TD Bank 2011 Annual Report Download - page 95

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TD BANK GROUP ANNUAL REPORT 2011 FINANCIAL RESULTS 93
Prices derived by using models are recorded net of valuation adjust-
ments. The inputs used in the valuation models depend on the type of
derivative and the nature of the underlying instrument and are specific
to the instrument being valued. Inputs can include, but are not limited
to, interest rate yield curves, foreign exchange rates, dividend yield
projections, recovery rates, volatilities, spot prices, and correlation.
A credit risk valuation adjustment (CRVA) is recorded against the
model value of OTC derivatives to account for the uncertainty that
either counterparty in a derivative transaction may not be able to fulfill
its obligations under the transaction. In determining CRVA, the Bank
takes into account master netting agreements and collateral, and
considers the creditworthiness of the counterparty and the Bank itself,
in assessing potential future amounts owed to, or by the Bank.
As at October 31, 2011, the CRVA recorded against the model value
of OTC derivatives was $183 million (2010 – $178 million).
In the case of defaulted counterparties, a specific provision is estab-
lished to recognize the estimated realizable value, net of collateral
held, based on market pricing in effect at the time the default is recog-
nized. In these instances, the estimated realizable value is measured by
discounting the expected future cash flows at an appropriate effective
interest rate immediately prior to impairment, after adjusting for the
value of collateral.
Deposits
The estimated fair value of term deposits is determined by discounting
the contractual cash flows using interest rates currently offered for
deposits with similar terms.
For deposits with no defined maturities, the Bank considers fair
value to equal carrying value, which is equivalent to the amount
payable on the balance sheet date.
For trading deposits, fair value is determined using discounted cash
flow valuation techniques which maximize the use of observable
market inputs such as benchmark yield curves and foreign exchange
rates. The Bank considers the impact of its own creditworthiness in the
valuation of these deposits by reference to observable market inputs.
Obligations Related to Securities Sold Short
The fair value of these obligations is based on the fair value of the
underlying securities, which can include equity or debt securities.
As these obligations are fully collateralized, the method used to deter-
mine fair value would be the same as that of the relevant underlying
equity or debt securities.
Subordinated Notes and Debentures
The fair values of subordinated notes and debentures are based on
quoted market prices for similar issues or current rates offered to the
Bank for debt of equivalent credit quality and remaining maturity.
Liabilities for Preferred Shares and Capital Trust Securities
The fair values for preferred share liabilities and capital trust
securities are based on quoted market prices of the same or similar
financial instruments.
Management validates that the estimates of fair value are reason-
able using a process of obtaining multiple quotes of external market
prices and values of inputs. Management consistently applies valuation
models and controls over a period of time in the valuation process.
The valuations are also validated by past experience and through
actual cash settlement under the contract terms.
Asset-backed securities are primarily fair valued using third-party
vendor prices. The third-party vendor employs a valuation model which
maximizes the use of observable inputs such as benchmark yield curves
and bid-ask spreads. The model also takes into account relevant data
about the underlying collateral, such as weighted average terms to
maturity and prepayment rate assumptions.
Equity Securities
The fair value of equity securities is based on quoted prices in active
markets, where available. Where quoted prices in active markets are
not readily available, or there is a wide bid-offer spread, fair value is
determined based on quoted market prices for similar securities. If
there are trading restrictions on the equity security held, a valuation
adjustment is recorded against available prices to reflect the nature
of the restriction.
Retained Interests
The methods and assumptions used to determine fair value of retained
interests are described in Note 5, Loan Securitizations.
Loans
The estimated fair value of loans carried at amortized cost, other than
debt securities classified as loans, reflects changes in market price that
have occurred since the loans were originated or purchased, including
changes in the creditworthiness. For fixed-rate performing loans, esti-
mated fair value is determined by discounting the expected future cash
flows related to these loans at current market interest rates for loans
with similar credit risks. The fair value of loans is not adjusted for
the value of any credit protection the Bank has purchased to mitigate
credit risk. For floating rate performing loans, changes in interest
rates have minimal impact on fair value since loans reprice to market
frequently. On that basis, in the absence of deterioration in credit,
fair value is assumed to approximate carrying value.
At initial recognition, debt securities classified as loans do not
include debt securities with quoted prices in active markets. Similar to
other debt securities not classified as loans, when quoted market
prices are not readily available, fair value is based on quoted market
prices of similar securities, other third-party evidence or by using
a valuation technique that maximizes the use of observable market
inputs. If quoted prices in active markets subsequently become
available, these are used to determine fair value for debt securities
classified as loans.
The fair value of loans carried at fair value, which includes trading
loans and loans designated as trading under the fair value option, is
determined using observable market prices, where available. Where
the Bank is a market maker for loans traded in the secondary market,
fair value is determined using executed prices, or prices for comparable
trades. For those loans where the Bank is not a market maker, the
Bank obtains broker quotes from other reputable dealers. The prices
are corroborated as part of the Bank’s independent review process,
which may include using valuation techniques or obtaining consensus
or composite prices from pricing services.
Derivative Financial Instruments
The fair value of exchange-traded derivative financial instruments is
based on quoted market prices. The fair value of over-the-counter
(OTC) derivative financial instruments is estimated using well estab-
lished valuation techniques, such as discounted cash flow techniques,
Black-Scholes model, and Monte Carlo simulation. The valuation
models incorporate prevailing market rates and prices of underlying
instruments with similar maturities and characteristics.