TD Bank 2011 Annual Report Download - page 68

TD BANK GROUP ANNUAL REPORT 2011 MANAGEMENT’S DISCUSSION AND ANALYSIS66
TD’s credit risk exposures are divided into two main portfolios, non-
retail and retail. In the non-retail portfolio, we manage exposures on an
individual borrower basis, using industry and sector-specific credit risk
models, and expert judgment. We have categorized non-retail credit
risk exposures according to the following Basel II counterparty types:
corporate (wholesale and commercial customers), sovereign and bank.
In the retail portfolio (individuals and small businesses), we manage
exposures on a pooled basis, using predictive credit scoring techniques.
We have three sub-types of retail exposures: residential secured (e.g.,
individual mortgages, home equity lines of credit), qualifying revolving
retail (e.g., individual credit cards, unsecured lines of credit and over-
draft protection products), and other retail (e.g., personal loans,
student lines of credit, and small business banking credit products).
Risk Parameters
Under the AIRB Approach, credit risk is measured using the following
risk parameters: probability of default (PD) – the likelihood that the
borrower will not be able to meet its scheduled repayments within a
one year time horizon; loss given default (LGD) – the amount of the
loss TD would likely incur when a borrower defaults on a loan, which
is expressed as a percentage of exposure at default (EAD) – the total
amount we are exposed to at the time of default. By applying these
risk parameters, we can measure and monitor our credit risk to ensure
it remains within pre-determined thresholds.
Non-retail Exposures
We evaluate credit risk for non-retail exposures by rating for both the
borrower risk and the facility risk. We use this system for all corporate,
sovereign and bank exposures. We determine the risk ratings using
industry and sector-specific credit risk models that quantify and moni-
tor the level of risk and facilitate its management. All borrowers and
facilities are assigned an internal risk rating that must be reviewed at
least once each year.
Each borrower is assigned a borrower risk rating that reflects the
PD of the borrower using proprietary models and expert judgment.
In assessing borrower risk, we review the borrower’s competitive posi-
tion, industry, financial performance, economic trends, management
and access to funds. TD’s 21-point borrower risk rating scale broadly
aligns to external ratings as follows:
We use a range of qualitative and quantitative methods to measure
and manage counterparty credit risk. These include statistical methods
to measure and limit future potential exposure and stress tests to iden-
tify and quantify exposure to extreme events. We set gross notional
limits to manage business volumes and concentrations and we regu-
larly assess market conditions and the pricing quality of underlying
financial instruments. Counterparty credit risk may increase during
periods of receding market liquidity for certain instruments. Treasury
Credit Management meets regularly with Trading and Credit Risk
Management and front office Trading to discuss how evolving market
conditions may impact on our assessment of market risk and counter-
party credit risk.
TD actively engages in risk mitigation strategies through the use
of multi-product derivative master netting agreements, collateral and
other credit risk mitigation techniques. Derivative-related credit risks
are subject to the same credit approval, limit, monitoring, and expo-
sure guideline standards that we use for managing other transactions
that create credit risk exposure. These standards include evaluating
the creditworthiness of counterparties, measuring and monitoring
exposures, including wrong-way risk exposures, and managing the
size, diversification, and maturity structure of the portfolios.
Credit Risk Exposures subject to the Standardized Approach
The Standardized Approach to credit risk is used primarily for assets
in the U.S. Personal and Commercial Banking portfolio and plans are
in place to transition to the AIRB Approach. Under the Standardized
Approach, the assets are multiplied by risk-weights prescribed by OSFI
to determine RWA. These risk-weights are assigned according to
certain factors including counterparty type, product type, and the
nature/extent of credit risk mitigation. We use external credit ratings
assigned by one or more of Moody’s Investors Service, Standard &
Poor’s, and Fitch to determine the appropriate risk weight for our
exposures to Sovereigns (governments, central banks and certain
public sector entities) and Banks (regulated deposit-taking institutions,
securities firms and certain public sector entities).
We apply the following risk weights to on-balance sheet exposures
under the Standardized Approach:
Sovereign 0%1
Bank 20%1
Residential secured 35% or 75%2
Other retail (including small business entities) 75%
Corporate 100%
1 The risk weight may vary according to the external risk rating.
2 35% applied when loan to value <=80%, 75% when loan to value >80%.
Lower risk-weights apply where approved credit risk mitigants exist.
Loans that are more than 90 days past due receive a risk-weight of
either 100% (residential secured) or 150% (all other).
For off-balance sheet exposures, specified credit conversion factors
are used to convert the notional amount of the exposure into a credit
equivalent amount.
Credit Risk Exposures subject to the AIRB Approach
The AIRB Approach to credit risk is used for all material portfolios except
in the areas noted in the “Credit Risk and the Basel II Framework” section.
Banks that adopt the AIRB Approach to credit risk must report credit risk
exposures by counterparty type, each having different underlying risk
characteristics. These counterparty types may differ from the presentation
in our financial statements.
The facility risk rating maps to LGD and takes into account facility-
specific characteristics such as collateral, seniority ranking of debt, and
loan structure. Internal risk ratings are key to portfolio monitoring and
management and are used to set exposure limits and loan pricing.
Internal risk ratings are also used in the calculation of regulatory capital,
economic capital, and general allowance for credit losses.
Derivative Exposures
Credit risk on derivative financial instruments, also known as counter-
party credit risk, is the risk of a financial loss occurring as a result of
the failure of a counterparty to meet its obligation to TD. We use the
Current Exposure Method to determine regulatory capital requirements
for derivative exposures. The Treasury Credit group within Wholesale
Banking is responsible for implementing and ensuring compliance with
credit policies established by TD for the management of derivative
credit exposures.
Description Rating Category Standard & Poor’s Moody’s Investor Services
Investment grade 0 to 1C AAA to AA- Aaa to Aa3
2A to 2C A+ to A- A1 to A3
3A to 3C BBB+ to BBB- Baa1 to Baa3
Non-investment grade 4A to 4C BB+ to BB- Ba1 to Ba3
5A to 5C B+ to B- B1 to B3
Watch and classified 6 to 8 CCC+ to CC and below Caa1 to Ca and below
Impaired/default 9A to 9B Default Default