TD Bank 2003 Annual Report Download - page 37

TD BANK FINANCIAL GROUP ANNUAL REPORT 2003 • Management’s Discussion and Analysis 35
Specific allowances
Specific allowances for credit losses are established to reduce
the book values of loans to estimated realizable amounts in the
ordinary course of business. Specific allowances for the corporate
and commercial portfolios are established by borrower and
reviewed quarterly. For the retail portfolio, provisions are calculated
on an aggregated facility basis using a formula which takes into
account recent loss experience.
General allowances
General allowances for credit risk are established to recognize
losses that management estimates to have occurred in the port-
folio as at the balance sheet date relating to loans or credits not
yet specifically identified as impaired. The level of general
allowances reflects exposures across all portfolios and categories
that give rise to credit risk and fluctuates in accordance with the
nature and composition of our portfolio, shifts in the economic
and credit cycles, our historic and expected loss experience, and
other relevant factors.
General allowances are computed on a periodic basis using
credit risk models developed by the Bank. The level of allowances
is based on the probability of a borrower defaulting on a loan
obligation (loss frequency), the loss given default (loss severity)
and the expected exposure at the time of default. For the corpo-
rate and commercial portfolios, allowances are computed at the
borrower level. The probability of default is assigned based on
the risk rating of the borrower. The loss given default is based
upon the security of the facility. Exposure at default is a function
of current usage, borrower risk rating and the committed amount.
For the retail portfolio, the general allowance is computed on a
portfolio-level and is based on a statistical estimate of loss using
historical loss and recovery data models and forecast balances.
Model parameters are validated against historical experience and
are updated annually. The general allowance methodology is
approved by the Board periodically.
Our general allowance for loan losses was $984 million at
October 31, 2003, compared with $1,141 million last year. The
reduction in the general allowance reflects the reduced risk in
our portfolio. We also had a general credit reserve for certain
derivative financial instruments of $65 million such that general
allowances totalled $1,049 million at October 31, 2003. This
represented 1% of risk-weighted assets of which $947 million
qualifies as Tier 2 capital, equal to .875% of risk-weighted assets
under guidelines issued by the Office of the Superintendent of
Financial Institutions Canada.
Sectoral allowances
Where the losses are not adequately covered by the general
allowances noted above, sectoral allowances for credit losses are
established for industry sectors and geographic regions that
have experienced specific adverse events or changes in economic
conditions, even though the individual loans comprising each
group are not classified as impaired.
Sectoral allowances are reviewed quarterly, on a portfolio basis,
taking into account the expected loss of the portfolio of borrowers
in the sector under review. The analysis includes a review of prob-
abilities of default, loss given default and the expected loss on
sale. The sectoral methodology and model inputs are reviewed on
a quarterly basis.
When accounts, which were identified as part of a group of
loans upon which a sectoral allowance has been established,
become impaired, any sectoral allowances on these loans are
transferred to specific allowances.
Our sectoral allowance for credit losses at October 31, 2003
was $541 million.
See Notes to Consolidated Financial Statements page 63, Note 3
We assign each business or government borrower a risk rating
using our 21-category rating system. We set limits on credit expo-
sure to related business or government accounts based on these
ratings. In addition, we use a Risk Adjusted Return on Capital
model to assess the return on credit relationships in relation to
the structure and maturity of the loans and internal ratings of the
borrowers. We review the rating and return on capital for each
borrower every year.
For accounts where exposures include derivatives, we use
master netting agreements or collateral wherever possible to
reduce our exposure.
Wholesale Banking is split into two distinct business groups:
the core business and the non-core business. The non-core
portfolio consists of relationships we intend to exit over the next
two years. The core portfolio represents the clients in Canada
and abroad where we have or have potential to have a broader
long-term relationship.
Financial institutions
Our financial institutions portfolio is divided into 15 major groups.
Individual companies in each group have similar attributes
and common risk factors. We have developed specific exposure
guidelines for 24 segments within these groups. Risk Management
conducts ongoing reviews of the segment and exposure guide-
lines for each group.
We assign each group a risk rating using our 21-category rating
system. These ratings are based on the strength of each firm’s
parent institution. We assign each group a credit rating based on
each firm’s net worth, the quality of its assets, the consistency
and level of its profits, as well as the ratings of the major credit
rating agencies. We may use additional criteria for certain types
of financial institutions.
Personal credit
Credit requests are evaluated using automated credit scoring
systems or are directed to regional credit centres operating within
clear authority limits. Once retail credits are funded, they are
continually monitored within quantitative account management
programs to identify changes in risk and to provide opportunities
that increase risk-adjusted performance. The centralized
approach to reviewing retail credits has resulted in well-balanced
portfolios with predictable performance characteristics. We are
increasing our investment in automated decision technology and
credit scoring techniques that improve our ability to control retail
credit losses within predictable ranges.
Classified risk
Classified risk refers to loans and other credit exposures that
pose a higher credit risk than normal, based on our standards.
A loan is considered impaired when, in management’s opinion,
we can no longer be reasonably assured that we will be able to
collect the full amount of the principal and interest when it is due.
We establish specific allowances for impaired loans when a
loss is likely or when the estimated value of the loan is less than its
recorded value, based on discounting expected future cash flows.
Allowances for our personal credit portfolios are based on
delinquency and type of security.
See Supplementary information page 51, table 12
See Notes to Consolidated Financial Statements page 59, Note 1, (g) and (h)
See Notes to Consolidated Financial Statements page 63, Note 3