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, consistent with preserving the appropriate mix of capital elements to meet targeted capitalization levels.
• To ensure ready access to sources of appropriate capital, at reasonable 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 overall 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
Enterprise Capital Management manages capital for the Bank and is responsible for forecasting and monitoring compliance with capital targets. The Board of Directors (the “Board”) oversees capital adequacy risk 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
Economic capital is the Bank’s internal measure of required capital and is one of the key components in the Bank’s assessment of internal capital adequacy. 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 utilized to fund acquisitions or investments to support future earnings growth. The Bank uses internal models to determine the amount of risk-based capital required to support the risks resulting from the Bank’s business operations. Characteristics of these models are described in the “Managing Risk” section of this document. The objective of the Bank’s economic capital framework is to hold risk-based capital to cover unexpected losses consistent with TD’s solvency and ratings standards. The Bank’s chosen standards 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 1 risks covering credit risk, market risk, and operational risk, the Bank’s economic capital framework captures other material Pillar 2 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 significant investments. The framework also captures diversification benefits across risk types and business segments. Please refer to the “Economic Capital and Risk-Weighted Assets by Segment” section for a business segment breakdown of the Bank’s economic capital.
REGULATORY CAPITAL
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. Risk sensitive regulatory capital ratios are calculated by dividing CET1, Tier 1, and Total Capital by their respective RWA. In 2015, Basel III implemented a non-risk sensitive leverage ratio to act as a supplementary measure to the risk-sensitive capital requirements. The objective of the leverage ratio is to constrain the build-up of excess leverage in the banking sector. The leverage ratio is calculated by dividing Tier 1 Capital by leverage ratio exposure which is primarily comprised of on balance sheet assets with adjustments made to derivative and securities financing transaction exposures, and credit equivalent amounts of off-balance sheet exposures.
OSFI’s Capital Requirements under Basel III The Office of the Superintendent of Financial Institutions Canada’s (OSFI) Capital Adequacy Requirements (CAR) guideline details how the Basel III capital rules apply to Canadian banks. Effective January 1, 2014, the CVA capital charge is to be phased
in over a five year period based on a scalar approach. For fiscal 2016, the scalars for inclusion of the CVA for CET1, Tier 1, and Total Capital RWA are 64%, 71%, and 77%, respectively, unchanged from fiscal 2015. This scalar for the CET1 calculation increases to 72% in 2017, 80% in 2018, and 100% in 2019. A similar set of scalar phase-in percentages apply to 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 to qualify as regulatory capital. NVCC provisions require the conversion of non-common capital instruments into a variable number of common shares of the Bank upon the occurrence of a trigger event as defined in the guidance. 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. The CAR guideline contains two methodologies for capital ratio calculation: (1) the “transitional” method; and (2) the “all-in” method. The minimum CET1, Tier 1, and Total Capital ratios, based on the “all-in” method, are 4.5%, 6%, and 8%, respectively. OSFI expects Canadian banks to include an additional capital conservation buffer of 2.5%, effectively raising the CET1, Tier 1 Capital, and Total Capital ratio minimum requirements to 7%, 8.5%, and 10.5%, respectively. At the discretion of OSFI, a common equity countercyclical capital buffer (CCB) within a range of 0% to 2.5% could be imposed. No CCB is currently in effect.
In July 2013, the BCBS published the updated final rules on global systemically important banks (G-SIB). None of the Canadian banks have been designated as a G-SIB. In March 2013, OSFI designated the six major Canadian banks as domestic systemically important banks (D-SIB), for which a 1% common equity capital surcharge is in effect from January 1, 2016. As a result, the six Canadian banks designated as D-SIBs, including TD, are required to meet an “all-in” Pillar 1 target CET1, Tier 1, and Total Capital ratios of 8%, 9.5%, and 11.5% respectively. The leverage ratio is calculated as per OSFI’s Leverage Requirements guideline and has a regulatory minimum requirement of 3%.
TD BANK GROUP ANNUAL REPORT 2016 MANAGEMENT’S DISCUSSION AND ANALYSIS
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