Global Diversified Investment Grade Income Trust II. Audited Financial Statements December 31, 2015 and 2014 (expressed in Canadian dollars)

Transcription

1 Global Diversified Investment Grade Income Trust II Audited Financial Statements

2 March 23, 2016 Independent Auditor s Report To the Unitholders of Global Diversified Investment Grade Income Trust II (the Trust ) We have audited the accompanying financial statements of the Trust, which comprise the statements of financial position as at and the statements of comprehensive income, changes in net assets attributable to holders of redeemable units and cash flows for the years then ended and the related notes, which comprise a summary of significant accounting policies and other explanatory information. Management s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards, 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. Auditor s 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 auditor s 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. PricewaterhouseCoopers LLP/s.r.l./s.e.n.c.r.l René-Lévesque Boulevard West, Suite 2500, Montréal, Quebec, Canada H3B 4Y1 T: , F: PwC refers to PricewaterhouseCoopers LLP/s.r.l./s.e.n.c.r.l., an Ontario limited liability partnership.

3 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 the Trust as at and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Emphasis of matter Without qualifying our opinion, we draw attention to note 2 to the financial statements, which describes matters and conditions that indicate the existence of a material uncertainty that may cast significant doubt about the Trust s ability to continue as a going concern. 1 CPA auditor, CA, public accountancy permit No. A (2)

4 Statements of Financial Position Note As at 2015 As at 2014 Assets Cash and interest-bearing deposit 7 627, ,472 Short-term investments 2,059,024 2,030,719 Interest receivable on investment and credit default swap receivable 42,108 74,789 Other assets 8 42, ,820 Credit default swap receivable designated at fair value through profit or loss 9 7,614,340 6,752,651 Investment designated at fair value through profit or loss 9 21,165,402 22,333,401 Liabilities 31,550,098 32,281,852 Accounts payable and accrued liabilities 142, ,691 Credit default swap payable 42, ,491 Distributions payable - 187,061 Credit default swap related liability 11 28,779,742 29,006,573 28,964,334 29,552,816 Net assets attributable to holders of redeemable units 13 2,585,764 2,729,036 Number of units outstanding 13 10,392,283 10,392,283 Net assets attributable to holders of redeemable units per unit Basis of presentation and going concern 2 Approved by the Trustee, Global DIGIT II Management Inc. (signed) Claude Dalphond Claude Dalphond, Director (signed) Benoît Deschamps Benoît Deschamps, Director The accompanying notes are an integral part of these financial statements.

5 Statements of Comprehensive Income For the years ended Note Income Interest on investment and credit default swap receivable 570, ,468 Income from credit default swap 1,168,829 4,666,996 Other interest income 34,006 42,795 Losses on investment and credit default swap Change in unrealized depreciation of fair value of the investment and credit default swap receivable (306,309) (446,991) Change in unrealized appreciation (depreciation) of fair value of credit default swap 226,831 (406,092) 1,694,014 4,754,176 Expenses Expenses on credit default swap 880,060 2,774,515 Audit fees 66,398 63,215 Legal fees 215, ,081 Directors fees of the Trustee , ,774 Administrative agent fees 14 31,043 31,043 Registrar and transfer agent fees 8,853 9,023 Custodial fees 14 1,742 2,614 Unitholder reporting costs and listing fees 48,634 34,428 Insurance 5,264 5,264 Regulatory fees and expenses 80,833 70,804 1,463,163 3,243,761 Increase in net assets attributable to holders of redeemable units 230,851 1,510,415 Increase in net assets attributable to holders of redeemable units per unit The accompanying notes are an integral part of these financial statements.

6 Statements of Changes in Net Assets Attributable to Holders of Redeemable Units For the years ended Note Increase in net assets attributable to holders of redeemable units 230,851 1,510,415 Distributions to holders of redeemable units Return of capital 13 (374,123) (2,244,733) Net decrease in net assets attributable to holders of redeemable units (143,272) (734,318) Net assets attributable to holders of redeemable units Beginning of year 2,729,036 3,463,354 Net assets attributable to holders of redeemable units End of year 2,585,764 2,729,036 The accompanying notes are an integral part of these financial statements.

7 Statements of Cash Flows For the years ended Cash flows from Operating activities Increase in net assets attributable to holders of redeemable units 230,851 1,510,415 Adjustments for: Change in unrealized depreciation of fair value of the investment and credit default swap receivable 306, ,991 Change in unrealized (appreciation) depreciation of fair value of credit default swap (226,831) 406,092 Decrease in investment 940,154 2,244,733 Increase in credit default swap receivable (940,154) (2,244,733) Decrease in interest receivable on investment and credit default swap receivable 32,681 - Decrease (increase) in other assets 362,712 (5,050) Increase (decrease) in accounts payable and accrued liabilities 12,793 (27,680) Decrease in credit default swap payable (187,383) - 300, , ,132 2,330,768 Financing activities Distributions paid to unitholders (561,183) (2,244,733) Increase (decrease) in cash and cash equivalents during the year (30,051) 86,035 Cash and cash equivalents Beginning of year 2,716,191 2,630,156 Cash and cash equivalents End of year 2,686,140 2,716,191 Cash and cash equivalents Cash and interest-bearing deposit 627, ,472 Short-term investments 2,059,024 2,030,719 2,686,140 2,716,191 Interest received 46,845 43,201 The accompanying notes are an integral part of these financial statements.

8 Schedule of Investment Portfolio 2015 Description Effective interest rate % Maturity Nominal amount Cost Fair value Short-term investments BMO Harris Canadian Money Market Fund Money market Bank of Montreal Mortgage Corp. (a) Term deposits 1.12 April 27, ,042,000 2,042,000 2,058,716 Credit default swap receivable and investment 2,042,308 2,042,308 2,059,024 Deutsche Bank (b) Receivable March 2, ,674,353 7,674,353 7,614,340 National Bank of Canada (c) Investment Term deposit March 2, ,332,220 21,332,220 21,165,402 29,006,573 29,006,573 28,779,742 a) The investments consist of guaranteed investment certificates issued by Bank of Montreal Mortgage Corporation, redeemable after 30 days at the option of the holder without penalty. These investments are fully guaranteed by the Bank of Montreal having a short-term solvency rating of A-1 from Standard and Poor s Rating Service ( S&P ). b) On a monthly basis, Deutsche Bank AG (the Bank ), having a short-term solvency rating of A-2 from S&P, acquires from the Trust a contractually determined portion of the term deposit pledged as security as defined in the supplemental long form prospectus filed on March 4, 2005; this portion is equal to the monthly payment for the month in consideration (note 11). c) The investment consists of a term deposit note issued on an unsubordinated and unsecured basis by National Bank of Canada having a short-term solvency rating of A-1 from S&P. The accompanying notes are an integral part of these financial statements.

9 1 Creation of Trust and nature of operations Global Diversified Investment Grade Income Trust II (TSX: GII.UN) is a limited purpose closed-end income trust (the Trust) which was established under the laws of the Province of Ontario on February 28, 2005 by a trust agreement. The address of the Trust s registered office is 130 King Street West, Suite 900, Toronto, Ontario, M5X 1K9 and the address of the principal place of business is 800 Victoria Square, Suite 3700, Montréal, Québec, H4Z 1E9. Global DIGIT II Management Inc. is the trustee (the Trustee) of the Trust and is responsible for the management of the Trust. National Bank of Canada acts as administrative agent and Natcan Trust Company acts as custodian of the assets of the Trust. Natcan Trust Company will also act as investment advisor to the Trust if so required by the Trustee. The promoter of the Trust is National Bank Financial Inc. The directors of the Trustee benefit from an indemnity provided by National Bank of Canada. These audited financial statements were authorized for issuance by the Trustee on March 23, The Trust provides its unitholders with an equity exposure to a portfolio (the portfolio) containing 181 securities ( securities) (the reference obligations), the initial objective was to provide unitholders with a stream of monthly distributions and to redeem all of the outstanding units on March 2, 2020 (the reset date ), or on any subsequent reset date on a multiple of five years. The maturity date will not be later than In order to meet its investment objectives, on March 2, 2005, the Trust entered into three credit default swaps. On December 20, 2011, the Trust settled seven credit events which resulted in a total loss for two of the three credit default swaps, namely credit exposures A and B (Swaps A and B). In November 2014, the Trust received six credit event notices (referred to in notes 2 and 11) that could result in a total loss for the remaining credit default swap namely credit exposure C (Swap C). 2 Basis of presentation and going concern The Trust audited financial statements have been prepared on a going concern basis in compliance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). Unless otherwise indicated, all amounts are expressed in Canadian dollars, the functional currency of the Trust. Going concern basis of presentation The going concern basis of presentation assumes that the Trust will continue its operations for the foreseeable future. However, the following facts raise substantial doubt about the Trust's ability to continue as a going concern: As at 2015, the fair value of Swap C was 0.8% of the notional amount (0% ) and this fair value is the value of the option of delivering to the Bank, the investment and credit default swap receivable in kind at a value corresponding to their nominal values in lieu of paying in cash upon the settlement of a loss arising from a credit event; (1)

10 In November 2014, the Trust received six credit event notices (referred to in note 11), which could result in a loss of up to $2.79 per unit which represents the full nominal value of Swap C. Pursuant to Swap C, the valuation of the defaulted reference obligations could take up to 720 days after the credit event notices were delivered by the Bank. Meanwhile, Swap C allows the Bank to withhold a portion of the premium payments corresponding to such defaulted reference obligations, until the final loss is determined. The Bank as calculating agent shall act in good faith and in a commercially reasonable manner to determine the amount of premium payments to withhold based on the expected final prices of such defaulted obligations. In March 2015, the Bank notified the Trust that it would withhold all premium payments and consequently, the Trust announced the suspension of the distributions until further notice. Further to the credit events notified by the Bank in November 2014 and the Bank s estimate of the final loss, the Trustee expects that the financial contract is most likely to be terminated in November 2016 and, according to the terms of the financial contract, all permitted investments securing the financial contract will then be transferred to the Bank in satisfaction of the loss it incurred. In such event, the Trust would then cease to have a purpose and the revenues would not be sufficient to continue to cover its ongoing costs. It may then be more desirable to initiate the liquidation and termination of the Trust. These audited financial statements do not reflect any adjustments that would be necessary if the going concern hypothesis was not appropriate. 3 Significant accounting policies Classification and measurement of financial instruments The accounting framework for financial instruments requires that all financial assets and liabilities be classified in accordance with the purpose for which the financial instruments were acquired or issued, their characteristics and the Trust s designation of such instruments. When they are initially recognized, all financial assets and liabilities, including derivative financial instruments, are recognized at fair value and their subsequent measurement is dependent on their classification as described below. Financial assets are classified as at fair value through profit or loss, held to maturity, available for sale or loans and receivables. Financial liabilities are classified as at fair value through profit or loss or as financial liabilities at amortized cost. Under the fair value option, a financial asset or liability may be irrevocably designated at fair value through incomes (losses) when it is initially recognized. Financial instruments thus designated are accounted for under the fair value option, and any change in fair value is recorded as income in the statement of comprehensive income. Interest income and expenses resulting from these financial instruments are recorded as income in the statement of comprehensive income. (2)

11 The Trust may use the option in the following cases: If, using this option allows the Trust to eliminate or significantly reduce the measurement or recognition disparity of measuring financial assets or liabilities on a different basis, and if the fair values are reliable; or If a group of financial assets and financial liabilities to which an instrument belongs is managed and its performance is evaluated on a fair value basis, in accordance with the Trust s documented risk management or investment strategy, and information is provided on that basis to the Trustee. Consequently, the Trust may use the fair value option if it has implemented a documented risk management strategy to manage the group of financial instruments together on the fair value basis, if it can demonstrate that significant financial risks are eliminated or significantly reduced, and if the fair values are reliable. Use of estimates and judgments In preparing these audited financial statements, management makes certain estimates and judgments which can affect the reported values of assets and liabilities, related income and expenses and note disclosure. Actual results could differ from these estimates. The main area for which the Trustee has made estimates is the fair value of the credit default swap related liability. Short-term investments and credit default swap payable The short-term investments and credit default swap payable are recorded at amortized cost and the carrying value approximates their fair values. Interest income and interest expense related to the short-term investments and credit default swap payable are recorded at the effective interest rate in the statement of comprehensive income. Investment and credit default swap receivable The investment and credit default swap receivable include a term deposit and a receivable which are recorded at fair value through profit or loss. Interest income related to the investment and credit default swap receivable is recognized at the effective interest rate. Interest receivable is shown separately in the statement of financial position based on the deposit notes stated rates of interest. Credit default swap The Trust entered into Swap C to provide an equity exposure to a portfolio of securities, the objective being to provide unitholders with a stream of monthly distributions. This contract was negotiated over-the-counter. The Trust has recorded the credit default swap at fair value in the statement of financial position and changes in fair value in the statement of comprehensive income. (3)

12 Income taxes The Trust qualifies as a unit trust within the meaning of the Income Tax Act (Canada). The Trust is subject to income taxes under the Act on the amount of taxable income for the year and can make deductions in computing its income tax for all amounts paid or payable to the Trust s unitholders in determining its income for tax purposes. As all realized net taxable income is distributed to unitholders, no provision for income taxes has been recorded in these audited financial statements. Classification of redeemable units The Trust reclassified its redeemable units as liabilities on transition to IFRS. The Trust s units do not meet the criteria in IAS 32 for classification as equity for the following reasons: The Trust distributions are non-discretionary: the Trust has a contractual obligation to distribute all of its net taxable income; Unitholders have the right to ask for redemption of their redeemable units, which results in the Trust having a contractual obligation to redeem the redeemable units for cash or recirculate the units on the exchange on which they are traded. 4 Fair value of financial instruments Establishing fair value When a financial instrument is initially recognized, its fair value is the amount of consideration that would be paid for the financial instrument in an arm s length transaction between knowledgeable, willing parties who are under no compulsion to act. The best evidence of the fair value of a financial instrument on initial recognition is the transaction price, i.e., the fair value of the consideration received or paid. When financial instruments are to be subsequently remeasured, quoted market prices in an active market provide the best indication of fair value, and when such prices are available, the Trust uses them to measure the financial instruments. If the market for a financial instrument is not active, the Trust establishes fair value using a valuation technique that primarily makes use of observable market inputs. Such valuation techniques include using available information concerning recent market transactions, reference to the current fair value of a comparable financial instrument, discounted cash flow analysis, option pricing models, and all other valuation techniques commonly used by market participants where it has been demonstrated that the technique provides reliable estimates. (4)

13 In cases where fair value is established using valuation models, the Trust makes assumptions about the amount and timing of estimated future cash flows and the discount rates used. These assumptions are based primarily on observable market inputs such as interest rate yield curves, foreign exchange rates, credit curves as well as price and rate volatility factors. When one or more significant inputs are not observable in the markets, fair value is established primarily on the basis of internal estimates and data that consider the valuation policies in effect at the Trust, the economic environment, the specific characteristics of the financial asset or liability and other relevant factors. Valuation methods and assumptions i) Valuation of the credit default swap The credit default swap is presented at its fair value with changes in the unrealized gain or loss for the period recorded in the statement of comprehensive income. As a market quotation is not readily available, the fair value of the credit default swap is established using valuation models. The Trust makes assumptions about the amount and timing of estimated future cash flows and the discount rate used. The main inputs are based on factors observable in external markets, such as interest rate yield curves and credit curves. Their fair value will also vary depending on a number of factors such as interest rates and the cumulative net losses to be incurred upon the settlement of the credit events in the portfolio of securities. Credit events include bankruptcy, failure to pay and other specified loss events. ii) Investment and credit default swap receivable The fair value of the investment and the credit default swap receivable is determined by discounting the estimated cash flows at the current market rate for similar instruments. iii) Other financial instruments The carrying value of a number of short-term financial instruments presented in the statement of financial position approximates their fair value. These financial instruments include short-term investments, other assets, accounts payable and accrued liabilities, credit default swap payable and distributions payable. Fair value hierarchy Financial instruments recorded at fair value in the statement of financial position are classified using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy has the following levels: Level 1 quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices); Level 3 inputs for the asset or liability that are not based on observable market data (unobservable inputs). (5)

14 The fair value hierarchy requires the use of observable market inputs whenever such inputs exist. A financial instrument is classified to the lowest level of the hierarchy for which a significant input has been considered in measuring fair value. The following table presents the financial instruments recorded at fair value in the statement of financial position on a recurring basis, classified using the fair value hierarchy described above: 2015 Level 1 Level 2 Level 3 Total Financial assets Credit default swap receivable - 7,614,340-7,614,340 Investment - 21,165,402-21,165,402 Total financial assets - 28,779,742-28,779,742 Financial liabilities Credit default swap related liability - 28,779,742-28,779, Level 1 Level 2 Level 3 Total Financial assets Credit default swap receivable - 6,752,651-6,752,651 Investment - 22,333,401-22,333,401 Total financial assets - 29,086,052-29,086,052 Financial liabilities Credit default swap related liability - 29,006,573-29,006,573 5 Management of risks associated with financial instruments The Trust is exposed to various types of risks owing to the nature of its business activities, including those related to the use of financial instruments. In order to manage the risks associated with using financial instruments, whenever applicable, controls consistent with the Trust s strategy have been implemented, such as limiting permitted financial instruments. The main risks to which the Trust is exposed are described below. (6)

15 Market risk Market risk corresponds to the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk associated with financial instruments comprises currency risk, interest rate risk, credit risk, liquidity risk and other price risks. More specifically, through to the maturity date of the credit default swap, the fair value will vary depending on a number of factors such as interest rates and the cumulative net losses to be incurred upon the settlement of the credit events in the portfolio of securities. Credit events include bankruptcy, failure to pay and other specified loss events. Since the Trust s objective is to provide unitholders with an equity exposure to the performance of the underlying portfolio of securities, there is no principal protection. Market rates can vary and cause fluctuations in the fair value of the term deposit. As at 2015, the effect of an increase or a decrease of 100 basis points of relevant credit spreads on the Trust s credit default swap is nil on the fair value on the Trust s credit default swap. In addition, there is a discount rate associated with the term deposit and the receivable. The effect of an increase or a decrease of 100 basis points in the discount rate on the term deposit and the receivable would result respectively in a $1,128,000 decrease or $1,187,000 increase (2014 $71,000 decrease or $72,000 increase) in the fair value of the Trust s term deposit and receivable. Credit risk The credit risk is the risk of financial loss arising from a counterparty s inability or failure to honour its contractual obligations. The amount that best represents the maximum exposure to credit risk of the Trust as at is the sum of financial assets in the statement of financial position. As described above, the credit default swap also has significant credit risk exposure with respect to the reference obligations included in the portfolio and counterparty credit risk (referred to in notes 9 and 11). Liquidity risk The liquidity risk represents the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. The Trust s overall liquidity is managed in accordance with policies to ensure that the Trust has sufficient cash resources to meet its current and future obligations, both under normal and unusual conditions. The financial liabilities of the Trust mature on a monthly basis except for the credit default swap related liability. The credit default swap related liability pertains to Swap C and is subject to a reset date at the option of the Bank in March 2020 or on any subsequent reset date on a multiple of five years. Under Swap C, the term deposit investment is pledged to the Bank. Accordingly, if losses occur, the Trust has the option to deliver its investment and credit default swap receivable to settle the related payment or pay it in cash. The amounts recoverable on the maturity date of the investments will be reduced by any loss incurred as a result of the credit events. The maximum loss that could be borne by the Trust for credit events with respect to the reference obligations under Swap C amounts to $29,006,573 (2014 $29,006,573), which corresponds to the nominal amount of the Trust s investment and credit default swap receivable. (7)

16 6 Carrying values of financial assets and financial liabilities by category Financial assets and financial liabilities are recognized in the statement of financial position at fair value through profit or loss (FVTPL), loans and receivables and cost or amortized cost, which approximates their fair value according to the categories determined by the accounting framework for financial instruments. The Trust has elected to use the fair value option for the credit default swap receivable and the investment that represents the collateral pledged to cover losses incurred on Swap C. The carrying value for each category of financial asset and financial liability is presented in the table below: 2015 Financial assets and liabilities at FVTPL Held for trading Designated at inception Loans and receivables Financial liabilities at cost or amortized cost Financial assets Cash and interest-bearing deposit ,116 - Short-term investments - - 2,059,024 - Interest receivable on investment and credit default swap receivable ,108 - Other assets ,108 - Credit default swap receivable - 7,614, Investment - 21,165, Total financial assets - 28,779,742 2,770,356 - Financial liabilities Accounts payable and accrued liabilities ,484 Credit default swap payable ,108 Credit default swap related liability 28,779, Total financial liabilities 28,779, ,592 (8)

17 2014 Financial assets and liabilities at FVTPL Held for trading Designated at inception Loans and receivables Financial liabilities at cost or amortized cost Financial assets Cash and interest-bearing deposit ,472 - Short-term investments - - 2,030,719 - Interest receivable on investment and credit default swap receivable ,789 - Other assets ,820 - Credit default swap receivable - 6,752, Investment - 22,333, Total financial assets - 29,086,052 3,195,800 - Financial liabilities Accounts payable and accrued liabilities ,691 Credit default swap payable ,491 Distributions payable ,061 Credit default swap related liability 29,006, Total financial liabilities 29,006, ,243 7 Cash and interest-bearing deposit Cash balances of the Trust have been invested in an interest-bearing deposit at a rate equal to the prime rate minus 1.80%. The prime rate was 2.70% as at 2015 (2014 3%). 8 Other assets The other assets of $42,108 (2014 $404,820) are part of the financial contract fee receivable corresponding to the amounts that were accrued monthly by the Bank for the benefit of the Trust Other assets Financial contract fee receivable 42, ,820 (9)

18 9 Financial instruments designated at fair value through profit or loss The Trust chose to designate the investment and the credit default swap receivable at FVTPL according to criteria presented in note 4. This designation allows the Trust to eliminate or significantly reduce the measurement disparity that would have resulted from measuring financial assets and liabilities on different bases due to the ability of the Trust to transfer to the Bank the investments and credit default swap receivable at their nominal value upon the settlement of a loss arising from a credit event. The information about the financial assets designated at FVTPL is provided in the following tables for the years ended : Carrying value Change in the (1) (2) total fair value Change in fair value since initial recognition (1) 2015 Financial assets designated at FVTPL Credit default swap receivable 7,614,340 (78,465) (60,013) Investment 21,165,402 (227,844) (166,818) Total financial assets designated at FVTPL 28,779,742 (306,309) (226,831) Carrying value Change in the (1) (2) total fair value Change in fair value since initial recognition (1) 2014 Financial assets designated at FVTPL Credit default swap receivable 6,752,651 (103,774) 18,452 Investment 22,333,401 (343,217) 61,026 Total financial assets designated at FVTPL 29,086,052 (446,991) 79,478 (1) Amounts exclude interest income presented separately in the statement of comprehensive income. (2) Amounts include the change in the fair value attributable to credit risk and the Trust has determined no material impact. (10)

19 a) Credit default swap receivable designated at FVTPL The fair value of the total credit default swap receivable of $7,614,340 (2014 6,752,651) from the Bank represents the best possible estimate of the amount for which reasonable assurance of collection exists, in light of current conditions and assuming the continuation of the business as a going concern. On 2015, the nominal amount of the credit default swap receivable is $7,674,353 (2014 6,734,199). The credit default swap receivable matures in March 2020 and bears interest at a rate of 1.742%, payable monthly until March 2020, after which date its rate of return will be reset for five years as of each reset date until the legal maturity of the Trust (referred to in note 1). b) Investment designated at FVTPL The investment consists of a term deposit note issued on an unsubordinated and unsecured basis by National Bank of Canada having a short-term solvency rating of A-1 from S&P. The term deposit has a fair value of $21,165,402 ( ,333,401) with a nominal amount of $21,332,220 ( ,272,374), bears interest at a rate of 1.742%, payable monthly until March 2020, after which date its rate of return will be reset for five years as of each reset date until the maturity of the Trust (referred to in note 1). 10 Offsetting of financial assets and liabilities A financial asset and a financial liability must be offset in the statement of financial position when the Trust has a legally enforceable right to set off the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously. The Trust has a legally enforceable right to set off a financial asset and a financial liability when such right is enforceable in the normal course of business or in the event of default, insolvency or bankruptcy. Over-the-counter derivatives subject to the International Swaps and Derivatives Association s master netting agreements do not meet the criteria for offsetting in the statement of financial position as they give a right to set off that is only enforceable in the event of default, insolvency or bankruptcy. (11)

20 Gross recognized amounts Set off amounts Net amount presented in the statement of financial position Associated amounts not set off in the statement of financial position Financial instruments Financial collateral pledged (1) Net amount 2015 Financial liabilities Credit default swap related liability 28,779,742-28,779,742-28,779, Financial liabilities Credit default swap related liability 29,006,573-29,006,573-29,006,573 - (1) Represents the lower of the fair value of the collateral pledged and its notional amount. 11 Derivative financial instruments and reference obligation portfolio Credit default swap agreements with the Bank The Trust has entered into three credit default swap agreements (Swap Agreements A, B and C), whereby the Trust may be required to compensate the Bank if credit events occur in connection with the reference obligations. On December 12, 2011, the Trust received confirmation from the Bank that the recovery level or final price for the credit event notices received in November 2009 was zero. On December 20, 2011, to settle these credit events, the Trust transferred to the Bank a total amount of $68,312,427, the proceeds of which were obtained through the sale of part of the investment and the sale of the credit default swap receivable (referred to in note 9). After settlement of these credit events, swaps A and B ceased to be in effect. The remaining Swap C is subject to a reset date at the option of the Bank in March 2020 or on any subsequent reset date on a multiple of five years. The maximum loss that could be borne by the Trust for credit events with respect to the reference obligations under Swap C amounts to $29,006,573 (2014 $29,006,573). Under Swap C, a monthly payment by the Trust to the Bank corresponding to a contractual rate of 6.40% is applied to the notional amount of the contracts and the contractual interest rate of 1.742% is applied to the investments pledged as security. These amounts are exchanged between the Trust and the Bank with the net return being paid to the Trust. On a monthly basis, the Bank acquires from the Trust a contractually determined portion of the term deposit pledged as security as defined in the supplemental long form prospectus filed on March 4, 2005; this portion is equal to the monthly payment for the month in consideration. At maturity, the Bank will pay an amount equal to the excess of the notional amount of the contracts less net losses incurred on those contracts over the residual amount of the investments pledged as security, as the case may be. (12)

21 The notional amount of Swap C as at 2015 is $29,006,573 (2014 $29,006,573) for the reference obligation portfolio of $2,780,590,429 (2014 $2,780,590,429). The Trust estimated the cumulative unrealized loss on Swap C and the credit default swap related liability as at 2015 at $28,779,742 (2014 $29,006,573), an amount consistent with the valuation provided by the Bank and with the favourable value of the option of delivering the investment and credit default swap receivable in kind at a value corresponding to their nominal values in lieu of paying in cash. The value of this option is $226,831 as of 2015 (2014 nil) and corresponds to the difference between the nominal values and fair values of the investment and credit default swap receivable. Credit risk As a result of entering into the credit default swap agreement with the Bank, the Trust is exposed to credit risk with respect to the reference obligations included in the portfolio. Credit events (bankruptcy, failure to pay or other specified loss event) in relation to the reference obligations could result in a loss for the Trust. The maximum loss that could be borne by the Trust for credit events with respect to the reference obligations under Swap C amounts to $29,006,573 (2014 $29,006,573). Credit events As described in note 1, the net assets of the Trust vary depending on a number of factors, in particular the cumulative net losses to be incurred upon the settlement of the credit events in the portfolio as described above. The Trust is exposed to credit risk with respect to the reference obligations included in the portfolio, and the maximum loss that could be borne by the Trust for credit events with respect to the reference obligations under Swap C is $29,006,573 (1.04% initially 1.50% and further reduced pursuant to the credit event settlements). In November 2014, the Trust received from the Bank credit event notices for the reference obligations of the following issuers: Exposure Exposure per unit Swap C Ace Securities Corp HE4 4,949, Ace Securities Corp RM2 656, CHL Mortgage Pass Through Trust ,245, Countrywide Asset Backed Certificate ,459, G-Star Ltd ,707, HarborView Mortgage Loan Trust Series ,415, Maximum loss in respect of the reference obligations under Swap C 29,006, Notional 29,006, Notional after maximum potential loss - - Further to these credit event notices, the aggregate maximum potential loss is $2.79 per unit which represents a total loss on Swap C for the Trust. (13)

22 Pursuant to Swap C, the valuation of the defaulted reference obligations could take up to 720 days after the credit event notices (in November 2016). Meanwhile, Swap C allows the Bank to withhold a portion of the premium payments corresponding to such defaulted reference obligations, until the final loss is determined. The Bank as calculating agent shall act in good faith and a commercially reasonable manner to determine the amount of premium payments to withhold based on the expected final prices of such defaulted obligations. Further to these credit event notices, the Bank estimated the final loss and notified the Trust, in March 2015, that it would withhold all premium payments and consequently, the Trust announced the suspension of the distributions until further notice. Reference obligation portfolio Since January 1, 2009, the Bank cannot add or replace reference obligations in the portfolio. Therefore, the principal amount of the portfolio will decline as maturing securities will not be replaced. This may, over time, modify the overall economic exposure of the Trust to the credit performance of this portfolio. The portfolio of reference obligations was structured between December 13, 2004 and February 28, 2005 (the inception date) and its notional amount as at 2015 is $29,006,573 (2014 $29,006,573). The weighted average ratings mentioned below are calculated by adding the product of the notional amount of each reference obligation and its assigned S&P rating factor and dividing such sum by the total notional amount and by assigning such result to the corresponding S&P rating. Swaps A and B Swaps A and B have effectively been terminated as a result of the settlement of the credit events on December 20, Swap C Swap C refers to the credit performance of 181 reference obligations as at 2015 ( ). The composition by asset class as at was as follows: Asset class Number of reference obligations % of Assets Number of reference obligations % of Assets Commercial asset-backed securities Consumer asset-backed securities Residential mortgage-backed securities Commercial mortgage-backed securities Structured exposure to mortgage-backed and corporate securities (14)

23 The S&P ratings of the mortgage-backed securities, asset-backed securities, structured finance securities, synthetic corporate exposures and other fixed-income securities were distributed as follows: 2015 (by equivalent S&P rating*) 2014 (by equivalent S&P rating) Rating % of Assets % of Assets AAA AA A BBB BB B CCC CC C D Not Rated Total * S&P rating if available; if not available, then the Moody s rating, and if no S&P and no Moody s ratings are available, then the rating from Fitch is used. Reference obligations that were once rated D by S&P are included in category D, regardless of the rating from other credit rating organizations. The weighted average assigned S&P rating factor of the mortgage-backed securities, asset-backed securities, other structured finance securities and synthetic corporate exposures was between at CCC+ and CCC as at 2015 (2014 B- and CCC+). 12 Income taxes The Trust qualifies as a unit trust within the meaning of the Income Tax Act (Canada). The Trust is subject to income taxes under the Act on the amount of taxable income for the year and can make deductions in computing its income tax for all amounts paid or payable to the Trust s unitholders in determining its income for tax purposes. Any amount payable under the credit default swap is considered to be payable under the swap agreement and is taxable as such. According to the terms of Swap C, the amount will be determinable only on the maturity date, and therefore the swap payment to the Trust should be taxable as income at that date. (15)

24 13 Net assets attributable to holders of redeemable units Authorized units The Trust is authorized to issue in series an unlimited number of transferable and redeemable units, each of which represents an equal, undivided interest in the net assets of the Trust. All units have equal rights and privileges. Each whole unit entitles the holder to one vote and to participate equally with respect to any and all distributions made by the Trust. Quarterly redemption Units may be surrendered to the Administrative Agent for redemption at any time prior to the twentieth business day preceding the last business day of each month of May, August and November (the Redemption Date ). Subject to the right of the Trust to suspend redemptions in certain circumstances, units surrendered for redemption will be redeemed on such Redemption Date at the redemption price. The payment of the redemption price will be made on the tenth business day following the Redemption Date. The redemption price will be equal to the lesser of: a) 95% of the daily weighted average trading price per unit on the principal exchange on which the units are listed for the five trading days following the redemption date; and b) an amount equal to: the closing price of the units on the principal exchange on which the units are listed; or the average of the highest and lowest prices of the units if the exchange or other markets on which the units are listed provides only the highest and lowest trading prices; or the average of the latest bid and ask prices on the principal exchange on which the units are listed if there was no trading on such redemption date. Annual redemption Units may also be surrendered to the Administrative Agent for redemption at any time prior to the 20th business day preceding the last business day of February (the Annual Redemption Date ). Subject to the right of the Trust to suspend redemptions in certain circumstances, units surrendered for redemption will be redeemed on such Annual Redemption Date at the unwind price. The payment of the unwind price will be made on the 10th business day following the Annual Redemption Date. The unwind price will be an amount equal to the sum of (i) the bid price received by the Trust to terminate the applicable tranche of Swap C and (ii) the market value of the tranche of the Trust s $21,332,220 (2014 $22,272,374) term deposit and receivable of the credit default swap of $7,674,353 (2014 6,734,199), less applicable unwind costs. (16)

25 No redemptions occurred during the years ended : Number of redeemable units Balance Beginning and end of year 10,392,283 10,392,283 As at, National Bank of Canada and its subsidiaries held 0.5% of the outstanding units of the Trust. Distributions and management of net assets attributable to holders of redeemable units The Trustee manages the capital of the Trust corresponding to the net assets attributable to holders of redeemable units with the goal of ensuring that it will be able to continue as a going concern while optimizing the return to holders of redeemable units The original objectives of the Trust were to provide holders of redeemable units with a fixed rate stream of monthly distributions equal to $ per unit ($ per annum) up to March 2, 2010 and thereafter, a fixed rate stream of monthly distribution reset every five calendar years intended to equal the five-year Government of Canada bond rate plus 4% to 4.5% and to repay to unitholders on a reset date falling on March 2, 2010 but no later than March 2, 2045 an amount equal to the residual value of the Trust. Further to the credit events notices as described in note 11, the Trust announced in March 2015 the suspension of the distributions until further notice. 14 Related party transactions The Trustee is responsible for the management of the Trust. National Bank of Canada is the administrative agent. Natcan Trust Company, a subsidiary of National Bank of Canada, acts as custodian of the assets of the Trust. Natcan Trust Company will also act as investment advisor of the Trust if so required by the Trustee. The promoter is National Bank Financial, a subsidiary of National Bank of Canada. As described in note 9, the term deposit has been subscribed from the National Bank of Canada. In addition to the transactions separately identified in these audited financial statements, the following transactions took place during the years ended : Revenues and expenses incurred during the year National Bank of Canada Interest on investment and credit default swap receivable 570, ,468 Natcan Trust Company Other interest income 6,645 5,422 Global DIGIT II Management Inc. Directors fees of the Trustee (124,780) (111,774) National Bank of Canada Administration agent (31,043) (31,043) Natcan Trust Company Custody fees (1,742) (2,614) 419, ,459 (17)

26 Accounts receivable and accounts payable and accrued liabilities National Bank of Canada 34,347 67,028 Global DIGIT II Management Inc. (7,761) (7,756) Natcan Trust Company (909) (700) 25,677 58,572 These transactions occurred in the normal course of business and were measured at the exchange value, which is the amount established and agreed to between the related parties. 15 Increase in net assets attributable to holders of redeemable units per unit The increase in net assets attributable to holders of redeemable units per unit for the years ended 2015 and 2014 is calculated as follows: Increase in net assets attributable to holders of redeemable units 230,851 1,510,415 Weighted average units outstanding during the year 10,392,283 10,392,283 Increase in net assets attributable to holders of redeemable units per unit (18)

27