TD Bank 2009 Annual Report Download - page 79

TD BANK FINANCIAL GROUP ANNUAL REPORT 2009 MANAGEMENT’S DISCUSSION AND ANALYSIS 75
The following graph shows our interest rate risk exposure (as
measured by EVaR) on all non-trading assets, liabilities and derivative
instruments used for interest rate risk management.
The Bank uses derivative financial instruments, wholesale instruments
and other capital market alternatives and, less frequently, product pricing
strategies to manage interest rate risk. As at October 31, 2009, an
immediate and sustained 100 bps increase in interest rates would have
decreased the economic value of shareholders’ equity by $85.6 million
(2008 – $122.8 million) after tax. An immediate and sustained 100 bps
decrease in interest rates would have reduced the economic value of
shareholders’ equity by $137.0 million (2008 – $29.0 million) after tax.
The following table shows the sensitivity of the economic value of
shareholders’ equity (after tax) by currency for those currencies where
the Bank has material exposure.
(millions of Canadian dollars) As at Oct. 31, 2009 As at Oct. 31, 2008
100 bps 100 bps 100 bps 100 bps
Currency increase decrease increase decrease
Canadian dollar $ (72.6) $ 72.6 $ (15.5) $ 15.5
U.S. dollar (22.6) 22.6 21.9 (21.9)
$ (95.2) $ 95.2 $ 6.4 $ (6.4)
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. When our foreign currency assets
are greater or less than our liabilities in that currency, they create a
foreign currency open position. An adverse change in foreign exchange
rates can impact our reported net income and shareholders’ equity
and also our capital ratios. Our objective is to minimize these impacts.
Minimizing the impact of an adverse foreign exchange rate change
on reported shareholders’ equity will cause some variability in capital
ratios, due to the amount of RWA that are denominated in a foreign
currency. If the Canadian dollar weakens, the Canadian-dollar equiva-
lent of our RWA in a foreign currency increases, thereby increasing our
capital requirement. 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 an acceptable
amount for a given change in foreign exchange rates.
WHY PRODUCT MARGINS FLUCTUATE OVER TIME
As explained above, the objective of our approach to asset/liability
management is to lock in margins on fixed-rate loans and deposits as
they are booked. It also offsets the impact of an instantaneous inter-
est-rate shock on the amount 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 earn-
ing assets is subject to 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
as the mix of business changes.
•Changes in the prime-Bankers’ Acceptances (BA) 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 affect the return we generate
on our modeled maturity profile for core deposits and the investment
profile for our 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.
Our approach tends to moderate the impact of these factors over time,
resulting in a more stable and predictable earnings stream.
We use simulation modeling of net interest income to assess the
level and changes in net interest income to be earned over time
under various interest rate scenarios. The model also includes the
impact of projected product volume growth, new margin and product
mix assumptions.
ALL INSTRUMENTS PORTFOLIO
Economic Value at Risk After-tax – Oct. 31, 2009 and Oct. 31, 2008
(millions of Canadian dollars)
(400)
(500)
(600)
(300)
(100)
(200)
$100
0
Parallel interest rate shock percentage
Change in present value
(2.0) (1.5) (1) (0.5) 0 0.5 1.0 1.5 2.0
2009: $(137) million2008: $(123) million
SENSITIVITY OF AFTER-TAX ECONOMIC VALUE
AT RISK BY CURRENCY
TABLE 41
(millions of Canadian dollars) As at Oct. 31, 2009 As at Oct. 31, 2008
100 bps 100 bps 100 bps 100 bps
Currency increase decrease increase decrease
Canadian dollar $ (0.5) $ (67.6) $ (0.4) $ (27.0)
U.S. dollar (85.1) (69.4) (122.4) (2.0)
$ (85.6) $ (137.0) $ 122.8 $ (29.0)
For the EaR measure (not shown on the graph), a 100 basis point
increase in interest rates on October 31, 2009 would have decreased
pre-tax net income by $95.2 million (2008 – $6.4 million increase)
in the next 12 months. A 100 basis point decrease in interest rates
on October 31, 2009 would have increased pre-tax net income by
$95.2 million (2008 – $6.4 million decrease) in the next 12 months.
SENSITIVITY OF PRE-TAX EARNINGS
AT RISK BY CURRENCY
TABLE 42
The following table shows the sensitivity of net income (pre-tax) by
currency for those currencies where the Bank has material exposure.