Summary of stakeholder comments – Commercial lending Guidance

• CCUA

• Desjardins

• Meridian

Stakeholders indicated that they are pleased to see FSRA’s on-going commitment to modernize and streamline CU regulation in Ontario.

They expressed appreciation with FSRA’s collaborative approach and recognition of the important role of ESG factors in the lending decisions of CUs.

They also noted appreciation for burden reduction as this guidance replaces three previous FSRA/DICO documents.

FSRA appreciates the time and effort that stakeholders have taken to review and provide input on the Guidance. FSRA has made applicable revisions to the Guidance as a result.

• CCUA

• Meridian

• DUCA

Board-Approved Commercial lending Framework

As presented, the language that speaks to Board responsibilities may be perceived as shifting Board responsibility into process and controls which are operational in nature. Operational actions are the responsibility of Senior Management.

The Guidance provides FSRA’s interpretation of applicable provisions under CUCPA 2020 and the SBFP Rule. The Board’s actions and responsibilities are articulated in a manner consistent with the Board’s oversight role, which includes approving the commercial lending framework and establishing parameters for operational activities.

• CCUA

• DUCA

Re-evaluations

Two stakeholders requested clarification with respect the re-evaluation of collateral.

One stakeholder noted that it would be helpful to have a better understanding of the rationale behind re-evaluation so that CUs do not become burdened by on-going re-evaluations where no material changes have occurred.

We recommend clarifying that re-evaluation does not necessarily mean appraisal from a third party but could be an internal assessment. Obtaining an updated appraisal report upon renewal or annual review without incremental exposure, credit deterioration, or loan default is not market practice.

It is FSRA’s view that, as part of a CU's prudent commercial lending practices, re-evaluations should be conducted when there is a material need to do so, which may or may not warrant a full appraisal. The Guidance indicates that a CU’s commercial lending and underwriting policies should clearly articulate the underlying factors and early warning indicators that would warrant a re-evaluation of collateral. The circumstances that would lead a CU to conduct a re-evaluation and type of re-evaluation should be defined by the CU. FSRA has made an amendment to this section of the Guidance to clarify this point.

In order for re-evaluations to be conducted in a prudent manner, the party conducting the re-evaluation should be independent. It is the CU’s responsibility to determine what constitutes independence in order to ensure a prudent outcome. The CU must also be able to demonstrate to FSRA that the party conducting the re-evaluation is independent.

• CCUA

• DUCA

Third Party Reviews

Stakeholders requested clarity with respect to FSRA’s expectation as to who would be conducting third party reviews, what is expected in replicating the decision and the expected frequency of such reviews.

FSRA has revised the Guidance to clarify that the review should be conducted occasionally on a sample basis by a sufficiently independent party, as opposed to an independent external third party.

• Meridian

Property Appraisals

The guidance states that commercial lending policy should specify which methods should be used when conducting property appraisals. It was noted that a sophisticated lender should have the latitude to determine the most appropriate method.

CUs should specify which appraisal methodology to use in particular circumstances, in turn providing latitude for lenders to determine the most appropriate appraisal methodology. The CU should be able to demonstrate to FSRA that it has selected the most appropriate methodology given the particular circumstances.

The commercial lending and underwriting policies should be written for both expert lenders and newcomers to commercial lending. At a minimum, this policy should provide for best practices or guidelines on methods to be used in certain circumstances.

FSRA has revised the wording with respect to property appraisals to clarify that the commercial lending and underwriting policies should cover which appraisal methods are used in certain scenarios.

• CCUA

• DUCA

Lending Collateral

Stakeholders raised concern with the concept of structuring the terms of a loan where the loan-to-value (LTV) ratio improves over the long term, particularly where the collateral’s market value is volatile. This is a concern because the CU has no control over market forces, fluctuations over the term of the loan, and current economic conditions.

FSRA’s view is that as a prudent practice, CUs should consider structuring the terms of commercial loans so that the loan to value ratio improves over the loan term. This is particularly important where the collateral’s market value may depreciate overtime or is subject to volatility.

• MCU

• CCUA

• DUCA

• Desjardins

Technology and Systems Expectations

A comment was made that although it appears to be FSRA’s view that technology needs to be increased within commercial lending, some stakeholders raised concerns with costs as well as the timing and implementation associated with updating current systems where deficiencies may exist.

Comments were also made that CUs should have discretion in the use of automation and technology as a cost vs benefit, to determine the timeline of implementation, complexity and customization needs involved.

Concerns were raised with the meaning of “root causes” in the context of commercial credit risk monitoring based on portfolio and other functions that existing systems may not have such as annual review streamlined administrative functions and root cause analysis.

Concern was raised that commercial lending at scale requires human judgement. Loan management systems are costly and long-term approach to digitizing commercial lending processes will be necessary to ensure regulatory burden doesn’t hinder CUs growth and competitiveness.

One stakeholder noted that a proportionate approach to commercial platforms should include and consider the robustness of a credit unions overall enterprise risk management (ERM) systems and platform, as a supplementary system to that of a standalone commercial system.

Some smaller CUs may be using their ERM platforms to support and supplement commercial lending activities due to size, scope, and limited commercial volumes. The management of risk versus actual activities is important to consider alongside the proportionality of the platform in use. FSRA should consider proportionate expectations where commercial lending volumes are low, or conservative in nature.

FSRA acknowledges that the costs associated with updating data systems can be expensive for smaller CUs.

However, FSRA’s view is that every CU engaged in commercial lending should have a data system that:

• appropriately supports their commercial lending activities, along with applicable expectations and requirements
• provides accurate reports to prudently manage this portfolio

Root causes refer to elements that may cause a loan portfolio to be at risk. This may include factors such as rising interest rates or a downturn in the economy resulting in job losses and therefore higher loan delinquencies. FSRA’s view is that CUs should be monitoring these factors, especially as they grow and expand their commercial lending activities and portfolio.

FSRA agrees that prudent commercial lending practices require human judgement. This concept is addressed in the underwriting criteria and assessment processes set out in this guidance.

FSRA will consider proportionality in the application of the Guidance, taking into consideration the CUs size, complexity, risk profile and the potential consequences of a CUs failure.

• Meridian

• CCUA

IT Considerations Restricted to the IT Risk Management Guidance

It was noted that Cyber-insurance should be removed from this guidance and shifted over to the IT Risk Management Guidance. Only the targeted expectations for commercial lending management should be included in this Guidance.

The Guidance outlines FSRA’s approach to assessing the safety of a CU’s data collection in relation to commercial lending activities, such as loan origination systems, automated decision-making tools, and web-applications.

FSRA has included cyber insurance as an example of what it will be assessing with respect to managing the risk associated with technology within the context of a CU’s commercial lending activities. This Guidance complements other applicable FSRA guidance such as the IT Risk Management Guidance, which sets out enterprise-wide IT management practices.

• Meridian

Artificial Intelligence and Advanced Technologies

One stakeholder stated that FSRA should not intrude in the development of the prudent use of advanced technologies such as artificial intelligence in commercial lending and adjudication by limiting their competitive advantages.

The use of advanced technologies, such as artificial intelligence in commercial lending, is not specifically addressed in the Guidance. However, to the extent that a CU uses such technology in the underwriting or adjudication process, a CU would need to ensure that appropriate measures are in place to manage and mitigate relevant risks in order to adhere to the principles set out in the guidance.

• DUCA

Effective Portfolio Management Systems

The guidance states that effective portfolio management systems must allow for at least an annual review of loans, collateral, and industry sectors.

It was recommended that Annual Reviews be done at the borrower level which should incorporate facilities, connected exposure, collateral, and industry commentary. Sector reviews should occur at an appropriate regularity with the timing and frequency being determined by relevant circumstances such as economic or industry conditions that indicate a material change in risk profile.

Reviews are required at least annually because they form an important part of the credit risk monitoring process. FSRA agrees that they should be conducted at the borrower level for several reasons such as: compliance with the terms of approval, maintaining financial covenants, requests for recent financial statements, renewal of collateral registrations, site visits and/or inspection of collateral. The level or type of review is at the discretion of the CU.

• CCUA

IFRS 9

An effective Risk Management Framework includes an assessment methodology to determine adequate loan loss provisioning against Commercial Loan losses, including the determination and assessment of a significant increase in credit risk (“SICR”) in accordance with International Financial Reporting Standards (“IFRS 9”).

A stakeholder noted that there may be credit unions who are using alternative or additional methods and calculations around loan loss provisioning, and these should be considered by FSRA case by case basis.

A transition window for CUs to shift to IFRS9/SICR reporting is recommended.

As of 2020, every CU must be in compliance with IFRS9 loan loss provisioning in accordance with FSRA Rule - By-Law #6. Alternative methods that do not adhere to IFRS 9 are not permitted.

• CCUA

• DUCA

• Desjardins

Stress Testing and Sensitivity Analysis

Concerns were also raised that stress testing was more applicable at an individual loan level and not portfolio level.

One submission noted that the guidance does not consider standard criteria for assessing the borrower's ability to repay.

Some stakeholders shared concerns that FSRA’s supervisory approach may not be taking into consideration types of lending where other repayment metrics beyond traditional debt service ratios are used in credit decision-making (e.g., homebuilders and other types of construction projects.

FSRA’s view is that stress testing and sensitivity analysis should be conducted at both the individual and portfolio level to address the impact to the CU and how it may affect its sustainability as reflected in the following sections of the Guidance:
 

• Approach to Principle 1: Financial Ratios and Stress Testing
• Approach to Principle 3: Stress Testing and Sensitivity Analysis

The Guidance addresses the borrower’s ability to repay under Approach to Principle 1: Underwriting Criteria and Assessment.

FSRA agrees that some types of commercial lending involve repayment metrics beyond traditional debt service ratios. In those instances, a CU should use its expertise and prudent discernment in its underwriting and decision-making process. FSRA provides examples of stress testing considerations that will be considered in its supervisory assessments, but it is not an exhaustive list of factors.

• Desjardins

Credit Risk Management and Internal Controls

It was noted that it would be beneficial for CUs if FSRA considered the possibility of establishing mechanisms for managing concentration risk that could include a variety of approaches without limiting the imposition of limits, such as sector-specific limits.

A CU should be able to apply its own mechanisms for managing concentration risk based on the proportionality factors outlined in the purpose section of the Guidance.

• CCUA

Diversified Lending Portfolios

One stakeholder raised a concern that commercial lending portfolios may be judged from a single perspective (asset or loan type). They also expressed some concern that FSRA is suggesting CUs take on unknown risks to be diversified.

FSRA expects CUs to diversify their commercial portfolio based on the CUs size, complexity, risk profile and the potential consequences of the CUs failure.

FSRA acknowledges that regional geography, composition, and market perspective may have implications for diversification opportunities.

• CCUA

Agricultural Lending

A stakeholder noted that, although agricultural lending falls within the CUCPA definition of commercial lending, it is unique in its form and nature. This is not mentioned in the guidance and would be worth FSRA developing a separate document for this.

The stakeholder expressed concern that FSRA should consider how it continues to build long-term knowledge and expertise within agricultural lending and risk to ensure that CUs engaged in the form of lending are well supported.

The Guidance sets out that agricultural loans as defined under Ontario Regulation 105/22 are considered to be commercial loans for the purposes of the Guidance.

FSRA will take these comments into consideration for potential future related Guidance in this area, if warranted.

• CCUA

Increased Data Collection

A concern was raised that increasing expectations to produce and extract data about borrowers that may not be captured in loan systems could become a burden to credit unions over time through this guidance, if not run in parallel with the current and ongoing Enhanced Data Collection (EDC) project.

FSRA should engage commercially active credit unions through the EDC project to discuss how transition can work to support prudent and appropriate data needs.

FSRA is engaging with all CUs on the implementation of EDC in a progressive and proportional manner, which includes commercial lending data. Prior to the implementation of EDC, supervisory requests for data may still be necessary but these requests will be subsets of EDC. FSRA will continue to consider questions from credit unions on commercial lending data in the context of supervisory needs and availability of data for credit unions.

• CCUA

New Commercial Entrants

Some CUs noted that the Guidance does not address transition for credit unions who wish to begin commercial lending activities.

A principles-based approach should allow transition runway and support to ensure a new credit union entrant in commercial lending can be successful from a regulatory perspective.

The Guidance allows CUs to develop a tailored commercial lending framework, along with lending and underwriting policies, based on the CUs size, complexity, risk profile and the potential consequences of a CUs failure.

FSRA will apply the Guidance in a proportional manner and will consider a variety of factors when assessing a CU’s ability to prudently manage their commercial lending activities. CUs that are considering entering the commercial lending market may contact their FSRA Relationship Manager for information.

• CCUA

• Meridian

RBSF Considerations

One stakeholder noted that a proportionate and flexible approach is needed as CUs transition to the Risk Based Supervisory Framework (RBSF) and come to understand expectations relating to commercial activities, and as this guidance is introduced over time.

It was noted that FSRA should use an evidence-based assessment approach against frameworks, policy, controls, and risk mitigation strategies for credit unions engaged in commercial lending and that Overall Risk Rating (ORR) scores should be reflective of this based on the Guidance and dialogue between the credit union and assessment team.

A stakeholder commented that larger, more complex CUs should not be penalized for having a larger commercial lending portfolio by shifting RBSF ratings to “medium” or “high,” based solely on commercial portfolio size.

As set out in the Guidance, FSRA considers proportionality assessing a CU against the principles contained in the Guidance and in accordance with FSRA’s Risk Based Supervisory Framework for Credit Unions (RBSF).

ORR’s are not determined solely on the basis of portfolio size. As described in the RBSF Guidance, the ORR takes into account both inherent and residual risk of each significant activity, as well as capital, liquidity, and resilience factors.

• CCUA

Third Party Support for Commercial lending Activities

It was noted that the Guidance does not call out requirements relating to commercial third-party support activities (I.e. underwriting support, analysis, etc.). The assumption is that FSRA does not have any concerns with CUs engaging third party support.

Depending upon the specific circumstances, a CU may engage competent outside expertise in cases where internal expertise may be lacking.

• CCUA

Sharing Data Insights

It was noted that commercial data held by FSRA should be made available back to credit unions regularly to support sector improvement and benchmarking.

FSRA shares applicable information with the sector through quarterly reports and other avenues. CUs may request any other data that pertains to them from their Relationship Managers.

In addition, FSRA engages in thematic reviews of specific CU activities, and intends to share aggregate observations and data with the sector in the future.

• CCUA

Member’s Interests

Additional clarity around the term may be helpful to better define how FSRA views member interests in relation to commercial lending activities specifically, as the term is vague and broad.

This section is intentionally broad, as CUs are well positioned to understand the needs of their members relating to specific commercial lending activities. Through FSRA’s risk-based supervision process, FSRA will consider whether a CU’s determination of members interests is appropriate based on the circumstances of the particular situation.