TD Bank 2012 Annual Report Download - page 57

TD BANK GROUP ANNUAL REPORT 2012 MANAGEMENT’S DISCUSSION AND ANALYSIS 55
THE BANK’S OBJECTIVES:
•
To be an appropriately capitalized financial institution as determined by:
– The Bank’s Risk Appetite Statement;
–
Capital requirements defined by relevant regulatory authorities; and,
– The Bank’s internal assessment of capital requirements consistent
with the Bank’s risk tolerance levels.
• To have the most economically achievable weighted average cost
of capital (after tax), consistent with preserving the appropriate mix
of capital elements to meet targeted capitalization levels.
• To ensure ready access to sources of appropriate capital, at reason-
able cost, in order to:
– Insulate the Bank from unexpected events;
– Facilitate acquisitions; and
– Support business expansion.
•
To support strong external debt ratings, in order to manage the Bank’s
overall cost of funds and to maintain accessibility to required funding.
CAPITAL SOURCES
The Bank’s capital is primarily derived from common shareholders and
retained earnings. Other sources of capital include the Bank’s preferred
shareholders, holders of innovative capital instruments, and holders of
the Bank’s subordinated debt.
CAPITAL MANAGEMENT
The Treasury and Balance Sheet Management group manages capital
for the Bank and is responsible for acquiring, maintaining, and retiring
capital. The Board of Directors oversees capital policy and management.
The Bank continues to hold sufficient capital levels to ensure that
flexibility is maintained to grow operations, both organically and
through strategic acquisitions. The strong capital ratios are the result
of the Bank’s internal capital generation, management of the balance
sheet, and periodic issuance of capital securities.
ECONOMIC CAPITAL
The Bank’s internal measure of required capital is called economic
capital or invested capital. Economic capital is comprised of both risk-
based capital required to fund losses that could occur under extremely
adverse economic or operational conditions and investment capital
that has been used to fund acquisitions or investments in fixed assets
to support future earnings growth.
The Bank uses internal models to determine how much risk-based
capital is required to support the enterprise’s risk and business expo-
sures. Characteristics of these models are described in the ‘Managing
Risk’ section. Within the Bank’s measurement framework, our objec-
tive is to hold risk-based capital to cover unexpected losses to a high
level of confidence and ratings standards. The Bank’s chosen internal
capital targets are well founded and consistent with our overall risk
profile and current operating environment.
Since November 1, 2007, the Bank has been operating its capital
regime under the Basel II Capital Framework. Consequently, in addi-
tion to addressing Pillar I risks covering credit risk, market risk and
operational risk, the Bank’s economic capital framework captures
other material Pillar II risks including business risk, interest rate risk
in the banking book and concentration risk.
REGULATORY CAPITAL
Basel II Capital Framework
The Bank complies with the OSFI guideline for calculating RWA
and regulatory capital. This guideline is based on the International
Convergence of Capital Measurement and Capital Standard –
A Revised Framework (Basel II) issued by the Basel Committee on
Banking Supervision. This framework replaced the Basel I Capital
Accord (Basel I) originally introduced in 1988 and supplemented in
1996. The framework allows qualifying banks to determine capital
levels consistent with the way they measure, manage and mitigate risks.
It provides a spectrum of methodologies, from simple to advanced, for
the measurement of credit, market, and operational risks. The Bank
uses the advanced approaches for the majority of its portfolios which
results in regulatory and economic capital being more closely aligned
than was the case under Basel I. Since the U.S. banking subsidiaries
(TD Bank N.A. including South Financial and Chrysler Financial) were
not originally required by their main regulators to convert to Basel II
prior to being acquired by the Bank, the advanced approaches are not
yet being utilized for the majority of assets in TD Bank, N.A.
For accounting purposes, IFRS is followed for consolidation of
subsidiaries and joint ventures. For regulatory capital purposes, insur-
ance subsidiaries are deconsolidated and reported as a deduction from
capital. Insurance subsidiaries are subject to their own capital adequacy
reporting such as OSFI’s Minimum Continuing Capital Surplus
Requirements and Minimum Capital Test. Currently, for regulatory
capital purposes, all the entities of the Bank are either consolidated or
deducted from capital and there are no entities from which surplus
capital is recognized.
Some of the Bank’s subsidiaries are individually regulated by either
OSFI or other regulators. Many of these entities have minimum capital
requirements which they must maintain and which may limit the
Bank’s ability to extract capital or funds for other uses.
Tier 1 Capital
Tier 1 capital was $31.0 billion as at October 31, 2012, up from
$28.5 billion last year. The increase to Tier 1 capital was largely due
to strong earnings. Capital management funding activities during the
year included the common shares issuance of $1.2 billion under the
dividend reinvestment plan and stock option exercises. The Bank
adopted IFRS on November 1, 2011. OSFI’s relief provision permits
phase-in of the impact of IFRS in the calculation of regulatory capital
on a straight-line basis over five quarters from November 1, 2011 to
January 31, 2013. The IFRS impact on Tier 1 capital is $1,937 million,
of which $1,550 million is included as at October 31, 2012. Effective
November 1, 2011, the Bank was also required to follow the new
requirement to deduct insurance subsidiaries 50% from Tier 1 capital
and 50% from Tier 2 capital.
Tier 2 Capital
Subsequent to year-end, on November 1, 2012, the Bank redeemed
$2.5 billion of subordinated debentures, which qualified as Tier 2
regulatory capital. See Note 17 to the Bank’s Consolidated Financial
Statements for more details.