TD Bank 2009 Annual Report Download - page 62

TD BANK FINANCIAL GROUP ANNUAL REPORT 2009 MANAGEMENT’S DISCUSSION AND ANALYSIS58
EXPOSURE TO NON-AGENCY COLLATERALIZED MORTGAGE
OBLIGATIONS (CMO)
Due to the acquisition of Commerce, the Bank has exposure to
non-agency CMOs collateralized primarily by Alt-A and Prime Jumbo
mortgages, most of which are pre-payable fixed-rate mortgages
without rate reset features. At the time of acquisition, the portfolio
was recorded at fair value, which became the new cost basis for this
portfolio. See Note 7 to the 2009 Consolidated Financial Statements
for more details. The portfolio was classified as available-for-sale, and
subsequently carried at fair value with changes in fair value recognized
in other comprehensive income. If there was an impairment in value
that was considered to be other than temporary in nature, the security
would be written down to fair value through the Consolidated State-
ment of Income.
In the fourth quarter of 2009, the Bank adopted amendments made
to CICA Handbook Section 3855, Financial Instruments – Recognition
and Measurement that allow debt securities which are not quoted in
an active market on November 1, 2008, to be classified as loans. The
non-agency CMO debt securities qualified for reclassification since the
market for the portfolio has been considered to be inactive since the
fourth quarter of 2008. As a result, the debt securities were reclassified
from available-for-sale to loans effective November 1, 2008, at their
amortized cost as of that date to align the accounting for the portfolio
with how it is managed by the Bank. After the reclassification, the
debt securities are carried at amortized cost using the effective interest
rate method, and are evaluated for loan losses using the incurred
credit loss model. For more details on the impact of reclassification of
these securities to loans, please refer to the “Changes in Accounting
Policies during the Current Year” section.
The liquidity in the market for this portfolio has decreased since the
third quarter of 2008, resulting in the market being considered inac-
tive since that time. The trading volume for this portfolio has declined
significantly relative to historical levels. There has been a significant
widening of the bid-ask spread and there are only a small number of
bidders for these securities in the market. Determination of whether
a market is inactive requires judgment, and the above factors are indi-
cators of an inactive market. In current markets, broker quotes cannot
be considered as a primary source of valuation. After the third quarter
of 2008, the Bank fair valued the portfolio using a valuation technique
which maximizes the use of observable inputs including broker quotes.
The valuation technique uses assumptions a market participant would
use in valuing this portfolio. This portfolio is valued using a yield
based pricing approach. The projected expected cash flows which are
contractual cash flows adjusted for expected prepayments and credit
losses are discounted at the derived yield for determining the fair value
of the portfolio. The derived yield is based on the current Fannie Mae
agency bond yield adjusted for the risk and structuring premium for
the portfolio.
The Bank assesses impairment of these reclassified debt securities
on a quarterly basis. Since these debt securities are classified as loans,
the impairment assessment follows the loan loss accounting model,
where there are two types of allowances against credit losses – specific
and general. Specific allowances provide against losses that are identi fi-
able at the individual debt security level for which there is objective
evidence that there has been a deterioration of credit quality, at which
point the book value of the loan is reduced to its estimated realizable
amount. A general allowance is established to recognize losses that
management estimates to have occurred in the portfolio at the balance
sheet date for loans not yet specifically identified as impaired. As
a
result of the reclassification of the debt securities to loans in 2009,
a provision for credit losses of $59 million after tax was recognized as
an adjustment to the November 1, 2008, opening retained earnings
and $147 million after tax for 2009 in the Consolidated Statement
of Income.
During the second quarter of 2009, the Bank re-securitized a portion
of the non-agency CMO portfolio. As part of the on-balance sheet
re-securitization, new credit ratings were obtained for the re-securitized
securities that better reflect the discount on acquisition and the Bank’s
risk inherent on the entire portfolio. As a result, 59% of the non-
agency CMO portfolio is now rated AAA for regulatory capital reporting.
The net capital benefit of the re-securitization transaction is reflected
in the changes in RWA and in the securitization deductions from Tier 1
and Tier 2 capital. For accounting purposes, the Bank retained a
majority of the beneficial interests in the re-securitized securities
resulting in no financial statement impact. The Bank’s assessment of
impairment for these reclassified securities is not impacted by the
change in the credit ratings.
The following table discloses the fair value of the securities by
vintage year:
NON-AGENCY ALT-A AND PRIME JUMBO CMO PORTFOLIO BY VINTAGE YEAR
TABLE 32
(millions of U.S. dollars) Alt-A Prime Jumbo Total
Amortized Fair Amortized Fair Amortized Fair
cost value cost value cost value
2009
2003 $ 359 $ 365 $ 598 $ 597 $ 957 $ 962
2004 624 621 636 645 1,260 1,266
2005 873 817 1,602 1,513 2,475 2,330
2006 492 438 584 543 1,076 981
2007 739 703 471 444 1,210 1,147
Total portfolio net of specific allowance $ 3,087 $ 2,944 $ 3,891 $ 3,742 $ 6,978 $ 6,686
Less: general allowance 256
Total $ 6,722 $ 6,686
2008
2003 $ 423 $ 360 $ 775 $ 664 $ 1,198 $ 1,024
2004 759 626 972 850 1,731 1,476
2005 979 787 2,031 1,711 3,010 2,498
2006 549 429 819 656 1,368 1,085
2007 818 644 587 478 1,405 1,122
Total $ 3,528 $ 2,846 $ 5,184 $ 4,359 $ 8,712 $ 7,205