TD Bank 2014 Annual Report Download - page 87

TD BANK GROUP ANNUAL REPORT 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS 85
The objective of portfolio management within the closed book is to
eliminate cash flow mismatches to the extent practically possible, so
that net interest income becomes more predictable. Product options,
whether they are freestanding options such as mortgage rate commit-
ments or embedded in loans and deposits, expose TD to a significant
financial risk.
• Rate Commitments: The Bank models its exposure from freestand-
ing mortgage rate commitment options using an expected funding
profile based on historical experience. Customers’ propensity to
fund, and their preference for fixed or floating rate mortgage prod-
ucts, is influenced by factors such as market mortgage rates, house
prices, and seasonality.
• Asset Prepayment: The Bank models its exposure to written
options embedded in other products, such as the right to prepay
residential mortgage loans, based on analysis of customer behav-
iour. Econometric models are used to model prepayments and the
effects of prepayment behaviour to the Bank. In general mortgage
prepayments are also affected by non-market incentives, such as
mortgage age, house prices, and GDP growth. The combined
impacts from these parameters are also assessed to determine a
core liquidation speed which is independent of market incentives.
• Non-Maturity Liabilities: The Bank models its exposure to non-
maturity liabilities, such as core deposits, by assessing interest rate
elasticity and balance permanence using historical data and business
judgement. Fluctuations of non-maturity deposits can occur because
of factors such as interest rate movements, equity market move-
ments, and changes to customer liquidity preferences.
To manage product option exposures the Bank purchases options or
uses a dynamic hedging process designed to replicate the payoff of a
purchased option. The Bank also models the margin compression that
would be caused by declining interest rates on certain interest rate
sensitive demand deposit accounts.
Other market risks monitored on a regular basis include:
• Basis Risk: The Bank is exposed to risks related to the difference
in various market indices.
• Equity Risk: The Bank is exposed to equity risk through its equity-
linked guaranteed investment certificate product offering. The expo-
sure is managed by purchasing options to replicate the equity payoff.
The following graph shows the Bank’s interest rate risk exposure, as
measured by EVaR, on all non-trading assets, liabilities, and derivative
instruments used for interest rate risk management.
The Bank uses derivative financial instruments, wholesale investments,
funding instruments, other capital market alternatives, and, less
frequently, product pricing strategies to manage interest rate risk.
As at October 31, 2014, an immediate and sustained 100 bps increase
in interest rates would have decreased the economic value of share-
holders’ equity by $67.7 million (October 31, 2013 – $31 million) after
tax. An immediate and sustained 100 bps decrease in Canadian inter-
est rates and a 25 bps decrease in U.S. interest rates would have
reduced the economic value of shareholders’ equity by $55.7 million
(October 31, 2013 – $9.4 million) after tax.
The following table shows the sensitivity of the economic value of
shareholders’ equity (after tax) by currency for those currencies where
TD has material exposure.
ALL INSTRUMENTS PORTFOLIO
Economic Value at Risk After-tax –
October 31, 2014 and October 31, 2013
(millions of Canadian dollars)
(50)
(250)
(200)
(100)
(150)
$150
100
50
0
Parallel interest rate shock percentage
Change in present value (millions)
(2.0) (1.5) (1.0) (0.5) 00.5 1.0 1.5 2.0
Q4 2013: $(31.0)
Q4 2014: $(67.7)
(millions of Canadian dollars) October 31, 2014 October 31, 2013
100 bps 100 bps 100 bps 100 bps
Currency increase decrease increase decrease
Canadian dollar $ 6.9 $ (46.9) $ 9.5 $ (1.3)
U.S. dollar1 (74.6) (8.8) (40.5) (8.1)
$ (67.7) $ (55.7) $ (31.0) $ (9.4)
1 EVaR sensitivity has been measured using a 25 bps rate decline for U.S. interest
rates, corresponding to an interest rate environment that is floored at 0%.
SENSITIVITY OF AFTER-TAX ECONOMIC VALUE AT RISK BY CURRENCY
TABLE 56
For the EaR measure (not shown on the graph), a 100 bps increase in
interest rates on October 31, 2014, would have increased pre-tax net
interest income by $438 million (October 31, 2013 – $562 million
increase) in the next twelve months. A 100 basis point decrease in
interest rates on October 31, 2014, would have decreased pre-tax net
interest income by $385 million (October 31, 2013 – $373 million
decrease) in the next twelve months. Over the last year, the reported
EaR exposures have grown due to an increasing portion of permanent
non-rate sensitive deposits being invested in a shorter term maturity
profile. This is consistent with net interest income management strate-
gies overseen by ALCO. Reported EaR remains consistent with the
Bank’s risk appetite and within established Board limits.