PWC Capital Inc. Announces Results for Its Second Quarter Ended April 30, 2014

SECOND QUARTER SUMMARY(1)
(compared to the same periods in the prior year unless otherwise noted)

PWC Capital Inc.

• Net income (loss) of PWC Capital Inc. (the “Corporation”) for the three months ended April 30, 2014, was ($1.8 million) or ($0.06) per share (basic and diluted) compared to ($2.6 million) or ($0.09) per share (basic and diluted) for the same period last year.
• For the six months ended April 30, 2014, net income (loss) was ($4.0 million) or ($0.13) per share (basic and diluted) compared to ($3.7 million) or ($0.13) per share (basic and diluted) for the same period last year.

Pacific & Western Bank of Canada

• Net interest margin or spread of the Bank for the current quarter increased to 1.93% from 1.77% a year ago. For the six months ended April 30, 2014, net interest margin was 1.96% compared to 1.66% for the same period a year ago.
• Total revenue of the Bank for the three months ended April 30, 2014, increased to $7.5 million from $6.5 million last year. For the six months ended April 30, 2014, total revenue increased to $14.8 million from $13.7 million for the same period a year ago.
• Net income for the quarter of $1.2 million or $0.06 per share (basic and diluted) compared to a loss of $39,000, after restructuring charges, or $0.00 per share (basic and diluted) a year ago.
• Net income for the six months ended April 30, 2014, was $2.2 million or $0.11 per share (basic and diluted) compared to $1.1 million or $0.07 per share (basic and diluted) for the same period a year ago. Net income for the current six month period includes restructuring charges of $434,000 compared to $502,000 a year ago. Restructuring charges relate to unamortized note issue costs resulting from the early retirement of subordinated notes payable.
• Credit quality remains strong with no gross impaired loans at April 30, 2014 compared to $1.7 million a year ago.
• At April 30, 2014, the Bank’s Common Equity Tier 1 (CET1) ratio compared favourably to the industry with a ratio of 12.21% compared to 10.34% a year ago.

(1)Certain highlights include non-GAAP measures. See definition under ‘Basis of Presentation’ in the attached Management’s Discussion and Analysis.

PRESIDENT’S COMMENTS

PWC Capital owns approximately 91% of Pacific & Western Bank of Canada and 100% of Versabanq Innovations Inc. The Bank is by far our largest and most important investment and the value of PWC is of course highly dependent on the Bank’s value.

I am pleased to tell you that our Bank’s net income for the 2nd quarter increased to $1.2 million or 6¢ per share compared to a loss of $39,000 for the same period a year ago. Net Income for the Bank for the six months ended April 30, 2014 was $2.2 million or 11¢ per share compared to $1.1 million or 7¢ per share for the same period a year ago. The Bank’s credit quality remains outstanding with no gross impaired loans at April 30, 2014. The Bank’s capital ratios also continued to improve. Its Common Equity Tier 1 ratio improved to 12.21% from 10.34% a year ago and its Total Risk Based capital ratio improved to 13.37% from 11.94% a year ago. While these capital ratios compare quite favourably to the industry, to provide for future growth, our Bank is planning to issue rate reset preference shares to accredited investors on similar terms to those that have been recently issued by the other banks. Our Bank is a highly technologically proficient financial institution and I believe it is ideally suited to grow profitability in various niche markets that only technologically proficient financial institutions can access. I believe that as the market recognizes the unique potential and value that our Bank represents, this will be reflected in the price of our PWC common shares.

In order to ensure that our Bank was well positioned for growth in the rapidly changing world, in previous year’s PWC issued Preference B shares and additional Series C notes to provide additional capital for the Bank. Although, these securities do not require large cash payments, they do attract large dividend and interest expenses of approximately $3.2 million per quarter, which is creating quarterly losses for PWC. This quarter the net loss incurred by PWC was $1.8 million, an improvement over the loss of $2.6 million taken in the same quarter a year ago, however, still a considerable loss. Our strategy to deal with this is to buy back some of the Preference B shares and Series C notes under the normal course issuer bid (NCIB) that we recently announced. To fund these purchases we intend to sell some of our holdings of PWB shares as market opportunities arise. I believe that through a combination of increasing profits from our Bank and a reduction in the expenses associated with our company’s liabilities, we will be able to return PWC to a profitable state.

* Adjusted net income (loss) is a non-GAAP measure and is defined as net income (loss) for the period for the Bank prior to deducting restructuring charges on an after-tax basis.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION

This management’s discussion and analysis (MD&A) of operations and financial condition for the second quarter of fiscal 2014, dated June 4, 2014, should be read in conjunction with the unaudited interim consolidated financial statements for the period ended April 30, 2014, included herein which have been prepared in accordance with International Financial Reporting Standards (IFRS). This MD&A should also be read in conjunction with the Corporation’s MD&A and the audited consolidated financial statements for the year ended October 31, 2013, all of which are available on SEDAR at www.sedar.com. Except as discussed below, all other factors discussed and referred to in the MD&A for the year ended October 31, 2013, remain substantially unchanged.

Basis of Presentation

Non-GAAP and Additional GAAP Measures

Net Interest Income and Net Interest Margin or Spread

Most banks analyze profitability by net interest income (as presented in the Consolidated Statements of Income (Loss)) and net interest margin or spread. Net interest margin or spread is defined as net interest income as a percentage of average total assets. Net interest margin or spread does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions.

Book Value Per Common Share

Book value per common share is defined as shareholders’ equity less amounts relating to preferred shares recorded in equity, divided by the number of common shares outstanding.

Adjusted Net Income

Adjusted net income of Pacific & Western Bank of Canada (the “Bank”) is defined as net income (loss) for the period prior to deducting restructuring charges on an after-tax basis.

Overview

PWC Capital Inc. (the `Corporation`) is a holding company whose shares trade on the Toronto Stock Exchange. Its principal subsidiary, the Bank, of which it owns approximately 91% of its issued common shares, provides commercial banking services to selected niche markets and operates as a Schedule I bank under the Bank Act (Canada). In August 2013, the Bank completed its initial public offering (IPO) and on August 27, 2013 its common shares commenced trading on the Toronto Stock Exchange.

In April 2014, PWC Capital Inc. changed its name from Pacific & Western Credit Corp.

PWC Capital Inc.

Net income (loss) of the Corporation for the three months ending April 30, 2014, was ($1.8 million) or ($0.06) per share (basic and diluted) compared to ($2.2 million) or ($0.07) per share (basic and diluted) for the previous quarter and ($2.6 million) or ($0.09) per share (basic and diluted) for the same period last year. Net income (loss) for the current quarter includes interest expense totalling $1.25 million relating to dividends paid on the Corporation’s Class B Preferred Shares. These dividends are recorded as interest expense in the consolidated financial statements as the preferred shares carry certain redemption features and are classified as preferred share liabilities on the Consolidated Balance Sheet.

For the six months ended April 30, 2014, net income (loss) was ($4.0 million) or ($0.13) per share (basic and diluted) compared to ($3.7 million) or ($0.13) per share (basic and diluted) for the same period last year. Net income (loss) for the current six month period includes interest expense totalling $2.5 million relating to dividends paid on the Corporation’s Class B Preferred Shares compared to $2.5 million on dividends paid on Class B Preferred Shares for the same period a year ago.

Pacific & Western Bank of Canada

Net income (loss) of the Bank for the three months ending April 30, 2014, was $1.2 million compared to $975,000 for the previous quarter and ($39,000) for the same period a year ago. Net income for the previous quarter included restructuring charges of $434,000 which related to the retirement of subordinated notes which took place in December 2013. Net income for the current quarter increased from the same period a year ago primarily due to an increase in net interest income and restructuring charges recorded in the prior year.

For the six months ended April 30, 2014, net income of the Bank was $2.2 million compared to $1.1 million for the same period a year ago. Net income for the current six month period includes restructuring charges of $434,000 as noted above, compared to restructuring charges of $502,000 in the same period a year ago. Before deducting restructuring charges, adjusted net income was $2.5 million for the current period compared to $1.4 million last year with the increase due to a higher level of net interest income earned in 2014.

Net interest income and net interest margin for the three months ended April 30, 2014 were $6.6 million and 1.93% respectively compared to $6.9 million and 1.95% for the previous quarter and $6.1 million and 1.77% for the same period a year ago. Net interest income and net interest margin increased from a year ago due to lower interest expense as a result of the repayment of subordinated notes over the past year and a lower level of deposits outstanding. Net interest income and net interest margin decreased from the previous quarter primarily as a result of a lower level of lending assets caused by a number of large loans which repaid during the quarter and a loan sale and a delay during the current quarter in the funding of higher spread construction loans due to the longer than normal winter season.

Net interest income and net interest margin for the six months ended April 30, 2014 were $13.6 million and 1.96% respectively compared to $12.0 million and 1.66% for the same period a year ago with the increases due to lower interest expense as a result of the repayment of subordinated notes over the past year and a decrease in the amount of deposits outstanding.

At April 30, 2014, total assets of the Bank were $1.39 billion compared to $1.44 billion at the end of the previous quarter and $1.39 billion a year ago. Lending assets at the end of the current quarter totalled $1.11 billion compared to $1.14 billion at the end of the previous quarter and $1.19 billion a year ago with the decrease from the previous quarter due to several large repayments that occurred in the commercial loan and government financing portfolios and the sale of a loan at the end of the current quarter. Cash and securities at April 30, 2014, totalled $250 million compared to $272 million at the end of the previous quarter and $167 million a year ago. The level of cash and securities decreased from the previous quarter as a result of a lower amount of deposits maturing in the coming months compared to the end of the previous quarter.

Credit quality remains strong with no gross impaired loans at the end of the current quarter compared to $6,000 at the end of the previous quarter and $1.7 million a year ago.

At April 30, 2014, the Bank continued to exceed the CET1 capital requirement of 7.0% with a ratio of 12.21% compared to 11.54% at the end of the previous quarter and 10.34% a year ago. In addition, at April 30, 2014, the Bank’s Tier 1 capital ratio was also 12.21% compared to 11.54% at the end of the previous quarter and its total capital ratio was 13.37% compared to 12.64% at the end of the previous quarter. Required minimum regulatory capital ratios are a Common Equity Tier 1 (CET1) capital ratio of 7.0%, a Tier 1 capital ratio of 8.5% and a total capital ratio of 10.5%, all of which include a 2.50% capital conservation buffer.

Total Revenue

Total revenue consists of net interest income and other income. For the three months ended April 30, 2014, total revenue of the Bank was $7.5 million compared to $7.3 million for the previous quarter and $6.5 million for the same period last year. Total revenue for the current quarter included gains of $582,000 from the sale of loans compared to $nil in the same period a year ago. For the six months ended April 30, 2014, total revenue of the Bank was $14.8 million compared to $13.7 million for the same period last year. Total revenue for the current six month period includes gains of $582,000 from the sale of loans compared to $1.0 million for the same period a year ago.

Net Interest Income and Net Interest Margin

Net interest income of the Bank for the three months ended April 30, 2014 was $6.6 million compared to $6.9 million for the previous quarter and $6.1 million for the same period last year. The increase in net interest income from a year ago was due primarily to a decrease in interest expense as a result of the repayment of subordinated notes payable, a decrease in the amount of deposits outstanding and loans that matured over the past year being replaced with loans with larger spreads. Net interest margin for the three months ended April 30, 2014 was 1.93% compared to 1.95% for the previous quarter and 1.77% for the same period last year with the increase from a year ago due to the factors noted above. The decrease in net interest margin from the previous quarter was due to a lower level of lending assets during the quarter.

For the six months ended April 30, 2014, net interest income was $13.6 million compared to $12.0 million for the same period a year ago with the increase due primarily to a decrease in interest expense as a result of the repayment of subordinated notes payable and a decrease in the amount of deposits outstanding. Net interest margin for the six months ended April 30, 2014 was 1.96% compared to 1.66% for the same period last year with the increase due to the factors noted above.

Other Income

Other income for the three months ended April 30, 2014 was $886,000 compared to $337,000 for the previous quarter and $400,000 for the same period a year ago. For the six months ended April 30, 2014, other income was $1.2 million compared to $1.7 million for the same period a year ago. Other income in the current and previous quarters consists primarily of fees from credit cards and gains from a loan sale as noted above. The Corporation expects that it may sell loans from time to time in the coming periods as market conditions warrant.

Non-Interest Expenses

Non-interest expenses of the Corporation, excluding restructuring charges, totalled $5.4 million for the current quarter compared to $5.5 million for the previous quarter and $5.8 million for the same period a year ago. For the six months ended April 30, 2014, non-interest expenses of the Corporation, excluding restructuring charges, totalled $10.9 million compared to $11.4 million for the same period a year ago. The decrease in non-interest expenses from a year ago was due primarily to a lower level of expenses relating to the credit card program and the timing of expenses.

As noted previously, during the six months ending April 30, 2014, the Corporation incurred restructuring charges totalling $434,000 compared to $118,000 for the same period last year. Restructuring charges in the current period relate to the repayment of subordinated notes of the Bank in December 2013.

Income Taxes

The Corporation’s statutory federal and provincial income tax rate and that of the Bank is approximately 27%, similar to that of the previous periods. The effective rate is impacted by the tax benefit on operating losses in the Corporation on a non-consolidated basis not being recorded for accounting purposes and certain items not being taxable or deductible for income tax purposes. The provision for income taxes consists of the following items:

For the three months ended April 30, 2014, the provision for income taxes was $858,000 compared to $393,000 for the same period a year ago with the increase due to a higher level of earnings in the Bank in the current quarter. The income tax provision in the current quarter and the same quarter last year includes a provision in the Corporation of $386,000 relating to an income tax on dividends paid on its Class B Preferred Shares. For the six months ended April 30, 2014, the provision for income taxes was $1.6 million compared to $1.2 million for the same period a year ago with the increase also due to a higher level of earnings in the Bank. The income tax provision in the current period and the same period last year includes a provision in the Corporation of $773,000 relating to an income tax provision on dividends paid on its Class B Preferred Shares.

At April 30, 2014, the Bank has a deferred income tax asset of $7.8 million compared to $8.7 million a year ago with the decrease due to the tax effect of operating results in the Bank over the past year. The deferred income tax asset is primarily a result of income tax losses totalling approximately $35 million from previous periods. The income tax loss carry-forwards in the Bank are not scheduled to begin expiring until 2027 if unutilized. In addition, the Corporation has income tax loss carry-forwards which total approximately $50.0 million, the benefit of which has not been recorded. Loss carry-forwards totalling approximately $1.0 million will expire in 2014 if unutilized; the remaining $49.0 million of loss carry-forwards are not scheduled to begin expiring until 2026 if unutilized.

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income (loss) for the period and other comprehensive income (loss) which consists of unrealized gains and losses on available-for-sale securities. Comprehensive income (loss) for the three months ended April 30, 2014 was ($1.8 million) compared to ($2.2 million) for the previous quarter and ($2.6 million) a year ago. The change from a year ago is due to the net loss in the current period being less than that last year. Comprehensive income (loss) for the six months ended April 30, 2014 was ($4.0 million) compared to ($3.7 million) a year ago. Due to the current composition of the Corporation’s treasury portfolio which consists primarily of liquid securities, unrealized gains or losses in the portfolio are not significant and as a result, comprehensive income (loss) does not materially differ from net income (loss).

Consolidated Balance Sheet

Total assets of the Corporation at April 30, 2014, were $1.38 billion compared to $1.43 billion at the end of the previous quarter and $1.39 billion a year ago with the decrease from the previous quarter due primarily to a lower level of lending assets. Despite an increase in loans sourced through our bulk loan purchase program, lending assets decreased due to several large loan repayments and a loan sale which took place during the current quarter.

Cash and Securities

Cash and cash equivalents consist of deposits with Canadian chartered banks, government treasury bills and bankers acceptances with less than ninety days to maturity from the date of acquisition. Securities in the Corporation’s treasury portfolio typically consist of Government of Canada and Canadian provincial and municipal bonds, bankers’ acceptances, term deposits and debt of other financial institutions. Cash and securities, which are held primarily for liquidity purposes, totalled $252 million or 18% of total assets compared to $274 million or 19% of total assets at the end of the previous quarter and $170 million or 12% of total assets a year ago. Cash and securities decreased from the previous quarter as there was a lower level of liquid assets required to fund a lower amount of deposits maturing in the coming months but increased from a year ago as a result of several large loan repayments and a loan sale in the current quarter.

At April 30, 2014, unrealized gains in the Corporation’s available-for-sale securities portfolio were $100,000 compared to unrealized gains of $92,000 at the end of the previous quarter and $41,000 a year ago. In addition, there was an unrealized loss of $210,000 at April 30, 2014 relating to a security the Corporation classifies as held-to-maturity, compared to an unrealized loss of $291,000 at the end of the previous quarter and $545,000 a year ago. This unrealized loss is due to changes in interest rates rather than due to changes in credit risk and management is of the opinion that no impairment charge is required.

The Basel III Committee on Banking Supervision (the Basel Committee) has issued a framework outlining new liquidity standards. The framework prescribes two new standards being the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) as minimum regulatory standards beginning in 2015 and 2018 respectively. The LCR establishes a common measure of liquidity risk and requires financial institutions to maintain sufficient liquid assets to cover a minimum of 30 days of cash flow in a stressed scenario. The NSFR describes a second common measure of liquidity establishing a minimum acceptable amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one year time horizon. Although the Basel Committee has introduced a phase-in period for compliance with the LCR guidelines, banks in Canada will be required to fully comply with the LCR in 2015 with no phase-in. Based on its review of these new liquidity standards, the Bank is of the view that it is well positioned to comply with the new requirements.

Loans

Loans totalled $1.11 billion at April 30, 2014, compared to $1.14 billion at the end of the previous quarter and $1.19 billion a year ago with the decrease from the previous quarter and a year ago due primarily to several large loan repayments and a loan sale which took place in the current quarter.

At April 30, 2014, the balances of individual loan categories remained comparable with those from the previous quarter with the exception of decreases in uninsured residential and commercial term mortgages and government financings, reduced by increases in commercial and consumer loans and leases. The decrease in government financings was due to market conditions and the Corporation shifting its focus to commercial and consumer lending opportunities. The decrease in uninsured residential and commercial term mortgages was due primarily to several large repayments and a loan sale in the current quarter. An additional factor for the decrease in lending assets was the result of delays in funding new construction loans due to the longer than normal winter season. The increase in commercial and consumer loans and leases was due to fundings sourced through the bulk purchase program exceeding repayments.

Commercial and consumer loans and leases sourced through the bulk purchase program showed significant growth during the quarter and from a year ago, totalling $279 million at April 30, 2014 compared to $229 million at the end of the previous quarter and $138 million a year ago. The bulk purchase program which is diversified, includes individual loans and leases and is well collateralized, including cash, continues to be a key initiative for the Corporation and the primary driver for growth of the Corporation’s lending portfolio in the coming years.

Overall, new lending for the quarter totalled $170 million compared to $139 million for the previous quarter and $118 million a year ago. Loan repayments, including a loan sale, for the quarter totalled $198 million compared to $162 million for the previous quarter and $94 million, including a loan sale, a year ago. On a year-to-date basis, new lending totalled $309 million and loan repayments, including a loan sale, totalled $360 million. At April 30, 2014, loan commitments, excluding those related to credit cards, totalled $127 million.

Residential mortgage exposure

In accordance with OSFI Guideline B-20 – Residential Mortgage Underwriting Practices and Procedures, additional information is provided regarding the Bank’s residential mortgage exposure. For the purposes of the Guideline, a residential mortgage is defined as a loan to an individual that is secured by residential property (one to four unit dwellings) and includes home equity lines of credit (HELOC’s). This differs from the classification of residential mortgages by the Bank which also includes multi-family mortgages.

Under OSFI’s definition, the Corporation’s exposure to residential mortgages is not significant and at April 30, 2014 totalled $1.1 million compared to $1.2 million at the end of the previous quarter and $1.8 million a year ago. The Corporation did not have any HELOC’s outstanding at April 30, 2014 or a year ago.

Credit Quality

The Corporation has maintained its high credit quality and strong underwriting standards and traditionally requires minimal provisions for credit losses. Gross impaired loans at April 30, 2014, were $nil compared to $6,000 at the end of the previous quarter and $1.7 million a year ago. The provision for (recovery of) credit losses in the current quarter was $267,000 compared to ($51,000) for the previous quarter and $266,000 a year ago. For the six months ended April 30, 2014, the provision for credit losses totalled $216,000 compared to $245,000 for the same period last year.

At April 30, 2014, the Corporation’s collective allowance totalled $2.9 million, similar to that of the previous quarter, and compared to $3.3 million a year ago with the decrease due to a lower level of lending assets. Included in the Corporation’s collective allowance at April 30, 2014 was $859,000 relating to credit card receivables, compared to $858,000 at the end of the previous quarter and $555,000 a year ago. The increase from a year ago was due to the growth and maturation of credit card balances.

Based on results from ongoing stress testing of the loan portfolio under various scenarios and the secured nature of the existing loan portfolio, the Corporation is of the view that any credit losses which exist but cannot be specifically identified at this time are adequately provided for.

Other Assets

Other assets totalled $23.1 million at April 30, 2014, compared to $23.9 million at the end of the previous quarter and $24.8 million a year ago. Included in other assets is the deferred income tax asset of the Bank of $7.8 million compared to $8.3 million at the end of the previous quarter and $8.7 million a year ago. Also included in other assets are capital assets and prepaid expenses of $11.6 million compared to $12.1 million at the end of the previous quarter and $13.3 million a year ago.

Deposits and Other Liabilities

Deposits are used as a primary source of financing growth in assets and are raised primarily through a well established and well diversified deposit broker network across Canada. Deposits at April 30, 2014 totalled $1.16 billion compared to $1.22 billion at the end of the previous quarter and $1.19 billion a year ago, and consist primarily of guaranteed investment certificates. Of the total amount of deposits outstanding, $20.5 million or approximately 1.8% of total deposits at the end of the current quarter were in the form of savings accounts compared to $21.6 million or 1.8% of total deposits at the end of the previous quarter and $24.0 million or approximately 2.0% of total deposits a year ago. In addition, the Corporation has chequing accounts related to trustees in the bankruptcy industry as discussed below.

In order to diversify its sources of deposits and reduce its cost of new deposits, the Corporation identified another source, that being chequing accounts of trustees in the Canadian bankruptcy industry. The Corporation developed banking software to enable this market to efficiently administer its chequing accounts and launched this product in April 2012. These services are being offered to trustees in the bankruptcy industry across Canada and at April 30, 2014, outstanding balances from this source totalled $62.0 million compared to $51.6 million at the end of the previous quarter and $4.2 million a year ago.

An additional source of financing growth in assets and a source of liquidity is the use of margin lines and securities sold under repurchase agreements. From time to time, the Corporation uses these sources of short-term financing when the cost of borrowing is less than the interest rates that would have to be paid on new deposits. At April 30, 2014, the Corporation did not have any amounts outstanding relating to margin lines or securities sold under repurchase agreements nor were any amounts outstanding over the past year.

Other liabilities consist primarily of accounts payable and accruals. At April 30, 2014, other liabilities totalled $32.8 million compared to $27.0 million at the end of the previous quarter and $16.2 million a year ago with the increase due to larger amounts being held as collateral for loans and leases sourced through the Corporation’s bulk financing program which have shown significant growth over the past year.

Securitization Liabilities

The Corporation has securitization liabilities outstanding which relate to amounts payable to counterparties for cash received upon initiation of securitization transactions. At April 30, 2014, securitization liabilities totalled $43.4 million compared to $43.5 million at the end of the previous quarter and $43.4 million a year ago. The Corporation has not entered into any securitization transactions in the past year. The amounts payable to counterparties bear interest at rates ranging from 1.97% - 3.95% and mature between 2016 and 2020. Securitized insured mortgages with a carrying value of $40.4 million are pledged as collateral for these liabilities.

Notes Payable

Notes payable, net of issue costs, totalled $75.4 million at April 30, 2014 compared to $75.2 million at the end of the previous quarter and $82.5 million a year ago with the decrease from last year due primarily to the repayment of subordinated notes of the Bank. In addition, during the six months ended April 30, 2014, the Corporation issued one year, unsecured notes totalling $988,000 bearing interest at 8.0% per annum and a five year unsecured note for $2.5 million, bearing interest at 6% per annum.

Notes payable are comprised of Series C Notes with a par value of $61.7 million maturing in 2018 and other notes totalling $3.7 million maturing between 2014 and 2018. The Series C Notes bear interest at 9.00% per annum. The Series C Notes were modified effective August 27, 2013, in conjunction with the completion of the Bank’s IPO and its common shares being listed on the Toronto Stock Exchange. This modification allows the Corporation at its option, commencing June 30, 2014, to satisfy interest obligations of the Series C Notes either in cash or in-kind in the form of common shares of the Bank held by the Corporation. It also modified the Series C Note indenture to make, at the option of the holder, the Series C Notes convertible into common shares of the Bank held by the Corporation. With this modification of the Series C Notes, $386,000, representing the equity element of the Series C Notes, net of applicable income taxes, has been recorded in shareholders’ equity on the Consolidated Balance Sheets.

Notes payable also include subordinated notes totalling $14.5 million issued by the Bank to an unrelated party. These subordinated notes, of which $4.5 million are currently callable and $10 million are callable beginning in 2016, bear interest at rates ranging from 8.00% to 11.00% and mature between 2019 and 2021.

Preferred Share Liabilities

At April 30, 2014, the Corporation had 1,909,458 Class B Preferred Shares outstanding with a total value of $47.7 million before deducting issue and conversion costs. As these Class B Preferred Shares carry certain redemption features and are convertible into common shares of the Corporation, an amount of $42.8 million, net of issue and conversion costs has been classified on the Corporation’s Consolidated Balance Sheet as Preferred Share Liabilities. In addition, an amount of $3.2 million, net of income taxes and issue costs, has been included in shareholders’ equity on the Corporation’s Consolidated Balance Sheet. As the Class B Preferred Shares must be redeemed by the Corporation in 2019 for $47.7 million, the preferred share liability amount of $42.8 million will be adjusted over the remaining term to redemption until the amount is equal to the estimated redemption amount. The increase is included in interest expense in the Consolidated Statement of Income (Loss), calculated using an effective interest rate of 11.8%.

Shareholders’ Equity

At April 30, 2014, shareholders’ equity was $11.3 million compared to $12.5 million at the end of previous quarter and $16.3 million a year ago with the decrease due primarily to operating losses in the periods. Common shares outstanding at April 30, 2014 totalled 33,639,242 compared to 33,015,129 at the end of the previous quarter and 30,139,732 a year ago with the increase from the previous quarter due to 624,113 common shares issued as part of the dividends on the Class B Preferred Shares.

At April 30, 2014, there were 314,572 Class A Preferred Shares outstanding, unchanged from a year ago and 1,909,458 Class B Preferred Shares outstanding, also unchanged from a year ago.

Common share options totalled 517,183 at April 30, 2014, unchanged from January 31, 2014. In addition, at April 30, 2014, there were 40,000 common share options outstanding in the Bank which is unchanged from the end of the previous quarter.

The Corporation’s book value per common share at April 30, 2014 was $0.21 compared to $0.25 at the end of the previous quarter and $0.40 a year ago.

Normal Course Issuer Bids

On March 11, 2014, the Corporation obtained approval from the Toronto Stock Exchange to proceed with Normal Course Issuer Bids (NCIBs) for its common shares, Class B Preferred Shares and Series C Notes. All three NCIBs commenced on March 14, 2014 and will terminate on March 13, 2015, or such earlier date as the Corporation may complete its purchases pursuant to the NCIBs. The prices that the Corporation will pay for any common shares, Class B Preferred Shares and Series C Notes will be the market price of such shares or notes at the time of purchase.

Pursuant to the NCIBs, the Corporation may purchase for cancellation:

• Up to 2,450,000 of its common shares representing 9.99% of the public float. Daily purchases are limited to 25% of the average daily trading volume (ADTV), which is 3,551 common shares, other than block purchase exceptions.
• Up to 190,000 of its Class B Preferred Shares representing 9.97% of the public float. Daily purchases are limited to 1,000 Class B Preferred Shares, other than block purchase exceptions.
• Up to $3,300,000 of its Series C Notes representing 9.79% of the public float. Daily purchases are limited to 25% of the ADTV, which is $1,775 Series C Notes, other than block purchase exceptions.

Reduction of Stated Capital

On May 30, 2012, at a special meeting of the shareholders of the Corporation, approval was given authorizing the reduction of the stated capital of the common shares of the Corporation by $50,472,000 and correspondingly reducing retained earnings (deficit) by the same amount. There was no impact on total shareholders’ equity.

Updated Share Information

As at June 4, 2014, there were no changes since April 30, 2014 in the number of outstanding common shares, common share options and Class A or Class B Preferred Shares.

Off-Balance Sheet Arrangements

As at April 30, 2014, the Corporation does not have any significant off-balance sheet arrangements other than loan commitments and letters of credit resulting from normal course business activities. See Note 12 to the unaudited interim consolidated financial statements for more information.

Related Party Transactions

The Corporation’s and the Bank’s Board of Directors and Senior Executive Officers represent key management personnel. Other than key management personnel, the Corporation has no other related parties for which there were transactions or outstanding balances during the period. See note 13 to the unaudited interim consolidated financial statements for details on related party transactions and balances.

Risk Management

The risk management policies and procedures of the Corporation are provided in its annual MD&A for the year ended October 31, 2013, and are found on pages 41 to 48 of the Corporation’s 2013 Annual Report.

Capital Management and Capital Resources

The Basel Committee on Banking Supervision has published the Basel III rules supporting more stringent global standards on capital adequacy and liquidity (Basel III). Significant changes under Basel III that are most relevant to the Bank include:

• Increased focus on tangible common equity.
• All forms of non-common equity such as the Bank’s conventional subordinated notes must be non-viability contingent capital (NVCC) compliant. NVCC compliant means the subordinated notes must include a clause that would require conversion to common equity in the event that OSFI deems the institution to be insolvent or a government is ready to inject a “bail out” payment.
• Changes in the risk-weighting of certain assets.
• Additional capital buffers.
• New requirements for levels of liquidity and new liquidity measurements.

OSFI requires that all Canadian banks must comply with the Basel III standards on an “all-in” basis for purposes of determining its risk-based capital ratios. Required minimum regulatory capital ratios are a 7.0% Common Equity Tier 1 (CET1) capital ratio and effective January 1, 2014, an 8.5% Tier 1 capital ratio and 10.5% total capital ratio, all of which include a 2.5% capital conservation buffer. The Basel III rules provide for “transitional” adjustments whereby certain aspects of the new rules will be phased in between 2013 and 2019. The only available transition allowed by OSFI for capital ratios is related to the 10 year phase out of non-qualifying capital instruments. However, OSFI has allowed Canadian banks to calculate their asset to capital ratios on a transitional basis between 2013 and 2019.

Under the Basel III standards, total capital of the Bank was $139.5 million at April 30, 2014 compared to $137.6 million at the end of the previous quarter and $133.1 million a year ago. The increase in total capital from the previous quarter was due primarily to earnings in the Bank during the period and prescribed regulatory adjustments. At April 30, 2014, the Bank exceeded the current regulatory capital requirements with a CET1 ratio of 12.21% compared to 11.54% at the end of the previous quarter and 10.34% a year ago. In addition, the Bank’s total capital ratio was 13.37% at April 30, 2014 compared to 12.64% at the end of the previous quarter exceeding the capital requirements that became effective January 1, 2014. The Bank’s assets-to-capital ratio at April 30, 2014 was 9.60 compared to 10.06 at the end of the previous quarter and 9.69 a year ago.

See note 14 to the interim consolidated financial statements for more information regarding capital management.

Capital Assets

The operations of the Corporation are not dependent upon significant amounts of capital assets to generate revenue. Currently, the Corporation does not have any significant commitments for capital expenditures or for significant additions to its level of capital assets.

Interest Rate Risk Management

The Bank is subject to interest rate risk which is the risk that a movement in interest rates could negatively impact net interest margin, net interest income and the economic value of assets, liabilities and shareholders’ equity. The following table provides the duration difference between the Bank’s assets and liabilities and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s earnings during a 12 month period and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s shareholders’ equity over a 60 month period if no remedial actions are taken.

The change in exposure to a 100 basis point shift in interest rates in a 60 month period and the change in the duration difference between assets and liabilities from a year ago was due primarily to the decrease in securities and lending assets and an increase in cash and cash equivalents, all of which resulted in a decrease in the duration of assets at the end of the current quarter. The duration of liabilities remained relatively the same since last year.

Liquidity

PWC Capital Inc., on a non-consolidated basis, has sufficient funds on hand to meet its cash obligations for the fiscal year. These obligations relate primarily to payments of interest on notes payable and the expected cash portion of dividends on Class B Preferred Shares. The Corporation on a non-consolidated basis may not be able to depend on funding to come from its subsidiary the Bank as regulatory requirements may restrict certain payments. As a result, the funding for the obligations beyond the current fiscal year is expected to come primarily from cash and proceeds from the sales of securities and borrowings.

The unaudited Consolidated Statement of Cash Flows for the Corporation for the six months ended April 30, 2014 shows cash provided by (used in) operations of $37.4 million compared to ($131.4 million) for the same period last year. The Corporation’s operating cash flow is primarily affected by the change in the balance of its deposits (a positive change in deposits has a positive impact on cash flow and a negative change in deposits has a negative impact on cash flow) as compared to the change in the balance of its loans (a positive change in loans has a negative impact on cash flow and a negative change in loans has a positive impact on cash flow). Based on factors such as liquidity requirements and opportunities for investment in loans and securities, the Corporation may manage the amount of deposits it receives and loans it funds in ways that result in the balances of these items giving rise to either negative or positive cash flow from operations. The Corporation will continue to fund its operations and meet contractual obligations as they become due from cash on hand and from managing the amount of deposits it receives as compared to the amount of loans it funds.

Contractual Obligations

Contractual obligations of the Corporation as disclosed in its MD&A and audited consolidated financial statements for the year ended October 31, 2013, have not changed significantly as at April 30, 2014.

The financial results of the Corporation for each of the last eight quarters are summarized above. The Corporation’s results, particularly total interest income and interest expense are comparable between quarters and over the past eight quarters reflect seasonality occurring in residential construction lending in the Bank. Total interest income decreased in the second quarter and first quarter of 2014 due primarily to a decrease in lending assets as a result of several large loan repayments and a loan sale which took place during the periods and a fewer number of days in the second quarter. Interest expense decreased in the first quarter of 2014 as a result of the repayment of $7 million in subordinated notes in the first quarter.

Other income during the quarters shows variability due to the level of gains realized in previous periods on the sale of securities and loans. The other component of other income consists primarily of credit card fees which have been comparable over the quarters.

Non-interest expenses reflect a strategy to reduce overhead expenses, primarily with respect to the credit card program and the timing of expenses. Restructuring charges in the first quarter of 2014 resulted from the write-off of unamortized issue costs related to the repayment of subordinated notes and in the fourth quarter of 2013, relate to expenses incurred from the IPO of the Bank.

The provision for income taxes in each of the quarters reflects the effective statutory income tax rate of the Bank applied to earnings and includes income taxes on dividends paid by the Corporation on its Class B Preferred Shares. The provision for income taxes in the fourth quarter of 2012 included an income tax adjustment of $1.9 million relating to a change in the estimate of previously recognized deferred income tax assets.

Significant Accounting Policies and Use of Estimates and Judgments

Significant accounting policies are detailed in Note 3 of the Corporation’s 2013 Audited Consolidated Financial Statements. There has been no change in accounting policies except that segment disclosure is no longer provided as the Corporation determined that credit card operations are not a significant part of its business. The impact of new standards adopted during the current period was not material.

In preparing the consolidated financial statements, management has exercised judgment and developed estimates in applying accounting policies and generating reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting periods. Areas where significant judgment was applied or estimates were developed include assessments of fair value and impairments of financial instruments, the calculation of the allowance for credit losses, and the measurement of deferred income taxes.

It is reasonably possible, on the basis of existing knowledge, that actual results may vary from that expected in the generation of these estimates. This could result in material adjustments to the carrying amounts of assets and/or liabilities affected in the future.

Estimates and their underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are applied prospectively once they are recognized.

The policies discussed below are considered particularly significant as they require management to make estimates or judgements, some of which may relate to matters that are inherently uncertain.

Financial Instruments

All financial assets are classified as one of the following: held-to-maturity, loans and receivables, or available-for-sale. All financial liabilities are classified as other liabilities. Financial assets held-to-maturity, loans and receivables and financial liabilities are measured at amortized cost based on the effective interest method. Available-for-sale instruments are measured at fair value with gains and losses, net of tax, recognized in other comprehensive income.

Estimates of fair value are developed using a variety of valuation methods and assumptions. The Corporation follows a fair value hierarchy to categorize the inputs used to measure fair value for its financial instruments. The fair value hierarchy is based on quoted prices in active markets (Level 1), valuation techniques using inputs other than quoted prices but with observable market data (Level 2), or valuation techniques using inputs that are not based on observable market data (Level 3). Valuation techniques may require the use of inputs, transaction values derived from models and input assumptions sourced from pricing services. Valuation inputs are either observable or unobservable. The Corporation looks to external readily observable market inputs when available and may include certain prices and rates for shorter-dated Canadian yield curves and bankers acceptances. Unobservable inputs may include credit spreads, probability of default and recovery rates.

Fair value measurements that fall into Level 2 of the fair value hierarchy include Canadian municipal bonds. For Canadian municipal bonds, fair value measurement is primarily based on quotes received from brokers that represent transaction prices in markets for identical instruments.

Securities

The Corporation holds securities primarily for liquidity purposes with the intention of holding the securities to maturity or until market conditions render alternative investments more attractive. Settlement date accounting is used for all securities transactions.

At the end of each reporting period, the Corporation assesses whether or not there is any objective evidence to suggest that a security may be impaired. Objective evidence of impairment results from one or more events that occur after the initial recognition of the security which has an impact that can be reliably estimated on the estimated future cash flows of the security such as financial difficulty of the issuer. An impairment loss is recognized for an equity instrument if the decline in fair value is significant or prolonged, as such circumstances provide objective evidence of impairment.

Impairment losses on a held-to-maturity security are recognized in income and loss in the period they are identified. When there is objective evidence of impairment of an available-for-sale security, the cumulative loss that has been recorded in accumulated other comprehensive income is reclassified to income or loss. For available-for-sale debt securities, if in a subsequent period the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then the previously recognized impairment loss is adjusted through income or loss to reflect the net recoverable amount of the impaired security. No adjustments of impairment losses are recognized for available-for-sale equity securities.

Loans

Loans are initially measured at fair value plus incremental direct transaction costs. Loans are subsequently measured at amortized cost, net of allowance for credit losses, using the effective interest method. On a monthly basis, the Corporation assesses whether or not there is any objective evidence to suggest that the carrying value of the loans may be impaired. Impairment assessments are facilitated through the identification of loss events and assessments of their impact on the estimated future cash flows of the loans.

A loan is classified as impaired when, in management's opinion, there has been deterioration in credit quality to the extent that there is no longer reasonable assurance as to the timely collection of the full amount of principal and interest. Loans, except credit cards, where interest or principal is contractually past due 90 days are automatically recognized as impaired, unless management determines that the loan is fully secured, in the process of collection and the collection efforts are reasonably expected to result in either repayment of the loan or restoring it to current status. All loans, except credit cards, are classified as impaired when interest or principal is past due 180 days, except for loans guaranteed or insured by the Canadian government, provinces, territories, or a Canadian government agency, which are classified as impaired when interest or principal is contractually 365 days in arrears. Credit card receivables are written off when payments are 180 days past due, or upon receipt of a bankruptcy notification.

As loans are classified as loans and receivables and measured at amortized cost, an impairment loss is measured as the difference between the carrying amount and the present value of future cash flows discounted using the effective interest rate computed at initial recognition, if future cash flows can be reasonably estimated. When the amounts and timing of cash flows cannot be reasonably estimated, the carrying amount of the loan is reduced to its estimated net realizable value based on either:

(i) the fair value of any security underlying the loan, net of expected costs of realization, or,

(ii) observable market prices for the loan.

Impairment losses are recognized in income or loss. If, in a subsequent period, the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then a recovery of a portion or all of the previously recognized impairment loss is adjusted through income or loss to reflect the net recoverable amount of the impaired loan.

Real estate held for resale is recorded at the lower of cost and fair value, less costs to sell.

Allowance for Credit Losses

The Corporation maintains an allowance for credit losses which, in management's opinion, is adequate to absorb all credit related losses in its loan portfolio. The allowance for credit losses consists of both individual and collective allowances and is reviewed on a monthly basis. The allowance is presented as a component of loans on the Corporation’s consolidated balance sheets.

The Corporation considers evidence of impairment for loans at both an individual asset and collective level. All individually significant loans are assessed for impairment first. All individually significant loans found not to be specifically impaired and all loans which are not individually significant are then collectively assessed for impairment by aggregating them into groups with similar credit risk characteristics.

The collective impairment allowance is determined by reviewing factors including historical loss experience in portfolios of similar credit risk characteristics, current portfolio credit quality trends, probability of default and recovery rates, and business and economic conditions. Historical loss experience is adjusted based on current observable data to reflect effects of current conditions that did not affect the period in which the historical loss experience is based. The collective impairment allowance may also be adjusted by management using its judgment taking into account other observable and unobservable factors.

Corporate Income Taxes

Current income taxes are calculated based on taxable income at the reporting period end. Taxable income differs from accounting income because of differences in the inclusion and deductibility of certain components of income which are established by Canadian taxation authorities. Current income taxes are measured at the amount expected to be recovered or paid using statutory tax rates at the reporting period end.

The Corporation follows the asset and liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities arise from temporary differences between financial statement carrying values and the respective tax base of those assets and liabilities. Deferred income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years when temporary differences are expected to be recovered or settled.

Deferred income tax assets are recognized in the Corporation’s consolidated financial statements to the extent that it is probable that the Corporation will have sufficient taxable income to enable the benefit of the deferred income tax asset to be realized. Unrecognized deferred income tax assets are reassessed for recoverability at each reporting period end.

The realization of the deferred income tax asset is dependent upon the Bank being able to generate taxable income during the carry-forward period sufficient to offset the income tax losses and deductible temporary timing differences. While management is of the opinion that it is probable that the Bank will be able to realize the deferred income tax asset, there is no guarantee the Bank will be able to generate sufficient taxable income during the carry-forward period.

Future Change in Accounting Policies

IFRS 9: Financial instruments (IFRS 9)

In November 2009, the IASB issued IFRS 9 as the first phase of an ongoing project to replace IAS 39. This first issuance of IFRS 9 introduced new requirements for classifying and measuring financial assets. IFRS 9 was then re-issued in October 2010, incorporating new requirements for the accounting of financial liabilities, and carrying over from IAS 39 the requirements for de-recognition of financial assets and financial liabilities. The mandatory effective date for the adoption of IFRS 9 was set for annual periods beginning on or after January 1, 2015, with earlier application permitted. In July 2013, the IASB deferred the mandatory effective date for the adoption of IFRS 9 to a date yet to be determined and to allow entities to early adopt only the own credit requirement in IFRS 9. The IASB continues to deliberate on the content of IFRS 9 and intends to expand the existing standard by adding new requirements for the impairment of financial assets measured at amortized cost and hedge accounting. On completion of these various projects, IFRS 9 will represent a complete replacement of IAS 39. The IASB has tentatively decided that IFRS 9 will be effective for annual periods beginning on or after January 1, 2018.

The most significant changes expected under IFRS 9 relate to decreases in the classification categories available for financial instruments, a requirement that debt instruments meet a business model and cash flow characteristic test before being eligible for measurement at amortized cost, and a requirement that changes in the fair value of equity instruments be reported in profit or loss (unless an irrevocable election is made at initial recognition to recognize such changes in other comprehensive income). Management has performed preliminary evaluations of the impact of IFRS 9, however the impact on the Corporation’s Consolidated Financial Statements is not determinable at this time as it is dependent upon the nature of financial instruments held by the Corporation when IFRS 9 becomes effective. The Corporation is choosing not to early adopt the own credit requirement of IFRS 9.

Controls and Procedures

During the most recent interim period, there have been no changes in the Corporation’s policies and procedures and other processes that comprise its internal control over financial reporting, that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

Forward-Looking Statements

The statements in this management’s discussion and analysis that relate to the future are forward-looking statements. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, many of which are out of our control. Risks exist that predictions, forecasts, projections and other forward-looking statements will not be achieved. Readers are cautioned not to place undue reliance on these forward-looking statements as a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. These factors include, but are not limited to, the strength of the Canadian economy in general and the strength of the local economies within Canada in which we conduct operations; the effects of changes in monetary and fiscal policy, including changes in interest rate policies of the Bank of Canada; the effects of competition in the markets in which we operate; inflation; capital market fluctuations; the timely development and introduction of new products in receptive markets; the impact of changes in the laws and regulations regulating financial services; changes in tax laws; technological changes; unexpected judicial or regulatory proceedings; unexpected changes in consumer spending and savings habits; and our anticipation of and success in managing the risks implicated by the foregoing. For a detailed discussion of certain key factors that may affect our future results, please see page 48 of our 2013 Annual Report.

The foregoing list of important factors is not exhaustive. When relying on forward-looking statements to make decisions, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. The forward-looking information contained in the management’s discussion and analysis is presented to assist our shareholders in understanding our financial position and may not be appropriate for any other purposes. Except as required by securities law, we do not undertake to update any forward-looking statement that is contained in this management’s discussion and analysis or made from time to time by the Corporation or on its behalf.

The accompanying notes are an integral part of these interim Consolidated Financial Statements.

The accompanying notes are an integral part of these interim Consolidated Financial Statements.

(1) Net of income tax benefit for three months of $2 (2013 – $12) and six months of $18 (2013 – $6)
(2) Net of income tax benefit for three months of $nil (2013 – $9) and six months of $nil (2013 – $9)

The accompanying notes are an integral part of these interim Consolidated Financial Statements.

The accompanying notes are an integral part of these interim Consolidated Financial Statements.

The accompanying notes are an integral part of these interim Consolidated Financial Statements

PWC CAPITAL INC.
Notes to Interim Consolidated Financial Statements
(Unaudited)

Three and six month periods ended April 30, 2014 and 2013

1. Reporting entity:

PWC Capital Inc. (the “Corporation”), formerly known as Pacific & Western Credit Corp., is a holding company whose shares trade on the Toronto Stock Exchange. It is incorporated and domiciled in Canada, and maintains its registered office at Suite 2002, 140 Fullarton Street, London, Ontario, Canada, N6A 5P2.

The Corporation’s principal subsidiary is Pacific & Western Bank of Canada (“PWB” or the “Bank”) which operates as a Schedule I bank under the Bank Act (Canada) and is regulated by the Office of the Superintendent of Financial Institutions (OSFI). The Bank, whose common shares commenced trading on the Toronto Stock Exchange on August 27, 2013, is involved in the business of providing commercial lending services to selected niche markets.

2. Basis of preparation:

a) Statement of compliance:

These interim Consolidated Financial Statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and have been prepared in accordance with International Accounting Standard (IAS) 34 – Interim Financial Reporting and do not include all of the information required for full annual financial statements. These interim Consolidated Financial Statements should be read in conjunction with the Corporation’s audited Consolidated Financial Statements for the year ended October 31, 2013.

The interim Consolidated Financial Statements for the three and six months ended April 30, 2014 and 2013 were approved by the Audit Committee of the Board of Directors on June 4, 2014.

b) Basis of measurement:

These interim Consolidated Financial Statements have been prepared on the historical cost basis except for securities designated as available-for-sale that are measured at fair value in the Consolidated Balance Sheets.

c) Functional and presentation currency:

These interim Consolidated Financial Statements are presented in Canadian dollars which is the Corporation’s functional currency. Except as indicated, the financial information presented has been rounded to the nearest thousand.

d) Use of estimates and judgments:

In preparing these interim Consolidated Financial Statements, management has exercised judgment and developed estimates in applying accounting policies and generating reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting periods. Areas where significant judgment was applied or estimates were developed include the calculation of the allowance for credit losses, assessments of fair value and impairments of financial instruments, and the measurement of deferred income taxes.

It is reasonably possible, on the basis of existing knowledge, that actual results may vary from that expected in the generation of these estimates. This could result in material adjustments to the carrying amounts of assets and/or liabilities affected in the future.

Estimates and their underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are applied prospectively once they are recognized.

3. Significant accounting policies:

The accounting policies applied by the Corporation in these interim Consolidated Financial Statements are the same as those applied by the Corporation as at and for the year ended October 31, 2013 and are detailed in Note 3 of the Corporation’s 2013 Audited Consolidated Financial Statements. There have been no changes in accounting policies except that segment disclosure is no longer provided as the Corporation determined that credit card operations are not a significant part of its business. The impact of new standards adopted during the current period was not material.

4. Securities:

Portfolio analysis:

All available-for-sale securities are carried at fair value based on quoted market prices (Level 1) except for Canadian municipal bonds and term deposits which fall into Level 2 of the fair value hierarchy. See Note 3 (c) of the October 31, 2013 consolidated financial statements for more information.

5. Loans:

a) Portfolio analysis:

The collective allowance for credit losses relates to the following loan portfolios:

The Corporation holds collateral against the majority of its loans in the form of mortgage interests over property, other registered securities over assets, cash held as collateral for the bulk purchase program, and guarantees.

b) Allowance for credit losses:

The allowance for credit losses results from the following:

c) Impaired loans

Interest income recognized on impaired loans for the three and six months ended April 30, 2014 was $nil (April 31, 2013 - $39,000) and $nil (April 31, 2013 - $77,000) respectively.

At April 30, 2014, loans, other than credit card receivables, past due but not impaired, totalled $nil (October 31, 2013 - $nil). At April 30, 2014, credit card receivables overdue by one day or more but not impaired totalled $2,402,000 (October 31, 2013 - $2,342,000).

6. Notes payable:

The Series C Notes were modified effective August 27, 2013 in conjunction with the completion of the Bank’s Initial Public Offering (IPO) and its common shares being listed on the Toronto Stock Exchange. This modification allows the Corporation at its option, commencing June 30, 2014, to satisfy all interest obligations of the Series C Notes either in cash or in-kind in the form of common shares of the Bank held by the Corporation. It also modified the Series C Note indenture to make, at the option of the holder, the Series C Notes convertible into common shares of the Bank held by the Corporation for $10 per share until October 16, 2016 and $12/share thereafter until maturity.

During the six months ended April 30, 2014, the Bank repaid $7,000,000 in subordinated notes which had a carrying value of $6,566,000. The difference of $434,000 relating to unamortized note issue costs was included in restructuring charges.

In addition, during the six months ended April 30, 2014, the Corporation issued one year, unsecured notes totalling $988,000 bearing interest at 8.0% per annum for net proceeds of $944,000 and a five year unsecured note for $2,500,000 bearing interest at 6% per annum.

7. Securitization liabilities:

Securitization liabilities include amounts payable to counterparties for cash received upon initiation of securitization transactions, accrued interest on amounts payable to counterparties, and the unamortized balance of deferred costs and discounts which arose upon initiation of the securitization transactions.

The amounts payable to counterparties bear interest at rates ranging from 1.97% - 3.95% and mature between 2016 and 2020. Securitized insured mortgages with a carrying value of $40,410,000 (October 31, 2013 - $40,832,000) are pledged as collateral for these liabilities.

8. Preferred share liabilities:

At April 30, 2014, the Corporation has outstanding 1,909,458 (October 31, 2013 - 1,909,458) Class B Preferred Shares with a total face value of $47.7 million (October 31, 2013 – $47.7 million) less issue costs of $1.9 million (October 31, 2013 – $2.1 million). As these Class B Preferred Shares carry certain redemption features and are convertible into common shares of the Corporation, an amount of $42.8 million (October 31, 2013 – $42.4 million), net of issue costs, has been classified on the Corporation’s Consolidated Balance Sheets as a preferred share liability. In addition, an amount of $3.2 million (October 31, 2013 – $3.2 million) representing the equity element of the Class B Preferred Shares, net of issue costs, has been classified in share capital on the Consolidated Balance Sheets.

As the preferred shares must be redeemed by the Corporation in 2019 for approximately $47.7 million, the preferred share liability amount of $42.8 million (October 31, 2013 – $42.4 million) is being adjusted over the remaining term to redemption, until the amount is equal to the estimated redemption amount. The increase is included in interest expense in the Consolidated Statement Loss calculated using the effective interest rate of 11.8%.

9. Share capital:

a) Share capital

At April 30, 2014, there were 314,572 (October 31, 2013 - 314,572) Class A Preferred Shares outstanding and 1,909,458 (October 31, 2013 - 1,909,458) Class B Preferred Shares outstanding.

b) Stock-based compensation

During the three and six months ended April 30, 2014, the Corporation recognized compensation expense of $19,000 (April 30, 2013 - $17,000) and $41,000 (April 30, 2013 - $21,000) respectively, relating to the estimated fair value of stock options granted in prior periods by the Corporation and a subsidiary. No stock options were granted during the current period.

During the six months ended April 30, 2013, 50,000 options were granted to an officer who is a member of the Corporation’s key management personnel. These options are exercisable into common shares at $1.26 per share and expire in February, 2023. The fair value of the options was estimated using the Black-Scholes option pricing model based on the following assumptions: (i) risk-free interest rate of 1.53%, (ii) expected option life of 60 months and (iii) expected volatility of 65.45%. The forfeiture rate for these options was estimated at 0%. The fair value of options granted was estimated at $0.70 per option.

The Corporation recorded amounts in the Consolidated Statement of Loss relating to DSU’s for the three and six months ended April 30, 2014 of $111,000 recovery (April 30, 2013 - $152,000 expense) and $133,000 recovery (April 30, 2013 - $139,000 expense) respectively. During the three and six months ended April 30, 2014, the Corporation did not issue any DSU’s (April 30, 2013 – 144,131) to its directors. At April 30, 2014 there were 443,587 (April 30, 2013 – 443,587) DSU’s of the Corporation outstanding.

10. Other income:

11. Income taxes:

The Corporation’s statutory federal and provincial income tax rate is approximately 27%, similar to that of the previous periods. The effective rate is impacted by the tax benefit on operating losses in the Corporation on a non-consolidated basis not being recorded for accounting purposes and certain items not being taxable or deductible for income tax purposes. The provision for income taxes consists of the following items:

12. Commitments and contingencies:

The amount of credit related commitments represents the maximum amount of additional credit that the Corporation could be obligated to extend. Under certain circumstances, the Corporation may cancel loan commitments at its option. The amounts with respect to the letters of credit are not necessarily indicative of credit risk as many of these arrangements are contracted for a limited period of usually less than one year and will expire or terminate without being drawn upon.

Cash totalling $9,825,000 (October 31, 2013 - $10,380,000) is pledged as collateral against liabilities and off-balance sheet items.

13. Related party transactions:

The Corporation’s and the Bank’s Board of Directors and Senior Executive Officers represent key management personnel. Other than key management personnel, the Corporation has no other related parties for which there were transactions or balances outstanding during the periods.

The Corporation issues both mortgages and personal loans to employees and key management personnel. At April 30, 2014 amounts due from key management personnel totalled $2,013,000 (October 31, 2013 - $2,100,000) and are unsecured. The interest rates charged on these loans are similar to those charged in an arms-length transaction. Interest income earned on the above loans for the three and six months ended April 30, 2014 was $18,000 (April 30, 2013 - $9,000) and $36,000 (April 30, 2013 - $19,000) respectively. There was no provision for credit losses related to loans issued to key management personnel for the three and six months ended April 30, 2014 and 2013.

14. Capital management:

a) Overview:

The Corporation’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The impact of the level of capital on shareholders’ return is also important and the Corporation recognizes the need to maintain a balance between the higher returns that might be possible with greater leverage and the advantages and security afforded by a sound capital position.

The Corporation’s primary subsidiary is Pacific & Western Bank of Canada, (the “Bank”) and as a result, the following discussion on capital management is with respect to the capital of the Bank. The Bank operates as a bank under the Bank Act (Canada) and is regulated by the Office of the Superintendent of Financial Institutions Canada (OSFI). OSFI sets and monitors capital requirements for the Bank.

Capital is managed in accordance with policies and plans that are regularly reviewed and approved by the Board of Directors and take into account forecasted capital needs and conditions in financial markets.

The goal is to maintain adequate regulatory capital to be considered well capitalized, protect consumer deposits and provide capacity for internally generated growth and strategic opportunities that do not otherwise require accessing the public capital markets, all the while providing a satisfactory return to shareholders. The Bank’s regulatory capital is comprised of share capital, retained earnings (deficit) and unrealized gains and losses on available-for-sale securities (Common Equity Tier 1 capital) and the face value of subordinated notes (Tier 2 capital).

The Bank monitors its capital adequacy and related capital ratios on a daily basis and has policies setting internal maximum and minimum amounts for its capital ratios. These capital ratios consist of the assets-to-capital multiple and the risk-based capital ratios.

During the three and six months ended April 30, 2014 there were no material changes in the Bank’s management of capital.

b) Risk-Based Capital Ratio:

The Basel Committee on Banking Supervision has published the Basel III rules supporting more stringent global standards on capital adequacy and liquidity (Basel III).

OSFI requires that all Canadian banks must comply with the Basel III standards on an “all-in” basis for purposes of determining its risk-based capital ratios. The required minimum regulatory capital ratios are a 7.0% Common Equity Tier 1 (CET1) capital ratio and effective January 1, 2014, an 8.5% Tier 1 capital ratio and 10.5% total capital ratio, all of which include a 2.50% capital conservation buffer. The Basel III rules provide for “transitional” adjustments whereby certain aspects of the new rules will be phased in between 2013 and 2019. The only available transition allowed by OSFI for capital ratios is related to the 10 year phase out of non-qualifying capital instruments. However, OSFI has allowed Canadian banks to calculate their asset to capital ratios on a transitional basis between 2013 and 2019.

OSFI also requires banks to measure capital adequacy in accordance with guidelines for determining risk adjusted capital and risk-weighted assets including off-balance sheet credit instruments as specified in the Basel III regulations. Based on the deemed credit risk for each type of asset, assets held by the Bank are assigned a weighting of 0% to 150% to determine the risk-based capital ratio.

The Bank’s risk-based capital ratios are calculated as follows:

c) Assets-to-Capital Multiple:

The Bank’s growth in total assets is governed by a permitted assets-to-capital multiple which is prescribed by OSFI and is defined as the ratio of the total assets of the Bank to its regulatory capital. The Bank’s assets-to-capital multiple is calculated as follows:

The Bank was in compliance with the assets-to-capital multiple prescribed by OSFI throughout the current periods.

15. Interest rate position:

The Bank is subject to interest rate risk which is the risk that a movement in interest rates could negatively impact net interest margin, net interest income and the economic value of assets, liabilities and shareholders’ equity. The following table provides the duration difference between the Bank’s assets and liabilities and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s earnings during a 12 month period and the potential after-tax impact of a 100 basis point shift in interest rates on the Bank’s shareholders’ equity over a 60 month period if no remedial actions are taken.

16. Fair Value of Financial Instruments:

Fair values are based on management’s best estimates of market conditions and valuation policies at a certain point in time. The estimates are subjective and involve particular assumptions and matters of judgment and as such, may not be reflective of future fair values. The Corporation’s loans and deposits lack an available market as they are not typically exchanged. Therefore, they are not necessarily representative of amounts realizable upon immediate settlement. See Note 24 to the October 31, 2013 consolidated financial statements for more information on fair values.