ZAG BANK
BASEL II & III PILLAR 3 DISCLOSURES
December 31, 2014
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Zag Bank (the “Bank”) is required to make certain disclosures to meet the requirements of the Office of the Superintendent of Financial Institutions Canada ("OSFI"), in particular OSFI’s Pillar 3
Disclosure Requirements issued in November 2007, pursuant to the Basel Committee on Banking Supervision’s update on “Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework – Comprehensive Version” issued in June 2006.
Basel II is structured around 3 pillars:
Pillar 1: Minimum Capital Requirements
Pillar 2: The Supervisory Review Process
Pillar 3: Market Discipline
Pillar 3 complements both Pillars 1 and 2, by setting disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of Zag Bank.
The amounts disclosed in the tables throughout are the balance sheet carrying amounts included in the financial statements of the Bank prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (the “IASB”) and using the accounting policies described therein.
This report is unaudited and is reported in thousands of Canadian dollars, unless otherwise disclosed.
1.SCOPE OF APPLICATION
Zag Bank (the “Bank”) is a bank chartered under the Bank Act (Canada) and has its head office at Suite 120 6807 Railway Street Southeast, Calgary, Alberta, T2H 2V6. The Bank is a wholly-owned subsidiary of Desjardins Group, through Desjardins Financial Corporation Inc. (“Desjardins”), a wholly-owned subsidiary of the Fédération des caisses Desjardins du Québec ultimately controlled by the Desjardins caisses. Prior to December 1, 2013, the Bank was a wholly-owned subsidiary of Western Financial Group Inc., a wholly-owned subsidiary of Desjardins.
In 2014, the Bank changed its name from Bank West to Zag Bank. The name change was approved by OSFI on July 22, 2014. The incorporating instrument of the Bank was amended in accordance with the Bank Act and the letters patent were effective on October 1, 2014.
The Bank provides banking services to individuals across western Canada. The Bank is currently focused on consumer and real estate loans. The Bank offers Guaranteed Investment Certificates (GICs) through third party brokers and is a member of the Canada Deposit Insurance Corporation (CDIC).
2. CAPITAL STRUCTURE
The Bank is subject to regulatory capital requirements governed by OSFI, based on standards issued by the Bank for International Settlements, Basel Committee on Banking Supervision (BCBS). Capital requirements of the BCBS are commonly referred to as Basel III.
Under Basel III, there are two tiers of capital. Tier 1 capital consists of two components: Common Equity Tier 1 (CET1) and Additional Tier 1. Tier 2 capital consists of supplementary capital
instruments. Total capital is defined as the sum of Tier 1 and Tier 2 capital.
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Common Equity Tier 1 (“CET1”) capital includes common shares, retained earnings and accumulated other comprehensive income. CET1 capital also includes regulatory adjustments and deductions for certain items including intangible assets. The Bank currently does not hold any additional Tier 1 or Tier 2 capital instruments. Therefore, the Bank’s CET1 is equal to its Tier 1 and Total regulatory capital.
The capital structure of the Bank is shown in the following table:
The Bank is authorized to issue an unlimited number of common shares, without par value.
As at December 31, 2014, the number of issued and outstanding common shares was 104,611,511.
3. CAPITAL ADEQUACY
The Bank’s objective is to maintain an adequate level of capital, in line with the Bank’s risk appetite, to support the Bank’s activities and meet regulatory capital requirements while producing an
acceptable return for its shareholder. In order to achieve this objective, the Bank has a Capital Management Framework that includes a Capital Management and Planning Policy and an Internal Capital Adequacy Assessment Process (ICAAP).
The ICAAP is an integrated process that evaluates capital adequacy relative to the Bank’s strategy, financial plan and risk appetite and helps set the minimum capital levels acceptable for the Bank.
The Bank’s capital level underscores its solvency and capacity to fully cover operating risks related to its operations while providing depositors and creditors with safeguards. The Board of Directors reviews and approves several capital-related documents on an annual basis, including the Capital Management and Planning Policy, the ICAAP, and the annual business plan. The Board’s Audit and Risk Management Committee reviews the overall capital adequacy of the Bank on a quarterly basis.
Senior management monitors regulatory capital ratios on a monthly basis through the Asset &
Liability Committee (ALCO).
Under Basel III, there are three primary regulatory capital ratios used to assess capital adequacy;
Common Equity Tier 1 (CET1), Tier 1 and Total capital ratios, which are determined by dividing those capital components by Risk-weighted assets (RWA). RWA are calculated for exposures to credit risk and operational risk (and where they have significant trading activity, market risk) and added together to determine total RWA. The calculation of RWA is prescribed by OSFI. The Bank uses the Standardized Approach to calculate RWA for credit risk and the Basic Indicator Approach to account for operational risk.
OSFI requires Canadian banks to meet a target CET1 ratio of 7% on an “all-in” basis (defined by OSFI as capital calculated to include all of the Basel III regulatory adjustments that will be required by 2019). For Tier 1 and Total capital ratios, the “all-in” capital targets are 8.5% and 10.5%,
All-in Transitional
(in thousands) basis basis
Common shares $ 104,612 $ 104,612
Deficit (16,119) (16,119)
Common Equity Tier 1 capital before regulatory adjustments 88,493 88,493
Total regulatory adjustments to Common Equity Tier 1 (3,897) (779)
Common Equity Tier 1 capital $ 84,596 $ 87,714
Tier 1 capital 84,596 87,714
Total regulatory capital $ 84,596 $ 87,714
December 31, 2014
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respectively, effective the first quarter of 2014. OSFI may also prescribe higher capital levels on an institution-specific basis.
OSFI continues to require Canadian banks to meet an assets-to-capital multiple (ACM) requirement until December 31, 2014, when it will be replaced by the Basel III leverage ratio. The ACM is calculated by dividing gross adjusted assets, including specified off-balance sheet items, by Total Capital.
The components of the Bank’s regulatory capital and ratios are shown in the following table:
The Bank has complied with regulatory capital requirements ratios throughout the year ended December 31, 2014.
4. CREDIT RISK
Credit risk is defined as the risk of financial loss due to a borrower or counterparty failing to meet its obligations in accordance with contractual terms and is the most significant risk to the Bank.
The Bank’s loan portfolio accounts for the majority of its credit risk exposure. The Bank also engages in non-lending activities that may give rise to credit risk, namely the purchase of securities for the liquidity portfolio, maintaining cash and deposits with other institutions and entering into derivative transactions to manage interest rate risk exposure.
The Bank’s exposure to credit risk is monitored by senior management, the Credit Risk Management Committee (CRMC) and ultimately the Board of Directors. CRMC is primarily responsible for
monitoring the performance and quality of the Bank’s credit portfolio, reviewing and approving provision for credit loss estimates and assessing the overall adequacy of the allowance for credit losses. CRMC also establishes, implements and monitors credit risk related policies and guidelines, taking into account business objectives and the Bank’s risk appetite.
The credit approval process is centrally controlled with all credit requests submitted to a credit adjudication group independent of the group responsible for originating transactions. Approval authorities are delegated based on the amount of credit requested. In certain cases, credit requests must be referred to the CRMC or to the Board for approval.
Credit concentration limits are established to control against adverse concentrations within portfolios. These include limits for individual borrowers, groups of related borrowers, industry sectors, geographic regions, and products.
All-in Transitional
(in thousands) basis basis
Risk-weighted assets
Credit risk $ 68,891 $ 72,008
Operational risk 19,793 19,793
Total risk-weighted assets $ 88,684 $ 91,801
Regulatory capital ratios
Common Equity Tier 1 capital ratio 95.4% 95.6%
Tier 1 capital ratio 95.4% 95.6%
Total capital ratio 95.4% 95.6%
Assets-to-capital ratio 1.4X 1.4X
December 31, 2014
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Each commercial borrower is assigned a borrower risk rating, reflecting the Bank’s assessment of the credit quality of the borrower. The borrower risk rating assigned when a facility is first authorized is re-evaluated and adjusted, if necessary, to reflect changes in the customer’s financial condition or business prospects. Re-evaluation is an ongoing process, and is done in the context of general economic changes and specific industry prospects.
Credit scoring is the primary basis for assessing consumer exposures and assigning borrower risk ratings. Risk ratings are reviewed on a regular and ongoing basis and are adjusted as necessary to reflect new information.
Techniques used by the Bank to reduce or mitigate credit risk include credit granting practices, policies and procedures to value and manage financial and non-financial security (collateral) and active portfolio monitoring and collections activities. Security for loans is primarily non-financial and includes commercial and residential real estate, vehicles and other equipment.
The Bank also maintains a liquidity portfolio consisting primarily of instruments issued by the Canadian federal government and other high quality securities. The Bank’s Liquidity and Funding Management Policy requires such investments to be investment grade.
Credit risk associated with deposits with other financial institutions is minimized by ensuring that funds are placed with financial institutions with strong investment grade credit ratings.
The Bank’s credit risk exposure arises predominantly in Western Canada. The geographic distribution of the Bank’s gross loan portfolio is shown in the table below:
The maximum credit risk exposure of the Bank in the event of other parties failing to meet their obligations is detailed below. No account is taken of any collateral held and the maximum exposure to loss is considered to be the balance sheet carrying amount.
Past due loans
A loan is classified as past due when the borrower has failed to make a payment by the contractual due date.
Impaired loans
Generally, loans on which repayment of principal or payment of interest is contractually 90 days in arrears are automatically considered impaired unless they are fully secured and in the process of collection. Loans guaranteed or insured by the Canadian government (federal or provincial) or a
Residential Business and
(in thousands) mortgages Personal government Total
Alberta $ 22,058 $ 34,348 $ 2,442 $ 58,848
Ontario 2,245 14,461 2,070 18,776
British Columbia 44 6,457 - 6,501
Manitoba 1,645 436 51 2,132
Saskatchewan 895 1,008 - 1,903
Other 420 1,321 2,914 4,655
27,307
$ $ 58,031 $ 7,477 $ 92,815 As at December 31, 2014
(in thousands) 2014
Financial assets, as stated in the balance sheet $ 112,959
Credit commitments -
Maximum credit exposure $ 112,959
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Canadian government agency are classified as impaired only when payments are contractually 365 days in arrears.
Specific allowances
The Bank conducts ongoing monitoring of its loan portfolios and a specific allowance for credit losses is established where objective evidence of impairment exists and the Bank has determined the loan to be impaired.
The specific allowance is measured as the difference between the carrying amount of the loan and the present value of estimated future cash flows including amounts recoverable under guarantees, collateral and unencumbered assets, discounted at the loan’s original effective interest rate. If the carrying amount is less than the discounted cash flows, then no allowance is necessary.
Collective allowance
Loans which are individually assessed and not determined to be impaired are grouped on the basis of similarities in credit risk characteristics and collectively assessed for impairment using a statistical model. A collective allowance is maintained for credit losses which are inherent in the portfolio as at the reporting date, but which have not yet been specifically identified from an individual assessment of the loan.
The collective allowance methodology incorporates both quantitative and qualitative factors to determine an appropriate level of the collective allowance. The quantitative factors include
probability of default, exposure at default, loss given default and estimates of the time period over which losses that are present would be identified and provided for. The initial quantitative estimate of loss experience is then adjusted to reflect qualitative factors such as management’s judgment on the level of impairment losses based on historical experience relative to the actual level reported at the balance sheet date, taking into consideration current portfolio credit quality trends, portfolio concentrations, risk mitigations, business, macroeconomic conditions, policy and process changes, and other related factors.
The allowance for credit losses (specific and collective) represents management’s best estimate of credit losses incurred in the loan portfolios.
Gross outstanding loans and impaired loans, net of allowances for credit losses, by loan type, are as follows:
The change in the Bank’s allowance for credit losses for the year ended December 31, 2014 is shown in the following table:
Gross loans Gross loans Gross
neither impaired past due but impaired Specific Collective
(in thousands) nor past due not impaired loans allowances allowance Net loans
Residential mortgages $ 27,307 $ - $ - $ - $ (30) $ 27,277 Personal 57,325 439 267 (191) (710) 57,130 Business and government 7,477 - - - (70) 7,407
92,109
$ $ 439 $ 267 $ (191) $ (810) $ 91,814 As at December 31, 2014
Page 7 of 8 5. MARKET RISK
Market risk represents the possibility of an adverse impact on earnings resulting from changes in market factors, such as interest rates, foreign exchange rates, commodity prices and equity prices.
The Bank does not engage in trading and has no material exposure to foreign exchange risk,
commodity risk or equity risk. The Bank’s primary source of market risk is structural interest rate risk in the banking book.
Structural interest rate risk in the banking book refers to the risk to net interest income that arises from differences in the maturities or re-pricing dates of assets and liabilities.
Interest rate risk is managed in accordance with Board-approved policies and limits, which are set according to the documented risk appetite of the Bank and designed to control the potential negative impact of interest rate changes on the Bank’s earnings and capital.
The earnings limit measures the effect of various interest rate “shock” scenarios on the Bank’s net interest income over a 12-month horizon (Earnings at Risk or “EaR”). The capital limit measures the impact of various interest rate “shock” scenarios on the present value of the Bank’s net assets (Equity Value at Risk or “EVaR”). The Bank’s policy also contains a duration gap limit (the difference between the duration of assets and the duration of liabilities) which measures the sensitivity of the market value of assets and liabilities to changes in interest rates. The Bank’s policy sets overall limits on EVaR and EaR based on immediate and sustained ±100 basis points parallel shifts of the yield curve.
Responsibility for oversight of the structural interest rate risk management process has been delegated by the Board to the ALCO. ALCO meets regularly to review the Bank’s interest rate risk profile and provide strategic direction for the management of structural interest rate risk within the risk appetite framework.
Based on the Bank’s interest rate positions, it is estimated that an immediate and sustained 100 basis point increase in interest rates would decrease net interest income over the next 12 months by
$72. It is estimated that an immediate and sustained 100 basis point decrease in interest rates would increase net interest income over the next 12 months by $84.
6. OPERATIONAL RISK
Operational risk, which is inherent in all business activities, is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Operational risk includes legal risk, but excludes strategic and reputational risk. The impact of operational risk may include financial loss, loss of competitive position, or regulatory enforcement actions, among others. The Bank uses the Basic Indicator Approach to calculate RWA for operational risks.
Specific Collective
(in thousands) allowances allowance Total
Balance at beginning of year $ 222 $ 825 $ 1,047
Provision for credit losses 592 (15) 577
Write-offs (731) - (731)
Recoveries 108 - 108
Balance at end of year $ 191 $ 810 $ 1,001
As at December 31, 2014
Page 8 of 8 7.REMUNERATION
Zag Bank remuneration is based on both business and individual specific performance objectives and is structured to incentivise employees to meet strategic business objectives in a manner that is compliant with the Bank’s Board-approved risk appetite and applicable governing legislation.
The Bank’s compensation structure is overseen by the Compensation Committee of the Bank’s Board of Directors (“CC”). The Committee is comprised of three or more directors, with the majority being independent, as determined by the Board, none of whom shall be an officer or employee of the Bank.
The framework of the Bank’s compensation program consists of base salary and a general incentive plan. Base salary is reviewed for all employees annually and as required by market conditions. The Bank’s general incentive plan is paid to eligible employees annually if threshold goals are achieved.
The general incentive targets are expressed as a percentage of base salary determined by position and level within the organization. The Committee has been delegated the responsibility of reviewing and approving the Bank’s general incentive plan.
For the year ended December 31, the compensation of the Bank’s key management personnel (includes the CEO & President and Vice-Presidents) was as follows:
(in thousands) 2014
Salaries and short-term benefits $ 1,289
Post-employment benefits 75
1,364
$
