TD Bank 2014 Annual Report Download - page 104

TD BANK GROUP ANNUAL REPORT 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS102
For certain complex or illiquid financial instruments, fair value is
determined using valuation techniques in which current market trans-
actions or observable market inputs are not available. Determining
which valuation technique to apply requires judgment. The valuation
techniques themselves also involve some level of estimation and judg-
ment. The judgments include liquidity considerations and model inputs
such as volatilities, correlations, spreads, discount rates, pre-payment
rates, and prices of underlying instruments. Any imprecision in these
estimates can affect the resulting fair value.
The inherent nature of private equity investing is that the Bank’s
valuation may change over time due to developments in the business
underlying the investment. Such fluctuations may be significant
depending on the nature of the factors going into the valuation
methodology and the extent of change in those factors.
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. If the market
for a complex financial instrument develops, the pricing for this
instrument may become more transparent, resulting in refinement
of valuation models.
The Bank has implemented FVA in the fourth quarter of 2014 in
response to growing evidence that market implied funding costs and
benefits are now considered in the pricing and fair valuation of uncol-
lateralized derivatives. The FVA involves estimates and judgment as
there is currently no common industry practice or standard for deter-
mining the FVA. Some of the key drivers of FVA include the market
implied cost of funding spread over LIBOR, expected term of the
trades, and expected average exposure by counterparty. The Bank will
continue to monitor industry practice, and may refine the methodology
and the products to which FVA applies to as market practices evolve.
An analysis of fair values of financial instruments and further details
as to how they are measured are provided in Note 5 to the Bank’s
Consolidated Financial Statements.
DERECOGNITION
Certain assets transferred may qualify for derecognition from the
Bank’s Consolidated Balance Sheet. To qualify for derecognition
certain key determinations must be made. A decision must be made
as to whether the rights to receive cash flows from the financial assets
has been retained or transferred and the extent to which the risks and
rewards of ownership of the financial asset has been retained or trans-
ferred. If the Bank neither transfers nor retains substantially all of the
risks and rewards of ownership of the financial asset, a decision must
be made as to whether the Bank has retained control of the financial
asset. Upon derecognition, the Bank will record a gain or loss on sale
of those assets which is calculated as the difference between the carry-
ing amount of the asset transferred and the sum of any cash proceeds
received, including any financial asset received or financial liability
assumed, and any cumulative gain or loss allocated to the transferred
asset that had been recognized in other comprehensive income. In
determining the fair value of any financial asset received, the Bank
estimates future cash flows by relying on estimates of the amount of
interest that will be collected on the securitized assets, the yield to be
paid to investors, the portion of the securitized assets that will be
prepaid before their scheduled maturity, expected credit losses, the
cost of servicing the assets and the rate at which to discount these
expected future cash flows. Actual cash flows may differ significantly
from those estimated by the Bank. Retained interests are classified as
trading securities and are initially recognized at relative fair value on
the Bank’s Consolidated Balance Sheet. Subsequently, the fair value of
retained interests recognized by the Bank is determined by estimating
the present value of future expected cash flows using management’s
best estimates of key assumptions including credit losses, prepayment
rates, forward yield curves and discount rates, that are commensurate
with the risks involved. Differences between the actual cash flows and
the Bank’s estimate of future cash flows are recognized in income.
These assumptions are subject to periodic review and may change due
to significant changes in the economic environment.
GOODWILL AND OTHER INTANGIBLES
The fair value of the Bank’s cash generating unit (CGU) is determined
from internally developed valuation models that consider various
factors and assumptions such as forecasted earnings, growth rates,
price-earnings multiples, discount rates, and terminal multiples.
Management is required to use judgment in estimating the fair value
of CGUs, and the use of different assumptions and estimates in
the fair value calculations could influence the determination of the
existence of impairment and the valuation of goodwill. Management
believes that the assumptions and estimates used are reasonable
and supportable. Where possible, fair values generated internally are
compared to relevant market information. The carrying amounts
of the Bank’s CGUs are determined by management using risk based
capital models to adjust net assets and liabilities by CGU. These models
consider various factors including market risk, credit risk, and opera-
tional risk, including investment capital (comprised of goodwill and
other intangibles). Any unallocated capital not directly attributable
to the CGUs is held within the Corporate segment. The Bank’s
capital oversight committees provide oversight to the Bank’s capital
allocation methodologies.
EMPLOYEE BENEFITS
The projected benefit obligation and expense related to the Bank’s
pension and non-pension post-retirement benefit plans are determined
using multiple assumptions that may significantly influence the value
of these amounts. Actuarial assumptions including discount rates,
compensation increases, health care cost trend rates, and mortality
rates are management’s best estimates and are reviewed annually with
the Bank’s actuaries. The Bank develops each assumption using rele-
vant historical experience of the Bank in conjunction with market-
related data and considers if the market-related data indicates there is
any prolonged or significant impact on the assumptions. The discount
rate used to measure plan obligations is based on long-term high qual-
ity corporate bond yields as at October 31. The other assumptions are
also long-term estimates. All assumptions are subject to a degree of
uncertainty. Differences between actual experiences and the assump-
tions, as well as changes in the assumptions resulting from changes
in future expectations, result in actuarial gains and losses which are
recognized in other comprehensive income during the year and also
impact expenses in future periods.
INCOME TAXES
The Bank is subject to taxation in numerous jurisdictions. There are
many transactions and calculations in the ordinary course of business
for which the ultimate tax determination is uncertain. The Bank main-
tains provisions for uncertain tax positions that it believes appropriately
reflect the risk of tax positions under discussion, audit, dispute, or
appeal with tax authorities, or which are otherwise considered to
involve uncertainty. These provisions are made using the Bank’s best
estimate of the amount expected to be paid based on an assessment
of all relevant factors, which are reviewed at the end of each reporting
period. However, it is possible that at some future date, an additional
liability could result from audits by the relevant taxing authorities.
Deferred tax assets are recognized only when it is probable that
sufficient taxable profit will be available in future periods against
which deductible temporary differences may be utilized. The amount
of the deferred tax asset recognized and considered realizable could,
however, be reduced if projected income is not achieved due to vari-
ous factors, such as unfavourable business conditions. If projected
income is not expected to be achieved, the Bank would decrease
its deferred tax assets to the amount that it believes can be realized.
The magnitude of the decrease is significantly influenced by the Bank’s
forecast of future profit generation, which determines the extent to
which it will be able to utilize the deferred tax assets.