TD Bank 2012 Annual Report Download - page 100

TD BANK GROUP ANNUAL REPORT 2012 FINANCIAL RESULTS98
Acquired loans for which an incurred loss is not present at the
acquisition date, are subsequently accounted for at amortized
cost based on their contractual cash flows and any acquisition
related discount or premium is considered to be an adjustment to
the loan yield and is recognized in interest income over the term
of the loan using the effective interest rate method. These loans are
included in the Bank’s originated loan portfolios and are subject to
assessment under the Bank’s allowance framework for counterparty-
specific, collectively assessed individually insignificant, and collectively
assessed allowances that are incurred but not identified, subsequent
to acquisition.
Acquired Credit-Impaired Loans
ACI loans are acquired loans with evidence of incurred credit losses
where it is probable at the purchase date that the Bank will be unable
to collect all contractually required principal and interest payments.
These loans are accounted for based on the present value of expected
cash flows as opposed to their contractual cash flows.
ACI loans were identified as impaired at acquisition based on
specific risk characteristics of the loans, including past due status,
performance history as well as recent borrower credit scores. The Bank
then determined the fair value of the ACI loans at the acquisition date
by discounting expected cash flows at a market observable discount
rate and where necessary adjusted for factors a market participant
would use when determining fair value. In determining the expected
cash flows to be collected, management incorporates assumptions
regarding default rates, loss severities and the amount and timing
of prepayments.
With respect to certain individually significant ACI loans, accounting
is applied individually at the loan level. The remaining ACI loans are
aggregated into one or more pools provided that they are acquired in
the same fiscal quarter and have common risk characteristics. A pool is
then accounted for as a single asset with a single composite interest
rate and an aggregate expectation of cash flows.
Subsequent to acquisition, the Bank will re-assess its estimate of
cash flows to determine if updates are required. Updates to cash flow
estimates incorporate assumptions regarding default rates, loss severi-
ties, the amount and timing of prepayments and other factors that are
reflective of current market conditions. Probable decreases in expected
cash flows trigger the recognition of additional impairment, which is
measured based on the present value of the expected cash flows
discounted at the effective interest rate of the loan. Impairment that
occurs subsequent to the acquisition date is recognized through the
provision for credit losses. As ACI loans are consistently evaluated for
credit losses by accounting for the loan based on present value of
expected cash flows, inclusive of incurred loss, both at acquisition and
subsequent to acquisition, they are not subject to an allowance for
incurred but not identified credit losses, as incurred credit losses are
specifically identified and reflected in the loan’s carrying value.
Probable and significant increases in expected cash flows would first
reverse any previously taken impairment; any remaining increases are
recognized in income immediately as interest income. In addition, for
fixed-rate ACI loans the timing of expected cash flows may increase
or decrease which may result in adjustments through interest income
to the acquisition discount (both favourably and unfavourably) in
order to maintain the inception yield of the ACI loan.
If the timing and/or amounts of expected cash flows on ACI loans
were determined not to be reasonably estimable, no interest would be
recognized and the loans would be reported as non-performing.
FDIC Covered Loans
Loans subject to loss share agreements with the Federal Deposit Insur-
ance Corporation (“FDIC”) are considered FDIC covered loans. The
amounts expected to be reimbursed by the FDIC are considered sepa-
rately as indemnification assets and are initially measured at fair value.
If losses on the portfolio are greater than amounts expected as at the
acquisition date, an impairment loss is taken by establishing an allow-
ance for credit losses, which is determined gross, exclusive of any
adjustments to the indemnification assets.
Indemnification assets are subsequently adjusted for any changes in
estimates related to the overall collectability of the underlying loan
portfolio. Any additional impairment of the underlying loan portfolio
generally results in an increase of the indemnification asset through
the provision for credit losses. Alternatively, decreases in the expecta-
tion of losses of the underlying loan portfolio generally results in a
decrease of the indemnification asset through net interest income (or
through the provision for credit losses if impairment was previously
taken). The indemnification asset is drawn down as payments are
received from the FDIC pertaining to the loss share agreements.
FDIC covered loans are recorded in “Loans” on the Consolidated
Balance Sheet. The indemnification assets are recorded in “Other
assets” on the Consolidated Balance Sheet.
At the end of each loss share period, the Bank may be required
to make a payment to the FDIC if the actual losses incurred are less
than the intrinsic loss estimate as defined in the loss share agreements.
The payment is determined as 20% of the excess between the intrinsic
loss estimate and actual covered losses determined in accordance with
the loss sharing agreement, net of specified servicing costs. The fair
value of the estimated payment is included in part of the indemnifica-
tion asset at the date of acquisition. Subsequent changes to the
estimated payment are considered in determining the adjustment to
the indemnification asset as described above.
Financial Liabilities Carried at Amortized Cost
Deposits
Deposits, other than deposits included in a trading portfolio, are
accounted for at amortized cost. Accrued interest on deposits, calcu-
lated using the effective interest rate method, is included in other
liabilities on the Consolidated Balance Sheet.
Subordinated Notes and Debentures
Subordinated notes and debentures are accounted for at amortized
cost. Interest expense is recognized on an accrual basis using the
effective interest rate method.
Liability for Preferred Shares and Capital Trust Securities
The Bank classifies issued instruments in accordance with the substance
of the contractual arrangement. Issued instruments that are mandato-
rily redeemable or convertible into a variable number of the Bank’s
common shares at the holder’s option are classified as liabilities on the
Consolidated Balance Sheet. Dividend or interest payments on these
instruments are recognized in interest expense.
Preferred shares that are not mandatorily redeemable or that are
not convertible into a variable number of the Bank’s common shares
at the holder’s option are classified and presented in Share Capital.
Guarantees
The Bank issues guarantee contracts that require payments to be made
to guaranteed parties based on: (i) changes in the underlying economic
characteristics relating to an asset or liability of the guaranteed party;
(ii) failure of another party to perform under an obligating agreement;
or (iii) failure of another third party to pay its indebtedness when due.
Financial standby letters of credit are financial guarantees that repre-
sent irrevocable assurances that the Bank will make payments in the
event that a customer cannot meet its obligations to third parties and
they carry the same credit risk, recourse and collateral security require-
ments as loans extended to customers. Performance standby letters of
credit are considered non-financial guarantees as payment does not
depend on the occurrence of a credit event and is generally related to
a non-financial trigger event. Financial and performance standby
letters of credit are initially measured and recorded at their fair value.
A guarantee liability is recorded on initial recognition at fair value
which is normally equal to the present value of the guarantee fees
received over the life of contract. The Bank’s release from risk is recog-
nized over the term of the guarantee using a systematic and rational
amortization method.
If a guarantee meets the definition of a derivative, it is carried at fair
value on the Consolidated Balance Sheet and reported as a derivative
asset or derivative liability at fair value. Guarantees that are considered
derivatives are a type of credit derivative which are over-the-counter
(OTC) contracts designed to transfer the credit risk in an underlying
financial instrument from one counterparty to another.