TD Bank 2010 Annual Report Download - page 76

TD BANK GROUP ANNUAL REPORT 2010 MANAGEMENT’S DISCUSSION AND ANALYSIS74
The second key determination is whether a VIE should be consoli-
dated. The Bank holds interests in a number of VIEs, including all of
the Bank’s securitization trusts that are considered to be VIEs. Current
GAAP requires consolidation of a VIE only when the Bank is the
primary beneficiary, and exposed to a majority of the VIE’s expected
losses or entitled to a majority of the VIE’s expected residual returns.
In addition, if the VIE is a QSPE, a conclusion which requires judgment,
then the Bank does not consolidate the VIE. Management uses judg-
ment to estimate the expected losses and expected residual returns to
determine if the Bank retains substantially all of the residual risk and
rewards of the VIE.
Under current GAAP, all of the Bank-originated assets transferred
to VIEs meet the criteria for sale treatment and non-consolidation. All
of the Bank’s segments are impacted by this accounting policy.
VALUATION OF GOODWILL AND OTHER INTANGIBLES
Goodwill is not subject to amortization. Instead, it is tested for impair-
ment at the reporting unit level on an annual basis unless certain
criteria are met in compliance with GAAP and if an event or change
in circumstances occurs that indicates that the carrying value of the
reporting unit might exceed its fair value. The first step of goodwill
impairment testing involves determining whether the fair value of the
reporting unit to which the goodwill is associated is less than its carry-
ing value. Where fair value of the reporting unit exceeds its carrying
value, goodwill of that reporting unit is considered not to be impaired.
When the fair value of the reporting unit is less than its carrying value,
a second step is required and the fair value of the goodwill in that
reporting unit is compared to its carrying value. If the fair value of
goodwill is less than its carrying value, goodwill is considered to be
impaired and a charge for impairment representing the excess of carry-
ing value over fair value of the goodwill is recognized immediately in
the Consolidated Statement of Income.
The fair value of the Bank’s reporting units are determined from
internally developed valuation models that consider various factors and
assumptions such as forecasted earnings, growth rates, price earnings
multiples, discount rates, and terminal multiples. Management is
required to use judgment in estimating the fair value of reporting units
and the use of different assumptions and estimates in the fair value
calculations could influence the determination of the existence of
impairment and the valuation of goodwill. Management believes that
the assumptions and estimates used are reasonable and supportable.
Where possible, fair values generated internally are compared to rele-
vant market information. The carrying values of the Bank’s reporting
units are determined by management using economic capital models
to adjust net assets and liabilities by reporting unit. These models
consider various factors including market risk, credit risk, and opera-
tional risk, and are designed to produce the equity capital a reporting
unit would have if it was a stand-alone entity. The Capital Management
Committee reviews the Bank’s allocation of economic capital to the
reporting units.
The Bank’s 2010 goodwill testing concludes that the goodwill in
each reporting unit is considered not to be impaired. Additionally,
none of the Bank’s reporting units are at risk of failing the first step
of goodwill impairment testing.
Other intangible assets with an indefinite life are not subject to
amortization; rather, they should be assessed annually for impairment.
As at October 31, 2010, the Bank does not have any indefinite life
intangibles. Finite life intangible assets that are subject to amortiza-
tion, after initial recognition, are amortized over their estimated useful
life. Finite life intangible assets are assessed for impairment when an
event or changes in circumstances indicate that the assets might be
impaired. Determining the estimated useful life and the identification
of any events or changes in circumstances affecting the recoverability
of carrying value of these finite life intangible assets requires an analysis
of facts and management’s judgment. When events or changes in
circumstances indicate that the carrying value may not be recoverable
and the carrying value is higher than the sum of undiscounted cash
flows expected from the asset’s use and eventual disposition, the asset
is written down to its fair value.
Available-for-sale securities are written down to their fair value
through the Consolidated Statement of Income when there is impair-
ment in value that is considered to be other than temporary in nature.
The determination of whether or not other than temporary impairment
exists is a matter of judgment. We review these securities regularly
“for possible impairment that is other than temporary and this review
typically includes an analysis of the facts and circumstances of each
investment and the expectations for that investment’s performance.
Impairment of the value of an investment may be indicated by the
presence of conditions which should be examined collectively. For
equity securities, some of these conditions are prolonged periods
during which the fair value of the investment is significantly less than
its carrying value, significant financial difficulty of the issuer, severe
losses by the investee in the current year or current and prior years,
continued losses by the investee for a period of years, suspension
of trading in the securities, a downgrade of an entity’s credit rating,
or liquidity or going concern problems of the investee.
Debt securities classified as available-for-sale are considered impaired
when there is uncertainty concerning the collectability of interest and
principal. Accordingly, professional judgment is required in assessing
whether a decline in fair value is the result of a general reduction in
market liquidity, change in interest rates or due to collectability issues
with respect to the expected cash flows over the life of the debt security.
See Note 29 to the Bank’s Consolidated Financial Statements for
additional disclosures regarding the Bank’s significant financial assets
and financial liabilities carried at fair value by valuation methodology.
All of the Bank’s segments are impacted by this accounting policy.
The Bank recognizes interest income and expense using the effective
interest rate method for financial instruments that are accounted for
at amortized cost and for those that are classified as available-for-sale.
The effective interest rate is the rate that discounts the estimated
future cash flows over the expected life of the financial instrument
resulting in recognition of interest income and expense on a constant
yield basis.
The potential effect of using reasonable possible alternative assump-
tions for valuing Level 3 financial instruments would range from a
reduction in the fair value by $113 million (2009: $159 million) to an
increase in the fair value by $111 million (2009: $161 million) (before
changes in valuation adjustments).
SECURITIZATIONS AND VARIABLE INTEREST ENTITIES
There are two key determinations relating to accounting for securitiza-
tions. The first key determination is in regard to bank-originated
securitized assets. A decision must be made as to whether the securiti-
zation should be considered a sale under GAAP. GAAP requires that
specific criteria be met in order for the Bank to have surrendered control
of the assets and thus be able to recognize a gain or loss on sale. For
instance, the securitized assets must be isolated from the Bank and
placed beyond the reach of the Bank and its creditors, even in the case
of bankruptcy or receivership. In determining the gain or loss on sale,
management estimates future cash flows by relying on estimates of
the amount of interest that will be collected on the securitized assets,
the yield to be paid to investors, the portion of the securitized assets
that will be prepaid before their scheduled maturity, expected credit
losses, the cost of servicing the assets and the rate at which to discount
these expected future cash flows. Actual cash flows may differ signifi-
cantly from those estimated by management. If actual cash flows
are different from our estimate of future cash flows then the gains
or losses on the securitization recognized in income will be adjusted.
Retained interests are classified as trading securities and are carried at
fair value on the Bank’s Consolidated Balance Sheet. Note 5 to the
Bank’s Consolidated Financial Statements provide additional disclosures
regarding securitizations, including a sensitivity analysis for key
assumptions. For 2010, there were no significant changes to the key
assumptions used in estimating the future cash flows. These assump-
tions are subject to periodic review and may change due to significant
changes in the economic environment.