TD Bank 2007 Annual Report Download - page 71

TD BANK FINANCIAL GROUP ANNUAL REPORT 2007 Management’s Discussion and Analysis 67
WHY PRODUCT MARGINS FLUCTUATE OVER TIME
As explained above, our approach to asset/liability management
locks in margins on fixed-rate loans and deposits as they are
booked. It also mitigates the impact of an instantaneous inter-
est-rate shock on the level of net interest income to be earned
over time as a result of cash flow mismatches and the exercise
of embedded options. Despite this approach, however, the
margin on average earning assets can change over time for the
following reasons:
•฀ Margins earned on new and renewing fixed-rate products rel-
ative to the margin previously earned on matured products
will affect the existing portfolio margin.
•฀ The weighted-average margin on average earning assets will
shift due to changes in the mix of business.
•฀ Changes in the prime-Bankers’ Acceptances (BA) basis and the
lag in changing product prices in response to changes in
wholesale rates may have an impact on margins earned.
•฀ The general level of interest rates will impact the return we
generate on our modeled maturity profile for core deposits
and the investment profile for our net equity position as it
evolves over time. The general level of interest rates is also a
key driver of some modeled option exposures, and will affect
the cost of hedging such exposures.
Our approach tends to moderate the impact of these
factors over time, resulting in a more stable and predictable
earnings stream.
Simulation modeling of net interest income is employed to
assess the level and changes in net interest income to be earned
over time under various interest rate scenarios. It also includes
the impact of projected product volume growth, new margin
and product mix assumptions.
Liquidity Risk
Liquidity risk is the risk that we cannot meet a demand for cash or
fund our obligations as they come due. Demand for cash can arise
from withdrawals of deposits, debt maturities and commitments
to provide credit. Liquidity risk also includes the risk of not being
able to liquidate assets in a timely manner at a reasonable price.
As a financial organization, we must always ensure that we
have access to enough readily-available funds to cover our
financial obligations as they come due and to sustain and grow
our assets and operations both under normal and stress condi-
tions. In the unlikely event of a funding disruption, we need to
be able to continue to function without being forced to sell too
many of our assets. The process that ensures adequate access
to funds is known as the management of liquidity risk.
WHO MANAGES LIQUIDITY RISK
The Asset/Liability Committee oversees our liquidity risk man-
agement program. It ensures that an effective management
structure is in place to properly measure and manage liquidity
risk. In addition, a Global Liquidity Forum, comprising senior
management from Finance, Treasury and Balance Sheet
Management and Wholesale Banking, identifies and monitors
our liquidity risks. When necessary, the Forum recommends
actions to the Asset/Liability Committee to maintain our liquid-
ity position within limits in both normal and stress conditions.
We have one global liquidity risk policy, but the major operat-
ing areas measure and manage liquidity risks as follows:
•฀ The Treasury and Balance Sheet Management Department is
responsible for consolidating and reporting the Bank’s global
liquidity risk position and for managing the Canadian Personal
and Commercial Banking liquidity position.
•฀ Wholesale Banking is responsible for managing the liquidity
risks inherent in the wholesale banking portfolios.
•฀ TD Banknorth is responsible for managing its liquidity position.
•฀ Each area must comply with the Global Liquidity Risk
Management policy that is periodically reviewed and approved
by the Risk Committee of the Board.
HOW WE MANAGE LIQUIDITY RISK
Our overall liquidity requirement is defined as the amount of
liquidity required to fund expected cash outflows, as well as
a prudent liquidity reserve to fund potential cash outflows in
the event of a disruption in the capital markets or other event
that could affect our access to liquidity. We do not rely on
short-term wholesale funding for purposes other than funding
marketable securities or short-term assets.
We measure liquidity requirements using a conservative base-
case scenario to define the amount of liquidity that must be
held at all times for a specified minimum period. This scenario
provides coverage for 100% of our unsecured wholesale debt
coming due, potential retail and commercial deposit run-off and
forecast operational requirements. In addition, we provide for
coverage of Bank-sponsored funding programs, such as BAs we
issue on behalf of clients, and Bank-sponsored ABCP. We also
use an extended liquidity coverage test to ensure that we can
fund our operations on a fully collateralized basis for a period
up to one year.
We meet liquidity requirements by holding assets that can
be readily converted into cash, and by managing our cash flows.
To be considered readily convertible into cash, assets must be
currently marketable, of sufficient credit quality and available
for sale. Liquid assets are represented in a cumulative liquidity
gap framework based on settlement timing and market depth.
Assets needed for collateral purposes or those that are similarly
unavailable are not considered readily convertible into cash.
While each of our major operations has responsibility for the
measurement and management of its own liquidity risks, we
also manage liquidity on a global basis to ensure consistent and
efficient management of liquidity risk across all of our opera-
tions. On October 31, 2007, our consolidated surplus liquid-
asset position up to 90 days was $7.8 billion, compared with
a surplus liquid-asset position of $18.8 billion on October 31,
2006. Our surplus liquid-asset position is our total liquid assets
less our unsecured wholesale funding requirements, potential
non-wholesale deposit run-off and contingent liabilities coming
due in 90 days.
If a liquidity crisis were to occur, we have contingency plans
in place to ensure that we can meet all our obligations as
they come due.
At the time of preparing this report, global debt markets
were experiencing a significant liquidity event. During that time,
we continued to operate within our liquidity risk management
framework and limit structure.
FUNDING
We have a large base of stable retail and commercial deposits,
making up over 64% of our total funding. In addition, we have
an active wholesale funding program to provide access to
widely diversified funding sources, including asset securitiza-
tion. Our wholesale funding is diversified geographically, by cur-
rency and by distribution network. We maintain limits on the
amounts of deposits that we can hold from any one depositor
so that we do not overly rely on one or a small group of cus-
tomers as a source of funding. We also limit the amount of
wholesale funding that can mature in a given time period.
In 2007, we securitized and sold $6.2 billion of mortgages and
$1.0 billion of lines of credit. In addition, we issued $5.1 billion
of other medium and long-term senior debt funding, $6.6 billion
of subordinated debt and $0.8 billion of preferred shares.