TD Bank 2003 Annual Report Download - page 62

TD BANK FINANCIAL GROUP ANNUAL REPORT 2003 • Financial Results60
(h) Allowance for credit losses
An allowance is maintained which is considered adequate to
absorb all credit-related losses in a portfolio of items which are
both on and off the Consolidated Balance Sheet. Assets in the
portfolio which are included in the Consolidated Balance Sheet
are deposits with banks, loans, mortgages, loan substitutes,
securities purchased under resale agreements, acceptances
and derivative financial instruments. Items not included in the
Consolidated Balance Sheet and referred to as off-balance sheet
items include guarantees and letters of credit. The allowance is
deducted from the applicable asset in the Consolidated Balance
Sheet except for acceptances and off-balance sheet items. The
allowance for acceptances and for off-balance sheet items is
included in other liabilities.
The allowance consists of specific, general and sectoral
allowances.
Specific allowances include the accumulated provisions for
losses on particular assets required to reduce the book values to
estimated realizable amounts in the ordinary course of business.
Specific provisions are established on an individual facility basis to
recognize credit losses on large and medium-sized business and
government loans. For personal and small business loans, exclud-
ing credit cards, specific provisions are calculated using a formula
method taking into account recent loss experience. No specific
provisions for credit cards are recorded and balances are written
off when payments are 180 days in arrears.
General allowances include the accumulated provisions for
losses which are prudential in nature and cannot be determined
on an item-by-item or group basis. The level of the general
allowance depends upon an assessment of business and eco-
nomic conditions, historical and expected loss experience, loan
portfolio composition and other relevant indicators. General
allowances are computed using credit risk models developed
by the Bank. The models consider probability of default (loss
frequency), loss given default (loss severity) and expected
exposure at default.
When an industry sector or geographic region experiences
specific adverse events or changes in economic condition, an
additional allowance is established even though the individual
loans comprising the group are still performing. These allowances
are considered sectoral and are established for losses which have
not been specifically identified, and where the losses are not
adequately covered by the general allowances noted above.
The amount of the allowance is reviewed and computed using
expected loss methodologies that incorporate probability of
default, loss given default and expected loss on sale.
Actual write-offs, net of recoveries, are deducted from the
allowance for credit losses. The provision for credit losses, which
is charged to the Consolidated Statement of Operations, is that
required to bring the total allowances (specific, general and
sectoral) to a level which management considers adequate to
absorb probable credit-related losses.
(i) Loan securitizations
When loan receivables are sold in a securitization to a special
purpose entity under terms that transfer control to third parties,
the transaction is recognized as a sale and the related loan assets
are removed from the Consolidated Balance Sheet. As part of the
securitization, certain financial assets are retained and may con-
sist of one or more subordinated tranches, servicing rights, and
in some cases a cash reserve account. The retained interests are
classified as investment account securities and are carried at cost
or amortized cost. With effect from July 1, 2001, a gain or loss
on sale of the loan receivables is recognized immediately in other
income, before the effects of hedges on the assets sold. The
amount of the gain or loss recognized depends in part on the
previous carrying amount of the receivables involved in the trans-
fer, allocated between the assets sold and the retained interests
based on their relative fair values at the date of transfer. To
obtain fair values, quoted market prices are used if available.
However, quotes are generally not available for retained interests
and the Bank generally estimates fair value based on the present
value of future expected cash flows estimated using manage-
ment’s best estimates of key assumptions – credit losses,
prepayment speeds, forward yield curves, and discount rates
commensurate with the risks involved. Prior to July 1, 2001, gains
arising on loan securitizations were deferred and amortized to
income whereas losses were recognized immediately. Transactions
entered into prior to July 1, 2001 or completed subsequently
pursuant to commitments to sell made prior to July 1, 2001 have
not been restated and deferred gains will be amortized over the
remaining terms of the commitment period.
Subsequent to the securitization, any retained interests that
cannot be contractually settled in such a way that the Bank can
recover substantially all of its recorded investment are adjusted
to fair value. The current fair value of retained interests is deter-
mined using the present value of future expected cash flows as
discussed above.
(j) Acceptances
The potential liability of the Bank under acceptances is reported
as a liability in the Consolidated Balance Sheet. The Bank’s
recourse against the customer in the event of a call on any of
these commitments is reported as an offsetting asset of the
same amount.
(k) Derivative financial instruments
Derivative financial instruments are financial contracts which
derive their value from changes in interest rates, foreign
exchange rates, credit spreads, commodity prices, equities and
other financial measures. Such instruments include interest rate,
foreign exchange, equity, commodity and credit derivative con-
tracts. These instruments are traded by the Bank and are also
used by the Bank for its own risk management purposes. To
be designated as a non-trading derivative contract and receive
hedge accounting treatment, the contract must substantially
offset the effects of price, interest rate or foreign exchange rate
exposures to the Bank, must be documented at inception as a
non-trading derivative contract, and must have a high correlation
at inception and throughout the contract period between the
derivative contract and the Bank’s exposure. If these criteria are
not met, the contract is accounted for as a trading derivative.
Trading derivatives are entered into by the Bank to meet the
needs of its customers and to take trading positions. Derivative
trading portfolios are marked to market with the resulting real-
ized and unrealized gains or losses recognized immediately in
other income. The market value for over-the-counter trading
derivatives is determined net of valuation adjustments which
recognize the need to cover market, liquidity, model, and credit
risks, as well as the cost of capital and administrative expenses
over the life of each contract.
Non-trading derivatives are entered into by the Bank in order
to meet the Bank’s funding, investing and credit portfolio man-
agement strategies. Unrealized gains and losses on non-trading
derivatives are accounted for on a basis consistent with the
related on-balance sheet financial instrument. Realized gains
and losses resulting from the early termination, sale, maturity
or extinguishment of such derivatives are generally deferred and
amortized over the remaining term of the related on-balance
sheet instruments. Premiums on purchased options are deferred at
inception and amortized into other income over the contract life.
(l) Goodwill and intangible assets
As of November 1, 2001, the Bank prospectively adopted the
accounting standard on goodwill and other intangible assets.
Goodwill represents the difference between the acquisition cost
of an investment and the fair value of the net tangible assets
acquired after an allocation is made for indefinite and finite life
intangible assets. Goodwill is not amortized but is subject to fair
value impairment tests, on at least an annual basis. Goodwill is
allocated to reporting units and any goodwill impairment is iden-
tified by comparing the carrying value of the reporting unit with
its fair value. If any impairment is identified, then the amount of
the impairment is quantified by comparing the carrying value of
goodwill to its fair value, based on the fair value of the assets
and liabilities of the reporting unit. Intangibles with a finite life
are amortized over their estimated useful life and also are tested