TD Bank 2005 Annual Report Download - page 57

TD BANK FINANCIAL GROUP ANNUAL REPORT 2005 Management’s Discussion and Analysis 53
REVISED CAPITAL ACCORD
In 2004, the Basel Committee on Banking Supervision finalized
the new Basel capital framework to replace the accord originally
introduced in 1988 and supplemented in 1996. The underlying
principles of the new framework are intended to be suitable for
application to banks of varying levels of complexity and sophisti-
cation. The framework will allow qualifying banks to determine
capital levels consistent with the manner in which they measure,
manage and mitigate risk. The new framework provides a
spectrum of methodologies, from simple to advanced, for
the measurement of both credit and operational risk. More
advanced measurement of risks should result in regulatory and
economic capital being more closely aligned. In addition, the
framework includes provisions for changes to the computation
of Tier 1 and total capital.
The objective of the framework is to reward for more rigorous
and accurate risk management by reducing regulatory capital
required under weaker or less sophisticated approaches. While
the overall objective of the new framework is to neither increase
nor decrease the level of overall capital in the system, some
financial institutions will see an increase in regulatory capital,
while others will see a decrease. The impact will depend upon
the particular institution’s asset mix, risk and loss experience.
The Bank is in the process of collecting, analyzing and report-
ing the necessary data and is on track to meet the requirements
of the new framework as applied to the Canadian context by
our regulator. For Canadian banks, formal implementation is
expected to be in fiscal 2008.
In the normal course of operations, the Bank engages in a
variety of financial transactions that, under Canadian Generally
Accepted Accounting Principles, are either not recorded on the
Consolidated Balance Sheet or are recorded in amounts that dif-
fer from the full contract or notional amounts. These off-balance
sheet arrangements involve, among other risks, varying elements
of market, credit and liquidity risk which are discussed in the
Managing Risk section on pages 57 to 66 of this Annual Report.
Off-balance sheet arrangements are generally undertaken for risk
management, capital management and/or funding management
purposes and include securitizations, commitments, guarantees,
and contractual obligations.
SPECIAL PURPOSE ENTITIES
The Bank carries out certain business activities via arrangements
with special purpose entities (SPEs). We use SPEs to obtain
sources of liquidity by securitizing certain of the Bank’s financial
assets, to assist our clients in securitizing their financial assets,
and to create investment products for our clients. SPEs may be
organized as trusts, partnerships or corporations and they may
be formed as qualifying special purpose entities (QSPEs) or vari-
able interest entities (VIEs). When an entity is deemed a VIE
under the CICA accounting guideline the entity must be consoli-
dated by the existing primary beneficiary. See Note 6 on page 83
to the Consolidated Financial Statements for further information
regarding the adoption of the accounting guideline for VIEs.
Securitizations arean important part of the financial markets,
providing liquidity by facilitating investor access to specific port-
folios of assets and risks. In a typical securitization structure, the
Bank sells assets to a SPE and the SPE funds the purchase of
those assets by issuing securities to investors. SPEs are typically
set up for a single, discrete purpose, are not operating entities
and usually have no employees. The legal documents that govern
the transaction describe how the cash earned on the assets held
in the SPE must be allocated to the investors and other parties
that have rights to these cash flows. The Bank is involved in SPEs
through the securitization of its own assets, securitization of
third party assets and other financial transactions.
Certain of the Bank’ssecuritizations of its own assets and of
third party assets are structured through QSPEs. QSPEs are trusts
or other legal vehicles that aredemonstrably distinct from the
Bank, have specified permitted activities, defined asset holdings
and may only sell or dispose of selected assets in automatic
response to limited conditions. QSPEs are not consolidated by
any party including the Bank.
The Bank monitors its involvement with SPEs through the
Structured Products Committee. The Committee is responsible
for the review of structured transactions and complex credits
with potentially significant reputational, legal, regulatory,
accounting or tax risks, including transactions involving SPEs.
SECURITIZATION OF BANK-ORIGINATED ASSETS
The Bank securitizes residential mortgages, personal loans,
credit card loans and commercial mortgages to enhance our
liquidity position, diversify sources of funding and to optimize
the management of the balance sheet. Details of these securiti-
zations areas follows.
Residential Mortgages Loans
The Bank securitizes residential mortgages through the creation
of mortgage-backed securities and the eventual transfer to VIEs.
The Bank continues to service the securitized mortgages and may
be exposed to the risks of the transferred loans through retained
interests. There are no expected credit losses on the retained
interests of the securitized residential mortgages as they are all
government guaranteed. We retain interests in the excess spread
on the sold mortgage-backed securities and continue to service
the mortgages underlying these mortgage-backed securities
for which we receive benefits, equivalent to market-based
compensation.
As at October 31, 2005, the Bank had outstanding securitized
residential mortgages of $15.5 billion as compared with $13.1
billion in fiscal 2004. The carrying value of our retained interests
in securitized residential mortgage loans at October 31, 2005,
was $273 million compared to $271 million in 2004.
Co-ownership Structures
The Bank securitizes real estate secured personal loans, credit
card loans and commercial mortgages through a co-ownership
structure. Through this structure ownership interests in a homog-
enous pool are sold to SPEs. The ownership interest entitles the
SPE to a portion of the loan collections to pay its expenses and
obligations to the holders of its asset-backed securities. Although
these interests in the receivables are no longer on our balance
sheet, we maintain the client account and retain the relationship.
The securitization of our real estate secured personal loans and
credit card receivables is a sale from a legal perspective and qual-
ifies for sale treatment from an accounting perspective. At the
time of sale these receivables are removed from our balance
sheet resulting in a gain or loss reported in non-interest income
on the Consolidated Statement of Income.
GROUP FINANCIAL CONDITION
Off-balance Sheet Arrangements