TD Bank 2011 Annual Report Download - page 79

TD BANK GROUP ANNUAL REPORT 2011 MANAGEMENT’S DISCUSSION AND ANALYSIS 77
ACCOUNTING STANDARDS AND POLICIES
Critical Accounting Estimates
The Bank’s accounting policies are essential to understanding its
results of operations and financial condition. A summary of the
Bank’s significant accounting policies is presented in the Notes to the
Consolidated Financial Statements. Some of the Bank’s policies require
subjective, complex judgments and estimates as they relate to matters
that are inherently uncertain. Changes in these judgments or estimates
could have a significant impact on the Bank’s Consolidated Financial
Statements. The Bank has established procedures to ensure that
accounting policies are applied consistently and that the processes for
changing methodologies are well controlled and occur in an appropri-
ate and systematic manner. In addition, the Bank’s critical accounting
policies are reviewed with the Audit Committee on a periodic basis.
Critical accounting policies that require management’s judgment and
estimates include accounting for loan losses, accounting for the fair
value of financial instruments, accounting for securitizations and vari-
able interest entities, the valuation of goodwill and other intangibles,
accounting for pensions and post-retirement benefits, accounting for
income taxes, and contingent liabilities.
LOAN LOSSES
Accounting for loan losses is an area of importance given the size of
the Bank’s loan portfolio. A loan is considered impaired when there
is objective evidence subsequent to the initial recognition of the loan
that there has been a deterioration of credit quality to the extent that
management no longer has reasonable assurance as to the timely
collection of the full amount of principal and interest. The Bank has
two types of allowances against loan losses – specific and general.
A specific allowance is recorded against loans that are classified as
impaired, which occurs when there is objective evidence of impairment
at the specific loan level. Judgment is required as to the timing of
designating a loan as impaired and the amount of the required specific
allowance. Management exercises judgment as to the amount that
will be recovered once the borrower defaults. Changes in the amount
management expects to recover can have a direct impact on the provi-
sion for credit losses and may result in a change in the allowance.
Changes in the specific allowance, if any, would primarily impact the
Canadian Personal and Commercial Banking, the U.S. Personal and
Commercial Banking, and the Wholesale Banking segments.
The general allowance captures the credit losses in circumstances
where the loss event is considered to have occurred, but for which
there is not yet objective evidence of impairment at the specific loan
level. In establishing the general allowance, the Bank refers to inter-
nally developed models that utilize parameters for probability of
default (PD), loss given default (LGD) and exposure at default (EAD).
Using these models the probable range of general allowance levels is
calculated. Management’s judgment is used to determine the point
within the range that is the best estimate of losses, based on an
assessment of business and economic conditions, historical loss experi-
ence, loan portfolio composition, and other relevant indicators that are
not fully incorporated into the model calculation. If the wholesale and
commercial parameters were independently increased or decreased by
10%, then the model would indicate an increase or decrease to the
mean of the range in the amount or $24.8 million for PD, $24.8 million
for LGD, and $81.6 million for EAD, respectively. Changes in the
general allowance, if any, would primarily impact the Corporate
and U.S. Personal and Commercial Banking segments.
The “Managing Risk – Credit Risk” section of this MD&A provides
a more detailed discussion regarding credit risk. Also, see Note 4 to the
Consolidated Financial Statements and the “Credit Portfolio Quality”
section of this MD&A for additional disclosures regarding the Bank’s
allowance for credit losses.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instrument is based on quoted prices in
active markets, where available, adjusted for daily margin settlements,
where applicable. Where there is no active market for the instrument,
fair value may be based on other observable current market transac-
tions involving the same instrument, without modification or repackag-
ing, or is based on a valuation technique which maximizes the use of
observable market inputs. Observable market inputs include interest
rate yield curves, foreign exchange rates, and option volatilities.
Valuation techniques include comparisons with similar instruments
where market observable prices exist, discounted cash flow analysis,
option pricing models, and other valuation techniques commonly used
by market participants. For certain complex or illiquid financial instru-
ments, fair values may be determined in whole or in part using valua-
tion techniques, such as internally developed valuation models, which
may incorporate non-observable market inputs.
Inputs estimated are subject to management’s judgment. For
example, certain credit products are valued using models with non-
observable inputs such as correlation and recovery rates. Uncertainty
in estimating the inputs can impact the amount of revenue or loss
recorded for a particular position. Management’s judgment is also
used in recording fair value adjustments to model valuations to
account for measurement uncertainty when valuing complex and
less actively traded financial instruments. Valuation adjustments are
described further in Note 2 to the Consolidated Financial Statements.
The Bank has controls in place to ensure that the valuations derived
from the models and inputs are appropriate. These include indepen-
dent review and approval of valuation models and inputs, and inde-
pendent review of the valuations by qualified personnel. If the market
for complex financial instrument products develops, the pricing for
these products may become more transparent, resulting in refinement
of valuation models. For a discussion of market risk, refer to the
“Managing Risk – Market Risk” section of this MD&A. As described in
Note 2 to the Consolidated Financial Statements, for financial instru-
ments whose fair value is estimated using valuation techniques based
on non-observable market inputs that are significant to the overall
valuation, the difference between the best estimate of fair value at
initial recognition represented by the transaction price, and the fair
value determined using the valuation technique, is recognized in
income as the non-observable inputs become observable. Note 2 also
summarizes the difference between the transaction price and amount
determined at inception using valuation techniques with significant
non-observable market inputs.
The process for obtaining multiple quotes of external market prices,
consistent application of models over a period of time, and the controls
and processes described above, support the reasonability of the valua-
tion models. The valuations are also validated by past experience and
through actual cash settlement under the contract terms.
The terms of the Stockholders Agreement provide for certain infor-
mation sharing rights in favour of TD to the extent TD requires such
information from TD Ameritrade to appropriately manage and evaluate
its investment and to comply with its legal and regulatory obligations.
Accordingly, management processes and protocols are aligned
between TD and TD Ameritrade to coordinate necessary intercompany
information flow. In addition to regular communication at the Chief
Executive Officer level, monthly operating reviews with TD Ameritrade
permit TD to examine and discuss TD Ameritrade’s operating results
and key risks. As well, certain functions, such as Internal Audit, Finance
and Compliance, have relationship protocols that allow for the sharing
of information on risk and control issues. Quarterly reports to our
Audit Committee and Risk Committee include comments on any
significant internal audit issues at TD Ameritrade; and risk issues are
reported up to our Risk Committee as required, and at least annually.