TD Bank 2005 Annual Report Download - page 64

TD BANK FINANCIAL GROUP ANNUAL REPORT 2005 Management’s Discussion and Analysis
60
measurable improvement in the management of credit risk. Thus,
the Bank’s personal credit strategy is to leverage the disciplined
management of the personal credit portfolio with state-of-the-
art systems, methods and processes.
CLASSIFIED RISK/IMPAIRED LOANS
Classified risk refers to loans and other credit exposures that
pose a higher than normal credit risk. 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 principal and interest when 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 personal credit portfolios are based on
delinquency and type of security.
Please refer to the Credit Portfolio Quality discussion on
pages 44 to 50.
Market Risk
Market risk is the potential for loss from changes in the value of
financial instruments. The value of a financial instrument can be
affected by changes in:
•Interest rates;
•Foreign exchange rates;
•Equity and commodity prices;
•Credit spreads.
Weare exposed to market risk in our trading and investment
portfolios, as well as through our non-trading activities. In our
trading and investment portfolios we areactive participants in
the market, seeking to realize returns for the Bank through
careful management of our positions and inventories. In our
non-trading activities we areexposed to market risk through
the transactions that our customers execute with us.
MARKET RISK IN TRADING ACTIVITIES
The four main trading activities that expose us to market risk are:
•Market making. Weprovide markets for a large number of
securities and other traded products. We keep an inventory of
these securities to buy from and sell to investors, profiting from
the spread between bid and ask prices. Profitability is driven by
trading volumes.
•Sales. We provide a wide variety of financial products to meet
the needs of our clients, earning money on these products
from mark ups and commissions. Profitability is driven by sales
volumes.
•Arbitrage. Wetake positions in certain markets or products
and offset the risk in other markets or products. Our knowl-
edge of various markets and products and how they relate
to one another allows us to identify and benefit from pricing
anomalies.
•Positioning. We aim to make profits by taking positions in
certain financial markets in anticipation of changes in those
markets. This is the riskiest of our trading activities and we
use it selectively.
WHO MANAGES MARKET RISK IN TRADING ACTIVITIES
Primary responsibility for managing market risk lies with
Wholesale Banking, with oversight from Trading Risk
Management within Risk Management.
The Market Risk and Capital Committee is chaired by the
Senior Vice President, Trading Risk Management and includes
members of senior management from Wholesale Banking and
Audit. They meet regularly to conduct a review of the market
risk profile of our trading businesses, approve changes to risk
policies, review underwriting inventories, and review the usage
of capital and assets in Wholesale Banking.
The Risk Committee of the Board oversees the management
of market risk and periodically approves all major market
risk policies.
HOW WE MANAGE MARKET RISK
IN TRADING ACTIVITIES
Managing market risk is a key part of our business planning
process. We begin new trading operations or expand existing
ones only if the risk has been thoroughly assessed and is judged
to be within our risk tolerance and business expertise, and if the
appropriate infrastructure is in place to monitor, control and
manage the risk.
Trading Limits
We set trading limits that are consistent with the approved
business plan for each business and our tolerance for the market
risk of that business. In setting limits we take into account
market volatility, market liquidity, trader experience and business
strategy. Limits are prescribed at the desk level, portfolio level,
business line level and Wholesale Banking in aggregate.
Our primary trading limits are sensitivity and specialized
limits, such as notional limits, credit spread limits, yield curve
shift limits, price and volatility shift limits. A variety of other
limits are also reviewed.
Another primary measure of trading limits is Value at Risk
(VaR). VaR measures the adverse impact that potential changes
in market rates and prices could have on the value of a portfolio
over a specified period of time. We use VaR to monitor and
control overall risk levels and to calculate the regulatory capital
required for market risk in trading activities.
At the end of each day, risk positions are compared with risk
limits and all instances where trading limits have been exceeded
are reported. Any excesses are escalated and managed according
to market risk policies and procedures. For selected high-impact
excesses, thereis an immediate escalation process to the Vice
Chair and Chief Risk Officer.
Calculating VaR
We estimate VaR by creating a distribution of potential changes
in the market value of the current portfolio. Wevalue the current
portfolio using the most recent 259 trading days of market price
and rate changes. VaR is then computed as the threshold level
that portfolio losses are not expected to exceed more than one
out of every 100 trading days.
The graph below discloses daily VaR usage.1
Value at Risk
(millions of Canadian dollars)
VaR (General)
-20
0
-5
-10
-15
Feb
1/05
Mar
1/05
Apr
1/05
Jun
1/05
Jui
1/05
Aug
1/05
Sept
1/05
Oct
3/05
Oct
31/05
May
2/05
Jan
3/05
Dec
1/04
Nov
1/04
1VAR data excludes TD Banknorth.