Friday, July 04, 2008

2nd Reported Incident of Risk Management Failure at TD Securities' London Office in < 8 Months

The Globe and Mail, Tara Perkins & Paul Waldie, 4 July 2008

Toronto-Dominion Bank, which painstakingly avoided the subprime mortgage trouble that forced its peers to take massive subprime writedowns, said it was taking a $96-million hit on Friday after discovering that a London trader had deceived the bank about the value of securities he traded.

The bank will now join the ranks of its competitors pushed to review their risk controls in recent months.

Chief executive officer Ed Clark said TD has a strong culture of risk control and “we deeply regret this incident.” He has staked the bank's reputation on its ability to avoid exposure structured credit products that are too risky.

The writedown that TD revealed on Friday stems from a circumvention of controls, a spokesperson for the bank said. This is not an instance of complicated securities plunging in value, but of an individual mispricing the value of credit derivatives in which the bank trades openly.

“We will work aggressively to strengthen our controls,” the spokesperson said. “We are very disappointed, because we have a reputation for a very strong risk culture.”

The bank's examination indicates that the person was acting alone, she added.

Mike Peterson, managing editor of London-based Creditflux, an industry publication on structured credit, believes TD revealed the writedown Friday as a result of questions the publication put to the bank.

“We got a cryptic anonymous tipoff a few days ago, and a more specific anonymous tipoff at the beginning of our day today,” he said Friday.

Creditflux reported Friday that the book at the centre of the apparent mispricing is the structured credit element of TD's proprietary credit trading business.

TD would not identify the individual involved, citing individual privacy. In a brief statement Friday, the bank said it had “regrettably identified incorrectly priced financial instruments in its London office.” The office houses roughly 225 employees.

“This situation is associated with the activities of an individual who is no longer with the company,” the bank said.

TD spokeswoman Simone Philogène said the individual stopped working at TD as of June 23. When the bank was transferring the individual's responsibilities, it identified financial instruments that were priced incorrectly, she said.

The company has apprised the Financial Services Authority, which regulates financial services in Britain, and the Office of the Superintendent of Financial Institutions, which regulates Canadian banks.

“The bank is investigating the matter,” said Rod Giles, a spokesman for OSFI.

The financial instruments that were apparently mispriced are credit derivatives – a contract between two parties who agree to sell or buy credit risk. Specifically, the securities were investment grade indexes and index tranches, and prices should have been relatively easy to establish.

“We take this very seriously and will make every effort to ensure that this doesn't happen again,” Mr. Clark said.

Other banks have faced such a situation recently. Morgan Stanley suspended a London trader in June for overstating the value of credit securities on the books, forcing a $120-million (U.S.) writedown.

Last year, Bank of Montreal parted ways with a natural gas trader and his boss after discovering mispricing in its natural gas book, which cost the bank more than $800-million.
Reuters, 4 July 2008

Toronto-Dominion Bank, Canada’s second-largest bank, said on Friday it will take a pretax charge of about C$96 million ($94 million) for the mispricing of derivatives by a senior trader who has left the London office of its investment dealer unit.

TD Bank said that the charge in its TD Securities unit was tied to credit derivatives that were not properly priced, and said the unnamed trader left the bank on June 23.

TD discovered the mispriced credit index swaps the same day, spokeswoman Simone Philogene said.

The bank said it was cooperating with regulators.

A spokeswoman for Britain’s Financial Services Authority said that it does not comment on individual firms.

TD Bank President and Chief Executive Ed Clark said the bank was ”very disappointed” with the loss.

”Our company has a strong risk culture and we deeply regret this incident. We take this very seriously and will make every effort to ensure that this doesn’t happen again.”

TD shares closed down 25 Canadian cents, or 0.4 percent, at C$63.09 a share on the Toronto Stock Exchange on Friday.

Analysts said investors would probably overlook the charge, even though it exceeds the C$93 million in wholesale banking profit that TD reported in the second quarter.

”I think in this case, TD has done extremely well through the credit crunch so far, and I don’t think people are going to change their assessment of the risk management culture yet,” said Ohad Lederer, a banking analyst at Veritas Investment Research in Toronto.

In June, Wall Street bank Morgan Stanley said it had suspended a London-based credit trader who had overvalued positions by $120 million, prompting a writedown of the same amount, and in May, Lehman Brothers Holdings Inc suspended two London equities traders after identifying a similar problem.

TD has largely steered clear of harm during the credit crisis, in part because retail banking in Canada and the United States makes up the bulk of its operations.

In the most recent quarter, which ended April 30, retail businesses produced about 90 percent of the bank’s total profit of C$852 million.

TD Securities does currency and international fixed income trading in London, as well as institutional equity sales and trading.

TD will swallow a relatively small loss from the mispriced credit derivatives, a second analyst said, compared with the billions of dollars in writedowns taken at U.S., European and other Canadian banks as a result of weak credit markets.

”That’s a pretty small hit,” said Douglas Davis, president at Davis-Rea. ”I think TD wants to be known as the most defensive bank with the cleanest balance sheet.”

TD’s Canadian peers, Bank of Montreal, Canadian Imperial Bank of Commerce, and Royal Bank of Canada, have reported bigger charges in the past year.

In the case of BMO, the culprits were commodity trading and structured-finance losses. CIBC has taken hits for various credit-market securities and hedges with downgraded bond insurers. And RBC’s charges covered a variety of asset-backed, structured credit and auction rate securities.
The Canadian Press, 4 July 2008

Toronto-Dominion Bank has disclosed a $96-million loss caused by “incorrectly priced financial instruments” at the TD Securities office in London.

The bank blamed “an individual who is no longer with the company” and said Friday it is co-operating with regulators.

TD did not say whether the losses were linked to trading mistakes or whether any wrongdoing or criminal activity was involved.

The loss is nothing like the €5-billion ($8-billion) hit suffered in January by France's Société Générale SA and attributed to rogue activity by trader Jerome Kerviel. But it is an embarrassment for TD, which has prided itself on avoiding much of the trouble which has engulfed other banks worldwide since a global credit crunch swept the financial sector last summer.

“We are very disappointed that this has occurred,” TD chief executive officer Ed Clark said in a brief statement which offered no details of the malfunction.

“Our company has a strong risk culture and we deeply regret this incident. We take this very seriously and will make every effort to ensure that this doesn't happen again.”

A TD spokeswoman said the individual was a senior trader in the London office who traded credit derivatives. Discrepancies in his accounts were discovered after he left TD on Monday, June 23.

“We identified financial instruments that were priced incorrectly,” said Simone Philogène.

She declined to release the trader's name or where he went, saying she could provide very little information about the former employee due to privacy considerations.

“What I can tell you is we had a senior trader in our London office leave our employ on Monday, June the 23rd, and upon transitioning his accountabilities we identified incorrectly priced financial instruments,” she said.

The financial instruments were credit index swaps — complex futures or derivatives contracts used by traders to spread credit risks.

“It's an account we trade for the bank, so there's no client money involved,” Ms. Philogène said.

The bank is co-operating with Britain's Financial Services Authority which is investigating the incident.

The TD Securities division provides a wide range of capital market products and services to corporate, government and institutional clients, including investment and corporate banking and interest-rate, currency and derivatives instruments.

TD was widely hailed by analysts earlier this year for its tight risk-management practices, which helped the financial institution avoid the massive debt writedowns that dragged its five main Canadian rivals to post billions of dollars in losses linked to the subprime-mortgage market in the United States.

The charge the bank is taking is not a large one, amounting to only about 7 per cent of the bank's $852-million profit in the second quarter ended April 30. TD will report its fiscal third quarter results Aug. 28 and may include the latest charge in its finances then.