underway. We have weathered some difficult economic times over the past few years and I am proud to say we remain a strong and viable credit union. Our work in Fiscal 2010 was focused on balancing financial achievement with a commitment to our communities and to the core values of the credit union system. In the spring of 2010, we gave our Members the opportunity to share in FirstOntario s continued success by offering Investment Shares. The overwhelming popularity of the sale of these shares spoke volumes for how well our Members feel we are doing. The strength of our credit union can also be seen by the growth in our expanding branch network. This past summer saw the move of our Barton Street branch to the newly refurbished Centre on Barton location. Recently, a new branch was opened on the Hamilton Mountain and there are plans for another in the downtown core, as well as a new branch in Burlington at Upper Middle Road and Walkers Line. As our commitment to supporting the revitalization of our communities and our strategy of growth continues, 2011 will see a key focus on the Niagara Region as we assess the opportunities we believe await us there. Corporate social responsibility is a core value of the credit union system. At FirstOntario, we have a well balanced approach to our support. Through events such as Soupfest in support of youth programs and Walk a Mile in HER Shoes for Gillian s Place a women s shelter, we are proud of our participation in events that help to raise money for such worthy causes. Our corporate donations also play an important role in our overall community investment strategy. By supporting young people through sports programs or the arenas they play in such as in Cayuga, we are giving them an opportunity to learn the life skills that come from team sports. Our donations also assist in keeping local events such as the Norfolk Annual Country Fair alive. Many of these events are the fiber that binds a community together and sustain it over time and we are proud to be a part of it. While social responsibility is mostly thought of as a charitable donation or corporate sponsorship, it can also take the form of a hand up. In May, FirstOntario launched a Micro Loan Program to help new entrepreneurs realize their dream of self-employment and self-sustainment. FirstOntario joined forces with local not-for-profit organizations. These organizations offer business education programs to help individuals gain the business insight and knowledge they need to be successful. Once the programs are complete, and upon recommendation by the not-for-profit organization, the individual is able to apply for a Micro Loan to help launch their new business. By November of this year, we successfully reached our goal for the first phase of this program and we are evaluating the potential for expansion. Growth and innovation seem to always go hand-in-hand and FirstOntario is a prime example of this. In May, FirstOntario received the National Credit Union Innovation Award from Credit Union Central of Canada for the creation of the Community Assistance Program (CAP). This award highlights the role of an individual credit union in creating breakthrough solutions that serve as a model for others. CAP was created in response to our Members need for assistance during the economic downturn. On the heels of this award was the launch of PAT. The Personal Assisted Teller (PAT) is the first of its kind in Canada and a key part of our strategy to expand our branch presence and offer extended hours of service. This too received an innovation award at the Central 1 conference in November, which highlighted the tremendous innovative spirit that drives the credit union system. FirstOntario was one of three credit unions presented with an award at the conference. I m sure you ll agree we ve had a very exciting year! On behalf of the Board of Directors, we would like to thank you for your ongoing support and loyalty. As we make plans for the future, we remain committed to ensuring that we serve the needs of our Members, invest in our communities and show leadership in the credit union system. Thank you.

2 President s Report Kelly McGiffin President & C.E.O. 2 Fiscal 2010 marked the second year in FirstOntario s 5-year strategic plan. Given the current economic climate, our credit union remains very well-positioned for continued success. Fiscal 2010 was a profitable year for FirstOntario, and while not as financially successful as fiscal 2009, when we were able to leverage several stimulus programs offered by the government, we were able to maintain our forward momentum for growth while making strong investments in our future. In 2008, we set out with a strategic plan designed to take advantage of market opportunities within the Golden Horseshoe, one based on an approach toward building volumes, while containing our costs effectively, and focusing on putting our Members and communities first. The past two years of success confirm we are succeeding on that path as we gain traction on growth, while balancing profitability with the major investments required to move FirstOntario forward. Our strategic plan for growth is a bold one. And to show our commitment to growth and revitalizing communities, we recently opened a new branch in South Hamilton Square at the corner of Upper James Street and Rymal Road. We are currently building a new branch at One James Street, in the heart of downtown Hamilton. A third new branch is also under construction at Upper Middle Road and Walkers Line in Burlington, and we will be shifting our current Fairview branch operations to this new location. These new branches will help FirstOntario serve our growing population and provide valuable learning as we assess our ability to serve our Members in Niagara and surrounding regions. All new FirstOntario branches will also feature our groundbreaking Personal Assisted Tellers or PAT for short. FirstOntario made Canadian history and headlines in 2010 with the introduction of PAT. A Personal Assisted Teller is new technology that offers our Members live-video banking, providing the service of a teller with the convenience of a banking machine. Through PAT we are also pleased to be able to offer our Members extended teller service hours and we invite you to drop in and Chat with PAT. While we were busy making Canadian history, FirstOntario was approached by the Deposit Insurance Corporation of Ontario (DICO) to consider purchasing Canal City Savings and Credit Union s operations and taking on their membership portfolio. This acquisition was a good fit for FirstOntario, and this past summer we welcomed approximately 2,300 Members to the FirstOntario family in the Niagara Region. FirstOntario has become well-positioned as a value-driven and principled credit union. We are well-known in the industry for doing the right thing for the right reasons. As we work towards raising the awareness of FirstOntario within our communities, we can continue to expect that other credit unions may approach us as a strategic partner. Like Prime Financial. Prime Financial recently approached us about the possibility of merging. Today, with the full approval of both boards, we are actively engaged in discussions to acquire Prime Financial and make it part of the FirstOntario banner. The acquisition of Prime Financial would bring approximately 6,600 Members into the FirstOntario family and this acquisition will allow us to build on each other s strengths and enhance our ability to help everyone in our communities prosper. While acquisitions are not a focus of our strategic plan, we will continue to remain open to these opportunities as they present themselves. Finally, this past September, we signed a five year collective agreement with the Canadian Office and Professional Employees Union (COPE) Local 343. After only six days of negotiations, three separate COPE agreements were amalgamated into one with unanimous affirmation from union members. This new agreement covers approximately 93 branch employees throughout portions of Southern Ontario and maintains a sustainable relationship between FirstOntario and COPE. We are extremely pleased with this agreement and the collaborative approach taken throughout the negotiation process. This five year agreement is on the heels of an agreement with our CAW partners in the Niagara Region signed in 2008, and both are a testament to the strong relationship we have developed with our union partners on a number of fronts. As the largest unionized financial institution in the province, we have embraced our union position and have become widely regarded as a role model for unionized credit unions. To be considered a role model is truly an honour and the successes of the past year are the result of collaboration, cooperation and determination by everyone at FirstOntario. I would like to sincerely thank all FirstOntario employees. Throughout all this change, our employees have remained strong and engaged, providing the best service to our Members, while still taking the time to support our communities. Special thanks also go to our Board of Directors, who continue to work tirelessly to keep FirstOntario on a course for success. I would also like to thank you, our Members, for your trust, and for your continued support. Together we will realize further successes as we grow and show our communities that where you put your money really does matter!

3 Introduction Fiscal 2010 was the second year of our five-year strategic plan developed in The essence of the strategic plan is to move to a growth strategy to allow FirstOntario to become the financial institution of choice in our communities. We have encountered many challenges since the development of our five-year strategic plan. Despite these challenges, in 2010 we generated solid and sustainable financial results. The following is a chart of pre-tax operating earnings over the past five years. Pre-tax operating earnings exclude unrealized gains and losses that are a result of changes in fair value of certain investments and derivatives required to be reported in earnings. While some of the losses may be realized in the future, management plans to minimize the realization of these losses. 8,000 7,000 Operating Income (in thousands of dollars) During 2010, unrealized investment losses of $0.2 million were excluded from pre-tax operating earnings ( $1.4 million). Unrealized pre-tax investment gains of $0.6 million were included in other comprehensive income in 2010 ( $1.0 million unrealized loss). Funds Under Management At FirstOntario, we exist to help our Members meet their financial needs. We meet our Members credit, deposit and investment needs. A key indicator of our success is the total loans, deposits and investments Members have with us - funds under management ( FUM ). During the year, our funds under management grew 9.6% to $2.5 billion. Members entrusted with us an additional $217.7 million in loans, deposits and investments. Loans are still a significant financial need for our Members with our loan portfolio increasing $156.9 million or 12.7%. This growth in our loan portfolio accounted for more than 72% of our FUM growth. Loans are funded by Member deposits and external funding partners. Members deposits grew by $65.5 million or 6.9%. Finally, our Members mutual fund holdings decreased by $3.8 million or 4.8%. 2,500,000 Funds Under Management (in thousands of dollars) 6,000 2,000,000 5,000 4,000 1,500,000 3,000 1,000,000 2,000 1, , Our 2010 pre-tax operating earnings of $3.4 million was a decrease from 2009 of $4.0 million. The 2010 decrease is mainly attributed to lower mortgage securitization gains partially offset by higher operating margin before other income due to significant loan growth throughout the year Loans* Deposits Mutual Funds *includes securitized loans 3

4 Members Equity In Fiscal 2010, Members equity increased to $77.7 million. A growth of $36.2 million. Growth is primarily due to the issuance of $32.4 million in investment shares during the year as well as net earnings for the year. Due to the difference in the redemption rights of the new investment shares issued in 2010, these shares are reported in Members equity rather than liabilities where the previous investment shares are reported. Net Interest Income By definition, net interest income ( Operating Margin Before the Following line on the Consolidated Statement of Earnings) is the difference between interest paid by Members on loans and income earned on our investment portfolio, minus interest paid to Members on their deposits and interest paid on outside debt obligations. FirstOntario derived over 79% of its gross revenue from net interest income. The ability to grow net interest income is dependent upon growth in Member loans and deposits. Net interest income is impacted by changes in interest rates over time (interest rate risk). FirstOntario strives to manage and minimize interest rate risk, sustaining a high but stable net interest income over a number of years. Net interest income increased by 24%, due to market interest rates, Members borrowing for longer terms than terms for deposits, Members transferring deposit funds to our investment share offering and the decrease in mortgage securitization activity. Net interest income as a percentage of average assets increased from 2.30% in 2009 to 2.56% in In 2010, approximately $27 million in residential mortgages were securitized compared to $246 million in Under generally accepted accounting principles, the sale of residential mortgage loans generates a gain on sale reported in other income rather than net interest income. This decline in securitization activity was a result in changes to the program that effectively closed the securitization program to FirstOntario until September Central 1 is the product of a merger between Credit Union Central of Ontario (CUCO) and Credit Union Central of British Columbia. As a pre-condition of the merger to form Central 1, CUCO was required to divest itself of investments in certain third party asset-backed commercial paper ( ABCP ). In order to comply, a limited partnership ( ABCP LP ) was created and subsequently purchased the ABCP. CUCO Member credit unions were required to hold a proportionate share in the ABCP LP, equal to their investment in CUCO. As a result, FirstOntario in 2008 was required to purchase approximately 6.7 million units in the ABCP LP. As at the year end, the ABCP LP units were being carried at $3.8 million, compared to $4.1 million at the end of The decrease of $0.3 million is a result of capital distributions received from the ABCP LP during the year. Other Income Other income decreased by 50% to $8.4 million in 2010, which equates to a return on average assets of 0.73%. This decrease is primarily attributable to securitization income. Securitization income decreased $8.3 million in 2010 due to a decrease in residential mortgages securitized (as previously discussed) and an increase in the cost of funds associated with our current securitized mortgages. Excluding securitization income, 2010 other income increased by 2.2% over The distribution of our non-interest income sources is depicted in the following chart: In thousands of dollars Income Mix Income Mix Securitization Income $ 8, % $ % Service Charges 3, % 3, % Commissions 1, % 2, % Mortgage & Loan Fees 1, % 1, % Foreign Exchange % % Other % % Total $ 16, % $ 8, % Investment in Affiliates FirstOntario is a member of Central 1 Credit Union whose primary function is to maintain a liquidity pool for use by its Member credit unions. This liquidity arrangement means that a credit union Member s deposits are backed by a larger organization and by the combined strength of a network of approximately 400 affiliated credit unions in Canada. 4

5 Operating Expenses Operating expenses increased by $2.3 million or 7.5% to $33.5 million in The increase in 2010 is mainly attributable to salary and benefits as well as administrative expenses. Salaries and benefit expenses increased by $1.5 million or 8.9%. Salaries decreased by 1.3% during 2010; however this was offset by a $1.7 million increase in benefit expenses over Due to changes in benefit plans that occurred in 2009, a onetime recovery of past expenses amounted to a $1.1 million recovery in After allowing for this recovery in 2009, benefits costs increased by 14.6% in Administrative expenses increased by $0.9 million or 8.3%. Increased costs were experienced in insurance premiums, debit card operations, Central 1 dues and human resources. Investments were made in corporate governance, technology, risk management and marketing to support our growth strategy, while ensuring protection of our Members deposits and equity. Loan Portfolio The following chart summarizes FirstOntario s total loans including on-balance sheet and securitized loans. Growth is the percentage year over year increase and the Portfolio Mix is the ratio of a category to the total loan portfolio. are well secured, on average outstanding loan balances were 39% of the value of security as determined by qualified appraisers. Our continued conservative lending practices have resulted in minimal delinquencies and write-offs over a number of years. Allowance for Impaired Loans The allowance for impaired loans is governed by Board policy and reviewed on an annual basis and approved by the Audit Committee of the Board. The allowance is monitored by Management on a monthly basis with a detailed review on a semi-annual basis. Watch list accounts, delinquencies, credit quality, bankruptcy trends and economic trends are considered during the semi-annual review. The provision for impaired loans is monitored to ensure compliance with Board policy and regulatory requirements. The following is a chart that provides a summary of our allowance for impaired loans, net write-offs (loan write-offs less recoveries), impaired loans and greater than 90 day delinquency. FirstOntario s loan portfolio continues its strong performance due to adherence to conservative lending practices, outperforming industry norms. Total Loan Portfolio (in thousands of dollars) Loan Portfolio Growth Portfolio Mix $1,234,455 $1,391,492 Growth Portfolio Mix Personal Loans 1.7% 10.4% 2.3% 9.4% Residential Mortgage Loans 13.6% 50.8% 20.1% 54.2% Commercial Loans 11.6% 38.8% 5.8% 36.4% Total 11.5% 100.0% 12.7% 100.0% Significant growth was experienced in our residential mortgage loan portfolio due to a focus on building relationships with mortgage brokers. New Members resulting from the mortgage broker channel are then introduced to FirstOntario and the full services we offer. Growth in our commercial loan portfolio moderated in 2010 as we cautiously evaluated new loan opportunities in the current economy. Commercial loans are generally secured by mortgages over lands and buildings. The geographic and industry diversification within the commercial portfolio continues to improve. As at August 31, 2010, 30% ( %) of the on-balance sheet loan portfolio is associated with five of our largest commercial Members. Commercial loans Due to continued slow recovery of the economy, our impaired loans increased to $2.9 million, an increase of $0.9 million. However, after deducting the value of security, our specific allowance for impaired loans only increased by $0.2 million to $0.8 million. Continued on next page. 5

6 Continued from previous page. FirstOntario uses an internal risk rating grid to assess and monitor new loans and our loan portfolio, both retail and commercial. The majority of the retail loan portfolio, 72%, has risk ratings of B or better. The commercial portfolio has 99% of loans rated as Satisfactory or Superior. These measures and the performance of the loan portfolio indicate FirstOntario has a very strong lending operation. Deposit Portfolio FirstOntario grew its deposit base 6.9% in Term deposits grew by 15.7%, Registered plans grew by 1.2%, Chequing grew by 15.6% and Savings increased by 2.1%. Growth in 2010 was impacted by our new investment share offering as many Members transferred funds from their deposits at FirstOntario. When combined, deposits and investments shares grew 10.1% in The average cost of Member deposit declined due to the growth in chequing accounts and continued low market interest rates. Risk Management Enterprise Risk Management The Board of Directors have overall responsibility for the oversight of FirstOntario s risk management. Board policy sets FirstOntario s philosophy to have appropriate and prudent policies, procedures and controls to manage operational risk. The Board s Audit Committee s responsibilities include the development and monitoring of controls to support the enterprise risk management framework. Interest Rate Risk Interest rate risk, is the risk to net interest income associated with changing interest rates on FirstOntario s interest bearing loans and investments and interest bearing deposits and other debt obligations. FirstOntario is required by legislation to measure and manage interest rate risk. FirstOntario complies with this requirement through its Board approved Structural Risk Management policy. FirstOntario uses sophisticated industry standard tools and techniques to aid in monitoring and controlling interest rate risk to within prudent limits. An Asset and Liability Committee, made up of senior Management reviews, interest rate risk on a regular basis. One of the tools used is an income simulation model. The purpose of the model is to simulate the 12 month net interest income of the current mix of business taking into account current and forecasted interest rates (yield curves), growth assumptions on new business (loans and deposits), behaviours of Members (impacted by prepayment assumptions) and competitive pricing conditions. The main form of interest rate risk measurement is the usage of a parallel shock test that is sustained for a twelve-month period. The purpose of the shock test is to have a single test that will replicate many of the unexpected interest rate risks facing the credit union. For this purpose, FirstOntario uses a 1% shock rate. However, depending on market and economic conditions, this shock rate can be amended from time to time. If Management determines that the level of interest rate risk is too high or approaching Board policy limits, various strategies are evaluated and implemented. Some of these strategies are internally focused such as product pricing on loans and deposits while other strategies are external. With respect to external strategies, FirstOntario will engage in the use of interest rate derivatives, primarily where FirstOntario will swap fixed funding for float funding or vice versa. Liquidity Risk FirstOntario is prescribed by the Act to maintain certain levels of liquidity. Under the Regulations, FirstOntario must establish and maintain prudent levels of liquidity that are sufficient to meet its cash flow needs, including deposit withdrawals and all other obligations as they come due. FirstOntario complies with this requirement through its Board approved Liquidity Risk Management policy. The policy addresses limits on the sources, quality and amount of liquid assets to meet normal operations (day to day commitments including Member withdrawals), contingency funding for significant deposit withdrawals and regulatory requirements. The Board s policy requires operational liquidity to be maintained within a range of 8.5% to 16%. Generally our liquidity levels are in the 9% to 11% range thereby allowing FirstOntario to maximize our net interest income returns. On occasion FirstOntario s liquidity levels do drop to the 8.5% to 9% range. When this happens, steps are taken to restore liquidity levels to above 9%. To ensure FirstOntario continually maintains the minimum liquidity levels, management measures and monitors liquidity levels on a daily basis. Management also prepares detailed monthly and three-month cash flow forecasts. If there is any risk of liquidity dropping below 8.5% a plan for corrective action would be developed and implemented. As at August 31, 2010, FirstOntario s liquidity ratio was 9.15%. To ensure FirstOntario has adequate sources of liquidity, Management has developed a liquidity plan, which sets out Continued on next page. 6

7 Continued from previous page. various liquidity sources. Our primary liquidity is derived internally from Member deposits. FirstOntario has three external liquidity sources. These include deposit brokers, securitization of residential mortgage loans through the Canada Mortgage Bond program and sale of commercial mortgage loans through other credit unions and other credit union affiliated partners. As part of our contingency liquidity plan, FirstOntario has available a $100 million operating loan facility with Central 1 Credit Union. At the present time there is $79.0 million in term loans with Central 1. Foreign Exchange Risk FirstOntario provides Members with the opportunity to buy and sell U.S. dollars (cash, cheques, money orders and drafts). In addition, FirstOntario provides Members with U.S. dollar deposits (chequing, savings and short-term deposits). By providing these services, FirstOntario is exposed to foreign exchange risk, which is the risk to income that could result from changes to U.S. currency rates. To measure and control our exposure to U.S. currency risk, FirstOntario tracks the net U.S. position (U.S. dollar assets less U.S. dollar liabilities) on a daily basis. Within our Liquidity Risk Management policy, the maximum U.S. currency exposure FirstOntario can take is $500,000. Management operates on a day-to-day basis at a lower limit of between $200,000 and $300,000. The following chart summarizes FirstOntario s capital position for 2009 and 2010: On both the leverage and risk weighted ratio basis, capital is well in excess of regulatory minimums. In addition, our Tier 1 capital was 95.74% on August 31, 2010 well in excess of regulatory minimum of 50%. Please see our Summarized Consolidated Balance Sheet and Summarized Consolidated Income Statement on page 8. To ensure we maintain our foreign exchange risk to within policy limits, FirstOntario enters into various foreign exchange forward contracts (contract to purchase U.S. dollars in the future at an agreed upon exchange rate). Capital Risk Management Capital is monitored monthly on both a capital leverage and a risk weighted basis. Capital adequacy is assessed during the annual planning process. Future capital requirements are based on planned asset growth and investments in fixed assets. During the year, additional capital of $32.4 million was raised, net of issuance costs, in the sale of additional investment shares. 7

8 Further detailed information on our 2010 financial results can be obtained from our 2010 Financial Reports available online at FirstOntarioCU.com. 8