Capital and Liquidity Management

Capital Management

As a regulated financial institution, Affinity is required to maintain an adequate level of capital reserves to mitigate risk. A strong capital position protects the credit union against the impact of unexpected losses and can be leveraged to support ongoing growth in our traditional business lines or through diversification opportunities. With Affinity’s main source of capital being derived from retained earnings, building capital is dependent upon generating strong earnings.

On an annual basis a capital plan is developed to ensure Affinity generates sufficient capital to meet our strategic objectives, provide the credit union with the ability to withstand economic downturns or extraordinary events, while still maintaining the minimum regulatory capital requirements. The 2022 plan considered various growth scenarios and the impact on key financial performance indicators for return on equity and operating efficiency to determine an optimal level of growth. The plan also evaluated Affinity’s internal economic capital requirement to ensure capital levels were appropriate for the credit union’s unique risk profile. Our capital position was monitored on a regular basis by forecasting changes in our business model against capital adequacy to support ongoing business decisions. This included a regular assessment of existing and emerging risks to ensure the adequacy of both the internal capital requirements and the minimum regulatory requirements.

Our regulator, Credit Union Deposit Guarantee Corporation (The Corporation) measures capital adequacy as total capital as a percentage of risk weighted assets. The Corporation’s minimum requirement is 11.5%, which aligns with our P-SIFI (Provincially Systemically Important Financial Institution) designation. Affinity’s capital adequacy policy requires an additional 1% buffer over the greater of (i) the regulatory minimum or (ii) Affinity’s Economic Capital requirement. For all measurement dates, Affinity’s Economic Capital requirement was lower than the regulatory minimum of 11.5%, meaning that inclusive of the buffer, Affinity’s minimum capital requirement in 2022 was 12.5%.

Affinity’s Capital continues to exceed all minimum policy and regulatory thresholds.

Capital / Risk Weighted

As a result of our earnings, asset growth, and Concentrarelated dividend, Affinity maintained its strong capital position to end the year at 16.7% up 120 basis points over 2021. On a normalized basis, eligible capital is 15.5%. This level of capital continues to strengthen Affinity’s capacity to withstand economic uncertainties and provides flexibility to pursue new opportunities.

Internal Capital Adequacy Assessment Process (ICAAP)

Affinity’s Internal Capital Adequacy Assessment Process (ICAAP) quantifies the credit union’s Economic Capital requirement. ICAAP is embedded as a key component of Affinity’s Enterprise Risk Framework. The ICAAP model considers mitigation strategies for each identified risk and evaluates the impact to capital from any residual, unmitigated risk to determine the base Economic Capital requirement. A stress test is then applied to each identified risk using a plausible yet severe stress scenario. The combined base capital together with the additional capital allocation for the stress scenario forms the credit union’s total Economic Capital requirement. All key risks are monitored using a risk register which is reviewed and refreshed on a quarterly basis.

Liquidity Management

Adequate liquidity is critical for the overall safety and soundness of the credit union. Affinity’s liquidity management framework aligns to the liquidity risk management principles issued by The Corporation. These principles complement the regulatory liquidity adequacy standards and cover all facets of liquidity management ranging from the initial setting of the Board’s risk appetite to the daily liquidity management function, including appropriate debt facilities and interaction with third-party liquidity providers. Finally, the principles address the identification, management, and resolution of a liquidity crisis event.

In 2022, liquidity management included continual monitoring of liquidity sources across multiple time periods to ensure that Affinity could satisfy cash demands. The Board established policy limits for minimum operating liquidity surpluses over a one-year timeline ensures sufficient liquidity is available to satisfy all expected cash outflows, as well as an adequate buffer to withstand the stress of an unusual or unexpected event. During 2022, we consistently exceeded the minimum policy limits for all time intervals within the 12-month period.

From a regulatory perspective Affinity must maintain a portfolio of statutory liquidity investments with Credit Union Central of Saskatchewan (SaskCentral) equal to 10% of the credit union’s deposits and borrowings to support the provincial credit union system’s liquidity program. CUDGC also requires all credit unions to maintain a minimum 100% liquidity coverage ratio (LCR). The LCR is a ratio between the credit union’s high-quality liquid assets and the cash outflows associated with the expected deposit run-off from a prescribed 30-day stress scenario. Affinity’s Board established a higher policy minimum of 120% for the LCR. Throughout 2022 we exceeded the higher LCR policy threshold and the 10% statutory liquidity requirement.

The deposit growth that began with the start of the pandemic in 2020 continued through most of 2022 resulting in excess liquidity levels that surpassed the credit union’s lending needs. Our investment strategies have been heavily influenced by the uncertainty surrounding the timing and velocity that our members may deploy the excess savings accumulated over the last two years. With this heightened uncertainty, excess liquidity was invested primarily in short-term deposits or marketable securities that could be easily liquidated as needed. This conservative approach yielded a positive impact on the policy measures noted above.

Affinity’s ability to borrow funds is a key component of the credit union’s overall liquidity management program and Affinity currently has access to $236 million in committed credit facilities. Throughout 2022 these stand-by facilities were largely unused, but this borrowing capacity can provide considerable funding support for the credit union during a stressed liquidity event.

Following the first mortgage-backed security (MBS) issuance in late 2020, Affinity issued two additional MBS pools during 2021 and two in 2022, bringing the total MBS outstanding to $52.4 million.

The credit union also maintained a contingency funding plan (CFP) that clearly sets out strategies for addressing liquidity shortfalls in emergency situations. The CFP outlines the roles, responsibilities, procedures, and action plans required to respond to a severe liquidity event. It incorporates various early warning indicators and trigger events that would initiate the CFP or Affinity’s Recovery Plan, which was developed following assessment criteria outlined in the P-SIFI directive. The CFP and Recovery Plan are reviewed and tested annually.

Overall Affinity’s liquidity remained healthy, and we were well positioned to support a rise in economic activity as well as weather downward economic pressures.

Outlook

Much of the recent inflation is linked to higher energy prices and supply chain issues, resulting in shortages of goods. Manufacturers are reluctant to depend on China and may use more resilient but expensive alternatives. The move to lower-carbon power sources and the effect of the Ukraine war on commodity markets are other forces behind elevated prices. Policymakers have little control over these supply-side factors, which heavily depend on regulatory policy, immigration, the quality of the education system and workers’ skills. Thus, inflation may stay over the 2% target for a prolonged period, forcing interest rate hikes that could lead the economy into recession. The Bank of Canada is well-aware that loss of credibility on its monetary policy hinders efforts to lower inflation rates and may keep interest rates high even as inflation starts to fall.

Although a technical recession is possible, underlying conditions work in the Canadian economy’s favour. For instance, the commodity price increase sparked by the war in Ukraine has left local producers with hefty net savings to support hiring, wages, and investment. In Saskatchewan, the potash and uranium demand shift should maintain growth in both industries over the following years. In the agriculture sector, some southwestern areas of the province were still affected by dry conditions in 2022, leaving room for further improvement in 2023. Non-residential investments will remain elevated, given new potash projects, canola-processing plants and biodiesel-manufacturing facilities. However, higher interest rates may negatively affect spending on big-ticket items, discretionary consumption, the housing market and residential investment. Softening demand will reduce home sales and prices. That said, the Conference Board of Canada expects Saskatchewan’s GDP growth to outperform the national average and all provinces in 2023 at 3.6%. Affinity and its members are poised to benefit from this optimistic forecast. However, if broader economic obstacles persist, we anticipate some challenges as businesses and consumers adjust. Therefore, we will follow the mentioned economic indicators closely and be prepared to provide excellent products and services in every scenario in 2023, always having our members’ interests at heart.

Affinity has taken the evolving business environment into consideration in developing plans for 2023 and beyond. We are confident that our continued focus on the member and their experience in banking with Affinity will continue to produce strong business results. We’ll maintain a specific focus on making member experiences even more seamless and personalized, to delivering high-quality financial advice that supports the financial wellness of members and to leveraging our key differentiators, like our local presence and co-operative business model. Of course, we’ll also maintain a strong focus on preserving a solid financial foundation to ensure the long-term sustainability of the business, which includes maintaining excellent governance and risk management practices.

Risk Management Overview

Affinity exists to provide value to its members and stakeholders. We do this by taking on strategic risk to create, preserve and realize value.

When taking on strategic risk, we are inherently exposed to other material risks which are consistent with our industry. Affinity’s material risk categories are: strategic, credit, operational, legal and regulatory, liquidity market and reputation risk. We consider our reputation as a strategically important asset and actively manage risks to our reputation as part of our overall risk management framework. Our Risk Appetite Framework contains risk appetite metrics for all material risk categories.

Affinity’s Risk Governance Framework provides overarching guidance to our risk program by outlining our risk philosophy, how we categorize the types of risk we are exposed to and our risk management governance. In addition, it provides the foundation for the Board of Directors’ oversight to management’s risk-based decision making.

Governance

Our Board approved Risk Governance Framework, primarily based on Committee of Sponsoring Organizations of the Treadway Commission (COSO) Enterprise Risk Management Integrated Framework provides an integrated approach to enterprise risk management that encompasses all elements of risk governance.

Members Require Strength, Stability and Safeguarded Assets

Board Desired Key Performance Indicators

Risk Appetite

Credit Risk Market Risk Liquidity Risk

Legal and Regulatory Compliance Requirements

External Rating

Operational Risk

Strategic Risk

Legal and Regulatory Risk

Reputational Risk

Integrated Enterprise Risk Management

The diagram above provides an overview of Affinity’s approach to risk governance through an integrated risk management approach.

Affinity utilizes the lines of defense model to segregate and clarify segregation of risk management accountabilities. Under this model, ownership for risk resides at all levels of Affinity. This provides a structure to organize Affinity’s risk management roles and responsibilities; each line of defense is clearly defined in terms of business lines, roles and accountabilities and is functionally independent.

Risk Management Committee Structure

Our integrated risk management program supports the Board in understanding our key risks and the activities to manage them. The Board has delegated its responsibility to oversee risk management and understanding of the types of risk Affinity is exposed to the Risk Committee. The diagram below outlines Affinity’s risk management committee structure.

Risk Management Committees:

The Strategic Risk Committee (SRCo) includes all members of executive management and sets the ‘tone from the top’. It provides oversight of the Asset Liability Committee, the Credit Risk Committee, and the Operational Risk Committee.

SRCo is responsible to be aware of key risks that have the potential to impact successful execution of strategies and annual operating plans as approved by the Board of Directors. In addition, SRCo monitors internal and external environments to identify and assess existing and emerging risks and the resulting business implications. Subsequently, it directs actions to ensure risks are maintained within the credit union’s risk appetite and makes recommendations to the Risk Committee for approvals of policies, frameworks and matters of significance that arise from the other risk management committees.

The Asset Liability Committee (ALCo) provides forwardlooking balance sheet management and execution within the parameters of Board approved risk appetite and policy. It reviews economic trends, interest rate forecasts, investment portfolio risk and performance, liquidity, foreign exchange exposures, and capital adequacy. The purpose of the committee is to develop and recommend balance sheet risk management strategies to SRCo and approve and monitor balance sheet risk management tactics.

The Credit Risk Committee (CRCo) assesses historical and emerging credit risk by reviewing internal reporting and environmental scanning. The committee assesses new areas of opportunity and recommends actions to SRCo to manage risks within approved tolerances while supporting planned growth and profitability objectives.

The Operational Risk Committee (ORCo) comprises cross functional subject matter experts to identify, discuss and mitigate current and emerging operational risk issues that affect, or have the potential to affect, the successful operation of the credit union. Further, it identifies and promotes opportunities to improve service to members, create an operational risk-aware culture, contribute to operational improvements, and foster cross functional synergy.

Risk Philosophy

The credit union balances risk and reward to meet goals for our members, community, employees, growth, and financial sustainability. In pursuit of these goals, we accept risks we understand and can manage within prudent levels.

Risk Culture

At Affinity, we understand that our risk culture is influenced by the actions of our people, the means by which work is done, and the manner in which decisions are made. Our risk culture is congruent with Affinity’s desired culture, and is fostered and supported through strong board oversight, an integrated risk governance structure, awareness and education, risk appetite, policies, program guides and procedures, and a variety of tools that support identification, measurement, analysis, risk communication and reporting, and risk informed decision-making.

Material Risk Categories

Strategic Risk:

Strategic risk is the risk Affinity ineffectively or improperly implements its strategies or is unable to adapt to changes in the business environment to meet the needs and expectations of members, other stakeholders or achieve expected benefits. It also includes the failure of organic growth initiatives.

Management identifies risks to achieving corporate strategy and develops action plans to mitigate risks that exceed risk appetite. Quarterly, management reviews the risk register and status of action plans at SRCo. Subsequently, Risk Management provides risk status reporting to the Board of Directors.

Credit and Counterparty Risk:

Credit risk is the risk Affinity faces when a borrower, guarantor or counterparty fails to meet its financial or contractual obligations.

Affinity manages credit risk by establishing credit risk policies, delegation of authority, concentration limits including maximum limits on individual and connected accounts. Prudent underwriting standards are designed to ensure an appropriate balance of risk and return. The credit union has approved residential mortgage portfolio limits and limits on relative segments of Affinity’s residential mortgage portfolio in alignment with CUDGC the Corporation’s Residential Mortgage Underwriting Guidelines.

Management monitors credit risk exposures including portfolio concentration on a regular basis and proactively implements enhanced account management of higher risk accounts. This has been effective at resolving problem accounts before they turn delinquent or incur a loss. A strong monitoring process is in place for larger borrowers that are encountering difficulty.

Residential mortgages, including Home Equity Lines of Credit (HELOC) comprise a significant amount of our credit portfolio. At December 31, 2022 Affinity’s residential mortgage gross carrying value was $2,391,387 (2021 $2,279,820). The following table provides a breakdown between insured (including those by both CMHC and Genworth) and uninsured mortgages:

The credit union has established policies and procedures for maximum amortization periods for residential mortgage loans, specific to the loan product.

At December 31, 2022, the credit union’s residential mortgage portfolio original amortizations are outlined in the table below. Portfolio percentages are illustrated for both the outstanding mortgage balance and the number of mortgage loans.

Operational Risk:

Affinity faces operational risk resulting from people, inadequate or failed internal processes, controls, and systems or from external events including the risk of fraud. Operational risk is inherent in all activities within the credit union, including processes and controls used to manage other material risks such as credit, market, liquidity, legal and regulatory and reputational risk. Unlike other material risk categories taking on operational risk does not generate financial gain, however Affinity weighs the cost of mitigating against the cost benefits.

Risk Control Self-Assessments (RCSAs) are the primary tool Affinity uses to identify and assess operational risk exposures. The RCSA process is one component of Affinity’s Internal Control Framework. Affinity relies on the services of third parties. Our Vendor Risk Management program is our primary tool to manage third party service provider risk.

Legal and Regulatory Risk:

Legal and regulatory risk is the risk Affinity faces when failing to comply with governing laws, satisfying contractual obligations or meeting regulatory requirements.

Affinity operates in a heavily regulated industry. We actively monitor and evaluate potential impacts of regulatory developments. Appropriate policies, procedures, training, internal oversight functions and Code of Conduct ensure we are successful in meeting regulatory obligations.

As a Provincial Systemically Important Financial Institution (P-SIFI), our regulator holds us to a higher standard of regulatory rigor.

Liquidity Risk:

Liquidity risk is the risk of loss due to an inability to access funding sources or having insufficient cash or cash equivalents to meet financial obligations as they come due in a timely and cost-effective manner.

Affinity prudently manages liquidity to ensure sufficient liquidity is available to meets its obligations. Strategies in place to manage liquidity levels include borrowing facilities with SaskCentral and other financial institutions, deposit gathering programs and asset securitization program.

The credit union maintains sufficient levels of unencumbered high quality liquid assets as prescribed by the Credit Union Regulations 1999 and the Standards of Sound Business Practices established by Credit Union Deposit Guarantee.

ALCo reviews liquidity risk and liquidity position and provides reporting to SRCo. Quarterly, an operating liquidity report is provided to the Board of Directors.

As a Provincial Systemically Important Financial Institution (P-SIFI), Affinity provides quarterly net cumulative cash flow reporting to its regulator.

Market Risk:

Market risk exposes Affinity to the risk of loss when decreases in the value of financial instruments or portfolios of financial instruments occur because of changes in interest rates and timing differences in the repricing of assets and liabilities. This also includes changes in movements and volatility of foreign exchange rates.

Affinity actively manages its market risk by modeling several interest rate change scenarios and their impacts to our short term interest rate margin and long term value of equity. ALCo reviews interest rate simulation reports and recommends strategies such as derivatives to manage interest rate risk. Derivatives are limited to interest rate swaps, forward rate agreements, caps and floors, and purchased interest rate options. Interest rate strategies are limited to activities permitted under the Credit Union Act, Regulations and Standards of Sound Business Practices.

Reputational Risk:

Reputation risk is the risk of financial loss, business sanctions or additional oversight, due to deterioration in stakeholders’ perception of Affinity from negative publicity, whether true or not. Reputation risk generally arises from a deficiency in managing another risk. All employees are responsible to manage Affinity’s reputation risk.