TD Bank 2009 Annual Report Download - page 135

TD BANK FINANCIAL GROUP ANNUAL REPORT 2009 FINANCIAL RESULTS 131
Certain financial instruments are carried on the balance sheet at their
fair value. These financial instruments include securities and loans held
in the trading portfolio, certain securities and loans, as well as loans
designated as trading under the fair value option, securities classified
as available-for-sale, derivative financial instruments, certain deposits
classified as trading, and obligations related to securities sold short.
DETERMINATION OF FAIR VALUE
The fair value of a financial instrument on initial recognition is normally
the transaction price, i.e. the fair value of the consideration given or
received. In certain circumstances, however, the initial fair value may
be based on other observable current market transactions involving
the same instrument, without modification or repackaging, or is based
on a valuation technique which includes inputs from observable
markets and accordingly give rise to an inception profit which is recog-
nized into income upon initial recognition of the instrument. Inception
profit is the difference between the fair value that is based on a valua-
tion technique which includes inputs from observable markets, and the
fair value at initial recognition represented by transaction price. When
an instrument is measured using a valuation technique that significantly
utilizes non-observable market inputs, it is initially valued at the transac-
tion price, which is considered the best estimate of fair value.
Subsequent to initial recognition, the fair value of financial instru-
ments
measured at fair value that are quoted in active markets are
based on bid prices for financial assets held and offer prices for financial
liabilities. When there is no active market for the instrument, fair
values are determined by using valuation techniques which utilize
observable market inputs. These techniques include comparisons with
similar instruments where market observable prices exist, discounted
cash flow analysis, option pricing models and other valuation tech-
niques commonly used by market participants. For certain financial
instruments, fair values may be determined in whole or in part from
valuation techniques using non-observable market inputs.
A number of factors such as bid-offer spread, credit profile, input
parameter, and model uncertainty are taken into account, as appropri-
ate, when values are calculated using valuation techniques.
If the fair value of a financial asset measured at fair value becomes
negative, it is recorded as a financial liability until its fair value
becomes positive, at which time it is recorded as a financial asset,
or it is extinguished.
METHODS AND ASSUMPTIONS
The Bank calculates fair values based on the following methods of
valuation and assumptions:
Financial Instruments Whose Carrying
Value Approximates Fair Value
For certain financial assets and financial liabilities that are short term
in nature or contain variable rate features, fair value is based on the
appropriate prevailing interest rates and/or credit curves. The fair value
of cash and due from banks, interest-bearing deposits with banks,
customers’ liability under acceptances, acceptances and securities
borrowed or purchased under reverse repurchase agreements are
considered to be equal to carrying value.
Securities
The methods used to determine fair value are described in Note 2. The
fair value of securities is based on quoted market prices or, where
quoted market prices are not readily available, quoted market prices
of similar securities, other third-party evidence or by using a valuation
technique that maximizes the use of observable market inputs.
Loans
The estimated fair value of loans carried at amortized cost, other than
debt securities classified as loans, reflects changes in market price that
have occurred since the loans were originated or purchased, including
changes in the creditworthiness. For fixed-rate performing loans,
estimated fair value is determined by discounting the expected future
cash flows related to these loans at current market interest rates for
loans with similar credit risks. The fair value of loans is not adjusted for
the value of any credit protection the Bank has purchased to mitigate
credit risk. For floating rate performing loans, changes in interest
rates have minimal impact on fair value since loans reprice to market
frequently. On that basis, in the absence of deterioration in credit,
fair value is assumed to equal carrying value.
Debt securities classified as loans, by definition, do not include
securities with quoted prices in active markets. As quoted market
prices are not readily available, fair value is based on quoted market
prices of similar securities, other third-party evidence or by using a
valuation technique that maximizes the use of observable market inputs.
The fair value of loans carried at fair value, which includes trading
loans and loans designated as trading under the fair value option, is
determined using broker quotes where available. Where broker quotes
are not available or reliable, fair value is determined using valuation
techniques which maximize the use of observable market inputs.
Derivative Financial Instruments
The fair value of exchange-traded derivative financial instruments
is based on quoted market prices. The fair value of OTC derivative
financial instruments is determined using valuation models that
incorporate prevailing market rates and prices of underlying instru-
ments with similar maturities and characteristics.
The fair value of OTC derivatives is estimated using well established
models, but is recorded net of valuation adjustments, which recognize
the need to address input parameter, liquidity, and credit risks not
appropriately captured by the valuation models. If there is uncertainty
in the assumptions used to build a model, or if the models used are
complex, a valuation adjustment to reflect model uncertainty is also
recorded. If the model includes inputs that are not observable in the
market, and those inputs are significant to the valuation, the derivative
is initially valued at transaction price which is considered the best
estimate of fair value. Any difference between the transaction price
and the value determined by the valuation model at initial recognition
is recognized into income as non-observable inputs become observable.
In the case of defaulted counterparties, a specific provision is
established to recognize the estimated realizable value, net of collat-
eral held, based on market pricing in effect at the time the default
is recognized. In these instances, the estimated realizable value
is measured by discounting the expected future cash flows at an
appropriate effective interest rate immediately prior to impairment
after adjusting for the value of collateral.
For non-trading derivatives, fair value is determined on the same
basis as for trading derivatives.
Deposits
The estimated fair value of term deposits is determined by discounting
the contractual cash flows using interest rates currently offered for
deposits with similar terms.
For deposits with no defined maturities, the Bank considers fair
value to equal carrying value which is equivalent to the amount
payable on the balance sheet date.
For trading deposits, fair value is determined using valuation tech-
niques which maximize the use of observable market inputs.
Subordinated Notes and Debentures
The fair values of subordinated notes and debentures are based on
quoted market prices for similar issues or current rates offered to the
Bank for debt of equivalent credit quality and remaining maturity.
Liabilities for Preferred Shares and Capital Trust Securities
The fair values for preferred share liabilities and capital trust securities
are based on quoted market prices of the same or similar financial
instruments.
The fair values in the following table exclude the value of assets
that are not financial instruments, such as land, buildings and equip-
ment, as well as goodwill and other intangible assets, including
customer relationships, which are of significant value to the Bank.
FAIR VALUE OF FINANCIAL INSTRUMENTS
NOTE 30