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Nat Bank of Canada (32SS)

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Wednesday 04 December, 2019

Nat Bank of Canada

Audited Financial Statements Part.1

RNS Number : 7143V
National Bank of Canada
04 December 2019
 

Regulatory Announcement

National Bank of Canada

December 4, 2019

2019 Annual Financial Statements Part 1

National Bank of Canada (the "Bank") announces publication of its 2019 Annual Report, including the audited consolidated financial statements for the years ended 31 October 2019 and 2018, together with the notes thereto and independent auditor's report thereon (the "2019 Financial Statements"). The 2019 Financial Statements have been uploaded to the National Storage Mechanism and will shortly be available at www.morningstar.co.uk/uk/nsm and are available on the Bank's website as part of the 2019 Annual Report at https://www.nbc.ca/en/about-us/investors/investor-relations/annual-reports-proxy-circulars-aif.html.

To view the full PDF of the 2019 Financial Statements, the 2019 Annual Report and the 2019 Annual CEO and CFO Certifications, please click on the following links:

http://www.rns-pdf.londonstockexchange.com/rns/7123V_1-2019-12-4.pdf

http://www.rns-pdf.londonstockexchange.com/rns/7123V_2-2019-12-4.pdf

http://www.rns-pdf.londonstockexchange.com/rns/7123V_3-2019-12-4.pdf

 

Financial Statements

 

 

 

 

 

 

Management's Responsibility for Financial Reporting

112

 

 

Independent Auditor's Report

113

 

 

Consolidated Balance Sheets

115

 

 

Consolidated Statements of Income

116

 

 

Consolidated Statements of Comprehensive Income

117

 

 

Consolidated Statements of Changes in Equity

118

 

 

Consolidated Statements of Cash Flows

119

 

 

Notes to the Audited Consolidated Financial Statements

120

 

Management's Responsibility for Financial Reporting                                                     

 

The consolidated financial statements of National Bank of Canada (the Bank) have been prepared in accordance with section 308(4) of the Bank Act (Canada), which states that, except as otherwise specified by the Office of the Superintendent of Financial Institutions (Canada) (OSFI), the financial statements are to be prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB). IFRS represent Canadian generally accepted accounting principles (GAAP). None of the OSFI accounting requirements are exceptions to IFRS.

 

Management maintains the accounting and internal control systems needed to discharge its responsibility, which is to provide reasonable assurance that the financial accounts are accurate and complete and that the Bank's assets are adequately safeguarded. Controls that are currently in place include quality standards on staff hiring and training; the implementation of organizational structures with clear divisions of responsibility and accountability for performance; the Code of Professional Conduct; and the communication of operating policies and procedures.

 

As Chief Executive Officer and as Chief Financial Officer, we have overseen the evaluation of the design and operation of the Bank's internal controls over financial reporting in accordance with Regulation 52-109 Respecting Certification of Disclosures in Issuers' Annual and Interim Filings released by the Canadian Securities Administrators. Based on the evaluation work performed, we have concluded that the internal controls over financial reporting were effective as at October 31, 2019 and that they provide reasonable assurance that the financial information is reliable and that the Bank's consolidated financial statements have been prepared in accordance with IFRS.

 

The Board of Directors (the Board) is responsible for reviewing and approving the financial information contained in the Annual Report. Acting through the Audit Committee, the Board also oversees the presentation of the consolidated financial statements and ensures that accounting and control systems are maintained. Composed of directors who are neither officers nor employees of the Bank, the Audit Committee is responsible, through Internal Audit, for performing an independent and objective review of the Bank's internal control effectiveness, i.e., governance processes, risk management processes and control measures. Furthermore, the Audit Committee reviews the consolidated financial statements and recommends their approval to the Board.

 

The control systems are further supported by the presence of the Compliance Service, which exercises independent oversight and evaluation in order to assist managers in effectively managing regulatory compliance risk and to obtain reasonable assurance that the Bank is compliant with regulatory requirements.

 

Both the Senior Vice-President, Internal Audit and the Senior Vice-President, Chief Compliance Officer and Chief Anti-Money Laundering Officer have a direct functional link to the Chair of the Audit Committee and to the Chair of the Risk Management Committee. They both also have direct access to the President and Chief Executive Officer.

 

In accordance with the Bank Act (Canada), OSFI is mandated to protect the rights and interests of the depositors. Accordingly, OSFI examines and enquires into the business and affairs of the Bank, as deemed necessary, to ensure that the provisions of the Bank Act (Canada) are being satisfied and that the Bank is in sound financial condition.

 

The independent auditor, Deloitte LLP, whose report follows, was appointed by the shareholders on the recommendation of the Board. The auditor has full and unrestricted access to the Audit Committee to discuss audit and financial reporting matters.

 



 

Louis Vachon

President and Chief Executive Officer

 

Ghislain Parent

Chief Financial Officer and Executive Vice-President, Finance

 

 

 

 

Montreal, Canada, December 3, 2019

 

Independent Auditor's Report

 

To the Shareholders of National Bank of Canada,

 

Opinion

We have audited the consolidated financial statements of National Bank of Canada (the Bank), which comprise the consolidated balance sheets as at October 31, 2019 and 2018, and the consolidated statements of income, the consolidated statements of comprehensive income, the consolidated statements of changes in equity and the consolidated statements of cash flows for the years then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies (collectively referred to as the "financial statements").

 

In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Bank as at October 31, 2019 and 2018, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS).

 

Basis for Opinion

We conducted our audit in accordance with Canadian generally accepted auditing standards (Canadian GAAS). Our responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Bank in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

 

Other Information

Management is responsible for the other information. The other information comprises:

 

·     Management's Discussion and Analysis;

·     The information, other than the financial statements and our auditor's report thereon, in the Annual Report.

 

Our opinion on the financial statements does not cover the other information and we do not and will not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated.

 

We obtained Management's Discussion and Analysis and the Annual Report prior to the date of this auditor's report. If, based on the work we have performed on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact in this auditor's report. We have nothing to report in this regard.

 

Responsibilities of Management and Those Charged With Governance for the Financial Statements

Management is responsible for the preparation and fair presentation of the financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

 

In preparing the financial statements, management is responsible for assessing the Bank's ability to continue as a going concern, disclosing, as applicable, matters related to a going concern and using the going concern basis of accounting unless management either intends to liquidate the Bank or to cease operations, or has no realistic alternative but to do so.

 

Those charged with governance are responsible for overseeing the Bank's financial reporting process.

 

Auditor's Responsibilities for the Audit of the Financial Statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor's report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian GAAS will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.



Independent Auditor's Report (cont.)

 

As part of an audit in accordance with Canadian GAAS, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:

 

·     Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.

·     Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank's internal control.

·     Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.

·     Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Bank's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor's report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor's report. However, future events or conditions may cause the Bank to cease to continue as a going concern.

·     Evaluate the overall presentation, structure and content of the financial statements, including the note disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

·     Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Bank to express an opinion on the financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.

 

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

 

We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

 

The engagement partner on the audit resulting in this independent auditor's report is Chantal Leclerc.

 

 

 

 

 

 

 

 

/s/ Deloitte LLP1

 

December 3, 2019

Montreal, Quebec

 

1 CPA auditor, CA, public accountancy permit No. A121444


Consolidated Balance Sheets

 

As at October 31




2019


2018











Assets








Cash and deposits with financial institutions




13,698


12,756











Securities


Notes 3, 4 and 6






At fair value through profit or loss




61,823


55,817


At fair value through other comprehensive income




10,648


5,668


At amortized cost




9,755


8,298







82,226


69,783











Securities purchased under reverse repurchase agreements









and securities borrowed




17,723


18,159











Loans


Note 7






Residential mortgage




57,171


53,651


Personal




36,944


37,357


Credit card




2,322


2,325


Business and government




50,599


46,606







147,036


139,939


Customers' liability under acceptances




6,893


6,801


Allowances for credit losses




(678)


(658)







153,251


146,082











Other








Derivative financial instruments


Note 16


8,129


8,608


Investments in associates and joint ventures


Note 9


385


645


Premises and equipment


Note 10


490


601


Goodwill


Note 11


1,412


1,412


Intangible assets


Note 11


1,406


1,314


Other assets


Note 12


2,738


3,111







14,560


15,691







281,458


262,471










Liabilities and equity








Deposits


Notes 4 and 13


189,566


170,830










Other








Acceptances




6,893


6,801


Obligations related to securities sold short




12,849


17,780


Obligations related to securities sold under repurchase agreements









and securities loaned




21,900


19,998


Derivative financial instruments


Note 16


6,852


6,036


Liabilities related to transferred receivables


Notes 4 and 8


21,312


20,100


Other liabilities


Note 14


6,177


5,824







75,983


76,539


Subordinated debt


Note 15


773


747











Equity








Equity attributable to the Bank's shareholders


Notes 18 and 22






Preferred shares




2,450


2,450


Common shares




2,949


2,822


Contributed surplus




51


57


Retained earnings




9,312


8,472


Accumulated other comprehensive income




16


175







14,778


13,976


Non-controlling interests


Note 19


358


379







15,136


14,355







281,458


262,471


The accompanying notes are an integral part of these audited consolidated financial statements.




 


Louis Vachon

President and Chief Executive Officer

Karen Kinsley

Director

 

 

Consolidated Statements of Income                                                    

 

Year ended October 31                                                                                                                                      




2019


2018










Interest income








Loans




6,468


5,632


Securities at fair value through profit or loss




1,086


771


Securities at fair value through other comprehensive income




195


152


Securities at amortized cost




210


174


Deposits with financial institutions 




215


206







8,174


6,935


Interest expense








Deposits




3,468


2,562


Liabilities related to transferred receivables 




444


414


Subordinated debt




25


18


Other




641


559







4,578


3,553


Net interest income(1)




3,596


3,382


Non-interest income








Underwriting and advisory fees




314


388


Securities brokerage commissions




178


195


Mutual fund revenues




449


438


Trust service revenues




609


587


Credit fees




417


403


Card revenues




175


159


Deposit and payment service charges




271


280


Trading revenues (losses)


Note 21


829


840


Gains (losses) on non-trading securities, net




77


77


Insurance revenues, net




136


121


Foreign exchange revenues, other than trading




96


95


Share in the net income of associates and joint ventures 


Note 9


34


28


Other


Notes 9 and 10


251


173







3,836


3,784


Total revenues




7,432


7,166


Provisions for credit losses


Note 7


347


327







7,085


6,839


Non-interest expenses








Compensation and employee benefits




2,532


2,466


Occupancy


Note 14


298


236


Technology


Notes 10 and 11


704


620


Communications




62


63


Professional fees




249


244


Other




456


434







4,301


4,063


Income before income taxes 




2,784


2,776


Income taxes


Note 24


462


544


Net income




2,322


2,232










Net income attributable to








Preferred shareholders




116


105


Common shareholders




2,140


2,040


Bank shareholders




2,256


2,145


Non-controlling interests




66


87







2,322


2,232











Earnings per share (dollars)


Note 25







Basic




6.39


6.01



Diluted




6.34


5.94


Dividends per common share (dollars)


Note 18


2.66


2.44


The accompanying notes are an integral part of these audited consolidated financial statements.








 

(1)    Net interest income includes dividend income. For additional information, see Note 1 to these audited consolidated financial statements.

Consolidated Statements of Comprehensive Income

 

Year ended October 31


2019


2018












Net income


2,322


2,232


Other comprehensive income, net of income taxes







Items that may be subsequently reclassified to net income








Net foreign currency translation adjustments









Net unrealized foreign currency translation gains (losses) on investments in foreign operations


(9)


41





Net foreign currency translation (gains) losses on investments in foreign operations reclassified to net income


(2)






Impact of hedging net foreign currency translation gains (losses)


4


(13)





Impact of hedging net foreign currency translation (gains) losses reclassified to net income








(7)


28




Net change in debt securities at fair value through other comprehensive income









Net unrealized gains (losses) on debt securities at fair value through other comprehensive income


54


(11)





Net (gains) losses on debt securities at fair value through other comprehensive income










reclassified to net income


(53)


(5)








1


(16)




Net change in cash flow hedges









Net gains (losses) on derivative financial instruments designated as cash flow hedges


(137)


51





Net (gains) losses on designated derivative financial instruments reclassified to net income


(20)


(46)








(157)


5




Share in the other comprehensive income of associates and joint ventures


3


1













Items that will not be subsequently reclassified to net income








Remeasurements of pension plans and other post-employment benefit plans


(135)


103




Net gains (losses) on equity securities designated at fair value through other comprehensive income


(21)


(2)




Net fair value change attributable to credit risk on financial liabilities designated at









 fair value through profit or loss


5


21







(151)


122


Total other comprehensive income (loss), net of income taxes


(311)


140












Comprehensive income


2,011


2,372












Comprehensive income attributable to







Bank shareholders


1,946


2,284



Non-controlling interests


65


88








2,011


2,372


 

Income Taxes - Other Comprehensive Income

 

The following table presents the income tax expense or recovery for each component of other comprehensive income.

 

Year ended October 31


2019


2018










Net foreign currency translation adjustments







Net unrealized foreign currency translation gains (losses) on investments in foreign operations


3


1









Net foreign currency translation (gains) losses on investments in foreign operations reclassified to net income


(1)




Impact of hedging net foreign currency translation gains (losses)


2




Impact of hedging net foreign currency translation (gains) losses reclassified to net income


2







6


1


Net change in debt securities at fair value through other comprehensive income







Net unrealized gains (losses) on debt securities at fair value through other comprehensive income


19


(4)



Net (gains) losses on debt securities at fair value through other comprehensive income








reclassified to net income


(19)


(1)







(5)


Net change in cash flow hedges







Net gains (losses) on derivative financial instruments designated as cash flow hedges


(50)


19



Net (gains) losses on designated derivative financial instruments reclassified to net income


(7)


(17)






(57)


2


Share in the other comprehensive income of associates and joint ventures




Remeasurements of pension plans and other post-employment benefit plans


(48)


37


Net gains (losses) on equity securities designated at fair value through other








comprehensive income


(6)


(1)


Net fair value change attributable to credit risk on financial liabilities designated at








fair value through profit or loss


2


7




(103)


41


The accompanying notes are an integral part of these audited consolidated financial statements.






Consolidated Statements of Changes in Equity

 

Year ended October 31




2019


2018











Preferred shares at beginning


Note 18


2,450


2,050


Issuances of Series 40 and 42 preferred shares





600


Redemption of Series 28 preferred shares for cancellation





(200)


Preferred shares at end




2,450


2,450











Common shares at beginning


Note 18


2,822


2,768


Issuances of common shares pursuant to the Stock Option Plan




122


128


Repurchases of common shares for cancellation




(40)


(64)


Impact of shares purchased or sold for trading




45


(10)


Common shares at end




2,949


2,822











Contributed surplus at beginning




57


58


Stock option expense


Note 22


11


12


Stock options exercised




(15)


(15)


Other




(2)


2


Contributed surplus at end




51


57











Retained earnings at beginning




8,472


7,706


Impact of adopting IFRS 15 on November 1, 2018 (IFRS 9 on November 1, 2017)




(4)


(139)


Net income attributable to the Bank's shareholders




2,256


2,145


Dividends on preferred shares


Note 18


(116)


(105)


Dividends on common shares


Note 18


(892)


(829)


Premium paid on common shares repurchased for cancellation


Note 18


(241)


(403)


Share issuance expenses, net of income taxes





(12)


Remeasurements of pension plans and other post-employment benefit plans




(135)


103


Net gains (losses) on equity securities designated at fair value through other comprehensive income




(21)


(2)


Net fair value change attributable to the credit risk on financial liabilities designated at fair value 









through profit or loss




5


21


Impact of a financial liability resulting from put options written to non-controlling interests




(12)



Other





(13)


Retained earnings at end




9,312


8,472











Accumulated other comprehensive income at beginning




175


168


Impact of adopting IFRS 9 on November 1, 2017






(10)


Net foreign currency translation adjustments




(6)


27


Net change in unrealized gains (losses) on debt securities at fair value through other comprehensive income




1


(16)


Net change in gains (losses) on cash flow hedges




(157)


5


Share in the other comprehensive income of associates and joint ventures




3


1


Accumulated other comprehensive income at end




16


175











Equity attributable to the Bank's shareholders




14,778


13,976











Non-controlling interests at beginning


Note 19


379


808


Impact of adopting IFRS 9 on November 1, 2017






(16)


Purchase of the non-controlling interest of the Advanced Bank of Asia Limited subsidiary


Note 31


(30)



Redemption of trust units issued by NBC Asset Trust





(400)


Net income attributable to non-controlling interests




66


87


Other comprehensive income attributable to non-controlling interests




(1)


1


Distributions to non-controlling interests




(56)


(101)


Non-controlling interests at end




358


379











Equity




15,136


14,355


 

Accumulated Other Comprehensive Income

 

As at October 31




2019


2018











Accumulated other comprehensive income








Net foreign currency translation adjustments




8


14


Net unrealized gains (losses) on debt securities at fair value through other comprehensive income




14


13


Net gains (losses) on instruments designated as cash flow hedges




(6)


151


Share in the other comprehensive income of associates and joint ventures





(3)







16


175


The accompanying notes are an integral part of these audited consolidated financial statements.








Consolidated Statements of Cash Flows

 

Year ended October 31




2019


2018










Cash flows from operating activities








Net income




2,322


2,232


Adjustments for









Provisions for credit losses




347


327



Amortization of premises and equipment and intangible assets




328


302



Gains on disposals of investments in associates and joint ventures


Note 9


(79)


(4)



Remeasurement at fair value of an investment


Note 9


33




Provisions for onerous contracts


Note 14


45




Gain on disposal  of premises and equipment


Note 10


(50)




Impairment losses on premises and equipment and on intangible assets


Notes 10 and 11


57




Deferred taxes




(207)


24



Losses (gains) on sales of non-trading securities, net




(77)


(77)



Share in the net income of associates and joint ventures




(34)


(28)



Stock option expense




11


12


Change in operating assets and liabilities









Securities at fair value through profit or loss




(6,006)


(3,589)



Securities purchased under reverse repurchase agreements and securities borrowed




436


2,630



Loans and acceptances, net of securitization




(6,221)


(9,160)



Deposits




18,736


14,159



Obligations related to securities sold short




(4,931)


2,417



Obligations related to securities sold under repurchase agreements and securities loaned




1,902


(1,769)



Derivative financial instruments, net




1,295


(761)



Interest and dividends receivable and interest payable




(41)


53



Current tax assets and liabilities




(7)


(127)



Other items




421


(777)







8,280


5,864










Cash flows from financing activities








Issuances of preferred shares





600


Redemption of preferred shares for cancellation





(200)


Issuances of common shares (including the impact of shares purchased for trading)




152


103


Repurchases of common shares for cancellation




(281)


(467)


Issuance of subordinated debt





750


Purchase of the non-controlling interest of the Advanced Bank of Asia Limited subsidiary


Note 31


(84)



Redemption of trust units issued by NBC Asset Trust





(400)


Share issuance expenses





(12)


Dividends paid




(992)


(918)


Distributions to non-controlling interests




(56)


(101)







(1,261)


(645)











Cash flows from investing activities








Disposal of shares of an investment in an associate


Note 9


128



Disposal of premises and equipment


Note 10


187



Net change in investments in associates and joint ventures




(16)


(3)


Purchases of non-trading securities




(16,355)


(7,790)


Maturities of non-trading securities




1,893


509


Sales of non-trading securities




8,413


6,173


Net change in tangible assets leased under operating leases





69


Net change in premises and equipment




(144)


(233)


Net change in intangible assets




(359)


(256)







(6,253)


(1,531)











Impact of currency rate movements on cash and cash equivalents




176


266










Increase (decrease) in cash and cash equivalents




942


3,954


Cash and cash equivalents at beginning




12,756


8,802


Cash and cash equivalents at end(1)




13,698


12,756










Supplementary information about cash flows from operating activities








Interest paid




4,545


3,440


Interest and dividends received




8,100


6,875


Income taxes paid




520


596


The accompanying notes are an integral part of these audited consolidated financial statements.








 

(1)    This item is the equivalent of Consolidated Balance Sheet item Cash and deposits with financial institutions. It includes an amount of $4.1 billion as at October 31, 2019 ($2.5 billion as at October 31, 2018) for which there are restrictions.

Notes to the Audited Consolidated Financial Statements

 

 

Note 1

Basis of Presentation and Summary of Significant Accounting Policies

120

Note 18

Share Capital

180

Note 2

Future Accounting Policy Changes

135

Note 19

Non-Controlling Interests

183

Note 3

Fair Value of Financial Instruments

136

Note 20

Capital Disclosure

184

Note 4

Financial Instruments Designated at Fair Value Through Profit or Loss

147

Note 21

Trading Activity Revenues

185

Note 5

Offsetting Financial Assets and Financial Liabilities

148

Note 22

Share-Based Payments

186

Note 6

Securities

149

Note 23

Employee Benefits - Pension Plans and Other


Note 7

Loans and Allowances for Credit Losses

151


  Post-Employment Benefits

189

Note 8

Financial Assets Transferred But Not Derecognized

164

Note 24

Income Taxes

193

Note 9

Investments in Associates and Joint Ventures

165

Note 25

Earnings Per Share

195

Note 10

Premises and Equipment

167

Note 26

Guarantees, Commitments and Contingent Liabilities

195

Note 11

Goodwill and Intangible Assets

168

Note 27

Structured Entities

199

Note 12

Other Assets

169

Note 28

Related Party Disclosures

202

Note 13

Deposits

170

Note 29

Management of the Risks Associated With Financial Instruments

203

Note 14

Other Liabilities

170

Note 30

Segment Disclosures

208

Note 15

Subordinated Debt

171

Note 31

Acquisition

209

Note 16

Derivative Financial Instruments

171

Note 32

Event After the Consolidated Balance Sheet Date

209

Note 17

Hedging Activities

174










 

 


Note 1 - Basis of Presentation and Summary of Significant Accounting Policies

 

National Bank of Canada (the Bank) is a financial institution incorporated and domiciled in Canada and whose shares are listed on the Toronto Stock Exchange. Its head office is located at 600 De La Gauchetière Street West in Montreal, Quebec, Canada. The Bank is a chartered bank under Schedule 1 of the Bank Act (Canada) and is regulated by the Office of the Superintendent of Financial Institutions Canada (OSFI).

 

National Bank of Canada offers financial services to individuals, businesses, institutional clients and governments throughout Canada as well as specialized services at the international level. It operates four business segments, namely, the Personal and Commercial segment, the Wealth Management segment, the Financial Markets segment, and the U.S. Specialty Finance and International (USSF&I) segment. Its full line of services includes banking and investing solutions for individuals and businesses, corporate banking and investment banking services, securities brokerage, insurance, and wealth management.

 

On December 3, 2019, the Board of Directors (the Board) authorized the publication of the Bank's audited annual consolidated financial statements (the consolidated financial statements) for the year ended October 31, 2019.

 

Basis of Presentation

 

The Bank's consolidated financial statements have been prepared in accordance with section 308(4) of the Bank Act (Canada), which states that, except as otherwise specified by OSFI, the financial statements are to be prepared in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB). IFRS represent Canadian generally accepted accounting principles (GAAP). None of the OSFI accounting requirements are exceptions to IFRS.

 

The accounting policies covered in the Summary of Significant Accounting Policies section have been applied consistently to all periods presented and include the changes described hereafter in the Accounting Policy Changes section, which have been applied since November 1, 2018 following adoption of IFRS 15 - Revenue From Contracts With Customers (IFRS 15). As permitted by IFRS 15, the Bank did not restate comparative consolidated financial statements.

 

Unless otherwise indicated, all amounts are expressed in Canadian dollars, which is the Bank's functional and presentation currency.

 



Accounting Policy Changes

 

Effective November 1, 2018, the Bank adopted IFRS 15, which replaces the previous revenue recognition standards and interpretations. Excluded from the scope of IFRS 15 are revenues related to lease contracts, insurance contracts, and financial instruments. Fees earned, which are an integral component of the effective interest rate of financial assets and liabilities measured at amortized cost, are within the scope of IFRS 9 - Financial Instruments and are therefore outside the scope of IFRS 15. Most of the Bank's revenues, including net interest income, are not impacted by the adoption of this standard.

 

IFRS 15 provides a single comprehensive model to use in accounting for revenue arising from contracts with customers. The new revenue recognition model is based on a control approach that differs from the risks and rewards approach applied under previous IFRS. The revenue streams that fall within the scope of IFRS 15 are fee and commission income, and the applicable significant accounting policies are described in the Summary of Significant Accounting Policies section. However, the adoption of IFRS 15 did not have a significant impact on the Bank's revenue recognition accounting policies.

 

The core principle of IFRS 15 is to recognize revenue when, or as, a performance obligation is satisfied, i.e., when control of a promised service is transferred to a customer and in an amount that reflects the consideration the entity expects to be entitled to receive in exchange for the service. Revenue may therefore be recognized at a point in time, upon completion of the service, or over time as services are provided.

 

The Bank has elected to apply IFRS 15 using the modified retrospective basis, recognizing the cumulative effect of initially applying the standard as an adjustment to the opening balance of Retained earnings without restating comparative figures. Adoption of IFRS 15 resulted in a $4 million decrease to opening Retained earnings as at November 1, 2018.

 

Summary of Significant Accounting Policies

 

Judgments, Estimates and Assumptions

In preparing consolidated financial statements in accordance with IFRS, management must exercise judgment and make estimates and assumptions that affect the reporting date carrying amounts of assets and liabilities, net income, and related information. Furthermore, certain accounting policies require complex judgments and estimates because they apply to matters that are inherently uncertain, in particular accounting policies applicable to the following: the fair value determination of financial instruments, the impairment of financial assets, the impairment of non-financial assets, pension plans and other post-employment benefits, income taxes, provisions, the consolidation of structured entities, and the classification of debt instruments. Descriptions of these judgments and estimates are provided in each of the notes related thereto in the consolidated financial statements. Actual results could therefore differ from these estimates, in which case the impacts are recognized in the consolidated financial statements of future fiscal periods. The accounting policies described in this note provide greater detail about the use of estimates and assumptions and reliance on judgment.

 

Basis of Consolidation

Subsidiaries

These consolidated financial statements include all the assets, liabilities, operating results and cash flows of the Bank and its subsidiaries, after elimination of intercompany transactions and balances. Subsidiaries are entities, including structured entities, controlled by the Bank. A structured entity is an entity created to accomplish a narrow and well-defined objective and is designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when voting rights relate solely to administrative tasks and the relevant activities are directed by means of contractual arrangements.

 

Management must exercise judgment in determining whether the Bank must consolidate an entity. The Bank controls an entity only if the following three conditions are met:

 

·     it has decision-making authority regarding the entity's relevant activities;

·     it has exposure or rights to variable returns from its involvement with the entity; and

·     it has the ability to use its power to affect the amount of the returns.

 

When determining decision-making authority, the Bank considers many factors, including the existence and effect of actual and potential voting rights held by the Bank that can be exercised as well as the holding of instruments that are convertible into voting shares. In addition, the Bank must determine whether, as an investor with decision-making rights, it acts as a principal or agent.

 

Based on these principles, an assessment of control is performed at the inception of a relationship between any entity and the Bank. When performing this assessment, the Bank considers all facts and circumstances, and it must reassess whether it still controls an investee if facts and circumstances indicate that there are changes to one or more of the three conditions of control.

 

The Bank consolidates the entities it controls from the date on which control is obtained and ceases to consolidate them from the date control ceases. The Bank uses the acquisition method to account for the acquisition of a subsidiary from a third party on the date control is obtained. 

 



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

Non-Controlling Interests

Non-controlling interests in subsidiaries represent the equity interests held by third parties in the Bank's subsidiaries and are presented in total Equity, separately from Equity attributable to the Bank's shareholders. The non-controlling interests' proportionate shares of the net income and other comprehensive income of the Bank's subsidiaries are presented separately in the Consolidated Statement of Income and in the Consolidated Statement of Comprehensive Income, respectively.

 

With respect to units issued to third parties by mutual funds and certain other funds that are consolidated, they are presented at fair value in Other liabilities on the Consolidated Balance Sheet. Lastly, changes in ownership interests in subsidiaries that do not result in a loss of control are recognized as equity transactions. The difference between the adjustment in the carrying value of the non-controlling interest and the fair value of the consideration paid or received is recognized directly in Equity attributable to the Bank's shareholders.

 

Investments in Associates and Joint Ventures

The Bank exercises significant influence over an entity when it has the power to participate in the financial and operating policy decisions of the investee. The Bank has joint control when there's a contractually agreed sharing of control of an arrangement, and joint control exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

 

Investments in associates, i.e., entities over which the Bank exercises significant influence, and investments in joint ventures, i.e., entities over which the Bank has rights to the net assets and exercises joint control, are accounted for using the equity method. Under the equity method, the investment is initially recorded at cost and, following acquisition, the Bank's shares in the net income and in the other comprehensive income are recognized, respectively, in Non-interest income in the Consolidated Statement of Income and in Other comprehensive income in the Consolidated Statement of Comprehensive Income. The carrying value of the investment is adjusted by an equivalent amount on the Consolidated Balance Sheet and reduced by distributions received.

 

Translation of Foreign Currencies

The consolidated financial statements are presented in Canadian dollars, which is the Bank's functional and presentation currency. Each foreign operation of the Bank determines its own functional currency, and the items reported in the financial statements of each foreign operation are measured using that currency.

 

Monetary items and non-monetary items measured at fair value and denominated in foreign currencies are translated into the functional currency at exchange rates prevailing at the Consolidated Balance Sheet date. Non-monetary items not measured at fair value are translated into the functional currency at historical rates. Revenues and expenses denominated in foreign currencies are translated at the average exchange rates for the period. Translation gains and losses are recognized in Non-interest income in the Consolidated Statement of Income, except for equity instruments designated at fair value through other comprehensive income, for which unrealized gains and losses are recorded in Other comprehensive income and will not be subsequently reclassified to net income.

 

In the consolidated financial statements, the assets and liabilities of all foreign operations are translated into the Bank's functional currency at the exchange rates prevailing at the Consolidated Balance Sheet date, whereas the revenues and expenses of such foreign operations are translated into the Bank's functional currency at the average exchange rates for the period. Any goodwill resulting from the acquisition of a foreign operation that does not have the same functional currency as the parent company, and any fair value adjustments to the carrying amounts of assets and liabilities resulting from the acquisition, are treated as assets and liabilities of the foreign operation and translated at the exchange rates prevailing at the Consolidated Balance Sheet date. Unrealized translation gains and losses relating to foreign operations, along with the impact of hedges and income taxes on the related results, are presented in Other comprehensive income. On disposal of a foreign operation, any accumulated translation gains and losses, along with the related hedges, recorded in the Accumulated other comprehensive income item of this foreign operation, are reclassified to Non-interest income in the Consolidated Statement of Income.

 

Classification and Measurement of Financial Instruments

At initial recognition, all financial instruments are recorded at fair value on the Consolidated Balance Sheet. At initial recognition, financial assets must be classified as subsequently measured at fair value through other comprehensive income, at amortized cost, or at fair value through profit or loss. The Bank determines the classification based on the contractual cash flow characteristics of the financial assets and on the business model it uses to manage these financial assets. At initial recognition, financial liabilities are classified as subsequently measured at amortized cost or as at fair value through profit or loss.

 

For the purpose of classifying a financial asset, the Bank must determine whether the contractual cash flows associated with the financial asset are solely payments of principal and interest on the principal amount outstanding. The principal is generally the fair value of the financial asset at initial recognition. The interest consists of consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period, and for other basic lending risks and costs as well as of a profit margin. If the Bank determines that the contractual cash flows associated with a financial asset are not solely payments of principal and interest, the financial assets must be classified as measured at fair value through profit or loss.

 



 

When classifying financial assets, the Bank determines the business model used for each portfolio of financial assets that are managed together to achieve a same business objective. The business model reflects how the Bank manages its financial assets and the extent to which the financial asset cash flows are generated by the collection of the contractual cash flows, the sale of the financial assets, or both. The Bank determines the business model using scenarios that it reasonably expects to occur. Consequently, the business model determination is a matter of fact and requires the use of judgment and consideration of all the relevant evidence available at the date of determination.

 

A financial asset portfolio falls within a "hold to collect" business model when the Bank's primary objective is to hold these financial assets in order to collect contractual cash flows from them and not to sell them. When the Bank's objective is achieved both by collecting contractual cash flows and by selling the financial assets, the financial asset portfolio falls within a "hold to collect and sell" business model. In this type of business model, collecting contractual cash flows and selling financial assets are both integral components to achieving the Bank's objective for this financial asset portfolio. Financial assets are mandatorily measured at fair value through profit or loss if they do not fall within either a "hold to collect" business model or a "hold to collect and sell" business model.

 

Financial Instruments Designated at Fair Value Through Profit or Loss

A financial asset may be irrevocably designated at fair value through profit or loss at initial recognition if certain conditions are met. The Bank may apply this option if, consistent with a documented risk management strategy, doing so eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or liabilities or recognizing gains and losses on them on different bases and if the fair values are reliable. Financial assets thus designated are recognized at fair value, and any change in fair value is recorded in Non-interest income in the Consolidated Statement of Income. Interest income arising from these financial instruments designated at fair value through profit or loss is recorded in Net interest income in the Consolidated Statement of Income.

 

A financial liability may be irrevocably designated at fair value through profit or loss when it is initially recognized. Financial liabilities thus designated are recognized at fair value, and any changes in fair value attributable to changes in the Bank's own credit risk are recognized in Other comprehensive income unless these changes offset the amounts recognized in Net income. Fair value changes not attributable to the Bank's own credit risk are recognized in Non‑interest income in the Consolidated Statement of Income. The amounts recognized in Other comprehensive income will not be subsequently reclassified to Net income. Interest expense arising from these financial liabilities designated at fair value through profit or loss is recorded in the Net interest income item of the Consolidated Statement of Income. The Bank may use this option in the following cases:

 

·     If, consistent with a documented risk management strategy, using this option allows the Bank to eliminate or significantly reduce a measurement or recognition inconsistency that would otherwise arise from measuring financial assets or liabilities on different bases, and if the fair values are reliable.

·     If a group of financial assets and financial liabilities to which an instrument belongs is managed and its performance is evaluated on a fair value basis, in accordance with the Bank's documented risk management or investment strategy, and information is provided on that basis to senior management. Consequently, the Bank may use this option if it has implemented a documented risk management strategy to manage a group of financial instruments together on the fair value basis, if it can demonstrate that significant financial risks are eliminated or significantly reduced, and if the fair values are reliable.

·     For hybrid financial instruments with one or more embedded derivatives that would significantly modify the cash flows of the financial instruments and that would otherwise be bifurcated and accounted for separately.

 

Financial Instruments Designated at Fair Value Through Other Comprehensive Income

At initial recognition, an investment in an equity instrument that is neither held for trading nor a contingent consideration recognized in a business combination may be irrevocably designated as being at fair value through other comprehensive income. In accordance with this designation, any change in fair value is recognized in Other comprehensive income with no subsequent reclassification to net income. Dividend income is recorded in Interest income in the Consolidated Statement of Income.

 

Securities Measured at Fair Value Through Other Comprehensive Income

Securities measured at fair value through other comprehensive income include: (i) debt securities for which the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding and that fall within a "hold to collect and sell" business model and (ii) equity securities designated at fair value through other comprehensive income with no subsequent reclassification of gains and losses to net income.

 

The Bank recognizes securities transactions at fair value through other comprehensive income on the trade date, and the transaction costs are capitalized. Interest income and dividend income are recognized in Interest income in the Consolidated Statement of Income.

 



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

Debt Securities Measured at Fair Value Through Other Comprehensive Income

Debt securities measured at fair value through other comprehensive income are recognized at fair value. Unrealized gains and losses are recognized, net of expected credit losses and income taxes, and provided that they are not hedged by derivative financial instruments in a fair value hedging relationship, in Other comprehensive income. When the securities are sold, realized gains or losses, determined on an average cost basis, are reclassified to Non-interest income - Gains (losses) on non-trading securities, net in the Consolidated Statement of Income. Premiums, discounts and related transaction costs are amortized over the expected life of the instrument to interest income using the effective interest rate method.

 

Equity Securities Designated at Fair Value Through Other Comprehensive Income

Equity securities designated at fair value through other comprehensive income are recognized at fair value. Unrealized gains and losses are presented, net of income taxes, in Other comprehensive income with no subsequent reclassification of realized gains and losses to net income. Transaction costs incurred upon the purchase of such equity securities are not reclassified to net income upon the sale of the securities.

 

Securities Measured at Amortized Cost

Securities measured at amortized cost include debt securities for which the contractual terms give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding and that fall within a "hold to collect" business model.

 

The Bank recognizes these securities transactions at fair value on the trade date, and the transaction costs are capitalized. After initial recognition, debt securities in this category are recorded at amortized cost. Interest income is recognized in Interest income in the Consolidated Statement of Income. Premiums, discounts and related transaction costs are amortized over the expected life of the instrument to interest income using the effective interest rate method. Securities measured at amortized cost are presented net of allowances for credit losses on the Consolidated Balance Sheet.

 

Securities Measured at Fair Value Through Profit or Loss

Securities not classified or designated as measured at fair value through other comprehensive income or at amortized cost are classified as measured at fair value through profit or loss.

 

Securities measured at fair value through profit or loss include (i) securities held for trading, (ii) securities designated at fair value through profit or loss, (iii) all equity securities other than those designated as measured at fair value through other comprehensive income with no subsequent reclassifications of gains and losses to net income, and (iv) debt securities for which the contractual cash flows are not solely payments of principal and any interest on the principal amount outstanding.

 

The Bank recognizes securities transactions at fair value through profit or loss on the settlement date on the Consolidated Balance Sheet. Changes in fair value between the trade date and the settlement date are recognized in Non-interest income in the Consolidated Statement of Income.

 

Securities at fair value through profit or loss are recognized at fair value. Interest income, any transaction costs, as well as realized and unrealized gains or losses on securities held for trading are recognized in Non-interest income - Trading revenues (losses) in the Consolidated Statement of Income. Dividend income is recorded in Interest income in the Consolidated Statement of Income. Interest income on securities designated at fair value through profit or loss is recorded in Interest income in the Consolidated Statement of Income. Realized and unrealized gains or losses on these securities are recognized in Non-interest income - Trading revenues (losses) in the Consolidated Statement of Income.

 

Realized and unrealized gains or losses on equity securities at fair value through profit or loss, other than those held for trading, as well as debt securities for which the contractual cash flows are not solely payments of principal and interest on the principal amount outstanding, are recognized in Non-interest income - Gains (losses) on non-trading securities, net in the Consolidated Statement of Income. The dividend and interest income on these financial assets are recognized in Interest income in the Consolidated Statement of Income.

 

Securities Purchased Under Reverse Repurchase Agreements, Obligations Related to Securities Sold

Under Repurchase Agreements, and Securities Borrowed and Loaned

The Bank recognizes these transactions at amortized cost using the effective interest rate method, except when they are designated at fair value through profit or loss and are recorded at fair value. These transactions are held within a business model whose objective is to collect contractual cash flows, i.e., cash flows that are solely payments of principal and interest on the principal amount outstanding. Securities sold under repurchase agreements remain on the Consolidated Balance Sheet, whereas securities purchased under reverse repurchase agreements are not recognized. Reverse repurchase agreements and repurchase agreements are treated as collateralized lending and borrowing transactions.



The Bank also borrows and lends securities. Securities loaned remain on the Consolidated Balance Sheet while securities borrowed are not recognized. As part of these transactions, the Bank pledges or receives collateral in the form of cash or securities. Collateral pledged in the form of securities remains on the Consolidated Balance Sheet. Collateral received in the form of securities is not recognized on the Consolidated Balance Sheet. Collateral pledged or received in the form of cash is recognized in financial assets or liabilities on the Consolidated Balance Sheet.

 

When the collateral is pledged or received in the form of cash, the interest income and expense are recorded in Net interest income in the Consolidated Statement of Income.

 

Loans

Loans Measured at Amortized Cost

Loans classified as measured at amortized cost include loans originated or purchased by the Bank that are not classified as measured at fair value through profit or loss or designated at fair value through profit or loss. These loans are held within a business model whose objective is to collect contractual cash flows, i.e., cash flows that are solely payments of principal and interest on the principal amount outstanding. All loans originated by the Bank are recognized when cash is advanced to a borrower. Purchased loans are recognized when the cash consideration is paid by the Bank.

 

All loans are initially recognized at fair value plus directly attributable costs and are subsequently measured at amortized cost using the effective interest rate method, net of an allowance for expected credit losses. For purchased performing loans, the acquisition date fair value adjustment on each loan is amortized to interest income over the expected remaining life of the loan using the effective interest rate method. For purchased credit-impaired loans, the acquisition date fair value adjustment on each loan consists of management's estimate of the shortfall of principal and interest cash flows that the Bank expects to collect and of the time value of money. The time value of money component of the fair value adjustment is amortized to interest income over the remaining life of the loan using the effective interest rate method. Loans are presented net of allowances for credit losses on the Consolidated Balance Sheet.

 

Loans Measured at Fair Value Through Profit or Loss

Loans classified as measured at fair value through profit or loss, loans designated at fair value through profit or loss, and loans for which the contractual cash flows are not solely payments of principal and interest on the principal amount outstanding are recognized at fair value on the Consolidated Balance Sheet. The interest income on loans at fair value through profit or loss is recorded in Interest income in the Consolidated Statement of Income.

 

Changes in the fair value of loans classified as at fair value through profit or loss and loans designated at fair value through profit or loss are recognized in Non-interest income - Trading revenues (losses) in the Consolidated Statement of Income. With respect to loans whose contractual cash flows are not solely payments of principal and interest on the principal amount outstanding, changes in fair value are recognized in Non-interest income - Other in the Consolidated Statement of Income.

 

Reclassification of Financial Assets

A financial asset, other than a derivative financial instrument or a financial asset that, at initial recognition, was designated as measured at fair value through profit or loss, is reclassified only in rare situations, i.e., when there is a change in the business model used to manage the financial asset. The reclassification is applied prospectively from the reclassification date.

 

Establishing Fair Value

The fair value of a financial instrument is the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction in the principal market at the measurement date under current market conditions (i.e., an exit price). 

 

Unadjusted quoted prices in active markets, based on bid prices for financial assets and offered prices for financial liabilities, provide the best evidence of fair value. A financial instrument is considered quoted in an active market when prices in exchange, dealer, broker or principal-to-principal markets are accessible at the measurement date. An active market is one where transactions occur with sufficient frequency and volume to provide quoted prices on an ongoing basis.

 

When there is no quoted price in an active market, the Bank uses another valuation technique that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. The chosen valuation technique incorporates all the factors that market participants would consider when pricing a transaction. Judgment is required when applying a large number of acceptable valuation techniques and estimates to determine fair value. The estimated fair value reflects market conditions on the valuation date and, consequently, may not be indicative of future fair value.

 

The best evidence of the fair value of a financial instrument at initial recognition is the transaction price, i.e., the fair value of the consideration received or paid. If there is a difference between the fair value at initial recognition and the transaction price, and the fair value is determined using a valuation technique based on observable market inputs or, in the case of a derivative, if the risks are fully offset by other contracts entered into with third parties, this difference is recognized in the Consolidated Statement of Income. In other cases, the difference between the fair value at initial recognition and the transaction price is deferred on the Consolidated Balance Sheet. The amount of the deferred gain or loss is recognized over the term of the financial instrument. The unamortized balance is immediately recognized in net income when (i) observable market inputs can be obtained and support the fair value of the transaction, (ii) the risks associated with the initial contract are substantially offset by other contracts entered into with third parties, (iii) the gain or loss is realized through a cash receipt or payment, or (iv) the transaction matures or is cancelled before maturity.



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

In certain cases, measurement adjustments are recognized to address factors that market participants would use at the measurement date to determine fair value but that are not included in the measurement technique due to system limitations or uncertainty surrounding the measure. These factors include, but are not limited to, the unobservable nature of inputs used in the valuation model, assumptions about risk such as market risk, credit risk, or risk related to the valuation model, and future administration costs. The Bank may also consider market liquidity risk when determining the fair value of financial instruments when it believes these instruments could be disposed of for a consideration below the fair value otherwise determined due to a lack of market liquidity or an insufficient volume of transactions in a given market.

 

As permitted when certain criteria are met, the Bank has elected to determine fair value based on net exposure to credit risk or market risk for certain portfolios of financial instruments, mainly derivative financial instruments.

 

Impairment of Financial Assets

At the end of each reporting period, the Bank applies a three-stage impairment approach to measure the expected credit losses (ECL) on all debt instruments measured at amortized cost or at fair value through other comprehensive income and on loan commitments and financial guarantees that are not measured at fair value. The ECL model is forward looking. Measurement of ECLs at each reporting period reflects reasonable and supportable information about past events, current conditions, and forecasts of future events and economic conditions.

 

Determining the Stage

The ECL three-stage impairment approach is based on the change in the credit quality of financial assets since initial recognition. If, at the reporting date, the credit risk of non-impaired financial instruments has not increased significantly since initial recognition, these financial instruments are classified in Stage 1, and an allowance for credit losses that is measured, at each reporting date, in an amount equal to 12-month expected credit losses is recorded. When there is a significant increase in credit risk since initial recognition, these non-impaired financial instruments are migrated to Stage 2, and an allowance for credit losses that is measured, at each reporting date, in an amount equal to lifetime expected credit losses is recorded. In subsequent reporting periods, if the credit risk of the financial instrument improves such that there is no longer a significant increase in credit risk since initial recognition, the ECL model requires reverting to Stage 1, i.e., recognition of 12-month expected credit losses. When one or more events that have a detrimental impact on the estimated future cash flows of a financial asset have occurred, the financial asset is considered credit-impaired and is migrated to Stage 3, and an allowance for credit losses equal to lifetime expected losses continues to be recorded or the financial asset is written off. Interest income is calculated on the gross carrying amount for financial assets in Stages 1 and 2 and on the net carrying amount for financial assets in Stage 3.

 

Assessment of Significant Increase in Credit Risk

In determining whether credit risk has increased significantly, the Bank uses an internal credit risk grading system, external risk ratings, and forward-looking information to assess deterioration in credit quality of a financial instrument. To assess whether or not the credit risk of a financial instrument has increased significantly, the Bank compares the probability of default (PD) occurring over its expected life as at the reporting date with the PD occurring over its expected life on the date of initial recognition and considers reasonable and supportable information indicative of a significant increase in credit risk since initial recognition. The Bank includes relative and absolute thresholds in the definition of significant increase in credit risk and a backstop of 30 days past due. All financial instruments that are 30 days past due are migrated to Stage 2 even if other metrics do not indicate that a significant increase in credit risk has occurred. The assessment of a significant increase in credit risk requires significant judgment.

 

Measurement of Expected Credit Losses

ECLs are measured as the probability-weighted present value of all expected cash shortfalls over the remaining expected life of the financial instrument, and reasonable and supportable information about past events, current conditions and forecasts of future events and economic conditions is considered. The estimation and application of forward-looking information requires significant judgment. The cash shortfall is the difference between all contractual cash flows owed to the Bank and all cash flows that the Bank expects to receive.

 

The measurement of ECLs is primarily based on the product of the financial instrument's PD, loss given default (LGD), and exposure at default (EAD). Forward-looking macroeconomic factors such as unemployment rates, housing price indices, interest rates, and GDP are incorporated into the risk parameters. The estimate of expected credit losses reflects an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes. The Bank incorporates three forward-looking macroeconomic scenarios in its ECL calculation process: a base scenario, an upside scenario and a downside scenario. Probability weights are attributed to each scenario. The scenarios and probability weights are reassessed quarterly and are subject to management review. The Bank applies experienced credit judgment to adjust the modelled ECL results when it becomes evident that known or expected risk factors and information were not considered in the credit risk rating and modelling process.



ECLs for all financial instruments are recognized in Provisions for credit losses in the Consolidated Statement of Income. In the case of debt instruments measured at fair value through other comprehensive income, ECLs are recognized in Provisions for credit losses in the Consolidated Statement of Income, and a corresponding amount is recognized in Other comprehensive income with no reduction in the carrying amount of the asset on the Consolidated Balance Sheet. As for debt instruments measured at amortized cost, they are presented net of the related allowance for credit losses on the Consolidated Balance Sheet. Allowances for credit losses for off-balance-sheet credit exposures that are not measured at fair value are included in Other liabilities on the Consolidated Balance Sheet.

 

Purchased or Originated Credit-Impaired Financial Assets

On initial recognition of a financial asset, the Bank determines whether the asset is credit-impaired. For financial assets that are credit-impaired upon purchase or origination, the lifetime expected credit losses are reflected in the initial fair value. In subsequent reporting periods, the Bank recognizes only the cumulative changes in these lifetime ECLs since initial recognition as an allowance for credit losses. The Bank recognizes changes in ECLs in Provisions for credit losses in the Consolidated Statement of Income, even if the lifetime ECLs are less than ECLs that were included in the estimated cash flows on initial recognition.

 

Definition of Default

The definition of default used by the Bank to measure ECLs and transfer financial instruments between stages is consistent with the definition of default used for internal credit risk management purposes. The Bank considers a financial asset, other than a credit card receivable, to be credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of the financial asset have occurred or when contractual payments are 90 days past due. Credit card receivables are considered credit-impaired and are fully written off at the earlier of the following: when a notice of bankruptcy is received, a settlement proposal is made, or contractual payments are 180 days past due.

 

Write-offs

A financial asset and its related allowance for credit losses are normally written off in whole or in part when the Bank considers the probability of recovery to be non-existent and when all guarantees and other remedies available to the Bank have been exhausted or if the borrower is bankrupt or winding up and balances owing are not likely to be recovered.

 

Derecognition of Financial Assets and Securitization

A financial asset is considered for derecognition when the Bank has transferred contractual rights to receive the cash flows or assumed an obligation to transfer these cash flows to a third party. The Bank derecognizes a financial asset when it considers that substantially all the risks and rewards of ownership of the asset have been transferred or when the contractual rights to the cash flows of the financial asset expire. When the Bank considers that it has retained substantially all the risks and rewards of ownership of the transferred asset, it continues to recognize the financial asset and, if applicable, recognizes a financial liability on the Consolidated Balance Sheet. If, due to a derivative financial instrument, the transfer of a financial asset does not result in derecognition, the derivative financial instrument is not recognized on the Consolidated Balance Sheet.

 

When the Bank has neither transferred nor retained substantially all the risks and rewards of ownership of the financial asset, it derecognizes the financial asset it no longer controls. Any rights and obligations retained following the asset transfer are recognized separately as an asset or liability. If the Bank retains control of the financial asset, it continues to recognize the asset to the extent of its continuing involvement in that asset, i.e., to the extent to which it is exposed to changes in the value of the transferred asset.

 

In order to diversify its funding sources, the Bank participates in two Canada Mortgage and Housing Corporation (CMHC) securitization programs: the Mortgage-Backed Securities Program under the National Housing Act (Canada) (NHA) and Canada Mortgage Bond (CMB) program. Under the first program, the Bank issues NHA securities backed by insured residential mortgages and, under the second, the Bank sells NHA securities to Canada Housing Trust (CHT). As part of these transactions, the Bank retains substantially all the risks and rewards related to ownership of the mortgage loans sold. Therefore, the insured mortgage loans securitized under the CMB program continue to be recognized in the Loans item of the Bank's Consolidated Balance Sheet and the liabilities for the considerations received from the transfer are recognized in Liabilities related to transferred receivables on the Consolidated Balance Sheet. Moreover, insured mortgage loans securitized and retained by the Bank continue to be recognized in Loans on the Consolidated Balance Sheet.

 

Derecognition of Financial Liabilities

A financial liability is derecognized when the obligation is discharged, cancelled or expires. The difference between the carrying value of the financial liability transferred and the consideration paid is recognized in the Consolidated Statement of Income.

 

Cash and Deposits With Financial Institutions

Cash and deposits with financial institutions consist of cash and cash equivalents, amounts pledged as collateral as well as amounts placed in escrow. Cash comprises cash and bank notes. Cash equivalents consist of deposits with the Bank of Canada, deposits with financial institutions, including net receivables related to cheques and other items in the clearing process as well as the net amount of cheques and other items in transit.

 

Acceptances and Customers' Liability Under Acceptances

The potential liability of the Bank under acceptances is recorded as a customer commitment liability on the Consolidated Balance Sheet. The Bank's potential recourse vis à vis clients is recorded as an equivalent offsetting asset. Fees are recorded in Non-interest income in the Consolidated Statement of Income.

 



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

Obligations Related to Securities Sold Short

This financial liability represents the Bank's obligation to deliver the securities it sold but did not own at the time of sale. Obligations related to securities sold short are recorded at fair value and presented as liabilities on the Consolidated Balance Sheet. Realized and unrealized gains and losses are recognized in Non-interest income in the Consolidated Statement of Income.

 

Derivative Financial Instruments

In the normal course of business, the Bank uses derivative financial instruments to meet the needs of its clients, to generate trading activity revenues, and to manage its exposure to interest rate risk, foreign exchange risk, credit risk and other market risks.

 

All derivative financial instruments are measured at fair value on the Consolidated Balance Sheet. Derivative financial instruments with a positive fair value are included in assets, and derivative financial instruments with a negative fair value are included in liabilities on the Consolidated Balance Sheet. Where there are offsetting financial assets and financial liabilities, the net fair value of certain derivative financial instruments is reported either as an asset or as a liability.

 

Embedded Derivative Financial Instruments

An embedded derivative is a component of a hybrid contract that also includes a non-derivative host, the effect being that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to one of the parties to the contract.

 

A derivative embedded in a financial liability is separated from the host contract and treated as a separate derivative if, and only if, the following three conditions are met: the economic characteristics and risks of the embedded derivative are not closely related to those of the host contract, the embedded derivative is a separate instrument that meets the definition of a derivative financial instrument, and the hybrid contract is not measured at fair value through profit or loss.

 

Embedded derivatives that are separately accounted for are measured at fair value on the Consolidated Balance Sheet, and subsequent changes in fair value are recognized in Non-interest income in the Consolidated Statement of Income. In general, all embedded derivatives are presented on a combined basis with the host contract. However, certain embedded derivatives that are separated from the host contract are presented in Derivative financial instruments on the Consolidated Balance Sheet.

 

Held-for-Trading Derivative Financial Instruments

Derivative financial instruments are recognized at fair value, and the realized and unrealized gains and losses (including interest income and expense) are recorded in Non-interest income in the Consolidated Statement of Income.

 

Derivative Financial Instruments Designated as Hedging Instruments

Policy

The purpose of a hedging transaction is to modify the Bank's exposure to one or more risks by creating an offset between changes in the fair value of, or the cash flows attributable to, the hedged item and the hedging instrument. Hedge accounting ensures that offsetting gains, losses, revenues and expenses are recognized in the Consolidated Statement of Income in the same period or periods.

 

Documenting and Assessing Effectiveness

The Bank designates and formally documents each hedging relationship, at its inception, by detailing the risk management objective and the hedging strategy. The documentation identifies the specific asset, liability, or cash flows being hedged, the related hedging instrument, the nature of the specific risk exposure or exposures being hedged, the intended term of the hedging relationship, and the method for assessing the effectiveness or ineffectiveness of the hedging relationship. At the inception of the hedging relationship, and for every financial reporting period for which the hedge has been designated, the Bank ensures that the hedging relationship is highly effective and consistent with its originally documented risk management objective and strategy. When a hedging relationship meets the hedge accounting requirements, it is designated as either a fair value hedge, a cash flow hedge or a foreign exchange hedge of a net investment in a foreign operation.

 

Fair Value Hedges

For fair value hedges, the Bank mainly uses interest rate swaps to hedge changes in the fair value of a hedged item. The carrying amount of the hedged item is adjusted based on the effective portion of the gains or losses attributable to the hedged risk, which are recognized in the Consolidated Statement of Income, as well as the change in the fair value of the hedging instrument. The resulting ineffective portion is recognized in Non-interest income in the Consolidated Statement of Income.



The Bank prospectively discontinues hedge accounting if the hedging instrument is sold or expires or if the hedging relationship no longer qualifies for hedge accounting or if the Bank revokes the designation. When the designation is revoked, the hedged item is no longer adjusted to reflect changes in fair value, and the amounts previously recorded as cumulative adjustments with respect to the effective portion of gains and losses attributable to the hedged risk are amortized using the effective interest rate method and recognized in the Consolidated Statement of Income over the remaining useful life of the hedged item. If the hedged item is sold or terminated before maturity, the cumulative adjustments with respect to the effective portion of gains and losses attributable to the hedged risk are immediately recorded in the Consolidated Statement of Income.

 

Cash Flow Hedges

For cash flow hedges, the Bank mainly uses interest rate swaps and total return swaps to hedge variable cash flows attributable to the hedged risk related to a financial asset or liability (or to a group of financial assets or liabilities). The effective portion of changes in fair value of the hedging instrument is recognized in Other comprehensive income and the ineffective portion in Non-interest income in the Consolidated Statement of Income.

 

The amounts previously recorded in Accumulated other comprehensive income are reclassified to the Consolidated Statement of Income of the period or periods during which the cash flows of the hedged item affect the Consolidated Statement of Income. If the hedging instrument is sold or expires or if the hedging relationship no longer qualifies for hedge accounting or if the Bank cancels that designation, then the amounts previously recognized in Accumulated other comprehensive income are reclassified to the Consolidated Statement of Income in the period or periods during which the cash flows of the hedged item affect the Consolidated Statement of Income.

 

Hedges of Net Investments in Foreign Operations

Derivative and non-derivative financial instruments are used to hedge foreign exchange risk related to investments made in foreign operations whose functional currency is not the Canadian dollar. The effective portion of the gains and losses on the hedging instrument is recognized in Other comprehensive income and the ineffective portion in Non-interest income in the Consolidated Statement of Income. Upon the total or partial sale of a net investment in a foreign operation, amounts reported in Accumulated other comprehensive income are reclassified, in whole or in part, to Non-interest income in the Consolidated Statement of Income.

 

Offsetting of Financial Assets and Liabilities

Financial assets and liabilities are offset, and the net amount is presented on the Consolidated Balance Sheet when the Bank has a legally enforceable right to set off the recognized amounts and intends to settle on a net basis or to realize the asset and settle the liability simultaneously.

 

Premises and Equipment

Premises and equipment, except for land and the head office building under construction, are recognized at cost less accumulated amortization and accumulated impairment losses. Land and the head office building under construction are recorded at cost less any impairment losses.

 

Premises and equipment and the significant components of a building that have different useful lives or that provide economic benefits at a different pace are systematically amortized over their useful lives. Amortization methods and useful lives are reviewed on an annual basis. The amortization expense is recorded in Non-interest expenses in the Consolidated Statement of Income.

 




Method


Useful life









Significant components of a building







Exterior design


Straight-line


20 years



Interior design, roofing and electromechanical system


Straight-line


30 years



Structure


Straight-line


75 years


Other buildings


5% declining balance




Computer equipment


Straight-line


3-4 years


Equipment and furniture


Straight-line


1-8 years


Leasehold improvements


Straight-line


(1)


 

(1)    The average amortization period is 15 years, determined using the lesser of the useful life or the lease term plus the first renewal option.

 

Goodwill

The Bank uses the acquisition method to account for business combinations. The consideration transferred in a business combination is measured at the acquisition-date fair value, and the transaction costs related to the acquisition are expensed as incurred. When the Bank acquires control of a business, all of the identifiable assets and liabilities of the acquiree, including intangible assets, are recorded at fair value. The interests previously held in the acquiree are also measured at fair value. Goodwill represents the excess of the purchase consideration and all previously held interests over the fair value of the identifiable net assets of the acquiree. If the fair value of the identifiable net assets exceeds the purchase consideration and all previously held interests, the difference is immediately recognized as a gain on a bargain purchase.

 



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

Non-controlling interests in the net assets of consolidated subsidiaries are identified separately from the Bank's ownership interest and can be initially measured at either fair value or at the non-controlling interest's proportionate share of the acquiree's identifiable net assets. The measurement basis is selected on a case-by-case basis. Following an acquisition, non-controlling interests consist of the value assigned to those interests at initial recognition plus the non-controlling interests' share of changes in equity since the date of the acquisition.

 

Intangible Assets

Intangible Assets With Finite Useful Lives

Software and certain other intangible assets are recognized at cost less accumulated amortization and accumulated impairment losses. These intangible assets are systematically amortized on a straight-line basis over their useful lives, which vary between four and ten years. The amortization expense is recorded in Non-interest expenses in the Consolidated Statement of Income.

 

Intangible Assets With Indefinite Useful Lives

The Bank's intangible assets with indefinite useful lives come from the acquisition of subsidiaries or groups of assets and consist of management contracts and a trademark. They are recognized at the acquisition-date fair value. The management contracts are for the management of open-ended funds. At the end of each reporting period, the Bank reviews the useful lives to determine whether events and circumstances continue to support an indefinite useful life assessment. Intangible assets are deemed to have an indefinite useful life following an examination of all relevant factors, in particular: (a) the contracts do not have contractual maturities; (b) the stability of the business segment to which the intangible assets belong; (c) the Bank's capacity to control the future economic benefits of the intangible assets; and (d) the continued economic benefits generated by the intangible assets.

 

Impairment of Non-Financial Assets

Premises and equipment and intangible assets with finite useful lives are tested for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. At the end of each reporting period, the Bank determines whether there is an indication that premises and equipment or intangible assets with finite useful lives may be impaired. Goodwill and intangible assets that are not yet available for use or that have indefinite useful lives are tested for impairment annually or more frequently if there is an indication that the asset might be impaired.

 

An asset is tested for impairment by comparing its carrying amount with its recoverable amount. The recoverable amount must be estimated for the individual asset. Where it is not possible to estimate the recoverable amount of an individual asset, the recoverable amount of the cash-generating unit (CGU) to which the asset belongs will be determined. A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. The Bank uses judgment to identify CGUs.

 

An asset's recoverable amount is the higher of fair value less costs to sell and the value in use of the asset or CGU. Value in use is the present value of expected future cash flows from the asset or CGU. The recoverable amount of the CGU is determined using valuation models that consider various factors such as projected future cash flows, discount rates, and growth rates. The use of different estimates and assumptions in applying the impairment tests could have a significant impact on income.

 

Corporate assets, such as the head office building and computer equipment, do not generate cash inflows that are largely independent of the cash inflows generated by other assets or groups of assets. Therefore, the recoverable amount of an individual corporate asset cannot be determined unless management has decided to dispose of the asset. However, if there is an indication that a corporate asset may be impaired, the recoverable amount is determined for the CGU or group of CGUs to which the corporate asset belongs, and that recoverable amount is compared with the carrying amount of this CGU or group of CGUs.

 

Goodwill is always tested for impairment at the level of a CGU or group of CGUs. For impairment testing purposes, from the acquisition date, goodwill resulting from a business combination must be allocated to the CGU or group of CGUs expected to benefit from the synergies of the business combination. Each CGU or group of CGUs to which goodwill is allocated must represent the lowest level for which the goodwill is monitored internally at the Bank and must not be larger than an operating segment. The allocation of goodwill to a CGU or group of CGUs involves management's judgment. If an impairment loss is to be recognized, the Bank does so by first reducing the carrying amount of goodwill allocated to the CGU or group of CGUs and then reducing the carrying amounts of the other assets of the CGU or group of CGUs in proportion to the carrying amount of each asset in the CGU or group of CGUs.

 

If the recoverable amount of an asset or a CGU is less than its carrying amount, the carrying amount is reduced to its recoverable amount and an impairment loss is recognized in Non-interest expenses in the Consolidated Statement of Income. An impairment loss recognized in prior periods for an asset other than goodwill must be reversed if, and only if, there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment was recognized. If this is the case, the carrying amount of the asset is increased, given that the impairment loss was reversed, but shall not exceed the carrying amount that would have been determined, net of amortization, had no impairment loss been recognized for this asset in previous years.



Leases

A lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed period of time in return for a payment or series of payments. A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of the leased asset to the lessee. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease. The Bank primarily enters into operating leases.

 

When the Bank is the lessee under an operating lease, the rental expense is recognized on a straight-line basis over the lease term in Non-interest expenses in the Consolidated Statement of Income. When the Bank is the lessor, the lease assets remain on the Consolidated Balance Sheet and are reported in premises and equipment, and the rental income is recognized net of related expenses in Non-interest income in the Consolidated Statement of Income.

 

Provisions

Provisions are liabilities of uncertain timing and amount. A provision is recognized when the Bank has a present obligation (legal or constructive) arising from a past event, when it is probable that an outflow of economic resources will be required to settle the obligation and when the amount of the obligation can be reliably estimated. Provisions are based on the Bank's best estimates of the economic resources required to settle the present obligation, given all relevant risks and uncertainties, and, when it is significant, the effect of the time value of money. Provisions are reviewed at the end of each reporting period. Provisions are presented in Other liabilities on the Consolidated Balance Sheet.

 

Interest Income and Expense

Interest income and expense, except for the interest income on securities classified as at fair value through profit or loss, are recognized in Net interest income and calculated using the effective interest rate method.

 

The effective interest rate is the rate that exactly discounts estimated future cash inflows and outflows through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the amortized cost of a financial liability. When calculating the effective interest rate, the Bank estimates expected cash flows by considering all the contractual terms of the financial instrument but does not consider expected credit losses. The calculation includes all fees and points paid or received between the parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts. Interest income is calculated by applying the effective interest rate to the gross carrying amount of a financial asset except for purchased or originated credit-impaired financial assets and financial assets that were not impaired upon their purchase or origination but became impaired thereafter. For purchased or originated credit-impaired financial assets, the Bank applies the credit-adjusted effective interest rate to the amortized cost of the financial asset from initial recognition. The credit-adjusted effective interest rate reflects expected credit losses. As for loans that have subsequently become credit-impaired, interest income is calculated by applying the effective interest rate to the net carrying amount (net of allowances for credit losses) rather than to the carrying amount.

 

Loan origination fees, including commitment, restructuring, and renegotiation fees, are considered an integral part of the yield earned on the loan. They are deferred and amortized using the effective interest rate method, and the amortization is recognized in Interest income over the term of the loan. Direct costs for originating a loan are netted against the loan origination fees. If it is likely that a commitment will result in a loan, commitment fees receive the same accounting treatment, i.e., they are deferred and amortized using the effective interest rate method and the amortization is recognized in Interest income over the term of the loan. Otherwise, they are recorded in Non-interest income over the term of the commitment.

 

Loan syndication fees are recorded in Non-interest income unless the yield on the loan retained by the Bank is less than that of other comparable lenders involved in the financing. In such cases, an appropriate portion of the fees is deferred and amortized using the effective interest rate method, and the amortization is recognized in Interest income over the term of the loan. Certain mortgage loan prepayment fees are recognized in Interest income in the Consolidated Statement of Income when earned.

 

Dividend Income

Dividends from an equity instrument are recognized in Net interest income in the Consolidated Statement of Income when the Bank's right to receive payment is established.

 

Fee and Commission Income

Fee and commission income is recognized when, or as, a performance obligation is satisfied, i.e., when control of a promised service is transferred to a customer and in an amount that reflects the consideration that the entity expects to be entitled to receive in exchange for the service. The revenue may therefore be recognized at a point in time, upon completion of the service, or over time as services are provided.

 

The Bank must also determine whether its performance obligation is to provide the service itself or to arrange for another party to provide the service (in other words, whether the Bank is acting as a principal or agent). A principal may itself satisfy its performance obligation to provide the specified good or service or it may engage another party to satisfy some or all of the performance obligation on its behalf. A principal also has the primary responsibility for fulfilling the promise to provide the good or service to the customer and has discretion in establishing the price for the service. If the Bank is acting as a principal, revenue is recognized on a gross basis in an amount corresponding to the consideration to which the Bank expects to be entitled. If the Bank is acting as an agent, then revenue is recognized net of the service fees and other costs incurred in relation to the commission and fees earned.

 



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

Underwriting and Advisory Fees

Underwriting and advisory fees include underwriting fees, financial advisory fees, and loan syndication fees. These fees are mainly earned in the Financial Markets segment and are recognized at a point in time as revenue upon successful completion of the engagement. Financial advisory fees are fees earned for assisting customers with transactions related to mergers and acquisitions and financial restructurings. Loan syndication fees represent fees earned as the agent or lead lender responsible for structuring, arranging, and administering a loan syndication and are recorded in Non-interest income unless the yield on the loan retained by the Bank is less than that of other comparable lenders involved in the financing. In such cases, an appropriate portion of the fees is deferred and amortized using the effective interest rate method, and the amortization is recognized in Interest income over the term of the loan.

 

Securities Brokerage Commissions

Securities brokerage commissions are earned in the Wealth Management segment and are recognized at a point in time when the transaction is executed.

 

Mutual Fund and Trust Service Revenues

Mutual fund and trust service revenues include management and administration fees. These fees are earned in the Wealth Management segment. Management fees are primarily calculated on assets under management and are recorded over the period the services are performed. Administration fees are generally based on assets under administration or management and are recorded over the period the services are performed. 

 

Card Revenues

Card revenues are earned in the Personal and Commercial segment and include card fees such as annual and transactional fees as well as interchange fees. Interchange fees are recognized when a card transaction is settled. Card fees are recognized on the transaction date except for annual fees, which are recorded evenly throughout the year. Reward costs are recorded as a reduction to interchange fees.

 

Credit Fees and Deposit and Payment Service Charges

Credit fees and deposit and payment service charges are earned in the Personal and Commercial, Financial Markets, and U.S. Specialty Finance and International segments. Credit fees are generally recognized in income over the period the services are provided. Deposit and payment service charges include fees related to account maintenance activities and transaction-based service charges. Fees related to account maintenance activities are recognized over the period the services are provided, whereas transaction-based service charges are recognized at a point in time when the transaction is completed.

 

Insurance Revenues

Insurance contracts, including reinsurance contracts, are arrangements under which one party accepts significant insurance risk by agreeing to compensate the policyholder if a specified uncertain future event was to occur. Gross premiums, net of premiums transferred under reinsurance contracts, are recognized when they become due. Royalties received from reinsurers are recognized when earned. Claims are recognized when received and an amount is estimated as they are being processed. All these amounts are recognized on a net basis in Non-interest income in the Consolidated Statement of Income.

 

Upon recognition of a premium, a reinsurance asset and insurance liability are recognized, respectively, in Other assets and in Other liabilities on the Consolidated Balance Sheet. Subsequent changes in the carrying value of the reinsurance asset and insurance liability are recognized on a net basis in Non‑interest income in the Consolidated Statement of Income.

 

Income Taxes

Income taxes include current taxes and deferred taxes and are recorded in net income except for income taxes generated by items recognized in Other comprehensive income or directly in equity.

 

Current tax is the amount of income tax payable on the taxable income for a period. It is calculated using the enacted or substantively enacted tax rates prevailing on the reporting date, and any adjustments recognized in the period for the current tax of prior periods. Current tax assets and liabilities are offset, and the net balance is presented in either Other assets or Other liabilities on the Consolidated Balance Sheet when the Bank has a legally enforceable right to set off the recognized amounts and intends to settle on a net basis or to simultaneously realize the asset and settle the liability.

 



Deferred tax is established based on temporary differences between the carrying values and the tax bases of assets and liabilities, in accordance with enacted or substantively enacted income tax laws and rates that will apply on the date the differences will reverse. Deferred tax is not recognized for temporary differences related to the following:

 

·     the initial accounting of goodwill;

·     the initial accounting of an asset or liability in a transaction that is not a business combination and that, at the time of the transaction, affects neither accounting income nor taxable income; 

·     investments in subsidiaries, associates and joint ventures when it is probable that the temporary difference will not reverse in the foreseeable future and that the Bank controls the timing of the reversal of the temporary difference;

·     investments in subsidiaries, associates and joint ventures when it is probable that the temporary difference will not reverse in the foreseeable future and that there will not be taxable income to which the temporary difference can be recognized.

 

Deferred tax assets are tax benefits in the form of deductions that the Bank may claim to reduce its taxable income in future years. At the end of each reporting period, the carrying amount of deferred tax assets is revised, and it is reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow the benefit of the deferred tax asset to be utilized.

 

Deferred tax assets and liabilities are offset, and the net balance is presented in either Other assets or Other liabilities on the Consolidated Balance Sheet when the Bank has a legally enforceable right to set off the current tax assets and liabilities and if the deferred tax assets and liabilities relate to taxes levied by the same taxation authority on the same taxable entity or on different taxable entities that intend to settle current tax assets and liabilities based on their net amount.

 

The Bank makes assumptions to estimate income taxes as well as deferred tax assets and liabilities. This process includes estimating the actual amount of current taxes and evaluating tax loss carryforwards and temporary differences arising from differences between the values of items reported for accounting and for income tax purposes. Deferred tax assets and liabilities presented on the Consolidated Balance Sheet are calculated according to the tax rates to be applied in future periods. Previously recorded deferred tax assets and liabilities must be adjusted when the date of the future event is revised based on current information.

 

The Bank is subject to the jurisdictions of various tax authorities. In the normal course of its business, the Bank is involved in a number of transactions for which the tax impacts are uncertain. As a result, the Bank accounts for provisions for uncertain tax positions that adequately represent the tax risk stemming from tax matters under discussion or being audited by tax authorities or from other matters involving uncertainty. The amounts of these provisions reflect the best possible estimates of the amounts that may have to be paid based on qualitative assessments of all relevant factors. The provisions are estimated at the end of each reporting period. However, it is possible that, at a future date, a provision might need to be adjusted following an audit by the tax authorities. When the final assessment differs from the initially provisioned amounts, the difference will impact the income taxes of the period in which the assessment was made.

 

Financial Guarantee Contracts

A financial guarantee contract is a contract or indemnification agreement that could require the Bank to make specified payments (in cash, financial instruments, other assets, Bank shares, or provisions of services) to reimburse a beneficiary in the event of a loss resulting from a debtor defaulting on the original or amended terms of a debt instrument.

 

To reflect the fair value of the obligation assumed at the inception of a financial guarantee, a liability is recorded in Other liabilities on the Consolidated Balance Sheet. After initial recognition, the Bank must measure financial guarantee contracts at the higher of the allowance for credit losses determined using the ECL model and of the initially recognized amount less, where applicable, the cumulative amount of income recognized. This revenue is recognized in Credit fees in the Consolidated Statement of Income.

 

Employee Benefits - Pension Plans and Other Post-Employment Benefits

The Bank offers defined benefit pension plans and other post-employment benefit plans to eligible employees. Other post-employment benefit plans include post-employment medical, dental, and life insurance coverage. While pension plans are funded, the other plans are not.

 

Plan expenses and obligations are actuarially determined based on the projected benefit method prorated on service. The calculations use management's best estimates of various actuarial assumptions such as discount rates, rates of compensation increase, health care cost trend rates, mortality rates, and retirement age.

 

The net asset or net liability of pension plans and other post-employment benefit plans are calculated separately for each plan as the difference between the present value of the future benefits earned by employees in respect of current- and prior-period service and the fair value of plan assets. The net asset or net liability is included in either the Other assets or Other liabilities item of the Consolidated Balance Sheet.



Note 1 - Basis of Presentation and Summary of Significant Accounting Policies (cont.)

 

The expense related to pension plans and other post-employment benefit plans consists of the following items: current service cost, net interest on the net plan asset or liability, administration costs, and past service cost, if any, recognized when a plan is amended. This expense is recognized in Compensation and employee benefits in the Consolidated Statement of Income. The net amount of interest income and expense is determined by applying a discount rate to the net plan asset or liability amount.

 

Remeasurements resulting from pension plans and other post-employment benefit plans represent actuarial gains and losses related to the defined benefit obligation and the actual return on plan assets, excluding net interest determined by applying a discount rate to the net asset or liability of the plans. Remeasurements are immediately recognized in Other comprehensive income and will not be subsequently reclassified to net income; these cumulative gains and losses are reclassified to Retained earnings.

 

Share-Based Payments

The Bank has several share-based compensation plans: the Stock Option Plan, the Stock Appreciation Rights (SAR) Plan, the Deferred Stock Unit (DSU) Plan, the Restricted Stock Unit (RSU) Plan, the Performance Stock Unit (PSU) Plan, the Deferred Compensation Plan (DCP) of National Bank Financial, and the Employee Share Ownership Plan.

 

Compensation expense is recognized over the service period required for employees to become fully entitled to the award. This period is generally the same as the vesting period, except where the required service period begins before the award date. Compensation expense related to awards granted to employees eligible to retire on the award date is immediately recognized on the award date. Compensation expense related to awards granted to employees who will become eligible to retire during the vesting period is recognized over the period from the award date to the date the employee becomes eligible to retire. For all of these plans, as of the first year of recognition, the expense includes cancellation and forfeiture estimates. These estimates are subsequently revised as necessary. The Bank uses derivative financial instruments to hedge the risks associated with some of these plans. The compensation expense for these plans, net of related hedges, is recognized in the Consolidated Statement of Income.

 

Under the Stock Option Plan, the Bank uses the fair value method to account for stock options awarded. The options vest at 25% per year, and each tranche is treated as though it was a separate award. The fair value of each of the tranches is measured on the award date using the Black-Scholes model, and this fair value is recognized in Compensation and employee benefits and Contributed surplus. When the options are exercised, the Contributed surplus amount is credited to Equity - Common shares on the Consolidated Balance Sheet. The proceeds received from the employees when these options are exercised are also credited to Equity - Common shares on the Consolidated Balance Sheet.

 

SARs are recorded at fair value when awarded and their fair value is remeasured at the end of each reporting period until they are exercised. The cost is recognized in Compensation and employee benefits in the Consolidated Statement of Income and in Other liabilities on the Consolidated Balance Sheet. The obligation that results from the change in fair value at each period is recognized in net income gradually over the vesting period, and periodically thereafter, until the SARs are exercised.  When a SAR is exercised, the Bank makes a cash payment equal to the increase in the stock price since the date of the award.

 

The obligation that results from the award of a DSU, RSU, PSU and DCP unit is recognized in net income, and the corresponding amount is included in Other liabilities on the Consolidated Balance Sheet. For the DSU, RSU and DCP plans, the change in the obligation attributable to variations in the share price and dividends paid on common shares for these plans is recognized in Compensation and employee benefits in the Consolidated Statement of Income for the period in which the variations occur. On the redemption date, the Bank makes a cash payment equal to the value of the common shares on that date. For the PSU Plan, the change in the obligation attributable to changes in the stock price, adjusted upward or downward depending on the relative result of the performance criteria, and the change in the obligation attributable to dividends paid on the shares awarded under the plan, are recognized in Compensation and employee benefits in the Consolidated Statement of Income for the period in which the changes occur. On the redemption date, the Bank makes a cash payment equal to the value of the common shares on that date, adjusted upward or downward according to the performance criteria.

 

The Bank's contributions to the employee share ownership plan are expensed as incurred.

 

Note 2 - Future Accounting Policy Changes

 

The IASB issues revisions and amendments to a number of standards, some of which have already had an impact on the Bank and others that could have an impact in the future. The Bank is currently assessing the impact that adoption of the following standards will have on its consolidated financial statements. A summary of these amendments and the effective dates applicable to the Bank are presented below.

 

Effective Date - November 1, 2019

IFRS 16 - Leases

In January 2016, the IASB issued IFRS 16 - Leases. The new standard replaces the previous lease accounting standard, IAS 17 - Leases, and related interpretations. Under IAS 17, lessees and lessors were required to classify their leases as either finance leases or operating leases and to account for these two types of leases differently. IFRS 16 provides a single accounting model for lessees, requiring lessees to recognize a right-of-use asset as well as a liability that reflects the present value of future lease payments. Lessees will also recognize depreciation expense on the right-of-use asset and interest expense on the lease liability in the Consolidated Statement of Income. As for lessors, IFRS 16 substantially carries forward the lessor accounting in IAS 17, with the distinction between finance and operating leases being retained.

 

The Bank has elected to apply IFRS 16 using the modified retrospective basis by adjusting the Consolidated Balance Sheet as at November 1, 2019, the date of initial application, with no restatement of comparative periods. The most significant impact to the Bank will be related to real estate leases, which are currently classified as operating leases.

 

On transition, the Bank will apply, on a lease-by-lease basis, certain practical expedients. More specifically, it will measure the right-of-use assets at an amount equal to the lease liability, it will rely on the Bank's assessment about whether leases are onerous as at October 31, 2019 as an alternative to performing an impairment test as at November 1, 2019, and it will exclude initial direct costs from the measurement of the right-of-use assets as at November 1, 2019. Furthermore, on transition and thereafter, the Bank will exclude leases for which the underlying asset is of low value, will exclude short-term leases and, for real estate leases, will elect not to separate non-lease components from lease components.

 

As at October 31, 2019, the Bank's best estimate of the impact of adopting IFRS 16 is an increase in total assets of approximately $653 million representing leased premises, an increase in total liabilities of approximately $653 million primarily representing lease liabilities, and a decrease of approximately 9 basis points in the Common Equity Tier 1 (CET 1) capital ratio as at November 1, 2019.

 

IFRIC Interpretation 23 - Uncertainty Over Income Tax Treatments

In June 2017, the IASB issued IFRIC Interpretation 23, which addresses how to reflect tax treatment uncertainty in accounting for income taxes. This interpretation will not have an impact on the Bank's Consolidated Balance Sheet as at November 1, 2019.

 

Effective Date - November 1, 2020

Conceptual Framework for Financial Reporting

On March 29, 2018, the IASB published Conceptual Framework for Financial Reporting to replace its 2010 conceptual framework. For the IASB, the revised conceptual framework has been in effect since its publication date. Early application is permitted.

 

Reform to Benchmark Interest Rates (Amendments to IFRS 9, IAS 39 and IFRS 7)

In September 2019, in response to uncertainty arising from the phasing-out of benchmark interest rates such as interbank offered rates (IBORs), the IASB issued amendments to its new and former financial instrument standards, IFRS 9 - Financial Instruments and IAS 39 - Financial Instruments: Recognition and Measurement as well as to the related standard on disclosures, IFRS 7 - Financial Instruments: Disclosures.

 

The amendments modify certain hedge accounting requirements in IFRS 9 and IAS 39 to provide relief from the potential effects of the uncertainty caused by the IBOR reform. In addition, the amendments to IFRS 7 require additional disclosure about hedging relationships directly affected by this uncertainty. When the Bank adopted IFRS 9 on November 1, 2017, it made an accounting policy choice to continue applying the IAS 39 hedge accounting requirements.

 

For the Bank, the effective date of these amendments is November 1, 2020. However, early adoption is permitted.

 

Effective Date - November 1, 2021

IFRS 17 - Insurance Contracts

In May 2017, the IASB issued IFRS 17 - Insurance Contracts, a new standard that replaces IFRS 4, the current insurance contract accounting standard. IFRS 17 introduces a new accounting framework that will improve the comparability and quality of financial information. At its meeting on November 14, 2018, the IASB tentatively decided to defer the IFRS 17 effective date to fiscal years beginning on or after January 1, 2022. 

 

Note 3 - Fair Value of Financial Instruments

 

Fair Value and Carrying Value of Financial Instruments by Category

 

Financial assets and financial liabilities are recognized on the Consolidated Balance Sheet at fair value or at amortized cost in accordance with the categories set out in the accounting framework for financial instruments.

 














As at October 31, 2019







Carrying value

and fair value


Carrying value



Fair

value


Total carrying value

Total

fair

value







Financial

instruments

classified as

at fair value

through profit

or loss


Financial

instruments

designated

at fair value

through profit

or loss


Debt securities classified as at fair value through other comprehensive income


Equity securities

designated at

fair value

through other

comprehensive income


Financial instruments at amortized cost, net



Financial instruments at amortized cost, net
























Financial assets



















Cash and deposits with financial




















institutions






13,698



13,698


13,698

13,698
























Securities


58,556


3,267


10,026


622


9,755



9,824


82,226

82,295
























Securities purchased under reverse




















repurchase agreements




















and securities borrowed



87




17,636



17,636


17,723

17,723
























Loans and acceptances, net of allowances


6,798





146,453



147,051


153,251

153,849
























Other



















Derivative financial instruments


8,129








8,129

8,129



Other assets






1,193



1,193


1,193

1,193







8,129








8,129

8,129


Financial liabilities



















Deposits



11,203






178,363

(1)


178,861


189,566

190,064
























Other



















Acceptances








6,893



6,893


6,893

6,893



Obligations related to securities sold short


12,849










12,849

12,849























Obligations related to securities sold under




















repurchase agreements and




















securities loaned








21,900



21,900


21,900

21,900



Derivative financial instruments


6,852










6,852

6,852



Liabilities related to transferred receivables



8,215






13,097



13,186


21,312

21,401



Other liabilities


24







3,018



3,019


3,042

3,043
























Subordinated debt








773



765


773

765


 

(1)    Includes embedded derivative financial instruments.

 

 

 













As at October 31, 2018







Carrying value

and fair value


Carrying

value


Fair

value


Total

carrying

value


Total

fair

value







Financial

instruments

classified as

at fair value

through profit

or loss


Financial instruments

designated

at fair value

through profit

or loss


Debt securities classified as at fair value through other comprehensive income


Equity securities

designated at

fair value

through other

comprehensive income


Financial

instruments

at amortized

cost, net


Financial

instruments

at amortized

cost, net

























Financial assets



















Cash and deposits with financial




















institutions






12,756


12,756


12,756


12,756
























Securities


51,927


3,890


5,317


351


8,298


8,237


69,783


69,722
























Securities purchased under reverse




















repurchase agreements and




















securities borrowed



479




17,680


17,680


18,159


18,159
























Loans and acceptances, net of allowances


6,108





139,974


139,551


146,082


145,659
























Other



















Derivative financial instruments


8,608







8,608


8,608



Other assets






1,804


1,804


1,804


1,804























Financial liabilities



















Deposits



10,126






160,704

(1)

160,938


170,830


171,064
























Other



















Acceptances








6,801


6,801


6,801


6,801



Obligations related to securities sold short


17,780









17,780


17,780



Obligations related to securities sold under




















repurchase agreements and




















securities loaned








19,998


19,998


19,998


19,998



Derivative financial instruments


6,036









6,036


6,036



Liabilities related to transferred receivables



7,714






12,386


12,361


20,100


20,075



Other liabilities


21







3,163


3,152


3,184


3,173
























Subordinated debt








747


734


747


734


 

(1)    Includes embedded derivative financial instruments.

 

Establishing Fair Value

 

The fair value of a financial instrument is the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction in the principal market at the measurement date under current market conditions (i.e., an exit price).

 

Unadjusted quoted prices in active markets provide the best evidence of fair value. When there is no quoted price in an active market, the Bank applies other valuation techniques that maximize the use of relevant observable inputs and that minimize the use of unobservable inputs. Such valuation techniques include the following: using information available from recent market transactions, referring to the current fair value of a comparable financial instrument, applying discounted cash flow analysis, applying option pricing models, or relying on any other valuation technique that is commonly used by market participants and has proven to yield reliable estimates. Judgment is required when applying many of the valuation techniques. The Bank's valuation was based on its assessment of the conditions prevailing as at October 31, 2019 and may change in the future. Furthermore, there may be valuation uncertainty resulting from the choice of valuation model used.

 



Note 3 - Fair Value of Financial Instruments (cont.) 

 

Valuation Governance

Fair value is established in accordance with a rigorous control framework. The Bank has policies and procedures that govern the process for determining fair value. These policies are documented and periodically reviewed by the Risk Management Group. All valuation models are validated, and controls have been implemented to ensure that they are applied.

 

The fair value of existing or new products is determined and validated by functions independent of the risk-taking team. Complex fair value matters are reviewed by valuation committees made up of experts from various specialized functions.

 

For financial instruments classified in Level 3 of the fair value hierarchy, the Bank has documented the classification policies to determine the hierarchy, and there are controls in place to ensure that fair value is measured appropriately, reliably, and consistently. Valuation methods and the underlying assumptions are reviewed on a regular basis.

 

Valuation Methods and Assumptions

Financial Instruments Whose Fair Value Equals Carrying Value

The carrying value of the following financial instruments is a reasonable approximation of fair value:

 

·     cash and deposits with financial institutions;

·     securities purchased under reverse repurchase agreements and securities borrowed;

·     obligations related to securities sold under repurchase agreements and securities loaned;

·     customers' liability under acceptances;

·     acceptances;

·     certain items of other assets and other liabilities.

 

Securities and Obligations Related to Securities Sold Short

These financial instruments, except for securities at amortized cost, are recognized at fair value on the Consolidated Balance Sheet. Their fair value is based on quoted prices in active markets, i.e., bid prices for financial assets and offered prices for financial liabilities. If there are no quoted prices in an active market, fair value is estimated using prices for securities that, in substance, are identical. If such prices are not available, fair value is determined using valuation techniques that incorporate assumptions based primarily on observable market inputs such as current market prices, the contractual prices of the underlying instruments, the time value of money, credit risk, interest rate yield curves and currency rates.

 

When one or more significant inputs are not observable in the markets, fair value is established primarily on the basis of internal estimates and data that consider the valuation policies in effect at the Bank, economic conditions, the specific characteristics of the financial asset or liability, and other relevant factors.

 

Securities Issued or Guaranteed by Governments

Securities issued or guaranteed by governments include government debt securities of the governments of Canada (federal, provincial and municipal) as well as debt securities of the U.S. government (U.S. Treasury), of other U.S. agencies and of other foreign governments. The fair value of these securities is based on unadjusted quoted prices in active markets. For those classified in Level 2, quoted prices for identical or similar instruments in active markets are used to determine fair value. In the absence of an observable market, valuation techniques such as the discounted cash flow method could be used, incorporating assumptions on benchmark yields (CDOR, LIBOR and other) and the risk spreads of similar securities.

 

Equity Securities and Other Debt Securities

The fair value of equity securities is determined primarily by using quoted prices in active markets. For equity securities and other debt securities classified in Level 2, a valuation technique based on quoted prices of identical and similar instruments in an active market is used to determine fair value. In the absence of observable inputs, valuation techniques such as the discounted cash flow method could be used, incorporating assumptions on benchmark yields (CDOR, LIBOR and other) and the risk spreads of similar securities. For those classified in Level 3, fair value can be determined based on the net asset value, which represents the estimated value of a security based on valuations received from investment or fund managers or the general partners of the limited partnerships. Fair value can also be determined using internal valuation techniques adjusted for risk factors related to the financial instruments and for economic conditions.



Derivative Financial Instruments

Derivative financial instruments are recorded at fair value on the Consolidated Balance Sheet. For exchange-traded derivative financial instruments, fair value is based on the quoted price in an active market, i.e., bid prices for financial assets or offered prices for financial liabilities.

 

For over-the-counter (OTC) derivative financial instruments, fair value is determined using well established valuation techniques that incorporate assumptions based primarily on observable market inputs such as current market prices and the contractual prices of the underlying instruments, the time value of money, interest rate yield curves, credit curves, currency rates as well as price and rate volatility factors. In establishing the fair value of OTC derivative financial instruments, the Bank also incorporates the following factors:

 

Credit Valuation Adjustment (CVA)

The CVA is a valuation adjustment applied to derivative financial instruments to reflect the credit risk of the counterparty. For each counterparty, the CVA is based on the expected positive exposure and probabilities of default through time. The exposures are determined by incorporating relevant factors such as current and potential future market values, master netting arrangements, collateral agreements and expected recovery rates. The default probabilities are inferred using credit default swap (CDS) spreads. When unavailable, relevant proxies are used. While the general methodology currently assumes independence between expected positive exposures and probabilities of default, adjustments are applied to certain types of transactions where there is a direct link between the exposure at default and the default probabilities.

 

Debit Valuation Adjustment (DVA)

The DVA reflects the Bank's own credit risk in the valuation of derivative financial instruments. The DVA is based on the expected negative exposure and probabilities of default of the Bank over time. The exposures are determined by incorporating relevant factors such as current and potential future market values, master netting arrangements, collateral agreements and expected recovery rates. The market-implied spreads of the Bank are used in the calculation of the DVA.

 

Funding Valuation Adjustment (FVA)

The FVA is a valuation adjustment applied to derivative financial instruments to reflect the market-implied cost or benefits of funding collateral for uncollateralized or partly collateralized transactions. The expected exposures are determined using methodologies consistent with the CVA and DVA framework. The funding level used to determine the FVA is based on the average funding level of relevant market participants.

 

When the valuation techniques incorporate one or more significant inputs that are not observable in the markets, the fair value of OTC derivative financial instruments is established primarily on the basis of internal estimates and data that consider the valuation policies in effect at the Bank, economic conditions, the specific characteristics of the financial asset or financial liability and other relevant factors.

 

Loans

The fair value of fixed-rate mortgage loans is determined by discounting expected future contractual cash flows, adjusted for several factors, including prepayment options, current market interest rates for similar loans, and other relevant variables where applicable. The fair value of variable-rate mortgage loans is deemed to equal carrying value.

 

The fair value of other fixed-rate loans is determined by discounting expected future contractual cash flows using current market interest rates charged for similar new loans. The fair value of other variable-rate loans is deemed to equal carrying value.

 

Deposits

The fair value of fixed-term deposits is determined primarily by discounting expected future contractual cash flows and considering several factors such as redemption options and market interest rates currently offered for financial instruments with similar conditions. For certain term funding instruments, fair value is determined using market prices for similar instruments. The fair value of demand deposits and notice deposits is deemed to equal carrying value.

 

The fair value of structured deposit notes is established using valuation models that maximize the use of observable inputs when available, such as benchmark indices, and also incorporates the DVA, which reflects the Bank's own credit risk. In calculating DVA, the market implied spreads of the Bank are used to infer its probabilities of default. Lastly, when fair value is determined using option pricing models, the valuation techniques are similar to those described for derivative financial instruments.

 

Liabilities Related to Transferred Receivables

These liabilities arise from sale transactions to Canada Housing Trust (CHT) of securities backed by insured residential mortgages and other securities under the Canada Mortgage Bond (CMB) program. These transactions do not qualify for derecognition. They are recorded as guaranteed borrowings, which results in the recording of liabilities on the Consolidated Balance Sheet. The fair value of these liabilities is established using valuation techniques based on observable market inputs such as Canada Mortgage Bond prices.

 



Note 3 - Fair Value of Financial Instruments (cont.) 

 

Other Liabilities and Subordinated Debt

The fair value of these financial liabilities is based on quoted market prices in an active market. If there is no active market, fair value is determined by discounting contractual cash flows using the current market interest rates offered for similar financial instruments that have the same term to maturity.

 

Hierarchy of Fair Value Measurements 

 

Determining the Levels of the Fair Value Measurement Hierarchy

IFRS establishes a fair value hierarchy that classifies the inputs used in financial instrument fair value measurement techniques according to three levels. This fair value hierarchy requires observable market inputs to be used whenever such inputs exist. According to the hierarchy, the highest level of inputs are unadjusted quoted prices in active markets for identical instruments and the lowest level of inputs are unobservable inputs. If inputs from different levels of the hierarchy are used, the financial instrument is classified in the same level as the lowest level input that is significant to the fair value measurement. The fair value hierarchy has the following levels:

 

Level 1

Inputs corresponding to unadjusted quoted prices in active markets for identical assets and liabilities and accessible to the Bank at the measurement date. These instruments consist primarily of equity securities, derivative financial instruments traded in active markets, and certain highly liquid debt securities actively traded in over-the-counter markets.

 

Level 2

Valuation techniques based on inputs, other than the quoted prices included in Level 1 inputs, that are directly or indirectly observable in the market for the asset or liability. These inputs are quoted prices of similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; inputs other than quoted prices used in a valuation model that are observable for that instrument; and inputs that are derived principally from or corroborated by observable market inputs by correlation or other means. These instruments consist primarily of certain loans, certain deposits, derivative financial instruments traded in over-the-counter markets, certain debt securities, certain equity securities whose value is not directly observable in an active market, liabilities related to transferred receivables and certain other liabilities.

 

Level 3

Valuation techniques based on one or more significant inputs that are not observable in the market for the asset or liability. The Bank classifies financial instruments in Level 3 when the valuation technique is based on at least one significant input that is not observable in the markets. The valuation technique may also be partly based on observable market inputs.

 

Financial instruments whose fair values are classified in Level 3 consist of the following:

 

·     financial instruments measured at fair value through profit or loss: investments in hedge funds for which there are certain restrictions on unit or security redemptions, equity securities and debt securities of private companies, as well as certain derivative financial instruments whose fair value is established using internal valuation models that are based on significant unobservable market inputs;

·     securities at fair value through other comprehensive income: equity and debt securities of private companies;

·     certain loans and certain deposits (structured deposit notes) whose fair value is established using internal valuation models that are based on significant unobservable market inputs.

 

Transfers Between the Fair Value Hierarchy Levels

Transfers of financial instruments between Levels 1 and 2 and transfers to (or from) Level 3 are deemed to have taken place at the beginning of the quarter in which the transfer occurred. Significant transfers can occur between the fair value hierarchy levels due to new information on inputs used to determine fair value and the observable nature of those inputs.

 

During fiscal 2019, $50 million in securities classified as at fair value through profit or loss and $1 million in obligations related to securities sold short were transferred from Level 2 to Level 1 resulting from changing market conditions ($324 million in securities classified as at fair value through profit or loss and $33 million in obligations related to securities sold short in fiscal 2018). In addition, during fiscal 2019, $20 million in securities classified as at fair value through profit or loss and $2 million in obligations related to securities sold short were transferred from Level 1 to Level 2 (for fiscal 2018, $37 million in securities classified as at fair value through profit or loss and $3 million in obligations related to securities sold short).

 

During fiscal years 2019 and 2018, financial instruments were transferred to (or from) Level 3 due to changes in the availability of observable market inputs resulting from changing market conditions.

 

Financial Instruments Recorded at Fair Value on the Consolidated Balance Sheet

 

The following tables show financial instruments recorded at fair value on the Consolidated Balance Sheet according to the fair value hierarchy.

 









As at October 31, 2019








Level 1


Level 2


Level 3


Total financial assets/liabilities at fair value
















Financial assets











Securities












At fair value through profit or loss













Securities issued or guaranteed by














Canadian government


2,102


8,321



10,423






Canadian provincial and municipal governments



6,762



6,762






U.S. Treasury, other U.S. agencies and other foreign governments


1,770


90



1,860





Other debt securities



2,666


27


2,693





Equity securities


38,836


818


431


40,085








42,708


18,657


458


61,823




At fair value through other comprehensive income













Securities issued or guaranteed by














Canadian government


196


4,236



4,432






Canadian provincial and municipal governments



1,674



1,674






U.S. Treasury, other U.S. agencies and other foreign governments


3,471


75



3,546





Other debt securities



374



374





Equity securities


53


207


362


622








3,720


6,566


362


10,648



Securities purchased under reverse repurchase agreements and












securities borrowed



87



87

















Loans



6,438


360


6,798

















Other












Derivative financial instruments


179


7,924


26


8,129




46,607


39,672


1,206


87,485
















Financial liabilities











Deposits



11,383



11,383

















Other












Obligations related to securities sold short


8,352


4,497



12,849




Derivative financial instruments


156


6,674


22


6,852




Liabilities related to transferred receivables



8,215



8,215




Other liabilities



24



24




8,508


30,793


22


39,323


Note 3 - Fair Value of Financial Instruments (cont.) 

 

 

 

 

 









As at October 31, 2018








Level 1


Level 2


Level 3


Total financial

assets/liabilities

at fair value
















Financial assets











Securities












At fair value through profit or loss













Securities issued or guaranteed by














Canadian government


5,469


9,130



14,599






Canadian provincial and municipal governments



10,628



10,628






U.S. Treasury, other U.S. agencies and other foreign governments


314


249



563





Other debt securities



3,391


25


3,416





Equity securities


25,928


395


288


26,611








31,711


23,793


313


55,817




At fair value through other comprehensive income













Securities issued or guaranteed by














Canadian government


265


2,320



2,585






Canadian provincial and municipal governments



2,184



2,184






U.S. Treasury, other U.S. agencies and other foreign governments


123




123





Other debt securities



425



425





Equity securities



118


233


351








388


5,047


233


5,668



Securities purchased under reverse repurchase agreements and












securities borrowed



479



479

















Loans



5,722


386


6,108

















Other












Derivative financial instruments


97


8,491


20


8,608







32,196


43,532


952


76,680
















Financial liabilities











Deposits



10,210


11


10,221

















Other












Obligations related to securities sold short


12,524


5,256



17,780




Derivative financial instruments


211


5,798


27


6,036




Liabilities related to transferred receivables



7,714



7,714




Other liabilities



21



21







12,735


28,999


38


41,772


Financial Instruments Classified in Level 3

The Bank classifies financial instruments in Level 3 when the valuation technique is based on at least one significant input that is not observable in the markets. The valuation technique may also be based, in part, on observable market inputs. The following table shows the significant unobservable inputs used for the fair value measurements of financial instruments classified in Level 3 of the hierarchy.

 













As at October 31, 2019







Fair

value


Primary

valuation techniques


Significant

 unobservable inputs


Range of input values







       Low


       High


Financial assets













Securities






























Equity securities and other debt securities


820


Net asset value


Net asset value


100

%

100

%









Market comparable


EV/EBITDA(1) multiple


13

x

16

x









Discounted cash flows


Credit spread


460

Bps(2)

705

Bps(2)









Discounted cash flows


Discount Rate


4.50

%

14.38

%


Loans














Loans at fair value through profit or loss


360


Discounted cash flows


Discount rate


5.26

%

8.89

%









Discounted cash flows


Liquidity premium


3.56

%

7.34

%


Other














Derivative financial instruments
















Interest rate contracts


6


Discounted cash flows


Discount rate


2.20

%

2.20

%





Equity contracts


20


Option pricing model


Long-term volatility


4

%

35

%











Market correlation


21

%

31

%







1,206










Financial liabilities













Other














Derivative financial instruments
















Equity contracts


22


Option pricing model


Long-term volatility


5

%

49

%











Market correlation


(29)

%

89

%






22






















































As at October 31, 2018







Fair

value


Primary

valuation techniques


Significant

unobservable inputs


Range of input values







       Low


       High


Financial assets


<