TD Bank 2009 Annual Report Download - page 64

TD BANK FINANCIAL GROUP ANNUAL REPORT 2009 MANAGEMENT’S DISCUSSION AND ANALYSIS60
CAPITAL SOURCES
The Bank’s capital is primarily derived from common shareholders and
retained earnings. Other sources of capital include the Bank’s preferred
shareholders, holders of innovative capital instruments and holders of
the Bank’s subordinated debt.
CAPITAL MANAGEMENT
The Treasury and Balance Sheet Management group manages capital
for the Bank and is responsible for acquiring, maintaining, and retiring
capital. The Board of Directors oversees capital policy and management.
The Bank continues to hold sufficient capital levels to ensure that
flexibility is maintained to grow operations, both organically and through
strategic acquisitions. The strong capital ratios are the result of the
Bank’s internal capital generation, management of the balance sheet,
and periodic issuance of capital securities.
ECONOMIC CAPITAL
The Bank’s internal measure of required capital is called economic
capital or invested capital. Economic capital comprises of risk-based
capital required to fund losses that could occur under extremely adverse
economic or operational conditions as well as investment capital that
has been used to fund acquisitions or investments in fixed assets to
support future earnings growth.
The Bank uses internal models to determine how much risk-based
capital is required to support the enterprise’s risk and business expo-
sures. Characteristics of these models are described in the ‘Managing
Risk’ section. Within the Bank’s measurement framework, our objective
is to hold risk-based capital to cover unexpected losses to a high level
of confidence and ratings standards. The Bank’s chosen internal capital
targets are well founded and consistent with our overall risk profile
and current operating environment.
Since November 1, 2007, the Bank has been operating its capital
regime under the Basel II Capital Framework. Consequently, in addition
to addressing Pillar I risks covering credit risk (including derivative
counterparty risk currently based on the Current Exposure Methodology),
market risk and operational risk, the Bank’s economic capital frame-
work captures other material Pillar II risks including business risk, interest
rate risk in banking book and concentration risk.
The Bank makes business decisions based on the return on economic
capital and economic profit, while also ensuring that, in aggregate,
regulatory and rating agency requirements and capital available are
kept in balance.
REGULATORY CAPITAL
Basel II Capital Framework
The Bank complies with the OSFI guideline for calculating RWA
and regulatory capital. This guideline is based on the International
Convergence of Capital Measurement and Capital Standard – A
Revised Framework (Basel II) issued by the Basel Committee on Bank-
ing Supervision. This framework replaced the Basel I Capital Accord
(Basel I) originally introduced in 1988 and supplemented in 1996.
The framework allows qualifying banks to determine capital levels
consistent with the way they measure, manage and mitigate risks.
It provides a spectrum of methodologies, from simple to advanced, for
the measurement of credit, market, and operational risks. The Bank
uses the advanced approaches for the majority of its portfolios which
results in regulatory and economic capital being more closely aligned
than was the case under Basel I. Since the U.S. banking subsidiaries
(TD Banknorth and Commerce) were not originally required by their
main regulators to convert to Basel II prior to being acquired by the
Bank, the advanced approaches are not yet being utilized for the
majority of assets in TD Bank, N.A.
For accounting purposes, GAAP is followed for consolidation of
subsidiaries and joint ventures. For regulatory capital purposes, insur-
ance subsidiaries are deconsolidated and reported as a deduction
from capital. Insurance subsidiaries are subject to their own capital
adequacy reporting such as OSFI’s Minimum Continuing Capital
Surplus Requirements and Minimum Capital Test. Currently, for
regulatory capital purposes, all the entities of the Bank are either
consolidated or deducted from capital and there are no entities
from which surplus capital is recognized. Effective April 30, 2009 for
accounting purposes, and effective October 31, 2008, for regulatory
capital purposes, the one month lag in reporting of the Bank’s U.S.
Personal and Commercial Banking segment entities was eliminated by
using the same period end as the rest of the Bank. Before October 31,
2008, the Bank’s regulatory capital was calculated incorporating the
U.S. Personal and Commercial Banking entities on a one month lag.
For regulatory capital purposes, the Bank’s investment in TD Ameritrade
is translated using the period end foreign exchange rate of the Bank.
Some of the Bank’s subsidiaries are individually regulated by either
OSFI or other regulators. Many of these entities have minimum capital
requirements which they must maintain and which may limit the Bank’s
ability to extract capital or funds for other uses.
Tier 1 Capital
Tier 1 capital was $21.4 billion at October 31, 2009, up from
$20.7 billion last year. Effective November 1, 2008, the Bank’s
substantial investments, including TD Ameritrade, are deducted 50%
from Tier 1 and 50% from Tier 2 capital. The increase to Tier 1
capital was largely due to strong earnings and capital issuances of
common shares, preferred shares, and innovative Tier 1 securities,
partially offset by the 50/50 deduction of substantial investments.
Capital management funding activities during the year consisted of
the following: the Bank issued $2.1 billion of common shares during
the year, consisting of a public issue of $1.38 billion and $0.7 billion
due to issuance under the dividend reinvestment plan and stock option
exercises; the Bank issued $220 million of 5-Year Rate Reset Preferred
Shares, Series AC; $300 million of 5-Year Rate Reset Preferred Shares,
Series AE; $375 million of 5-Year Rate Reset Preferred Shares, Series
AG; $275 million of 5-Year Rate Reset Preferred Shares, Series AI;
and $350 million of 5-Year Rate Reset Preferred Shares, Series AK;
and a subsidiary of the Bank, TD Capital Trust IV, issued $550 million
of TD Capital Trust IV Notes – Series 1, $450 million of TD Capital
Trust IV Notes – Series 2 and $750 million of TD Capital Trust IV Notes
– Series 3. On November 5, 2009, a subsidiary of the Bank, TD Capital
Trust, announced its intention to redeem all its outstanding $900 million
Capital Trust Securities – Series 2009 on December 31, 2009. See
Notes 16 and 18 to the Bank’s Consolidated Financial Statements for
more details.
Issue of Common Shares
On December 5, 2008, the Bank enhanced its capital position by
issuing 35 million common shares at a price of $39.50 per common
share for gross cash consideration of $1.38 billion. The issue qualifies
as Tier 1 capital for the Bank.
INTERNAL CAPITAL ADEQUACY ASSESSMENT PROCESS
The Bank’s Internal Capital Adequacy Assessment Process (ICAAP) is
an integrated process that encompasses the governance, management ,
and control of risk and capital functions within the Bank. It provides
a framework for relating risks to capital requirements through the Bank's
economic capital and stress testing practices and helps determine the
Bank’s capital adequacy requirements.
The ICAAP is facilitated by Risk Management and is supported by
numerous functional areas which together help determine the Bank's
internal capital adequacy assessment which ultimately represents the
capacity to bear risk in congruence with the risk profile and stated risk
appetite of the Bank. Risk Management leads the ICAAP and assesses
whether the Bank’s internal view of required capital is appropriate for the
Bank’s risks. Treasury and Balance Sheet Management determines the
adequacy of the Bank’s available capital in relation to required capital.
DIVIDENDS
The Bank’s dividend policy is approved by the Board of Directors.
At October 31, 2009, the quarterly dividend was $0.61 per share,
consistent with the Bank’s current target payout range of 35-45%
of adjusted earnings. Cash dividends declared and paid during 2009
totalled $2.44 per share (2008 – $2.36; 2007 – $2.11). For cash divi-
dends payable on the Bank’s preferred shares, see Notes 15 and 18 to
the Bank’s Consolidated Financial Statements. As at October 31, 2009,