TD Bank 2006 Annual Report Download - page 72

TD BANK FINANCIAL GROUP ANNUAL REPORT 2006 Management’s Discussion and Analysis
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recognized and considered realizable could, however, be
reduced if projected income is not achieved due to various
factors, such as unfavourable business conditions. If projected
income is not expected to be achieved, the Bank would record
an additional valuation allowance to reduce its future tax assets
to the amount that it believes can be realized. The magnitude
of the valuation allowance is significantly influenced by the
Bank’s forecast of future profit generation, which drives the
extent to which it will be able to utilize the future tax assets.
•Future tax assets are calculated based on tax rates expected
to be in effect in the period in which they will be realized.
Previously recorded tax assets and liabilities need to be adjusted
when the expected date of the future event is revised based on
current information.
•The Bank has not recognized a future income tax liability for
undistributed earnings of certain operations as it does not
plan to repatriate them. Estimated taxes payable on such
earnings in the event of repatriation would be $454 million
at October 31, 2006.
VALUATION OF INVESTMENT SECURITIES
The Bank’s investment securities comprise both publicly traded
securities and investments in private equity securities that are not
publicly traded. Under GAAP, investment securities are carried at
cost or amortized cost and are adjusted to net realizable value to
recognize other-than-temporary impairment.
The Bank discloses the estimated fair value of investment
securities in Note 2 to the Consolidated Financial Statements.
Valuation of publicly traded securities is determined by using
quoted market prices, which fluctuate from one reporting period
to another. Valuation of private equity investments requires
management’s judgement due to the absence of quoted market
prices, inherent lack of liquidity and the longer-term nature of
such investments. Private equity investments are initially recorded
at cost and compared with fair value on a periodic basis. Fair
value is determined using valuation techniques, including
discounted cash flows and a multiple of earnings before taxes,
depreciation and amortization. Management applies judgement
in the selection of the valuation methodology and the various
inputs to the calculation, which may vary from one reporting
period to another.These estimates are monitored and reviewed
on a regular basis by us for consistency and reasonableness.
Any imprecision in these estimates can affect the resulting fair
value. The inherent nature of private equity investing is that
management’s valuation will change over time as the underlying
investment matures and an exit strategy is developed and
realized. Estimates of fair value may also fluctuate due to
developments in the business underlying the investment. Such
fluctuations may be significant depending on the nature of the
factors going into the valuation methodology and the extent of
change in those factors.
Investment securities are written down to their net realizable
value when there is an impairment in value that is considered
to be other than temporary in nature. The determination of
whether or not other-than-temporary impairment exists is a
matter of judgement. We review these investment securities
regularly for possible impairment that is other than temporary
and this review typically includes an analysis of the facts and
circumstances of each investment and the expectations for that
investment’s performance. Specifically, impairment of the value
of an investment may be indicated by conditions, such as a
prolonged period during which the quoted market value of the
investment is less than its carrying value, severe losses by the
investee in the current year or current and prior years, continued
losses by the investee for a period of years, suspension of trading
in the securities or liquidity or going concern problems of the
investee. All segments of the Bank are impacted by this account-
ing policy.
ACCOUNTING FOR SECURITIZATIONS AND
VARIABLE INTEREST ENTITIES
There are two key determinations relating to accounting for
securitizations. The first key determination is in regard to bank-
originated securitized assets. A decision must be made as to
whether the securitization should be considered a sale under
GAAP. GAAP requires that specific criteria be met in order for the
Bank to have surrendered control of the assets and thus be able
to recognize a gain or loss on sale. For instance, the securitized
assets must be isolated from the Bank and placed beyond the
reach of the Bank and its creditors, even in the case of bankrupt-
cy or receivership. In determining the gain or loss on sale,
management estimates future cash flows by relying on estimates
of the amount of interest that will be collected on the securitized
assets, the yield to be paid to investors, the portion of the securi-
tized assets that will be prepaid before their scheduled maturity,
expected credit losses, the cost of servicing the assets and the
rate at which to discount these expected future cash flows.
Actual cash flows may differ significantly from those estimated
by management. If actual cash flows are different from our
estimate of future cash flows then the gains or losses on the
securitization recognized in income will be adjusted. Retained
interests are taken into income over the life of the securitized
asset. Note 4 to the Bank’s Consolidated Financial Statements
provides additional disclosures regarding securitizations, includ-
ing a sensitivity analysis for key assumptions. For 2006, there
were no significant changes to the key assumptions used in esti-
mating the future cash flows. These assumptions are subject to
periodic review and may change due to significant changes in
the economic environment.
The second key determination is whether the VIEshould be
consolidated. All of the Bank’s securitization trusts are consid-
ered VIEs. Current GAAP requires consolidation of a VIE only
when the Bank is the primary beneficiary, exposed to a majority
of the VIE’s expected losses or entitled to a majority of the VIE’s
expected residual returns, or both. In addition, if the VIE is a
QSPE then the Bank does not consolidate the VIE. Management
uses judgment to estimate the expected losses and expected
residual returns in order to determine if the Bank retains substan-
tially all of the residual risk and rewards of the VIE. Under current
GAAP,all of the Bank-originated assets transferred to VIEs meet
the criteria for sale treatment and non-consolidation. This
accounting policy impacts Canadian Personal and Commercial
Banking, Wholesale Banking and the Corporate segment.
VALUATION OF GOODWILL AND INTANGIBLES
Under GAAP, goodwill is not amortized, but is instead assessed
for impairment at the reporting unit level annually, and if an event
or change in circumstances indicates that the asset might be
impaired. Goodwill is assessed for impairment by determining
whether the fair value of the reporting unit to which the goodwill
is associated is less than its carrying value. When the fair value of
the reporting unit is less than its carrying value, the fair value of
the goodwill in that reporting unit is compared to its carrying
value. If the fair value of goodwill is less than its carrying value,
goodwill is considered to be impaired and a charge for impairment
is recognized immediately. The fair value of the Bank’s reporting
units aredetermined from internally developed valuation models
that consider various factors, such as normalized and projected
earnings, price earnings multiples and discount rates.
Management uses judgment in estimating the fair value of report-
ing units and imprecision in any assumptions and estimates used
in the fair value calculations could influence the determination
of goodwill impairment and affect the valuation of goodwill.
Management believes that the assumptions and estimates used
are reasonable and supportable in the existing environment.
Wherepossible, fair values generated internally are compared to
market information. The carrying values of the Bank’s reporting