TD Bank 2006 Annual Report Download - page 67

TD BANK FINANCIAL GROUP ANNUAL REPORT 2006 Management’s Discussion and Analysis 63
2, 3 EVAR and EAR information excludes the impact of TD Banknorth exposures.
The following graph shows our interest rate risk exposure
(EVaR) on all instruments within the financial position, i.e. the
closed (non-optioned) instruments plus product options. In 2006,
the portfolio was most sensitive to an immediate and sustained
100-basis point decrease in rates. Had this occurred, the eco-
nomic value of shareholders’ equity would have decreased by
$51 million, after tax. In contrast, the portfolio in 2005 was
more sensitive to a 100-basis point increase in rates, which
would have caused an after-tax decrease of $36 million. During
the year ending October 31, 2006, the EVaR for the total portfo-
lio ranged from $24 to $53 million.The current exposure
represents a small proportion of Board approved limits and repre-
sents a closely-hedged portfolio based on product assumptions.
For the Earnings at Risk measure (not shown on the graph),
a 100-basis point decrease in rates on October 31, 2006 would
have reduced pre-tax net income by $0.5 million in the next
12 months. In 2005, the Bank was also most exposed to a
decrease in rates, which would have reduced pre-tax income
by $15 million.
Managing Non-trading Foreign Exchange Risk
Foreign exchange risk refers to losses that could result from
changes in foreign currency exchange rates. Assets and liabilities
that are denominated in foreign currencies have foreign
exchange risk.
We are exposed to non-trading foreign exchange risk from our
investments in foreign operations, and when our foreign curren-
cy assets aregreater or less than our liabilities in that currency,
they create a foreign currency open position. An adverse change
in foreign exchange rates can impact the Bank’s reported net
income and equity,and also the Bank’s capital ratios. Our objec-
tive is to minimize these impacts.
Minimizing the impact of an adverse foreign exchange rate
change on reported equity will cause some variability in capital
ratios, due to the amount of RWA that are denominated in
aforeign currency. If the Canadian dollar weakens, the
Canadian-dollar equivalent of the Bank’s RWA in a foreign
currency increases, thereby increasing the Bank’s capital require-
ment. For this reason, the foreign exchange risk arising from the
Bank’s net investments in foreign operations is hedged to the
point where capital ratios change by no more than a tolerable
amount for a given change in foreign exchange rates. The tolera-
ble amount increases as the Bank’s capital ratio increases.
WHY PRODUCT MARGINS FLUCTUATE OVER TIME
As explained above, the Bank’s approach to asset/liability man-
agement locks in margins on fixed rate loans and deposits as
they are booked. It also mitigates the impact of an instantaneous
interest-rate shock on the level of net interest income to be
earned over time as a result of cash flow mismatches and the
exercise of embedded options. Despite this approach, however,
the margin on average earning assets can change over time for
the following reasons:
•Margins earned on new and renewing fixed-rate products
relative to the margin previously earned on matured products
will affect the existing portfolio margin.
•The weighted-average margin on average earning assets will
shift due to changes in the mix of business.
•Changes in the prime-Bankers’ Acceptances basis and the lag
in changing product prices in response to changes in wholesale
rates may have an impact on margins earned.
•The general level of interest rates will impact the return the
Bank generates on its modeled maturity profile for core
deposits and the investment profile for its net equity position as
it evolves over time. The general level of interest rates is also a
key driver of some modeled option exposures, and will affect
the cost of hedging such exposures.
The Bank’s approach tends to moderate the impact of these
factors over time, resulting in a more stable and predictable
earnings stream.
Net interest income simulation modeling is employed to assess
the level and changes in net interest income to be earned over
time under various interest rate scenarios. It also includes the
impact of projected product volume growth, new margin and
product mix assumptions.
Liquidity Risk
Liquidity risk is the risk that we cannot meet a demand for
cash or fund our obligations as they come due. Demand for
cash can arise from withdrawals of deposits, debt maturities and
commitments to provide credit. Liquidity risk also includes the
risk of not being able to liquidate assets in a timely manner at
areasonable price.
The Bank must always ensurethat it has access to enough
readily available funds to cover its financial obligations as they
come due and to sustain and grow its assets and operations both
under normal and stress conditions. In the unlikely event of a
funding disruption, the Bank needs to be able to continue to
function without being forced to sell too many of its assets. The
process that ensures adequate access to funds is known as the
management of liquidity risk.
WHO MANAGES LIQUIDITY RISK
The Asset/Liability Committee oversees the Bank’s liquidity risk
management program. It ensures that an effective management
structure is in place to properly measure and manage liquidity
risk. In addition, a Global Liquidity Forum, comprising senior
management from Finance, Treasury and Balance Sheet
Management, Risk Management and Wholesale Banking,
identifies and monitors our liquidity risks. When necessary, the
Forum recommends actions to the Asset/Liability Committee to
maintain our liquidity position within limits in both normal and
stress conditions.
All instruments portfolio
Economic Value at Risk After Tax – Oct 31, 2006 and Oct 31, 2005
(millions of Canadian dollars)
-160
-40
-80
-120
$40
0
Rate shift %
Change in present value
-2.0 -1.5 -1 -0.5 0 0.5 1.0 1.5 2.0
2006
2006: -51 million
2005
2005: -36 million
Excludes TD Banknorth, includes TD Bank USA (as of Sept. 30, 2006)