TD Bank 2014 Annual Report Download - page 61

TD BANK GROUP ANNUAL REPORT 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS 59
THE BANK’S CAPITAL MANAGEMENT OBJECTIVES
The Bank’s capital management objectives are:
• To be an appropriately capitalized financial institution
as determined by:
– the Bank’s Risk Appetite Statement (RAS);
– capital requirements defined by relevant regulatory
authorities; and
– the Bank’s internal assessment of capital requirements
consistent with the Bank’s risk profile and 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; and
– support and facilitate business growth and/or acquisitions
consistent with the Bank’s strategy and risk appetite.
• To support strong external debt ratings, in order to manage
the Bank’s overall cost of funds and to maintain accessibility
to required funding.
These objectives are applied in a manner consistent with the Bank’s over-
all objective of providing a satisfactory return on shareholders’ equity.
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 and holders of the Bank’s subordinated debt.
CAPITAL MANAGEMENT
The Enterprise Capital Management department manages capital for
the Bank and is responsible for acquiring, maintaining, and retiring
capital. The Board of Directors (the “Board”) oversees capital adequacy
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 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 of this document. Within the Bank’s measurement frame-
work, its objective 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
its overall risk profile and current operating environment.
Since November 1, 2007, the Bank has been operating its capital
regime under the Basel Capital Framework. Consequently, in addition
to addressing Pillar I risks covering credit risk, market risk, and opera-
tional risk, the Bank’s economic capital framework captures other
material Pillar II risks including non-trading market risk for the retail
portfolio (interest rate risk in the banking book), additional credit risk
due to concentration (commercial and wholesale portfolios) and risks
classified as “Other”, namely business risk, insurance risk, and the
Bank’s investment in TD Ameritrade.
Please refer to the Risk-Weighted Assets section below for a break-
down of the Bank’s economic capital by business segment, and Pillar I
and Pillar II risks.
REGULATORY CAPITAL
Basel III Capital Framework
Capital requirements of the Basel Committee on Banking and
Supervision (BCBS) are commonly referred to as Basel III. Under Basel III,
Total Capital consists of three components, namely CET1, Additional
Tier 1 and Tier 2 Capital. The sum of the first two components is
defined as Tier 1 Capital. CET1 Capital is mainly comprised of common
shares, retained earnings, and accumulated other comprehensive
income, is the highest quality capital and the predominant form of
Tier 1 Capital. CET1 Capital also includes regulatory adjustments and
deductions for items such as goodwill, intangible assets, and amounts
by which capital items (that is, significant investments in CET1 Capital
of financial institutions, mortgage servicing rights, and deferred tax
assets from temporary differences) exceed allowable thresholds. Tier 2
Capital is mainly comprised of subordinated debt, certain loan loss
allowances, and minority interests in subsidiaries’ Tier 2 instruments.
Regulatory capital ratios are calculated by dividing CET1, Tier 1 and
Total Capital by their respective RWAs.
6
OSFI’s Capital Requirements under Basel III
OSFI’s Capital Adequacy Requirements (CAR) guideline details how the
Basel III rules apply to Canadian banks.
Effective January 1, 2014, the CVA capital charge is phased in over
a five year period, given the delays in the implementation of Basel III
standards in the U.S. and European Union countries. The bilateral over-
the-counter (OTC) derivative market is a global market and given the
significant impact of the CVA capital charge, OSFI believed a coordi-
nated start with the two most significant jurisdictions in the global
derivatives market was warranted. The CVA capital charge phase-in
is based on a scalar approach whereby a CVA capital charge of 57%
applies in 2014 for the CET1 calculation. This percentage will increase
to 64% for 2015 and 2016, 72% in 2017, 80% in 2018, and 100%
in 2019. A similar set of scalar phase-in percentages would also apply
for the Tier 1 and Total Capital ratio calculations.
Effective January 1, 2013, all newly issued non-common Tier 1 and
Tier 2 capital instruments must include non-viability contingent capital
(NVCC) provisions (NVCC Provisions) to qualify as regulatory capital.
NVCC Provisions require the conversion of non-common capital instru-
ments into a variable number of common shares of the Bank if OSFI
determines that the Bank is, or is about to become, non-viable and
that after conversion of the non-common capital instruments, the
viability of the Bank is expected to be restored, or if the Bank has
accepted or agreed to accept a capital injection or equivalent support
from a federal or provincial government without which the Bank
would have been determined by OSFI to be non-viable. Existing non-
common Tier 1 and Tier 2 capital instruments which do not include
NVCC Provisions are non-qualifying capital instruments and are subject
to a phase-out period which began in 2013 and ends in 2022.
6 Effective the third quarter of 2014, each capital ratio has its own RWA measure
due to the OSFI prescribed scalar for inclusion of the CVA. Effective the third
quarter of 2014, the scalars for inclusion of CVA for CET1, Tier 1 and Total Capital
RWA were 57%, 65% and 77% respectively.