TD Bank 2007 Annual Report Download - page 111

TD BANK FINANCIAL GROUP ANNUAL REPORT 2007 Financial Results 107
NOTE 22 FAIR VALUE OF FINANCIAL INSTRUMENTS
Certain financial instruments are carried on the balance sheet
at their fair value. These financial instruments include securities
held in the trading portfolio, certain securities and loans
designated as trading under the fair value option, securities
classified as available-for-sale, derivative financial instruments,
certain deposits classified as trading and obligations related to
securities sold short.
DETERMINATION OF FAIR VALUE
The fair value of a financial instrument on initial recognition is
normally the transaction price, i.e. the fair value of the consider-
ation given or received. In certain circumstances, however, the
initial fair value may be based on other observable current market
transactions involving the same instrument, without modification
or repackaging, or based on a valuation technique whose vari-
ables include only inputs from observable markets and accordingly
give rise to an inception profit.
Subsequent to initial recognition, the fair values of financial
instruments measured at fair value that are quoted in active
markets are based on bid prices for financial assets held and
offer prices for financial liabilities. When independent prices
are not available, fair values are determined by using valuation
techniques which utilize observable market inputs. These include
comparisons with similar instruments where market observable
prices exist, discounted cash flow analysis, option pricing models
and other valuation techniques commonly used by market
participants.
For certain derivatives, fair values may be determined in whole
or in part from valuation techniques using non-observable market
inputs or transaction prices.
A number of factors such as bid-offer spread, credit profile and
model uncertainty are taken into account, as appropriate, when
values are calculated using valuation techniques.
If the fair value of a financial asset measured at fair value
becomes negative, it is recorded as a financial liability until its fair
value becomes positive, at which time it is recorded as a financial
asset, or it is extinguished.
When a valuation technique significantly utilizes non-observ-
able market inputs or transaction prices, no inception profit is
recognized when the asset or liability is first recognized.
METHODS AND ASSUMPTIONS
The Bank calculates fair values based on the following methods
of valuation and assumptions:
Financial Instruments Whose Carrying Value
Approximates Fair Value
For certain financial assets and financial liabilities that are short
term in nature or contain variable rate features, fair value is based
on the appropriate prevailing interest rates and/or credit curves.
The fair value of cash and due from banks, interest-bearing
deposits with banks, customers’ liability under acceptances,
acceptances and securities borrowed or purchased under
reverse repurchase agreement are considered to be equal to
carrying value.
Securities
The methods used to determine the fair value are described in
Note 2. The fair values of securities are based on quoted market
prices or, where quoted market prices are not readily available,
quoted market prices of similar securities, other third-party
evidence or by using another valuation technique.
Loans
The estimated fair value of loans reflects changes in interest rates
which have occurred since the loans were originated and changes
in the creditworthiness of individual borrowers. For fixed-rate per-
forming loans, estimated fair value is determined by discounting
the expected future cash flows related to these loans at market
interest rates for loans with similar credit risks. The fair value of
loans is not adjusted for the value of any credit protection the
Bank has purchased to mitigate credit risk. For floating rate per-
forming loans, changes in interest rates have minimal impact on
fair value since loans reprice to market frequently. On that basis,
in the absence of deterioration in credit, fair value is assumed
to equal carrying value.
Derivative Financial Instruments
The fair value of exchange-traded derivative financial instruments
is based on quoted market prices. The fair value of over-the-
counter derivative financial instruments is determined using valua-
tion models that incorporate prevailing market rates and prices on
underlying instruments with similar maturities and characteristics.
The fair value of over-the-counter trading derivatives is
estimated using well established models, but is recorded net
of valuation adjustments, which recognize the need to address
market, liquidity, model and credit risks not appropriately cap-
tured by the models. If the model includes inputs that are not
observable in the market, inception gains and losses associated
with these contracts are deferred and recognized as the inputs
become observable.
For non-trading derivatives, the fair value is determined on the
same basis as for trading derivatives.
Deposits
The estimated fair value of term deposits is determined by dis-
counting the contractual cash flows using interest rates currently
offered for deposits with similar terms. For deposits with no
defined maturities, the Bank considers fair value to equal cash
value based on carrying value being the equivalent to the amount
payable on the reporting date.
Subordinated Notes and Debentures
The fair values of subordinated notes and debentures are based
on quoted market prices for similar issues or current rates offered
to us for debt of the same remaining maturity.
Liabilities for Preferred Shares and Capital Trust Securities
The fair values for preferred share liabilities and capital trust
securities are based on quoted market prices of the same or
similar financial instruments.
The fair values in the following table exclude the value of assets
that are not financial instruments. Also excluded from this table
are assets, such as land, buildings and equipment, as well
as goodwill and other intangible assets, including customer
relationships, which add significant value to the Bank.