Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-K

 
x
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the fiscal year ended December 31, 2005.

o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from ________ to ________.

Commission File Number: 1-14103

NB CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)

Maryland
52-2063921
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

65 East 55TH Street, 31st Floor
  
New York, New York
10022
(Address of principal executive offices)
(Zip code)

Registrant's telephone number, including area code: (212) 632-8697

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

8.35% Non-cumulative Exchangeable Preferred Stock, Series A, par value $ .01 per share,
traded in the form of Depository Shares, each representing a one-fortieth interest therein

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer x

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of December 31, 2005, all Common Stock, par value $ .01 per share, was held by an affiliate.

As of December 31, 2005, the number of shares of Common Stock outstanding was 100.

Documents Incorporated by reference:

None.

FORWARD-LOOKING STATEMENTS

From time to time, NB Capital Corporation (the "Company" or "NB Capital") makes written and oral forward-looking statements, included in this annual report on Form 10-K for filing with the U.S. Securities and Exchange Commission, in reports to shareholders, in press releases and in other communications. All such statements are made pursuant to the “safe harbor” provisions of the United States Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements with respect to the economy, market changes, the achievement of strategic objectives, certain risks as well as statements with respect to our beliefs, plans, expectations, anticipations, estimates and intentions. These forward-looking statements are typically identified by the words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” and words and expressions of similar import.

By their very nature, such forward-looking statements require us to make assumptions that involve inherent risks and uncertainties, both general and specific. There is significant risk that express or implied projections contained in such statements will not materialize or will not be accurate. A number of factors could cause actual future results, conditions, actions or events to differ materially from the targets, expectations, estimates or intentions expressed in the forward-looking statements. Such differences may be caused by factors, many of which are beyond the Company’s control, which include, but are not limited to, changes in North American and/or global economic and financial conditions (particularly fluctuations in interest rates, currencies and other financial instruments), liquidity, market trends, regulatory developments and competition in geographic areas where the Company operates, technological changes, the possible impact on our businesses of international conflicts and other developments including those relating to the war on terrorism and the Company’s anticipation of and success in managing the risks implied by the foregoing.

The Company cautions that the foregoing list of important factors is not exhaustive. Investors and others who base themselves on the Company’s forward-looking statements should carefully consider the above factors as well as the uncertainties they represent and the risk they entail. The Company therefore cautions readers not to place undue reliance on these forward-looking statements. The Company does not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of the Company.

EXCHANGE RATE

References to “$” are to United States dollars; references to “C$” are to Canadian dollars. As of December 31, 2005, the Canadian dollar exchange rate was C$1.1630 = $1.00 and certain amounts stated herein reflect such exchange rate. The exchange rate was obtained from the Bank of Canada.
 
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PART I

ITEM 1: BUSINESS

General

On August 20, 1997, NB Capital Corporation (the "Company") was incorporated under the laws of the State of Maryland for the purposes of providing U.S. investors with the opportunity to invest in Canadian residential mortgages and other real estate assets. The Company began operations on September 3, 1997 with the consummation of an offering of 300,000 shares of its 8.35% Non-cumulative Exchangeable Preferred Stock, Series A (the "Series A Preferred Shares"). The Series A Preferred Shares trade on the New York Stock Exchange in the form of Depository Shares, each representing a one-fortieth interest in a Series A Preferred Share (the "Depository Shares"). National Bank of Canada (the "Bank") owns all of the Company's issued and outstanding common stock, par value $.01 per share (the "Common Stock"). Accordingly, the Company is a wholly owned subsidiary of the Bank.

The Company's principal business objective is to acquire, hold, finance and manage assets consisting of obligations secured by real property ("Mortgage Assets") as well as certain other qualifying real estate investment trust ("REIT") assets. The Mortgage Assets currently consist of 65 "hypothecation" loans issued to the Company by NB Finance, Ltd. ("NB Finance"), a Bermuda corporation and a wholly owned subsidiary of the Bank, that are recourse only to the "Mortgage Loans". Hypothecation loans are loans secured by the pledge of mortgages as security therefore. The Mortgage Loans consist of 65 pools of, at December 31, 2005, an aggregate 12,244 residential first mortgages insured by Canada Mortgage and Housing Corporation, an agency of the Government of Canada ("CMHC"), that are secured by real property located in Canada. The Company has acquired and expects to continue to acquire its Mortgage Assets from the Bank and affiliates of the Bank. The Company may also from time to time, however, acquire Mortgage Assets from unrelated third parties.

The Bank administers the day-to-day operations of the Company pursuant to an Advisory Agreement, dated September 3, 1997, between the Bank and the Company (the "Advisory Agreement"). The Bank also services the Mortgage Loans pursuant to a Servicing Agreement, dated September 3, 1997, between the Bank and NB Finance (the "Servicing Agreement"). Pursuant to an Assignment Agreement, NB Finance has assigned to the Company all of its right, title and interest in the Servicing Agreement.

In order to preserve the Company’s status as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), substantially all of the assets of the Company consist of the Mortgage Assets issued by NB Finance and other real estate assets that are of the type set forth in Section 856(c)(6)(B) of the Code.

For information regarding the Company's revenue and operating profit, see the Company's financial statements, beginning on page F-1.

Automatic Exchange
 
Each Series A Preferred Share will be exchanged automatically for one newly issued 8.45% Non-cumulative First Preferred Share, Series Z, of the Bank (a "Bank Preferred Share"): (i) immediately prior to such time, if any, at which the Bank fails to declare and pay or set aside for payment when due on any dividend on any issue of its cumulative First Preferred Shares or the Bank fails to pay or set aside for payment when due any declared dividend on any of its non-cumulative First Preferred Shares, (ii) in the event that the Bank has a Tier 1 risk-based capital ratio of less than 4.0% or a total risk-based capital ratio of less than 8.0%, (iii) in the event that the Superintendent of Financial Institutions Canada (the "Superintendent") takes control of the Bank pursuant to the Bank Act (Canada), as amended (the "Bank Act"), or proceedings are commenced for the winding-up of the Bank pursuant to the Winding-up and Restructuring Act (Canada), or (iv) in the event that the Superintendent, by order, directs the Bank to act pursuant to subsection 485(3) of the Bank Act and the Bank elects to cause the exchange (each, an "Exchange Event"). Upon an Exchange Event, the holders of the Series A Preferred Shares shall be unconditionally obligated to surrender to the Bank the certificates representing the Series A Preferred Share held by such holder, and the Bank shall be unconditionally obligated to issue to such holder in exchange for each such Series A Preferred Share a certificate representing one Bank Preferred Share.
 
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The Automatic Exchange shall occur as of 8:00 a.m. Eastern Time on the date for such exchange set forth in the requirements of the Superintendent or, if such date is not set forth in such requirements as of 8:00 a.m. on the earliest possible date such exchange could occur consistent with such requirements (the "Time of Exchange"), as evidenced by the issuance by the Bank of a press release prior to such time. As of the Time of Exchange, all of the Series A Preferred Shares will be deemed cancelled without any further action by the Company, all rights of the holders of the Series A Preferred Shares as stockholders of the Company will cease, and such persons shall thereupon and thereafter be deemed to be and shall be for all purposes holders of Bank Preferred Shares. The Company will mail notice of the occurrence of an Exchange Event to each holder of the Series A Preferred Shares within 30 days of such event, and the Bank will deliver to each such holder certificates for the Bank Preferred Shares upon surrender of such holder’s certificates for the Series A Preferred Shares. The charter provides that, immediately after the delivery of such notice, the existence of the Company shall terminate and the Company will be liquidated and its affairs wound up in accordance with the procedures of the Maryland General Corporation Law relating to forfeiture of the charter of a corporation and expiration of corporate existence. Until such replacement stock certificates are delivered (or in the event such replacement certificates are not delivered), certificates previously representing the Series A Preferred Shares shall be deemed for all purposes to represent the Bank Preferred Shares. Once an Exchange Event occurs, no action will be required to be taken by holders of the Series A Preferred Shares, by the Bank or by the Company in order to effect an automatic exchange as of the Time of Exchange.

Holders of the Series A Preferred Shares, by purchasing the Series A Preferred Shares, have agreed to be bound by the unconditional obligation to exchange such Series A Preferred Shares for the Bank Preferred Shares upon the occurrence of an Exchange Event. The obligation of the holders of the Series A Preferred Shares to surrender such shares and the obligation of the Bank to issue the Bank Preferred Shares in exchange for the Series A Preferred Shares shall be enforceable by the Bank and such holders, respectively, against the other.

Upon the occurrence of an Exchange Event, the Bank Preferred Shares to be issued as part of an automatic exchange would constitute a newly issued series of First Preferred Shares of the Bank and would constitute 100% of the issued and outstanding Bank Preferred Shares. The Bank Preferred Shares would have the same liquidation preference and be subject to redemption on the same terms as the Series A Preferred Shares (except that there would be no redemption for certain tax-related events). Any accrued and unpaid dividends on the Series A Preferred Shares as of the Time of Exchange would be accounted for as accrued and unpaid dividends on the Bank Preferred Shares. The Bank Preferred Shares would rank pari passu, in terms of dividend payments and liquidation preference, with, or senior to, any outstanding First Preferred Shares of the Bank. The Bank Preferred Shares would not entitle the holders to vote except in certain circumstances. Dividends on the Bank Preferred Shares would be non-cumulative and payable at the rate of 8.45% per annum of the liquidation preference, if, when and as declared by the Board of Directors of the Bank. The Bank does not intend to apply for listing of the Bank Preferred Shares on any national securities exchange or for quotation of the Bank Preferred Shares through the National Association of Securities Dealers Automated Quotation System. Absent the occurrence of an Exchange Event, however, the Bank will not issue any Bank Preferred Shares, although the Bank will be able to issue First Preferred Shares in series other than that of the Bank Preferred Shares. There can be no assurance as to the liquidity of the trading markets for the Bank Preferred Shares, if issued, or that an active public market for the Bank Preferred Shares would develop or be maintained.

Holders of the Series A Preferred Shares cannot exchange the Series A Preferred Shares for the Bank Preferred Shares voluntarily. In addition, absent the occurrence of an automatic exchange, holders of the Series A Preferred Shares will have no dividend, voting, liquidation preference or other rights with respect to the Bank or any security of the Bank.
 
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Advisory Agreement

The Company entered into the Advisory Agreement with the Bank to administer the day-to-day operations of the Company. The Bank is responsible for (i) monitoring the credit quality of Mortgage Assets held by the Company, (ii) advising the Company with respect to the reinvestment of income from and payments on, and with respect to the acquisition, management, financing and disposition of, Mortgage Assets held by the Company, (iii) holding documents relating to the Company’s Mortgage Assets as custodian, (iv) monitoring the Company’s compliance with the requirements necessary to qualify as a REIT and (v) maintaining its status as a lender approved by the Canadian National Housing Act (an "NHA-Approved Lender"). As long as any Series A Preferred Shares and, accordingly, any Depository Shares remain outstanding, the Company may not renew, terminate, or modify the Advisory Agreement without the approval of a majority of the Board of Directors of the Company (the "Board of Directors") as well as of a majority of the Independent Directors. An "Independent Director" is a Director meeting the criteria specified in 10A-3 of the Securities Exchange Act of 1934. The Bank may, with the approval of a majority of the Board of Directors as well as a majority of the Independent Directors, subcontract all or a portion of its obligations under the Advisory Agreement to one or more related or unrelated third parties. The Bank will not, in connection with the subcontracting of any of its obligations under the Advisory Agreement, be discharged or relieved in any respect from any of its obligations under the Advisory Agreement. As of the date of this Form 10-K, the Bank has not subcontracted any of its obligations under the Advisory Agreement.

The Advisory Agreement had an initial term of one year, and has been renewed eight times for additional one-year periods. The last renewal was dated November 1, 2005 and its expiration date is November 1, 2006. The Company may terminate the Advisory Agreement at any time upon 60 days’ prior written notice. As long as any of the Series A Preferred Shares or Depository Shares remain outstanding, any decision by the Company to renew, terminate or modify the Advisory Agreement must be approved by a majority of the Board of Directors, as well as by a majority of the Independent Directors. The Bank received an advisory fee equal to $100,000 for fiscal year 2005 and is entitled to receive $100,000 for fiscal year 2006, payable in equal quarterly instalments with respect to the advisory and management services provided by it to the Company. Payment of such fees is subordinated to payments of dividends on the Series A Preferred Shares and, accordingly, the Depository Shares.

Servicing Agreement

The Mortgage Loans are serviced by the Bank pursuant to the terms of the Servicing Agreement. The Bank receives a fee equal to 0.25% per annum on the principal balances (in US$) of the loans serviced.

The Servicing Agreement, put in place on September 3, 1997, had an initial term of one year, and has been renewed eight times for additional one-year periods. The last renewal was made on May 9, 2005 for a one-year period ending on June 28, 2006. The Servicing Agreement requires the Bank to service Mortgage Loans in a manner generally consistent with normal mortgage servicing practices of prudent mortgage lending institutions that service mortgage loans of the same type as the Mortgage Loans, with any servicing guidelines promulgated by the Company and with relevant government agency guidelines and procedures. The Servicing Agreement requires the Bank to service Mortgage Loans solely with a view toward the interests of the Company and without regard to the interests of the Bank or any of its other affiliates (including NB Finance). The Bank collects and remits principal and interest payments, administers mortgage escrow accounts, submits and pursues mortgage insurance claims and supervises foreclosure proceedings on any Mortgage Loans it services. The Bank also provides accounting and reporting services with respect to such Mortgage Loans. The Servicing Agreement requires the Bank to follow such collection procedures as are customary in normal mortgage servicing practices of prudent mortgage lending institutions that service mortgage loans of the same type as the Mortgage Loans. The Bank may from time to time subcontract all or a portion of its servicing obligations under the Servicing Agreement to a third party subject to the prior written approval of the Company. The Bank will not, in connection with subcontracting any of its obligations under the Servicing Agreement, be discharged or relieved in any respect from its obligation to the Company to perform its obligations under the Servicing Agreement. As of the date of this Form 10-K, the Bank has not subcontracted any of its obligations under the Servicing Agreement.
 
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The Bank is required to pay all expenses related to the performance of its duties under the Servicing Agreement. The Bank is required to make advances of taxes and required insurance premiums that are not collected from mortgagors with respect to any Mortgage Loan serviced by it, unless it determines that such advances are non recoverable from the mortgagor, insurance proceeds or other sources with respect to such Mortgage Loan. If such advances are made, the Bank generally will be reimbursed prior to the Company being reimbursed out of the payments with respect to such Mortgage Loan. The Bank also is entitled to reimbursement for expenses incurred by it in connection with the liquidation of defaulted Mortgage Loans serviced by it and in connection with the restoration of mortgaged property. The Bank is responsible to the Company for any loss suffered as a result of the Bank's failure to make and pursue timely claims or as a result of actions taken or omissions made by the Bank which cause the policies to be cancelled by the insurer. Subject to approval by the Company, the Bank may institute foreclosure proceedings, exercise any power of sale contained in any Mortgage Loan or deed of trust, obtain a deed in lieu of foreclosure or otherwise acquire title to a mortgaged property underlying a Mortgage Loan by operation of law or otherwise in accordance with the terms of the Servicing Agreement. The Bank does not, however, have the authority to enter into contracts in the name of the Company.

The Company may terminate the Servicing Agreement upon the occurrence of one or more events specified in the Servicing Agreement. Such events relate generally to the Bank's proper and timely performance of its duties and obligations under the Servicing Agreement. In addition, the Company may also terminate the Servicing Agreement without cause upon 60 days' notice and payment of a termination fee.  The termination fee will be based on the aggregate outstanding principal amount of the Mortgage Loans then serviced under the Servicing Agreement.

As is customary in the mortgage loan servicing industry, the Bank is entitled to retain any late payment charges, penalties and assumption fees collected in connection with the Mortgage Loans serviced by it. The Bank will receive any benefit derived from interest earned on collected principal and interest payments between the date of collection and the date of remittance (15th calendar day) to the Company and, to the extent permitted by law, from interest earned on tax and insurance impound funds with respect to Mortgage Loans serviced by it.

When any mortgaged property underlying a Mortgage Loan is conveyed by a mortgagor, the Bank generally will enforce any "due-on-sale" clause contained in the Mortgage Loan, to the extent permitted under applicable law and governmental regulations. A "due-on-sale" clause states that the Mortgage loan must be paid when the mortgaged property is sold. The terms of a particular Mortgage Loan or applicable law, however, may provide that the Bank is prohibited from exercising the "due-on-sale" clause under certain circumstances related to the security underlying the Mortgage Loan and the buyer's ability to fulfill the obligations thereunder. Upon any assumption of a Mortgage Loan by a transferee, a nominal fee is typically required, which sum will be retained by the Bank as additional servicing compensation.

Investment Policy

The Company’s principal business objective is to acquire, hold, finance and manage Mortgage Assets as well as certain other qualifying REIT assets. The Company's current investment policy is to invest at least 80% of its portfolio in Mortgage Assets issued by NB Finance and the remainder in any other assets eligible to be held by a REIT. Such other assets include Mortgage Loans, residential mortgage loans, mortgage-backed securities, commercial mortgage loans, partnership interests, cash, cash equivalents, government securities and shares or interests in other REITs. As of December 31, 2005, Mortgage Assets issued by NB Finance comprised 85.48% of the Company’s portfolio.

The Company expects to continue to follow the foregoing investment policy approved at the Board on December 6, 2000. However, this policy may be amended or revised from time to time at the discretion of the Board of Directors (in certain circumstances subject to the approval of a majority of the Independent Directors) without a vote of the Company's stockholders. All investments will be made primarily for income.

Description of the Mortgage Assets

The Mortgage Assets issued by NB Finance are comprised of 65 hypothecation loans issued by NB Finance to the Company. As of December 31, 2005, the principal amount of the Mortgage Assets was approximately $410 million. Each of the 65 hypothecation loans comprising the Mortgage Assets issued by NB Finance is secured by a pool of Mortgage Loans. As of December 31, 2005, the Mortgage Loans were comprised of, in the aggregate, 12,244 Mortgage Loans in an aggregate amount of approximately C$682 million ($587 million). The value of each pool of Mortgage Loans comprising the Mortgage Assets exceeds the principal amount of the hypothecation loan that it secures. Accordingly, the Mortgage Assets issued by NB Finance are over collateralized by the Mortgage Loans. The aggregate amount of such over collateralization is, as of December 31, 2005, $177 million. The Company acquired the Mortgage Assets issued by NB Finance pursuant to the terms of a loan agreement with NB Finance.
 
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Each Mortgage Asset issued by NB Finance is recourse only to the Mortgage Loans securing such Mortgage Asset. Each pool of Mortgage Loans is comprised of entirely CMHC-insured residential first mortgages. Each Mortgage Asset issued by NB Finance is further secured by the residential real properties underlying such CMHC-insured first mortgages. Such residential real properties are located primarily in Quebec, Ontario and New Brunswick. Since the Mortgage Loans are insured, the Company expects little or no loss of principal or interest. However, CMHC insurance does not guarantee timely payment of interest and principal. The Mortgage Assets have maturities ranging from January 2006 to January 2015. The Mortgage Assets pay interest at rates ranging from 5.49% to 10.21%, with a weighted-average rate of approximately 7.76% per annum.

Payments of interest are made monthly out of payments on the Mortgage Loans. Pursuant to an agreement between the Company and NB Finance (the "Mortgage Loan Assignment Agreement"), dated September 3, 1997, the Company receives all scheduled payments made on the Mortgage Loans, retains a portion of any such payments equal to the amount due and payable on the Mortgage Assets issued by NB Finance and remits the balance, if any, to NB Finance. The Company also retains a portion of any prepayments of principal in respect of the Mortgage Loans equal to the proportion of such prepayments that the outstanding principal amount of the Mortgage Loan bears to the outstanding principal amount of the Mortgage Assets issued by NB Finance, which amount would be applied to reduce the outstanding principal amount of the Mortgage Assets issued by NB Finance. Repayment of the Mortgage Assets issued by NB Finance is secured by an assignment of the Mortgage Loans to the Company pursuant to the Mortgage Loan Assignment Agreement, which is governed by the laws of Bermuda.

The assignment of the Mortgage Loans by NB Finance to the Company is without recourse. The Company has a security interest in the real property securing the Mortgage Loans and, subject to fulfilling certain procedural requirements under applicable Canadian law, is entitled to enforce payment on the Mortgage Loans in its own name if a mortgagor should default thereon. In the event of such a default, the Company has the same rights as NB Finance to force a sale of the mortgaged property and satisfy the obligations of NB Finance out of the proceeds. In the event of a default in respect of a Mortgage Loan, the amount of the Mortgage Assets issued by NB Finance will be reduced by an amount equal to the portion thereof allocable to the defaulting mortgage.

Following repayment of the Mortgage Assets issued by NB Finance, the Company will reassign any outstanding Mortgage Loans (without recourse) and deliver them to, or as directed by, NB Finance. All payments in respect of the Mortgage Loans are made in Canadian dollars. The amounts due on the Mortgage Assets issued by NB Finance are retained by the Company free and clear of and without withholding or deduction for or on account of any present or future taxes imposed by or on behalf of Bermuda or any political subdivision thereof or therein.

Description of the Mortgage Loans
 
All of the Mortgage Loans were originated in accordance with underwriting policies customarily employed by the Bank, or with underwriting policies acceptable to the Bank. With respect to its underwriting policies, the Bank will not make any residential mortgage loans that exceed a loan to value ratio of 75% unless such loan is insured. If the residential mortgage loan is CMHC-insured (i) a cash down payment of between 5% and 24.9% is required, (ii) the monthly payment for capital, interest, taxes and heating must not exceed 32% of the gross monthly revenue of the borrower and (iii) the monthly payment for capital, interest, taxes, heating and all other monthly payments (including, without limitation, personal loans, lease payments and credit card debt service) must not exceed 40% of the net monthly revenue of the borrower. Additionally, for all mortgage loans, an external credit check must be positive. When a loan is insured, an additional amount may be added to the principal amount of the mortgage loan representing the premium related thereto. The premium rates vary in accordance with the principal amount of the loan. Generally, the greater the loan to value ratio, the greater the premium rate. As is generally the case in the Canadian residential mortgage business, such underwriting policies are derived from CMHC - approved underwriting criteria.
 
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As a CMHC - approved lender, the Bank has access to the National Housing Act mortgage insurance program. All of the Mortgage Loans are insured by CMHC pursuant to that program. The bulk of those loans were insured at origination. Whether a loan is insured at origination or through the CMHC portfolio insurance program, the insurance is valid until the expiration of the loan.

All of the Mortgage Loans are balloon mortgages. This means that the Mortgage Loans do not provide for the amortization of the principal balance thereof equally over their term to maturity: thus, a principal payment equal to the original balance less any principal amount paid will be due on each Mortgage Loan at maturity. Balloon mortgages are the most prevalent type of mortgage offered by Canadian mortgage lenders. At the expiration of the term, the mortgage is generally renewed, based on then current market conditions, for a new term. Although the Bank offers terms varying from 3 months to 10 years, terms exceeding 5 years are relatively rare. Moreover, although the Bank offers monthly, semi-monthly and weekly pay mortgages, the majority of the Mortgage Loans are monthly pay mortgages. In general, loans are amortized over a period not exceeding 25 years.

The Mortgage Loans provide for limited prepayment rights. For example, typically up to 10% of the original principal amount of a Mortgage Loan may be prepaid once annually without penalty. Moreover, a Mortgage Loan may also be prepaid without penalty if the mortgaged property is sold and the mortgagor enters into a new mortgage with the same terms and conditions as the Mortgage Loan. In most other circumstances, prepayments or renegotiations of either the interest rate or the term of a Mortgage Loan will be subjected to prepayment penalties. During the first five years following the most recent interest adjustment date, such penalties are tantamount to a yield maintenance clause. After five years, such penalties will be limited to three months of interest.

The Company intends and has the ability to hold the Mortgage Loans to maturity unless there is a prepayment by the customer or a Mortgage Loan is impaired.

Tax Status

The Company elected to be taxable as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company generally will not be liable for United States federal income tax to the extent that it distributes its income to the holders of its Common Stock and its preferred stock, including the Series A Preferred Shares and, accordingly, Depository Shares, and maintains its qualification as a REIT.

As a REIT, the Company is subject to a number of organizational and operational requirements, including a requirement that it currently distribute to stockholders at least 90% of its “REIT taxable income”. REIT taxable income is essentially taxable income, as determined in accordance with the Code, with certain adjustments. The most significant of such adjustments are (i) no deduction is allowed for dividends received, (ii) a deduction is allowed for dividends paid (other than the portion of any dividend attributable to net income from foreclosure property) and for taxes imposed for failing to satisfy certain statutory REIT requirements, and (iii) net income from foreclosure property and net income derived from prohibited transactions is excluded from the determination.

Employees

The Company has nine employees whose salaries are covered by the Advisory Agreement. The Company does not anticipate that it will require any additional employees because the Company retains the Bank to perform certain functions pursuant to the Advisory Agreement. The Company maintains corporate records and audited financial statements that are separate from those of the Bank and of any of the Bank's affiliates.
 
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Competition

The Company does not engage in the business of originating Mortgage Assets. While the Company will purchase additional Mortgage Assets, it anticipates that such Mortgage Assets will be purchased from the Bank and/or affiliates of the Bank. Accordingly, the Company does not compete with mortgage conduit programs, investment banking firms, savings and loan associations, banks, thrift and loan associations, finance companies, mortgage bankers or insurance companies in acquiring its Mortgage Assets.

As of October 31, 2005, the Bank held more than C$20.8 billion of residential mortgage assets. Slightly more than 76.4% of such mortgages were located in Quebec, the Bank's principal place of business. The major competitor of the Bank in Quebec is the Caisses Populaires Desjardins (a credit union). According to the Bank’s economics and strategy department, the market share of the Bank for such mortgages in Quebec is approximately 15.4% compared with a significantly greater market share for Caisses Populaires Desjardins.

Risk Factors

In order to maintain its REIT Status, the Company must maintain certain compliance ratios. If the Company fails to respect the compliance ratios then it would risk losing its REIT status as well as having to pay a penalty. As at December 31, 2005 the Company had respected the compliance ratios.

The Company believes that there are no other significant risk factors.

ITEM 2: PROPERTIES

The principal executive offices of the Company were located in the U.S. branch office of the Bank at 65 East 55th Street, New York, New York 10022 on December 31, 2005. The Company neither owns nor leases any properties.

ITEM 3: LEGAL PROCEEDINGS

The Company is not subject to any material litigation. The Company is not currently involved in nor, to the Company's knowledge, is it currently threatened with any material litigation other than routine litigation arising in the ordinary course of business, most of which is expected to be covered by liability insurance.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.
 
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PART II

ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Since the incorporation of the Company, the Bank has owned, and the Bank expects to continue to own, all of the issued and outstanding shares of the Common Stock of the Company. The Common Stock is the Company’s only class of common equity issued and outstanding. Accordingly, there is no established public trading market for the Company's common equity.
 
For the year ended December 31, 2004, the Company paid one dividend with respect to the Common Stock in an amount of $10,500,000. For the year ended December 31, 2005, the Company paid one dividend with respect to the Common Stock in an amount of $6,500,000.
 
On January 19, 1998, the Company sold 110 shares of its Adjustable Rate Cumulative Senior Preferred Shares, par value $.01 per share (the "Senior Preferred Shares") in a non-public offering. The Senior Preferred Shares are not and were not required to be registered under the Securities Act of 1933, as amended (the "Securities Act"). The offering of the Senior Preferred Shares was not underwritten. The Senior Preferred Shares were offered to (a) accredited investors (as defined in Rule 501(a) of Regulation D under the Securities Act) in reliance on an exemption from registration pursuant to Section 4(2) of the Securities Act relating to transactions not involving a public offering and (b) certain directors and officers of the Company and its affiliates who reside in Canada and who were able to make certain representations and warranties pursuant to Regulation S of the Securities Act. Investors were required to complete an Investor Questionnaire to verify their status as: (a) an accredited investor or (b) a resident of Canada. The Senior Preferred Shares are not convertible or exchangeable. The Senior Preferred Shares were offered and sold for $3,000 each or $330,000 in the aggregate and the proceeds were used to meet the working capital needs of the Company.

ITEM 6: SELECTED FINANCIAL DATA 

   
Year Ended
December 31, 2005
  
Year Ended
December 31, 2004
  
Year Ended
December 31, 2003
  
Year Ended
December 31, 2002
  
Year Ended
December 31, 2001
  
Statement of Income Data:
                      
Operating Revenues
  
 
$35,342,570
  
 
$36,322,291
  
 
$37,895,366
  
 
$37,707,287
  
 
$38,387,349
  
Income from Operations
  
 
$33,344,602
  
 
$34,459,040
  
 
$36,103,421
  
 
$36,054,804
  
 
$36,800,230
  
Income from Operations / Common Share
 
 
$333,446
  
 
$344,590
  
 
$361,034
  
 
$360,548
  
 
$368,002
  
Balance Sheet Data:
                        
Total assets
  
 
$479,610,581
  
 
$477,763,501
  
 
$478,884,177
  
 
$482,278,189
  
 
$481,787,476
  
Total liabilities
  
 
$518,994
  
 
$444,371
  
 
$456,663
  
 
$386,175
  
 
$379,706
  
Stockholders’ Equity
  
 
$479,091,587
  
 
$477,319,130
  
 
$478,427,514
  
 
$481,892,014
  
 
$481,407,770
  
Cash Dividends Declared / Common Share
  
 
$65,000
  
 
$105,000
  
 
$145,000
  
 
$105,000
  
 
$105,000
  
                                 
 
 
-10-

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

General

The Company’s principal business objective is to acquire, hold, finance and manage Mortgage Assets as well as other qualifying REIT assets. The Company elected to be taxed as a REIT under the Code and, accordingly, is generally not liable for United States federal income tax to the extent that it distributes at least 90% of its taxable income, subject to certain adjustments, to its stockholders.

Results of Operations

Income from operations for the year ended December 31, 2005 decreased by $1,114,438 or 3.23 % over the prior year ended December 31, 2004, which decreased by $1,644,381 or 4.56 % over the prior year ended December 31, 2003. Operating revenues for the year ended December 31, 2005, the year ended December 31, 2004 and the year ended December 31, 2003, each of which were comprised entirely of interest income, were $35,342,570, $36,322,291 and $37,895,366, respectively. The decrease in 2005 was mainly due to lower interest rates on newly acquired Mortgage Assets as well as a lower average outstanding balance of Promissory notes in 2005 of $430,053,653 compared to $433,743,251 in 2004. Because the Company has elected to be taxed as a REIT, no income tax was recorded during the year except for non-resident income taxes withheld.
 
Ninety-six percent of revenues were derived from the Mortgage Assets issued by NB Finance. The Mortgage Assets issued by NB Finance are collateralized by the Mortgage Loans that consist of 65 pools of residential first mortgages insured by CMHC and that are secured by real property located in Canada. The balance of the revenues resulted from interest on bank deposits and short-term investments (i.e., commercial paper and U.S. Treasury bills).
 
Expenses for the year ended December 31, 2005, the year ended December 31, 2004 and the year ended December 31, 2003 totalled $1,997,968, $1,863,251 and $1,791,945, respectively. Servicing and advisory fees for the year ended December 31, 2005, the year ended December 31, 2004 and the year ended December 31, 2003 totalled $1,614,444, $1,598,279 and $1,527,130, respectively. Pursuant to the Servicing Agreement and the Advisory Agreement, the Bank performs all necessary operations in connection with administering the Mortgage Assets issued by NB Finance and the Mortgage Loans. Other professional fees include payment to the transfer agent, external accounting fees and miscellaneous expenses.
 
During the year ended December 31, 2005, the Board of Directors of the Company authorized dividends of, in the aggregate, $25,072,145 on Preferred Stock (i.e., Senior Preferred Shares and the Series A Preferred Shares and, accordingly, the Depository Shares) and a dividend of $6,500,000 on Common Stock.

Capital Resources and Liquidity

The Company’s revenues are derived primarily from interest payments on the Mortgage Assets. As of December 31, 2005, $410 million of Mortgage Assets issued by NB Finance were over-collateralized by C$682 million ($587 million) of Mortgage Loans. The Company believes that the amounts generated from the payment of interest and principal on such Mortgage Loans will provide more than sufficient funds to make full payments with respect to the Mortgage Assets issued by NB Finance and that such payments will provide the Company with sufficient funds to meet its operating expenses and to pay quarterly dividends on the Senior Preferred Shares and the Series A Preferred Shares and, accordingly, the Depository Shares. To the extent that the cash flow from its Mortgage Assets exceeds those amounts, the Company will use the excess to fund the acquisition of additional Mortgage Assets and make distributions on the Common Stock.
 
The Company does not require any capital resources for its operations and, therefore, it does not expect to acquire any capital assets in the foreseeable future.
 
-11-
 
As of December 31, 2005, the Company had cash resources of $59,900,966, or 12.49% of total assets compared to $58,327,311 or 12.21% of total assets as of December 31, 2004 and $19,405,571, or 4.05% of total assets as at December 31, 2003. It is expected that the Company will invest in additional Mortgage Assets when cash resources reach 15% of total assets. The liquidity level is sufficient for the Company to pay fees and expenses pursuant to the Servicing Agreement and the Advisory Agreement. The Company expects to make a purchase of additional Mortgage Assets in the beginning of 2006.
 
The Company’s principal short-term and long-term liquidity needs are to pay quarterly dividends on the Senior Preferred Shares and the Series A Preferred Shares and, accordingly, the Depository Shares, to pay fees and expenses of the Bank pursuant to the Servicing Agreement and the Advisory Agreement, and to pay expenses of advisors, if any, of the Company.

Disclosure of Contractual Obligations

The Company does not have any indebtedness (current or long-term), material capital expenditures, balloon payments or other payments due on other long-term obligations. No negative covenants have been imposed on the Company.

Off-Balance Sheet Accounting

The Company does not have any off-balance sheet obligations.

Disclosure About Market Risk

Any market risk to which the Company would be exposed would result from fluctuations in: (a) interest rates and (b) currency exchange rates affecting the interest payments received by the Company in respect of the Mortgage Assets issued by NB Finance. Since the Mortgage Assets are significantly over collateralized by the Mortgage Loans, interest rate fluctuations should not present significant market risk. The Company expects that the interest and principal generated by the Mortgage Loans should enable full payment by NB Finance of all of its obligations as they come due. Since the Mortgage Loans are guaranteed by a fixed ratio of exchange predetermined on the date of purchase and applicable until the maturity of the Mortgage Loans pursuant to the Mortgage Loan Assignment Agreement, fluctuations in currency exchange rates should not present significant market risk.

Critical Accounting Policies

In December 2001, the Securities and Exchange Commission requested that all registrants discuss their most "critical accounting policies" in management's discussion and analysis of financial condition and results of operations. The SEC indicated that a "critical accounting policy" is one which is both important to the portrayal of the Company's financial condition and results and requires management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe, based on our current business, that there are no critical accounting policies in connection with the preparation of the financial statements of the Company.

Recently Issued Accounting Pronouncements

In May 2005, FASB issued FAS 154 “Accounting Changes and Error Corrections” which replaces APB opinion No.20 and FASB Statement No.3. FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections and states that unless impracticable, retrospective application is the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The adoption of Statement No.154, which will apply to the Company effective January 1st 2006, will not have a material impact on the Company's financial reporting and disclosure.
 
-12-

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This information is included under Item 7 of this report under the caption “Disclosure About Market Risk”.

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements are contained on pages F-1 through F-9 of this Form 10-K.

Selected Quarterly Financial Data (Unaudited)

   
Quarter Ended
March 31,
2005
  
Quarter Ended
June 30,
2005
  
Quarter Ended
September 30,
2005
  
Quarter Ended
December 31,
2005
  
Statement of Income Data:
                  
Operating Revenues
  
 
$8,888,526
  
 
$8,978,728
  
 
$8,693,089
  
 
$8,782,227
  
Income from Operations
  
 
$8,399,897
  
 
$8,499,388
  
 
$8,187,874
  
 
$8,257,443
  
Income from Operations per Common Share
  
 
$83,999
  
 
$84,994
  
 
$81,879
  
 
$82,574
  
                         
 
 
Quarter Ended
March 31,
2004
  
Quarter Ended
June 30,
2004
  
Quarter Ended
September 30,
2004
  
Quarter Ended
December 31,
2004
  
Statement of Income Data:
                  
Operating Revenues
  
 
$8,885,094
  
 
$9,339,454
  
 
$9,226,625
  
 
$8,871,118
  
Income from Operations
  
 
$8,439,642
  
 
$8,874,899
  
 
$8,741,613
  
 
$8,402,886
  
Income from Operations per Common Share
  
 
$84,396
  
 
$88,749
  
 
$87,416
  
 
$84,029
  
                           
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.

ITEM 9A: CONTROLS AND PROCEDURES

Based on their evaluation as of the end of the period covered by this report, the Company’s President and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
 
-13-

PART III
 
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

MANAGEMENT

Directors and Executive Officers

The Board of Directors of the Company consists of the individuals set forth below. Mr. Belzile, Mr. Michel and Mr. Dubé are Independent Directors. The Company currently has nine employees and does not anticipate that it will require additional employees.

As of December 31, 2005, the persons who are directors and executive officers of the Company are as follows:

Name
  
Age
  
Position and Offices Held
  
Director Since
Christian Dubé
  
49
  
Director and Member of the Audit Committee
  
2001
Donna Goral
  
48
  
Director and Vice President
  
2001
André Belzile
  
44
  
Director and Member of the Audit Committee
  
1999
Alain Michel
  
56
  
Director and Chairman of the Audit Committee
  
1997
Monique Baillergeau
  
47
  
Director and Vice President
  
2003
Hoda Abdelmessih
  
51
  
Director and Vice President
  
2004
Serge Lacroix
  
47
  
Director, Chairman of the Board and President
  
2002
Jean Dagenais
  
47
  
Chief Financial Officer
  
N/A

James J. Hanks, Jr. (Secretary) is an officer of the Company. Valérie Pelletier (Assistant Secretary), Martin-Pierre Boulianne (Assistant Secretary) and Martin Ouellet (Vice-President) are the only other employees of the Company. The following is a summary of the experience of the executive officers and current directors of the Company.
 
-14-
 
Since May 2004, Mr. Belzile has been Senior Vice-President Finance and Corporate Affairs of The Jean Coutu Group (PJC) Inc., a leading retail drugstore chain operating in Canada and the United States. From 1992 to 2004, he was Vice-President and Chief Financial Officer of Cascades Inc., a producer and marketer of packaging products. From 1986 to 1992, he worked in financial reporting for Cascades Inc. From 1984 to 1986, he worked as an external auditor for the accounting firm Coopers & Lybrand.
 
Since September 2005, Mr. Michel has been Executive Chairman of the Board of the Cari-All Group (9159-5793 Québec Inc). From 2001 until 2005, Mr. Michel was a business consultant for the Caisse de dépôt et placement du Québec, a financial institution that performs management services for public and private pension and insurance funds. From 1994 until 2001, he was Senior Vice-President and Chief Financial Officer of Le Groupe Vidéotron Ltée. From 1992 until 1994, he was Vice-President of Finance and Treasurer of Le Groupe Vidéotron Ltée.
 
Since May 2004, Mr. Christian Dubé has been Vice-President and Chief Financial Officer of Cascades Inc., a leader in the manufacturing of packaging products, tissue paper and specialty fine papers. From 1998 until 2004, Mr. Dubé occupied the position of Senior Vice-President and Chief Financial Officer of Domtar Inc. From 1996 until 1998, he was Vice-President Corporate Development and Vice-President Treasurer of Domtar Inc. He currently serves on the Board of Directors for Heroux-Devtek Inc.
 
As of March 21, 2006, Mrs. Goral was elected President and Chairman of the Board of NB Capital Corporation. She is a director of NB Finance, Ltd. and has also been Vice-President - Taxation, USA Operations for National Bank of Canada since 1992. Ms. Goral’s tax experience also includes positions with KPMG Peat Marwick and Ernst & Whinney. She is a member of the American Institute of Certified Public Accountants and the New York State Society of CPAs.
 
Mr. Serge Lacroix was Chairman of the Board and President of NB Capital Corporation since June 2002 and director of NB Finance, Ltd. since July 2002. He was with National Bank of Canada or one of its subsidiaries since 1993 in various positions, most recently as Managing Director and Senior Vice-President of the New York Branch. Mr. Lacroix was also General Manager, President and CEO of NBC Financial (UK) Ltd. and Senior Vice-President at National Bank Financial. From 1982 until 1993, he held various positions at Wood Gundy in London, Montreal and Vancouver. Prior to that, he was a Trader at Nesbitt Thompson Inc. and he started his career in 1976 as a Foreign Exchange Trader with Banque Canadienne Nationale. As of February 1, 2006, Mr. Lacroix resigned as President and Chairman of the Board of NB Capital Corporation.
 
Ms. Hoda Abdelmessih joined the Bank in 1993 as the Treasury Manager. In 1996, Hoda assumed the responsibility of Treasury Control and in 1999 was promoted to Assistant Vice President of Treasury. In 2001, the Bank decided to repatriate all treasury back office functions to Montreal and Hoda was appointed as the Project Manager for New York to decommission the back office. With the sale of the loan portfolio to PNC Hoda's mandate changed, she became a key person in ensuring the conversion of the loan system that would support all cross border loans administered in New York.
 
Monique Baillergeau was appointed Director of NB Capital and NB Finance, Ltd. in May 2003. She has been with the National Bank of Canada New York branch since February 1986. In 1998, she was assigned to manage the Operations of the London branch. In May 2003, she accepted the position of Vice President in charge of Operations and Administration in New York. 
 
Vincent Lima was appointed Director of NB Capital in March 2006. Vincent joined National Bank of Canada in December 1987, and over the years has held several positions such as Assistant Controller, Assistant Vice President/Credit Analyst - Commercial Financing Group, and Vice President - Cross Border Financing Group. He started his career in 1978 with a major international bank in the Money Transfer/Cash Management Dept., and over the years has held various positions in both operations and accounting with various international banks.
 
Jean Dagenais joined the National Bank of Canada in 1990 as Manager and Chief Accountant. In 1997, he was promoted to Vice-President. As such, he is responsible for the preparation of the Bank’s consolidated financial statements as well as other financial information presented to management, shareholders and regulatory authorities. He began is career in 1980 as external auditor with a major international accounting firm. From 1985 to 1990, he held various positions in accounting and financial reporting with large corporations. He studied at the University of Sherbrooke, where he obtained a Bachelor in Administration. He was admitted to the Order of Certified Management Accountants in 1982 and to the Order of Chartered Accountants in 1983.
 
-15-
 
The Company pays the Independent Directors fees for their services. The Independent Directors receive annual compensation of $10,000 plus a fee of $750 for attendance (in person or by telephone) at each meeting of the Board of Directors. The Company also pays the directors who comprise the Audit Committee a fee for their additional services. The Audit Committee is comprised of the Independent Directors. Each Independent Director receives annual compensation of $1,500 per year plus a fee of $750 for attendance (in person or by telephone) at each meeting of the Audit Committee. Additionally, Mr. Michel receives annual compensation of $1,000 for acting as Chairman of the Audit Committee.
 
The Company does not pay any compensation to its officers or employees or to directors who are not Independent Directors.

Audit Committee Financial Expert

The Audit Committee of the Company consists of the three following members: Mr. Alain Michel (Chairman of the Audit Committee), Mr. Christian Dubé and Mr. André Belzile. On May 14, 2003, the Board of Directors of the Company determined that all three of the members of the Audit Committee are Audit Committee Financial Experts and are independent of the Company and of the Bank.

Code of Ethics

On October 31, 2003, the Company adopted a Code of Conduct and Ethics (as an exhibit to this Form 10-K) (the “Code”) that applies to all of the Company’s directors, officers and employees. No amendments to the provisions of the Code have been made nor have any waivers been granted by the Company since its adoption. The Company undertakes to provide a copy of this Code without charge, upon request. Investors may send a request for a copy of the Code in writing to the Company’s principal executive office by certified mail with a self-addressed envelope attached to such request.
 
In 2003, the Company named Ms. Alexa Topolski the Compliance Officer of the Company in connection with the Company’s effort to keep open lines of dialogue between management and employees and her mandate was renewed in 2005.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's officers and directors and certain other persons to file timely certain reports regarding ownership of, and transactions in, the Company's securities with the Securities and Exchange Commission. Copies of the required filings must also be furnished to the Company.
 
Based solely on its review of such forms received by it, or written representations from certain reporting persons, the Company believes that during the year ended December 31, 2005, all reports for the Company’s executive officers and directors that were required to be filed under Section 16 of the Securities Exchange Act of 1934 were timely filed.
 
-16-

ITEM 11: EXECUTIVE COMPENSATION

The services of executive officers of the Company are provided pursuant to the Advisory Agreement between the Bank and the Company (see "Business - Advisory Agreement").  The advisory fee paid by the Company to the Bank in 2005 was $100,000.  This amount includes all compensation payable to the Company's executive officers for services rendered to the Company.  Accordingly, no executive officer of the Company was paid more than $100,000 of compensation for the fiscal year ended December 31, 2005 that would be attributable to services performed for the Company and its subsidiaries.  The compensation disclosed in the following table with respect to Mr. Lacroix represents the entire compensation paid to him by the Bank for services rendered by him to the Bank and its subsidiaries, including the Company.

Summary Compensation Table
                   
       
Annual Compensation
  
Long Term
Compensation Awards
      
Name and Principal Position
  
Year
  
Salary
(US $)
  
Bonus
(US $)
  
Other
Annual
Compensation
  
Securities
Underlying
Options/SARs(3)
  
All Other
Compensation
  
Serge Lacroix, CEO
    
2005
  
$
184,704
  
$
95,000(1
)
$
0
    
—
    
—
  
     
2004
  
$
181,000
  
$
135,000(2
)
$
0
    
—
    
—
  
                                       
(1)
$50,000 paid in June 2005 and $45,000 granted in December 2005 but paid in January 2006.
(2)
$50,000 paid in May 2004 and $75,000 granted in December 2004 but paid in January 2005; plus an extra $10,000 bonus paid in December 2004 by the Cross border NY Group.
(3)
“SAR” means stock appreciation rights.

SAR Grants in Last Fiscal Year

Mr. Serge Lacroix did not receive a SAR award during the fiscal year ended December 31, 2005.


       
Individual Grants
      
   
Number of
Securities
Underlying
Options/SARs
Granted
  
% of Total
Options/SAR
Granted
to
Employees
in Fiscal
  
Base
Price
  
Expiration
  
Potential
Realizable Value at
Assumed Annual
Rates of Stock Price
Appreciation
For Options/SAR Term
  
Name
  
(#)
  
Year
  
(C$/Sh)
  
Date
  
5% (C$)
  
10% (C$)
  
Serge Lacroix
    
0
    
0
%
                        
 
 
-17-

 
Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
2005
  
Name
  
Shares Acquired on Exercise (#)
  
Value Realized ($)
  
Number of Securities Underlying Unexercised Options/SARs at Fiscal Year-End (#) Exercisable / Unexercisable
  
Value of Unexercised In-The-Money Options/SARs at Fiscal Year End (Canadian $) Exercisable / Unexercisable
  
Serge Lacroix
    
0
    
0
    
4,425 / 375
  
$
144,951 / $11,014
  

Value based on a share price of Canadian $60.32 at the closing on last day of the fiscal year ending December 30, 2005 (December 31st was a Saturday, the TSX was closed).


Pension Plan Table
Canadian Dollars
Remuneration
  
Years of Service
 
   
15
  
20
  
25
  
30
  
35
  
C$100,000
    
C$26,814
    
C$36,194
    
C$45,663
    
C$55,132
    
C$64,777
  
125,000
    
34,314
    
46,194
    
58,163
    
70,132
    
82,277
  
150,000
    
41,814
    
56,194
    
70,663
    
85,132
    
99,777
  
175,000
    
49,314
    
66,194
    
83,163
    
100,132
    
117,277
  
200,000
    
56,814
    
76,194
    
95,663
    
115,132
    
134,777
  
225,000
    
64,314
    
86,194
    
108,163
    
130,132
    
152,277
  
250,000
    
71,814
    
96,194
    
120,663
    
145,132
    
169,777
  
300,000
    
71,814
    
96,194
    
120,663
    
145,132
    
169,777
  

The above table illustrates the estimated annual retirement benefit payable on a straight line annuity basis to participating employees at normal retirement age (generally age 60), in the earnings and years of service classifications indicated, under the defined benefit pension plan sponsored by the Bank (the "Bank Pension Plan") and an excess benefit plan which covers certain employees of the Bank and its subsidiaries. For each year of service credited to a participant in the Bank Pension Plan, a participant will be entitled to 2% of his or her annual eligible earnings, less the amount earned under the Canada or Quebec pension plans while participating in the Bank Pension Plan. Annual eligible earnings is defined as a participant's average earnings for such participant's 60 highest-paid consecutive months, based on salary and 50% of bonus (limited to 25% of salary).
 
In addition to the Bank Pension Plan, certain employees of the Bank and its subsidiaries, including those of the Company, may also participate in an excess benefit plan for participants in the Bank Pension Plan whose benefits are reduced pursuant to limitations on pensions imposed by the Income Tax Act (Canada). Employees covered by the excess benefit plan receive a benefit equal to the amount of benefit disallowed under the Pension Plan due to such limitations.
 
-18-

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The Common Stock is the only voting security of the Company issued and outstanding. As of December 31, 2005, 100 shares of Common Stock were issued and outstanding and 100% were beneficially owned directly by the Bank. The Bank’s address is National Bank Tower, 600 de La Gauchetière West, Montreal, Quebec, H3B 4L2, Canada. No officer or director beneficially owns more than five percent of any class of the Company's securities.
 
The Company does not maintain any equity compensation plans for its executive officers.

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Bank administers the day-to-day operations of the Company pursuant to the Advisory Agreement. See "Business-Advisory Agreement." The Bank also services the Mortgage Loans pursuant to the Servicing Agreement. See "Business- Servicing Agreement."

ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
 
Audit Fees

Deloitte & Touche LLP’s aggregate fees billed for professional services rendered for the audit of our annual financial statements for the 2005 fiscal year and the review of the quarterly financial statements for the 2005 fiscal year were $41,000 (compared to $36,950 for 2004). The engagement of Deloitte & Touche LLP for the 2005 fiscal year and the scope of audit, audit-related and tax services were pre-approved by our Audit Committee.

Audit-Related Fees

Deloitte & Touche LLP’s aggregate fees billed for audit-related professional services (special report on procedures performed on the mortgage loans) for the 2005 fiscal year were $5,600 (compared to $5,300 for 2004).
 
Deloitte & Touche LLP’s aggregate fees billed for work related to Sarbanes Oxley readiness assessment was $5,000 (compared to $0 for 2004).

Tax Fees
 
Deloitte & Touche LLP’s aggregate fees for all tax related services for the 2005 fiscal year were $35,000 for tax compliance and consulting services (compared to $35,000 for 2004).
 
The Company’s Audit Committee pre-approves the services - both permitted audit services and permitted non-audit services - of the external auditor before the external auditor is engaged by the Company to render such permitted audit services or permitted non-audit services. The Audit Committee evidences its pre-approval by resolution of the Audit Committee.
 
-19-

PART IV

ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)
The following documents are filed as part of this report:

 
(1)
The report of independent registered chartered accountants and financial statements appearing in Item 8.

 
(2)
The Company is not filing separately financial statement schedules because of the absence of conditions under which they are required or because the required information is included in the financial statements or the notes thereto.

 
(3)
The exhibits required by this item are listed in the Exhibit Index which appears elsewhere in this Form 10-K and is incorporated herein by reference. The Company is not a party to any management contracts or compensation plans or arrangements required to be filed as exhibits to this Form 10-K.

 
(b)
During the quarter ended December 31, 2005, the Company did not file any Current Reports on Form 8-K.

 
(c)
Each Series A share is exchangeable, upon the occurrence of certain events, for one newly issued 8.45% Non-Cumulative First Preferred Share, Series Z, of National Bank of Canada. National Bank of Canada is the parent company of NB Capital Corporation and the holder of 100% of the common shares of NB Capital Corporation. In light of this exchangeable feature, the audited consolidated financial statements for the National Bank of Canada for the years ended October 31, 2005 and October 31, 2004, as well as the Independent Auditors' Report, are filed as part of this annual report on Form 10-K. 
 
 
-20-

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31 of March, 2006.

NB CAPITAL CORPORATION
   
   
By:
/s/ Donna Goral
 
Donna Goral
 
Chairman of the Board and President
 
(Principal Executive Officer)
   
   
   
By:
/s/ Jean Dagenais
 
Jean Dagenais
 
Chief Financial Officer
 
(Principal Financial Officer)
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 31 day of March, 2006.
 
By:
/s/ Donna Goral
   By:
/s/ Alain Michel
 
Donna Goral
    
Alain Michel
 
Director
    
Director
         
         
By:
/s/ Hoda Abdelmessih
   By:
/s/ André Belzile
 
Hoda Abdelmessih
    
André Belzile
 
Director
    
Director
         
         
      By:
/s/ Christian Dubé
       
Christian Dubé
       
Director
         
         
      By:
/s/ Monique Baillergeau
       
Monique Baillergeau
       
Director
         
         
      By:
/s/ Vincent Lima
       
Vincent Lima
       
Director
 
 
-21-

INDEX TO EXHIBITS
 
  Exhibit Number Description
     
 
3.1.1
Articles of Incorporation and Articles of Amendment and Restatement and Articles Supplementary of NB Capital Corporation*

 
3.2.1
Bylaws of NB Capital Corporation*

 
4.1
Registration Rights Agreement dated as of September 3, 1997 by and among NB Capital Corporation, National Bank of Canada and Merrill Lynch, Pierce, Fenner & Smith Incorporated*

 
10.1
Advisory Agreement dated as of September 3, 1997 between National Bank of Canada and NB Capital Corporation*

 
10.2
Servicing Agreement dated as of September 3, 1997 between National Bank of Canada and NB Finance, Ltd.*

 
10.3
Loan Agreement dated as of September 3, 1997 between NB Finance, Ltd. and NB Capital Corporation*

 
10.4
Custodial Agreement dated as of September 3, 1997 between National Bank of Canada and NB Capital Corporation*

 
10.5
Deed of Sale of Mortgage Loans dated September 3, 1997 between National Bank of Canada and NB Finance, Ltd.*

 
10.6
Mortgage Loan Assignment Agreement dated September 3, 1997 among National Bank of Canada, NB Capital Corporation and NB Finance, Ltd.*

 
10.7
Promissory Notes representing the 16 hypothecation loans executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.8
Deposit Agreement among NB Capital Corporation, National Bank of Canada and The Bank of Nova Scotia Trust Company of New York, including Form of Depository Receipt*

 
10.9
First Supplemental Servicing Agreement dated December 4, 1998 between National Bank of Canada and NB Capital Corporation*

 
10.10
Loan Agreement dated as of December 4, 1998 between NB Finance, Ltd. and NB Capital Corporation*

 
10.11
Custodial Agreement dated as of December 4, 1998 between NB Capital Corporation and National Bank of Canada*

 
10.12
Amended and Restated Servicing Agreement dated June 28, 2001 between National Bank of Canada and NB Capital Corporation.*

 
10.13
Deed of Sale of Mortgage Loans dated December 4, 1998 between National Bank of Canada and NB Finance, Ltd.*
 
 
-22-
 
 
10.14(i)
Mortgage Loan Assignment Agreement dated as of December 4, 1998 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.14(ii)
Mortgage Loan Assignment Agreement dated as of December 4, 1998 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.15(i)
Promissory Note representing $25,836,597.23 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.15(ii)
Promissory Note representing $29,880,126.51 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.16
Mortgage Loan Assignment Agreement dated as of September 7, 1999 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.17
Promissory Note representing $85,989,203.22 executed by NB Finance, Ltd. in favor of NB Capital Corporation*.

 
10.18
Mortgage Loan Assignment Agreement dated as of April 14, 2000 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.19
Promissory Note representing $98,836,341.23 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.20
Mortgage Loan Assignment Agreement dated as of September 28, 2000 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.21
Promissory Note representing $67,323,437.74 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.22
Mortgage Loan Assignment Agreement dated as of January 30, 2001 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

10.23
Promissory Note representing $107,179,964.89 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.24
Mortgage Loan Assignment Agreement dated as of June 12, 2001 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.25
Promissory Note representing $121,357,226.22 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.26
Mortgage Loan Assignment Agreement dated as of September 24, 2001 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.27
Promissory Note representing $55,963,732.07 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.28
Mortgage Loan Assignment Agreement dated as of January 29, 2002 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.29
Promissory Note representing $71,866,079.87 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.30
Mortgage Loan Assignment Agreement dated as of June 20, 2002 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*
 
 
-23-
 
 
10.31
Promissory Note representing $64,221,362.98 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.32
Mortgage Loan Assignment Agreement dated as of December 16, 2002 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.33
Promissory Note representing $52,054,168.88 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.34
Mortgage Loan Assignment Agreement dated as of May 27, 2003 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.35
Promissory Note representing $70,420,135.45 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.36
Mortgage Loan Assignment Agreement dated as of October 21,2003 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.37
Promissory Note representing $106,552,720.44 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.38
Mortgage Loan Assignment Agreement dated as of April 28, 2004 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.39
Promissory Note representing $76,053,456.93 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
10.40
Mortgage Loan Assignment Agreement dated as of August 26, 2004 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada*

 
10.41
Promissory Note representing $94,559,444.49 executed by NB Finance, Ltd. in favor of NB Capital Corporation*

 
Mortgage Loan Assignment Agreement dated as of February 24, 2005 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada**

 
Promissory Note representing $73,037,930.00 executed by NB Finance, Ltd. in favor of NB Capital Corporation**

 
Mortgage Loan Assignment Agreement dated as of August 29, 2005 among NB Finance, Ltd., NB Capital Corporation and National Bank of Canada**

 
Promissory Note representing $97,736,747.47 executed by NB Finance, Ltd. in favor of NB Capital Corporation**

 
NB Capital Code of Ethics**

 
Certification of Chairman and President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

 
Written Statement of Chairman and President Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)**

 
Written Statement of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)**
     
*
As previously filed.
**
As filed herewith.
 
 
-24-
 
 
NB CAPITAL CORPORATION
 
Financial statements as of December 31, 2005, 2004 and 2003, and
Report of Independent Registered Chartered Accountants
 

NB CAPITAL CORPORATION
Table of contents

F-1
F-2
F-3
F-4
F-5
F-6 to F-9
 

 

Report of Independent Registered Chartered Accountants

To the Board of Directors and Stockholders of
NB Capital Corporation

We have audited the accompanying balance sheets of NB Capital Corporation (the "Company") as of December 31, 2005 and 2004 and the related statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosure in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
 
/s/ Deloitte & Touche LLP
Montreal, Canada

February 17, 2006
 
F-1

NB CAPITAL CORPORATION
Balance sheets
as of December 31 2005 and 2004
(in U.S. dollars)
       
 
2005
  
2004
  
          
$
  
$
  
           
Assets
          
Current Assets
          
Cash and cash equivalents
    
59,900,966
    
58,327,311
  
Due from an affiliated company
    
9,680,137
    
9,474,360
  
Promissory notes - current portion
    
79,840,304
    
51,678,372
  
Prepaid expenses
    
31,800
    
30,520
  
Accrued interest on cash equivalents
    
18,691
    
25,499
  
Total Current Assets
    
149,471,898
    
119,536,062
  
               
Promissory notes
    
330,138,683
    
358,227,439
  
Total assets
    
479,610,581
    
477,763,501
  
               
               
Liabilities
              
Current Liabilities
              
Due to the parent company
    
402,482
    
414,084
  
Accounts payable
    
116,512
    
30,287
  
Total liabilities
    
518,994
    
444,371
  
               
               
Stockholders’ equity
              
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized,
300,000 Series A shares issued and paid
    
3,000
    
3,000
  
110 Senior preferred shares issued and paid
    
1
    
1
  
               
Common stock, $0.01 par value per share;
1,000 shares authorized,
100 shares issued and paid
    
1
    
1
  
               
Additional paid-in capital
    
476,761,014
    
476,761,014
  
               
Retained earnings
    
2,327,571
    
555,114
  
Total stockholders’ equity
    
479,091,587
    
477,319,130
  
Total liabilities and stockholders’ equity
    
479,610,581
    
477,763,501
  
 
 
See accompanying notes to financial statements.
 
F-2

NB CAPITAL CORPORATION
Statements of income
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
      
2005
  
2004
  
2003
  
   
$
  
$
  
$
  
               
               
Revenue
              
Interest income
              
Short-term investments
    
1,346,146
    
441,053
    
346,591
  
Promissory notes
    
33,995,506
    
35,879,238
    
37,529,935
  
Bank interest
    
918
    
2,000
    
18,840
  
              
35,342,570
    
36,322,291
    
37,895,366
  
                     
Expenses
                    
Legal
    
127,883
    
62,265
    
41,292
  
Other professional fees
    
255,641
    
202,707
    
223,523
  
Servicing fees
    
1,514,444
    
1,498,279
    
1,497,130
  
Advisory fees
    
100,000
    
100,000
    
30,000
  
              
1,997,968
    
1,863,251
    
1,791,945
  
                     
Net income
    
33,344,602
    
34,459,040
    
36,103,421
  
                     
Preferred stock dividends
    
25,072,145
    
25,067,424
    
25,067,921
  
Income available to common stockholders
    
8,272,457
    
9,391,616
    
11,035,500
  
                     
Weighted average number of common shares outstanding
    
100
    
100
    
100
  
Earnings per common share - basic and diluted
    
82,725
    
93,916
    
110,355
  
 
 
See accompanying notes to financial statements.
 
F-3
 
NB CAPITAL CORPORATION
Statements of stockholders’ equity
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
   
Series A
  
Senior
      
Additional
          
   
Preferred
  
Preferred
  
Common
  
Paid-in
  
Retained
      
          
Stock
  
Stock
  
Stock
  
Capital
  
Earnings
  
Total
  
   
$
  
$
  
$
  
$
  
$
  
$
  
                           
Stockholders’ equity as of December 31, 2002
    
3,000
    
1
    
1
    
476,761,014
    
5,127,998
    
481,892,014
  
                                       
                                       
Net income
    
—
    
—
    
—
    
—
    
36,103,421
    
36,103,421
  
Dividends on senior preferred stock and Series A preferred stock
    
—
    
—
    
—
    
—
    
(25,067,921
)
  
(25,067,921
)
Dividend on common stock
    
—
    
—
    
—
    
—
    
(14,500,000
)
  
(14,500,000
)
Stockholders’ equity as of December 31, 2003
    
3,000
    
1
    
1
    
476,761,014
    
1,663,498
    
478,427,514
  
                                       
Net income
    
—
    
—
    
—
    
—
    
34,459,040
    
36,459,040
  
Dividends on senior preferred stock and Series A preferred stock
    
—
    
—
    
—
    
—
    
(25,067,424
)
  
(25,067,424
)
Dividend on common stock
    
—
    
—
    
—
    
—
    
(10,500,000
)
  
(10,500,000
)
Stockholders’ equity as of December 31, 2004
    
3,000
    
1
    
1
    
476,761,014
    
555,114
    
477,319,130
  
                                       
Net income
    
—
    
—
    
—
    
—
    
33,344,602
    
33,344,602
  
Dividends on senior preferred stock and Series A preferred stock
    
—
    
—
    
—
    
—
    
(25,072,145
)
  
(25,072,145
)
Dividend on common stock
    
—
    
—
    
—
    
—
    
(6,500,000
)
  
(6,500,000
)
Stockholders’ equity as of December 31, 2005
    
3,000
    
1
    
1
    
476,761,014
    
2,327,571
    
479,091,587
  
 
 
See accompanying notes to financial statements.
 
F-4

NB CAPITAL CORPORATION
Statements of cash flows
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
        
2005
  
2004
  
2003
  
   
$
  
$
  
$
  
               
               
Operating activities
              
Net income
    
33,344,602
    
34,459,040
    
36,103,421
  
Adjustment to reconcile net income to net cash provided by operating activities
                    
Prepaid expenses
    
(1,280
)
  
(2,520
)
  
(1,333
)
Due from an affiliated company
    
(205,777
)
  
1,637,556
    
(4,134,609
)
Due to the parent company
    
(11,602
)
  
(870
)
  
70,008
  
Accounts payable
    
86,225
    
(11,422
)
  
(26,187
)
Accrued interest on cash equivalents
    
6,808
    
(20,265
)
  
(4,934
)
Net cash provided by operating activities
    
33,218,976
    
36,061,519
    
32,006,366
  
                     
Investing activities
                    
Investment in promissory notes
    
(170,774,678
)
  
(170,612,901
)
  
(176,972,855
)
Repayments of promissory notes
    
170,701,502
    
209,040,546
    
198,485,678
  
Net cash provided by (used in) investing activities
    
(73,176
)
  
38,427,645
    
21,512,823
  
                     
Financing activities
                    
Dividends
    
(31,572,145
)
  
(35,567,424
)
  
(39,567,921
)
Net cash used in financing activities
    
(31,572,145
)
  
(35,567,424
)
  
(39,567,921
)
                     
Cash and cash equivalents, beginning of year
    
58,327,311
    
19,405,571
    
5,454,303
  
Cash and cash equivalents, end of year
    
59,900,966
    
58,327,311
    
19,405,571
  
 
 
See accompanying notes to financial statements.
 
F-5

NB CAPITAL CORPORATION
Notes to the financial statements
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
 
1.
Incorporation and nature of operations
 
NB Capital Corporation (the “Company”) was incorporated in the state of Maryland on August 20, 1997. The Company’s principal business is to acquire, hold, finance and manage mortgage assets. The Company issued, through an Offering Circular, dated August 22, 1997, $300 million of preferred stock and simultaneously, National Bank of Canada, the parent company, made a capital contribution in the amount of $183 million. The Company used the aggregate net proceeds of $477 million to acquire promissory notes of NB Finance, Ltd., a wholly-owned subsidiary of National Bank of Canada.
 
2.
Significant accounting policies
 
Financial statements
 
The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and are expressed in U.S. dollars.

Cash and cash equivalents
 
Cash equivalents include short-term, highly liquid investments that are readily convertible to known amounts of cash and have a maturity of three months or less at the acquisition date.
 
Promissory notes
 
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115 “Accounting for certain Investments in debt and equity Securities” and based on the Company’s intentions regarding these instruments, the Company has classified the Promissory notes as held to maturity and has accounted for them at amortized cost.

Income taxes
 
The Company has elected to be taxable as a Real Estate Investment Trust (“REIT”) under the Internal Revenue Code of 1986, as amended, and accordingly, is generally not liable for United States federal income tax to the extent that it distributes at least 90% of its taxable income to its stockholders, maintains its qualification as a REIT and complies with certain other requirements.

Per share data
 
Basic and diluted earnings per share with respect to the Company for the years ended December 31, 2005, 2004 and 2003 are computed based upon the weighted average number of common shares outstanding during the year.

Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates.
 
F-6
 
NB CAPITAL CORPORATION
Notes to the financial statements
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
 
 
2.
Significant accounting policies (continued)
 
Interest on promissory notes and short-term investments.
 
Interest income on promissory notes and short-term investments is accrued using the simple interest method based on the amount of principle outstanding. The accrual of interest is discontinued when management believes that the collection of interest is doubtful.
 
3.
Promissory notes
 
The Company entered into loan agreements evidenced by promissory notes with NB Finance, Ltd., an affiliated company. The promissory notes are collateralized only by mortgage loans which are secured by residential first mortgages and insured by the Canada Mortgage and Housing Corporation.

The promissory notes have maturities ranging from January 2006 to January 2015, at rates ranging from 5.49% to 10.21%, with a weighted-average rate of approximately 7.76% per annum.

The fair value of the Promissory notes as at December 31, 2005 is $422,649,877. Fair value is estimated by using the present value of expected future cash flows and may not be indicative of the net realizable value.

These rates approximate market interest rates for loans of similar credit and maturity provisions and, accordingly, management believes that the carrying value of the promissory notes receivable approximates their fair value.
 
   
2005
   
2004
  
   
$
  
$
  
Promissory notes, beginning of year
    
409,905,811
    
448,333,456
  
Acquisitions
    
170,774,678
    
170,612,901
  
Principal repayments
    
(170,701,502
)
  
(209,040,546
)
Promissory notes, end of year
    
409,978,987
    
409,905,811
  

The scheduled principal repayments as of December 31, 2005 are as follows:

   
$
      
$
  
2006
    
79,840,304
    
2011
    
64,300,710
  
2007
    
109,484,543
    
2012
    
37,244,565
  
2008
    
24,645,507
    
2013
    
8,063,924
  
2009
    
34,060,036
    
2014
    
4,142,782
  
2010
    
39,607,180
    
2015
    
8,589,436
  
 
 
F-7
 
NB CAPITAL CORPORATION
Notes to the financial statements
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
 
4.
Transactions with an affiliated company
 
During the year, the Company earned interest from NB Finance, Ltd. on the promissory notes, in the amount of $33,995,506 ($35,879,238 in 2004 and $37,529,935 in 2003) (see Note 3).

The amounts due from an affiliated company as of December 31, 2005 and 2004 represent interest and principal repayments due on the promissory notes from NB Finance, Ltd.
 
5.
Transactions with the parent company
 
The Company entered into agreements with National Bank of Canada in relation to the administration of the Company’s operations. The agreements are as follows:

Advisory agreement
 
In exchange for a fee equal to $100,000 per year ($100,000 in 2004 and $30,000 in 2003), payable in equal quarterly installments, National Bank of Canada will furnish advice and recommendations with respect to all aspects of the business and affairs of the Company.

Servicing agreement
 
National Bank of Canada will service and administer the promissory notes and the collateralized mortgage loans and will perform all necessary operations in connection with such servicing and administration.

The fee will equal one-twelfth (1/12) of 0.25% per annum of the aggregate outstanding balance (in US$) of the collateralized mortgage loans as of the last day of each calendar month. The average outstanding balance of the collateralized mortgage loans securing the promissory notes amounted to $537,567,066 ($542,179,064 in 2004 and 551,360,385 in 2003). During the year, fees of $1,514,444 ($1,498,279 in 2004 and $1,497,130 in 2003) were charged to the Company.

Custodian agreement
 
National Bank of Canada will hold all documents relating to the collateralized mortgage loans. During the years ended December 31, 2005, 2004 and 2003, no fee was charged to the Company.

Interest on bank account and short-term investments

The Company received $918 ($2,000 in 2004 and $18,840 in 2003) in interest on a bank account held with National Bank of Canada.
 
The Company received $1,346,146 ($441,053 in 2004 and $346,591 in 2003) in interest on term deposits held with National Bank of Canada.
 
F-8
 
NB CAPITAL CORPORATION
Notes to the financial statements
years ended December 31, 2005, 2004 and 2003
(in U.S. dollars)
 
 
6.
Stockholders’ equity
 
Common stock

The Company is authorized to issue up to 1,000 shares of $0.01 par value common stock. The common shares issued as at December 31, 2005 are as follows:

·
100 shares are authorized, issued and paid.

Preferred stock

The Company is authorized to issue up to 10,000,000 shares of $0.01 par value preferred stock. The preferred shares issued as at December 31, 2005 are as follows:

·
300,000 shares authorized and issued as 8.35% Non-Cumulative Exchangeable Preferred Stock, Series A, non-voting, ranked senior to the common stock and junior to the Adjustable Rate Cumulative Senior Preferred Shares, with a liquidation value of $1,000 per share, redeemable at the Company’s option on or after September 3, 2007, except upon the occurrence of certain changes in tax laws in the United States of America and in Canada, on or after September 3, 2002.

Each Series A share is exchangeable, upon the occurrence of certain events, for one newly issued 8.45% Non-Cumulative First Preferred Share, Series Z, of National Bank of Canada.

These Series A shares are traded in the form of Depositary Shares, each representing a one-fortieth interest therein.

·
1,000 shares authorized and 110 shares issued as Adjustable Rate Cumulative Senior Preferred Shares, non-voting, ranked senior to the common stock and to the 8.35% Non-Cumulative Exchangeable Preferred Stock, with a liquidation value of $3,000 per share, redeemable at the Company’s option at any time and retractable at the holders’ option on December 30, 2007 and every ten-year anniversary thereof.
 
7.
Recent pronouncements
 
In May 2005, FASB issued FAS 154 “Accounting Changes and Error Corrections” which replaces APB opinion No. 20 and FASB Statement No.3. FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections and states that unless impracticable, retrospective application is the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. The adoption of Statement No.154, which will apply to the Company effective January 1, 2006, will not have a material impact on the Company's financial reporting and disclosure.
 
F-9
 
Item 15(c) to the Annual Report of NB Capital Corporation on Form 10-K for the Year Ended December 31, 2005
 
Consolidated Financial Statements of National Bank of Canada (Expressed in Canadian dollars)
 
consolidated financial statements

Management’s Report

The consolidated financial statements of National Bank of Canada (the “Bank”) and the other financial information presented in the Annual Report were prepared by Management, which is responsible for their integrity, including the material estimates and judgments incorporated therein. The consolidated financial statements were prepared in accordance with Canadian generally accepted accounting principles.

In discharging its responsibilities and ensuring that the Bank’s assets are safeguarded, Management maintains the necessary accounting and control systems. These controls include standards for hiring and training personnel, the defining and evaluation of tasks and functions, operating policies and procedures and budget controls.

The Board of Directors (the “Board”) is responsible for reviewing and approving the financial information which appears in the Annual Report. Acting through the Audit and Risk Management Committee (the “Committee”), the Board also oversees the presentation of the consolidated financial statements and ensures that accounting and control systems are maintained.

The Committee, composed of directors who are neither officers nor employees of the Bank, is responsible for evaluating internal control procedures on an ongoing basis and reviewing the consolidated financial statements and recommending them to the Board for approval. The Committee oversees a team of internal auditors, which reports to it on a regular basis.

The control systems are further supported by the Bank’s observance of the laws and regulations that apply to its operations. The Superintendent of Financial Institutions Canada regularly examines the affairs of the Bank to ensure that the provisions of the Bank Act with respect to the safety of the Bank’s depositors are being duly observed and that the Bank is in a sound financial condition.

The independent auditors, Samson Bélair/Deloitte & Touche s.e.n.c.r.l., whose report follows, were appointed by the shareholders on the recommendation of the Board. They were given full and unrestricted access to the Committee to discuss their audit and financial reporting matters.

 
Réal Raymond
Pierre Fitzgibbon
President and
Senior Vice-President
Chief Executive Officer
Finance, Technology and Corporate Affairs


Montreal, December 8, 2005
 
15(c)-1
 
Deloitte.
Samson Bélair/Deloitte & Touche
 
s.e.n.c.r.l.
 
1 Place Ville Marie
 
Suite 3000
 
Montreal QC H3B 4T9
 
Canada
   
 
Tel: 514-393-5317
 
Fax: 514-390-4111
 
www.deloitte.ca

Independent Auditors’ report

To the Board of Directors of
National Bank of Canada
 
We have audited the Consolidated Balance Sheets of National Bank of Canada as at October 31, 2005 and 2004 and the Consolidated Statements of Income, Changes in Shareholders’ Equity and Cash Flows for each of the years in the two year period ended October 31, 2005. These consolidated financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

With respect to the consolidated financial statements for the year ended October 31, 2005, we conducted our audit in accordance with Canadian generally accepted auditing standards and auditing standards generally accepted in the United States of America. With respect to the consolidated financial statements for year ended October 31, 2004, we conducted our audit in accordance with Canadian generally accepted auditing standards. These standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing 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 over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Bank as at October 31, 2005 and 2004 and the results of operations and its cash flows for each of the years in the two year period ended October 31, 2005 in accordance with Canadian generally accepted accounting principles.

/s/ Samson Bélair/Deloitte & Touche s.e.n.c.r.l.
Samson Bélair/Deloitte & Touche s.e.n.c.r.l.
 
Montreal, Canada
December 8, 2005
 
15(c)-2

Consolidated Statement of Income
Year ended October 31
(millions of dollars)

        
Note
  
2005
  
2004
  
               
Interest income and dividends
             
Loans
          
2,122
    
1,884
  
Securities
          
739
    
588
  
Deposits with financial institutions
          
193
    
113
  
              
3,054
    
2,585
  
                     
Interest expense
                    
Deposits
          
1,113
    
800
  
Subordinated debentures
          
100
    
99
  
Other
          
404
    
323
  
                
1,617
    
1,222
  
Net interest income
          
1,437
    
1,363
  
                     
Other income
                    
Financial market fees
          
682
    
633
  
Deposit and payment service charges
          
201
    
200
  
Trading revenues
         
192
    
198
  
Gains on investment account securities, net
          
91
    
91
  
Card service revenues
          
63
    
49
  
Lending fees
          
247
    
258
  
Acceptances, letters of credit and guarantee
          
61
    
65
  
Securitization revenues
          
195
    
180
  
Foreign exchange revenues
          
76
    
72
  
Trust services and mutual funds
          
285
    
244
  
Other
          
173
    
192
  
               
2,266
    
2,182
  
Total revenues
          
3,703
    
3,545
  
Provision for credit losses
    
6
    
33
    
86
  
                     
Operating expenses
                    
Salaries and staff benefits
          
1,451
    
1,359
  
Occupancy
          
184
    
200
  
Computers and equipment
          
356
    
334
  
Communications
          
81
    
77
  
Professional fees
          
136
    
118
  
Other
          
291
    
300
  
                
2,499
    
2,388
  
Income before income taxes and non-controlling interest
         
1,171
    
1,071
  
Income taxes
    
15
    
291
    
318
  
           
880
    
753
  
Non-controlling interest
          
25
    
28
  
Net income
          
855
    
725
  
Dividends on preferred shares
    
13
    
26
    
23
  
Net income available to common shareholders
          
829
    
702
  
Average number of common shares outstanding (thousands)
    
16
              
Basic
          
166,382
    
170,918
  
Diluted
          
168,964
    
173,276
  
Net earnings per common share (dollars)
    
16
              
Basic
          
4.98
    
4.10
  
Diluted
          
4.90
    
4.05
  
Dividends per common share (dollars)
    
13
    
1.72
    
1.42
  
 

 
15(c)-3

Consolidated Balance Sheet
As at October 31
(millions of dollars)

       
Note
  
2005
  
2004
  
ASSETS
              
Cash
              
227
    
481
  
Deposits with financial institutions
              
10,087
    
5,296
  
                     
Securities
                    
Investment account
    
4
    
6,869
    
7,446
  
Trading account
    
4
    
26,183
    
20,561
  
                      
33,052
    
28,007
  
                     
Securities purchased under reverse repurchase agreements
                
7,023
    
4,496
  
                     
Loans
    
5 and 6
              
Residential mortgage
          
15,677
    
15,500
  
Personal and credit card
          
9,796
    
7,825
  
Business and government
               
22,096
    
18,751
  
           
47,569
    
42,076
  
Allowance for credit losses
              
(451
)
  
(578
)
                  
47,118
    
41,498
  
Other
                    
Customers’ liability under acceptances
          
3,242
    
3,076
  
Fair value of trading derivative financial instruments
    
18
    
2,390
    
2,735
  
Premises and equipment
    
7
    
355
    
267
  
Goodwill
    
8
    
662
    
662
  
Intangible assets
    
8
    
178
    
180
  
Other assets
    
9
    
3,264
    
1,799
  
                  
10,091
    
8,719
  
                   
107,598
    
88,497
  
                     
LIABILITIES AND SHAREHOLDERS’ EQUITY
                    
Deposits
    
10
              
Personal
          
26,385
    
24,008
  
Business and government
          
29,636
    
23,966
  
Deposit-taking institutions
              
5,956
    
5,458
  
                  
61,977
    
53,432
  
Other
                    
Acceptances
          
3,242
    
3,076
  
Obligations related to securities sold short
          
15,504
    
10,204
  
Securities sold under repurchase agreements
          
12,915
    
8,182
  
Fair value of trading derivative financial instruments
    
18
    
1,846
    
2,386
  
Other liabilities
    
9
    
5,928
    
5,235
  
                   
39,435
    
29,083
  
                     
Subordinated debentures
    
11
    
1,102
    
1,408
  
Non-controlling interest
    
11
    
487
    
370
  
                     
Shareholders’ equity
                    
Preferred shares
    
13
    
400
    
375
  
Common shares
    
13
    
1,565
    
1,545
  
Contributed surplus
          
13
    
7
  
Unrealized foreign currency translation adjustments
          
(26
)
  
(10
)
Retained earnings
              
2,645
    
2,287
  
                    
4,597
    
4,204
  
                   
107,598
    
88,497
  
 
Réal Raymond
Pierre Bourgie
President and Chief Executive Officer
Director
 
 
15(c)-4

Consolidated Statement of Changes in Shareholders’ Equity
Year ended October 31
(millions of dollars)

        
Note
  
2005
  
2004
  
               
Preferred shares at beginning
          
375
    
375
  
Issuance of preferred shares, Series 16
          
200
    
—
  
Redemption of preferred shares, Series 13 for cancellation
          
(175
)
  
—
  
Preferred shares at end
    
13
    
400
    
375
  
                     
Common shares at beginning
         
1,545
    
1,583
  
Issuance of common shares
                    
Dividend Reinvestment and Share Purchase Plan
          
12
    
12
  
Stock Option Plan
          
46
    
30
  
Repurchase of common shares for cancellation
          
(39
)
  
(80
)
Impact of shares acquired or sold for trading purposes
              
1
    
—
  
Common shares at end
   
13
    
1,565
    
1,545
  
                     
Contributed surplus at beginning
         
7
    
2
  
Stock option expense
    
14
    
6
    
5
  
Contributed surplus at end
             
13
    
7
  
                     
Unrealized foreign currency translation adjustments at beginning
          
(10
)
  
6
  
Losses on foreign exchange operations with a functional currency
                    
other than the Canadian dollar, net of income taxes
              
(16
)
  
(16
)
Unrealized foreign currency translation adjustments at end
              
(26
)
  
(10
)
                     
Retained earnings at beginning
          
2,287
    
2,131
  
Net income
          
855
    
725
  
Impact of initial adoption of AcG-15
    
2
    
1
    
—
  
Dividends
                    
Preferred shares
    
13
    
(26
)
  
(23
)
Common shares
    
13
    
(286
)
  
(243
)
Premium paid on common shares repurchased for cancellation
    
13
    
(185
)
  
(302
)
Share issuance expenses and other, net of income taxes
             
(1
)
  
(1
)
Retained earnings at end
              
2,645
    
2,287
  
                     
Shareholders’ equity
              
4,597
    
4,204
  

 
15(c)-5

Consolidated Statement of Cash Flows
Year ended October 31
(millions of dollars)

      
Note
  
2005
  
2004
  
               
Cash flows from operating activities
              
Net income
          
855
    
725
  
Adjustments for:
                    
Provision for credit losses
          
33
    
86
  
Amortization of premises and equipment
          
63
    
52
  
Future income taxes
          
(31
)
  
50
  
Translation adjustment on foreign currency subordinated debentures
          
(11
)
  
(29
)
Gains on sale of investment account securities, net
          
(91
)
  
(91
)
Gains on asset securitizations and other transfers of receivables, net
          
(125
)
  
(64
)
Stock option expense
          
6
    
5
  
Change in interest payable
          
(73
)
  
58
  
Change in interest and dividends receivable
          
11
    
268
  
Change in income taxes payable
          
6
    
(161
)
Change in net fair value amounts on trading derivative financial instruments
          
(195
)
  
(116
)
Change in trading account securities
          
(5,622
)
  
(1,410
)
Excess of pension plan contributions over expenses
         
—
    
(20
)
Change in other items
         
(430
)
  
929
  
                    
(5,604
)
  
282
  
Cash flows from financing activities
                    
Change in deposits
         
8,250
    
1,969
  
Issuance of subordinated debentures
          
350
    
—
  
Redemption of subordinated debentures
          
(350
)
  
(79
)
Issuance of common shares
          
58
    
42
  
Issuance of preferred shares
          
200
    
—
  
Repurchase of common shares for cancellation
          
(224
)
  
(382
)
Redemption of preferred shares for cancellation
          
(175
)
  
—
  
Dividends paid on common shares
          
(278
)
  
(179
)
Dividends paid on preferred shares
          
(27
)
  
(23
)
Change in obligations related to securities sold short
          
5,300
    
1,747
  
Change in securities sold under repurchase agreements
          
4,733
    
(492
)
Change in other items
               
(19
)
  
(16
)
                   
17,818
    
2,587
  
Cash flows from investing activities
                    
Change in deposits with financial institutions pledged as collateral
          
(3,594
)
  
(123
)
Change in loans
          
(8,016
)
  
(4,851
)
Proceeds from securitization of assets and other transfers of receivables
          
3,069
    
1,648
  
Maturity of securitized assets
          
(706
)
  
—
  
Purchases of investment account securities
          
(52,611
)
  
(15,479
)
Sales of investment account securities
          
53,313
    
15,140
  
Change in securities purchased under reverse repurchase agreements
          
(2,527
)
  
(541
)
Consolidation of assets in accordance with AcG-15
    
2
    
(132
)
  
—
  
Net acquisitions of premises and equipment
              
(67
)
  
(56
)
                   
(11,271
)
  
(4,262
)
                     
Increase (decrease) in cash and cash equivalents
         
943
    
(1,393
)
Cash and cash equivalents at beginning
             
5,333
    
6,726
  
Cash and cash equivalents at end 
              
6,276
    
5,333
  
                     
Cash and cash equivalents
                    
Cash
         
227
    
481
  
Deposits with financial institutions
          
10,087
    
5,296
  
Less: amount pledged as collateral
              
(4,038
)
  
(444
)
                   
6,276
    
5,333
  
Supplementary information
                    
Interest paid
          
1,589
    
1,218
  
Income taxes paid
               
257
    
529
  


15(c)-6

Notes to the Consolidated Financial Statements
As at October 31
(millions of dollars)

1 | Summary of Significant Accounting Policies

The consolidated financial statements of National Bank of Canada (the “Bank”) were prepared in accordance with Section 308(4) of the Bank Act, which states that Canadian generally accepted accounting principles (“GAAP”) are to be applied unless otherwise specified by the Superintendent of Financial Institutions Canada (the “Superintendent”). These principles differ in some regards from United States GAAP, as explained in Note 24.

The preparation of consolidated financial statements in conformity with Canadian GAAP requires Management to make estimates and assumptions that affect assets and liabilities, income and other related information. The most significant assets and liabilities subject to estimates are the allowance for credit losses, fair value financial instruments, the valuation of investment account securities, asset securitization, goodwill and intangible assets, pension plans and other employee future benefits, income taxes and the provision for contingencies. If actual results differ from these estimates, the impact is recognized in future periods.

The significant accounting policies used in preparing these consolidated financial statements are summarized below.

Basis of consolidation
The consolidated financial statements include the assets, liabilities and operating results of all subsidiaries after the elimination of intercompany transactions and balances. Since November 1, 2004, in accordance with Accounting Guideline No. 15 “Consolidation of Variable Interest Entities” (AcG-15), as explained in detail in Note 2a, the Bank began consolidating the variable interest entities of which it is the primary beneficiary.

Investments in companies over which the Bank exercises significant influence are accounted for using the equity method and are included in “Other assets” in the Consolidated Balance Sheet. The Bank’s share of income (losses) from these companies is included in “Other income” in the Consolidated Statement of Income.

Translation of foreign currencies
The monetary assets and liabilities of the Bank and its integrated branches and subsidiaries denominated in foreign currencies as well as all assets and liabilities of its self-sustaining branches and subsidiaries denominated in foreign currencies are translated into Canadian dollars at the year-end exchange rate. Non-monetary assets and liabilities of the Bank and its integrated branches and subsidiaries denominated in foreign currencies are translated into Canadian dollars at historical rates. Revenues and expenses denominated in foreign currencies are translated using average exchange rates.

Translation gains and losses arising from the translation of the financial statements of self-sustaining branches and subsidiaries, including the related impact on hedging and income taxes, are recorded in “Unrealized foreign currency translation adjustments” in the Consolidated Balance Sheet. Translation gains and losses arising from operations in integrated branches and subsidiaries are included in the Consolidated Statement of Income.

Cash and deposits with financial institutions
Cash and deposits with financial institutions consist of cash and cash equivalents. Cash comprises cash on hand, bank notes and coin. 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.

Securities
Securities are held, depending on Management’s intentions, in the investment or trading account. The Bank records securities transactions on a trade date basis.

Investment account securities are purchased with the intention of holding them to maturity or until market conditions favour other types of investment. Equity securities are stated at acquisition cost if the Bank does not exercise a significant influence over the investee. Debt securities are stated at unamortized acquisition cost, and any premiums or discounts are amortized using the effective yield method over the period to maturity or disposal of the security. Dividend and interest income as well as the amortization of premiums and discounts are recorded in “Interest income and dividends.” Gains or losses realized on the disposal of securities, calculated using the average cost method, and any loss in value that is other than a temporary impairment are recorded in “Other income.”

Trading account securities generally purchased for resale in the short term are presented at fair value based on publicly disclosed market prices. In the event market prices are not available, the fair value is estimated on the basis of the market prices of similar securities or using other methods. Dividend and interest income are recorded in “Interest income and dividends.” Realized and unrealized gains or losses on these securities are recorded in “Other income.”
 
15(c)-7

Securities purchased under reverse repurchase agreements and sold under repurchase agreements
The Bank purchases securities under reverse repurchase agreements and sells securities under repurchase agreements. Reverse repurchase agreements and repurchase agreements are treated as guaranteed loans and borrowings and are recorded at cost in the Consolidated Balance Sheet. Interest income from reverse repurchase agreements and interest expense under repurchase agreements are recorded on an accrual basis in the Consolidated Statement of Income.

Loans
A loan, other than a credit card loan, is considered impaired when, in the opinion of Management, there is reasonable doubt as to the ultimate collectibility of a portion of principal or interest or where payment of interest is contractually 90 days past due, unless there is no doubt as to the collectibility of the principal or interest. A loan may revert to performing status only when principal and interest payments have become fully current. Credit card loans are written off when payments are more than 180 days in arrears.

When a loan is deemed impaired, interest ceases to be recorded and the carrying value of the loan is adjusted to its estimated realizable amount by writing off all or part of the loan or by taking an allowance for credit losses.

Foreclosed assets held for sale in settlement of an impaired loan are presented at fair value less selling costs at the date of foreclosure. Any difference between the carrying value of the loan before foreclosure and the initially estimated realizable amount of the assets is recorded to “Provision for credit losses.” For any subsequent change in their fair value, gains or losses are recognized under “Other income” in the Consolidated Statement of Income. Gains may not exceed losses in value recognized after the date of foreclosure. Revenues generated by foreclosed assets and the related operating expenses are included in the Consolidated Statement of Income under “Other.”

Foreclosed assets held for use in settlement of an impaired loan are measured at fair value at the date of foreclosure. Any difference in the carrying value of the loan exceeding fair value is recorded under “Provision for credit losses.” These assets are subsequently presented at the date of foreclosure as premises and equipment and are subject to the same accounting rules as those applicable to the premises and equipment to which they relate.

Loan origination fees, including commitment, restructuring and renegotiation fees, are considered an integral part of the yield earned on the loan and are deferred and amortized to interest income over the term of the loan. If there is a reasonable expectation that a commitment will result in a loan, commitment fees are amortized to interest income over the term of the loan; otherwise, they are included in “Other income” over the term of the commitment. Loan syndication fees are recorded to “Other income,” unless the yield on any 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 to interest income over the term of the loan.

Since the adoption on November 1, 2003 of Section 1100 of the CICA Handbook “Generally Accepted Accounting Principles,” certain mortgage loan prepayment fees have been recognized in the Consolidated Statement of Income under “Lending fees” when earned. Prior to November 1, 2003, these fees were deferred and amortized to interest income over the term of the loan. Following the adoption of Section 1100, an unamortized balance of mortgage loan prepayment fees, which amounted to $25 million as at October 31, 2003 ($16 million net of income taxes) was recorded during 2004 in the Consolidated Statement of Income under “Lending fees.”

Allowance for credit losses
The allowance for credit losses reflects Management’s best estimate of losses in its loan portfolio as at the balance sheet date. The allowance relates primarily to loans, but may also cover the credit risk associated with deposits with other banks, derivative products, loan substitute securities and other credit instruments such as acceptances, letters of guarantee and letters of credit. The allowance for credit losses, which consists of specific allowances for impaired loans, the country risk allowance and the general allowance for credit risk, is increased by the provision for credit losses, which is charged to income, and decreased by the amount of write-offs, net of recoveries.

The specific allowances for impaired loans are established for all such loans that can be identified and for which impairment can be estimated individually, reducing them to their estimated realizable amounts. The estimated realizable amounts are measured by discounting expected future cash flows. For groups of impaired loans consisting of large numbers of homogeneous balances of relatively small amounts, the realizable amounts are determined by discounting expected future cash flows for each group of loans using formulas that take into account past loss experience, economic conditions and other relevant circumstances. No specific allowance is established for credit card loans, as balances are written off if payment has not been received within 180 days.

The allowance for loan impairment in relation to loans to countries designated by the Superintendent is revalued on an ongoing basis according to risk exposure in the various countries and their related economic conditions.
 
15(c)-8
 
The allocated general allowance for credit risk represents Management’s best estimate of probable losses within the portion of the portfolio that has not yet been specifically identified as impaired. This amount is determined by applying expected loss factors to outstanding and undrawn facilities. The allocated general allowance for corporate and government loans is based on the application of expected default and loss factors, determined by statistical loss migration analysis, delineated by loan type. For more homogeneous portfolios, such as residential mortgage loans, small and medium-sized enterprise loans, personal loans and credit card loans, the allocated general allowance is determined on a product portfolio basis. Losses are determined by the application of loss ratios determined through statistical analysis of loss migration over an economic cycle. The unallocated general allowance for credit risk is based on Management’s assessment of probable losses in the portfolio that have not been captured in the determination of the specific allowances for impaired loans, the country risk allowance and the allocated general allowance. This assessment takes into account general economic and business conditions, recent loan loss experience, and trends in credit quality and concentrations. This allowance also reflects model and estimation risks. The unallocated general allowance does not represent future losses or serve as a substitute for the allocated general allowance.

Asset securitization
The Bank securitizes residential and commercial mortgage loans, consumer loans, personal loans and credit card receivables by selling them to qualified special purpose entities or trusts that issue securities to investors. These transactions are recorded as sales when the Bank is deemed to have surrendered control over the assets sold and to have received consideration other than beneficial interests in these assets. Gains and losses on securitization transactions are recognized in income on the transaction date.
 
As part of securitization transactions, the Bank may retain certain interests in the securitized receivables in the form of subordinated certificates, rights to future excess interest and, in some cases, a cash reserve account. Gains and losses on securitizations, net of transaction fees, are carried in the Consolidated Statement of Income under “Securitization revenues.” Gains and losses recognized on the sale of receivables are dependent in part on the allocation of the previous carrying amount of the receivables to the assets sold and the retained interests. This allocation is based on their relative fair value at the date of transfer. Fair value is based on market prices, when available. However, as quotes are usually not available for retained interests, fair value is determined using the present value of expected future cash flows based on assumptions regarding credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved.

Retained interests are recorded at cost and included in investment account securities. Any impairment in the value of retained interests that is other than temporary is recorded in the Consolidated Statement of Income under “Securitization revenues.”

The Bank generally transfers receivables on a fully serviced basis. At the time of transfer, a servicing liability is recognized and amortized to income over the term of the transferred assets. This servicing liability is presented in the Consolidated Balance Sheet under “Other liabilities.”

Guaranteed mortgage loans
The Bank finances a portion of its residential mortgage loan portfolio through the mortgage-backed securities program provided for in the National Housing Act. Under this program, the Bank pools eligible mortgage loans and sells ownership rights in these pools to investors. Investors are paid a pre-set coupon rate and the principal from the underlying mortgages. The Canada Mortgage and Housing Corporation (“CMHC”) unconditionally guarantees the payments to the investors. The Bank continues to service the securitized mortgage loans.

The Bank is committed to the CMHC to make sufficient funds regularly available to the paying agent and the transfer agent to pay the amounts due to investors, whether or not the mortgagors have made their payments. Moreover, the Bank must place all funds due to investors at maturity of the securities at the disposal of the paying agent and the transfer agent. Should the Bank default, the CMHC can assign the servicing of the securitized loans to another servicer.

Acceptances and customers’ liability under acceptances
The potential liability of the Bank under acceptances is recorded as a liability in the Consolidated Balance Sheet. The Bank’s potential recourse against customers is recorded as an equivalent offsetting asset. Fees are recorded in “Other income” in the Consolidated Statement of Income.
 
15(c)-9

Premises and equipment
Buildings, equipment and furniture and leasehold improvements are recognized at cost less accumulated amortization and are amortized over their estimated useful lives according to the following methods and rates. Land is recorded at cost.

             
Methods
  
Rates
  
Buildings
    
(a) or (b
)
  
2% to 14
%
Equipment and furniture
    
(a) or (b
)
  
20% to 50
%
Leasehold improvements
    
(a
)
  
(c
)

(a) straight-line
(b) diminishing balance
(c) over the lease term plus the first renewal option

Goodwill
The purchase method is used to account for the acquisition of subsidiaries. Goodwill represents the excess of the price paid for the acquisition of subsidiaries over the fair value of the net assets acquired. Goodwill is tested for impairment annually, or more frequently if changes in circumstances indicate that the asset might be impaired, to ensure that the fair value remains greater than or equal to the carrying value. Any excess of the carrying value over the fair value is charged to income for the period during which the impairment has been determined.

Intangible assets
The intangible assets of the Bank result from the acquisition of subsidiaries or groups of assets and are mainly composed of management contracts recorded at fair value at the time of acquisition. Since these assets have indefinite lives, they are not amortized, but are tested for impairment annually, or more frequently if changes in circumstances indicate that they might be impaired. The impairment test consists in comparing the fair value of the asset with its carrying value. Any excess of the carrying value over the fair value is charged to income for the period during which the impairment is determined. Intangible assets with finite useful lives are amortized over their useful lives. These assets are written down when the long-term expectation is that their carrying values will not be recovered. Any excess of the carrying value over the recoverable value is charged to income.

Obligations related to securities sold short
These liabilities represent the Bank’s obligation to deliver securities it sold but did not own at the time of sale. Obligations related to securities sold short are recorded as liabilities at fair value; obligations related to securities that are used as hedges are accounted for at unamortized cost. Realized and unrealized gains and losses on trading activities are recorded in “Trading revenues” in the Consolidated Statement of Income.

Gains and losses on securities sold short used for hedging purposes are included in the Consolidated Statement of Income concurrently with the gains and losses on the hedged items.

Income taxes
The Bank provides for income taxes under the asset and liability method. The Bank determines future income tax assets and liabilities based on the differences between the carrying values and the tax bases of assets and liabilities, according to income tax laws and income tax rates enacted or substantively enacted on the date the differences will reverse. Future income tax assets represent tax benefits related to deductions the Bank may claim to reduce its taxable income in future years. No future income tax expense is recorded for the portion of retained earnings of foreign subsidiaries that is permanently reinvested.

Derivative financial instruments
Certain types of derivatives are used to meet the risk management, investment and trading needs of the Bank and its clients.

The main derivative instruments used by the Bank are exchange-traded contracts such as futures and options as well as over-the-counter products such as forwards, options and swaps.

Trading derivatives
Derivatives used to accommodate the needs of clients and enable the Bank to generate income from its trading activities are recognized on a fair value basis. Derivatives with a positive fair value are presented as assets, and derivatives with a negative fair value as liabilities, in the Consolidated Balance Sheet. Realized and unrealized gains and losses on trading activities are recorded in “Other income” in the Consolidated Statement of Income.

Non-trading derivatives
The Bank also uses derivative instruments in its own risk management and investment activities.

Derivative instruments used to manage the Bank’s own risks, in particular interest and exchange rate risks, are recorded using hedge accounting, when appropriate. Non-trading derivatives that do not qualify for hedge accounting are carried at fair value in assets or liabilities. Realized and unrealized gains and losses on non-trading activities are recorded in “Other income” in the Consolidated Statement of Income.
 
15(c)-10

Hedge accounting
 
Documentation
The Bank prepares formal documentation for all hedging relationships which identifies the hedging derivative and the specific asset or liability or cash flow being hedged. It also documents the risk management objective and strategy used for all hedging activities. The Bank also systematically determines, at inception of the hedge and over the term of the hedging relationship, whether changes in the fair value or cash flows of the hedged item can be effectively offset by changes in the fair value or cash flows of the hedging derivative.

Recognition
When the derivative is designated and deemed effective as a fair value or cash flow hedge, the related gains and losses are recorded in “Other income” in the Consolidated Statement of Income at the same time as the gains or losses on the assets or liabilities hedged.

Discontinuance of hedge accounting
Realized and unrealized gains and losses on terminated derivatives or derivatives that have ceased to be effective before they expire are presented with assets or liabilities in the Consolidated Balance Sheet and recognized in “Other income” in the period during which the underlying hedged item is recognized. Should the derivative once again qualify for hedge accounting, any fair value already presented in the Consolidated Balance Sheet will be amortized to “Other income” over the remaining term of the hedged item. If a designated hedged item is sold, terminated or expires before the related derivative is terminated, any realized or unrealized gain or loss on the derivative is recognized in “Other income” in the Consolidated Statement of Income.

Equity-linked deposit contracts
The Bank recognizes the fair value of certain deposit obligations that vary according to the performance of certain securities or equity indexes and entitle investors, after a predetermined period, to receive a given percentage of their capital or a variable amount, whichever is greater, based on the performance of an equity index or shares. Future fluctuations in fair value are reflected in the Consolidated Statement of Income as they arise.

Insurance revenues and expenses
Premiums less claims and changes in actuarial liabilities are reflected in “Other income.” Income from securities held by the insurance subsidiaries is included in “Interest income and dividends” in the Consolidated Statement of Income. Amortization of deferred gains and losses on the disposal of securities is included in “Other income.” Administrative costs are recorded in “Operating expenses” in the Consolidated Statement of Income.

Assets under administration and assets under management
The Bank administers and manages assets that are owned by clients but which are not reflected on the Consolidated Balance Sheet. Asset management fees are earned for providing investment and mutual fund management services. Asset administration fees are earned for providing trust, estate administration and custodial services. Fees are recognized in “Other income” as the services are provided.

Employee future benefits
The Bank offers defined benefit pension plans that cover substantially all salaried employees. These defined benefit plans are funded pension plans. The Bank also offers its employees certain post-retirement and post-employment benefits, compensated leave and termination benefits (non-pension employee benefits), which are generally not funded. These benefits include healthcare, life insurance and dental benefits. Employees eligible for the post-retirement benefits are those who retire at certain retirement ages. Employees eligible for post-employment benefits are those on long-term disability or maternity leave.

The Bank records its benefit obligation under employee pension plans and the related costs net of plan assets.

Actuarial valuations are made periodically to determine the present value of plan obligations. The actuarial valuation of accrued pension and post-retirement benefit obligations is based on the projected benefit method prorated on services using the most likely assumptions according to Management as regards future salary levels, cost escalation, retirement age and other actuarial factors. The accrued benefit obligation is valued using market rates as at the measurement date. With regard to the expected long-term returns on plan assets used to calculate pension expense, most of the fixed-income securities in the plans are measured using fair value while equity securities and other assets are measured using a market-related value. This value takes into account the changes in the fair value of assets over a three-year period. Prior to November 1, 2003, all portfolio securities were valued at market-related values. The impact of this change for the years ended October 31, 2005 and 2004 is negligible.

The cost of pension and other post-retirement benefits earned by employees is established by calculating the sum of the following: the current period accrued benefit cost; the notional interest on the actuarial liability of the plans and the expected long-term return on plan assets; the amortization, over the average remaining service lives of employees, of actuarial gains and losses; and the amounts resulting from changes made to the assumptions and the plans. The cumulative excess of pension plan contributions over the amounts recorded as expenses is recognized in “Other assets” in the Consolidated Balance Sheet while the cumulative cost of post-retirement benefits, net of disbursements, is recognized in “Other liabilities.”
 
15(c)-11

Past service costs arising from amendments to the plans are amortized on a straight-line basis over the average remaining service period of active employees on the date of the amendments. The portion of the net actuarial gain or loss which exceeds 10% of either the accrued benefit obligation or the fair value of plan assets, whichever is higher, is amortized over the average remaining service period of active employees. This average remaining service period varies from 9 to 12 years depending on the plan. When the restructuring of an employee benefit plan gives rise to both a curtailment and a settlement of obligations, the curtailment is accounted for prior to the settlement.

Stock-based compensation plans
Rights awarded under the Bank’s Stock Appreciation Rights (SAR) Plan are recorded at intrinsic value by measuring, on an ongoing basis, the excess of the stock price over the exercise price of the option. The Bank’s obligation, which results from the variation in the stock’s market price, is recognized in income on a straight-line basis over the vesting period, i.e., four years, and the corresponding amount is included in “Other liabilities.” When the vesting period expires and until the SARs are exercised, the change in the obligation attributable to variations in the stock price is recognized by increasing or decreasing the compensation expense for the period in which the variations occur.

The Bank has used the fair value based method to account for stock options awarded under its stock option plan since November 1, 2002. The fair value of the stock options is estimated on the award date using the Black-Scholes model.

This cost is recognized on a straight-line basis over the vesting period, i.e., four years, as an increase in compensation expense and contributed surplus. When the options are exercised, the contributed surplus is credited to common share paid-up capital. The proceeds received from the employees when these options are exercised are also credited to common share paid-up capital. The exercise price of each option awarded is equal to the closing price of the common shares of the Bank on the Toronto Stock Exchange on the business day preceding the date of the award.

The Bank also offers a Deferred Stock Unit (DSU) Plan for Officers intended for certain members of senior management and other key employees of the Bank and its subsidiaries. Under the Plan, a portion of the value of the officer’s compensation is tied to the future value of the Bank’s common shares as an incentive award. A DSU is a right whose value corresponds to the market value of a common share of the Bank at the time the DSU is awarded. DSUs vest according to specific criteria and on the dates established in the officer’s award letter. Additional DSUs are allocated to the officer’s account in proportion to the dividends paid on common shares of the Bank. DSUs can only be exercised when the officer retires or ceases to be a Bank employee. The compensation expense for this plan is recorded in the year the incentive award vests to the officer. Any change in the value of DSUs is recorded as an increase or decrease in compensation expense and the corresponding amount is reflected in “Other liabilities” in the Consolidated Balance Sheet.

The Bank’s Restricted Stock Unit (RSU) Plan is intended for all officers designated as eligible persons (the “participants”) by a committee or the Board of Directors of the Bank, provided they are employees of the Bank or of one of its subsidiaries. The purpose of the Plan is to directly link a portion of the compensation of designated officers to the growth in shareholder value. The amount granted to a participant at the award date is converted into phantom restricted stock units conditional on the participant remaining in the Bank’s employ for a set period of time. The participant’s account is credited with additional RSUs when dividends are paid. RSUs vest to the participant and expire on the last day of the 35th month following the award date. Any change in the value of RSUs is recorded as an increase or decrease in compensation expense and the corresponding amount is reflected in “Other liabilities” in the Consolidated Balance Sheet.

Comparative figures
Certain comparative figures have been reclassified to conform with the presentation adopted in the current year.

2 | Changes in Accounting Policies

2a. Recent Accounting Standards Adopted
Variable interest entities
On November 1, 2004, the Bank adopted CICA Accounting Guideline No. 15 “Consolidation of Variable Interest Entities” (AcG-15). This Guideline provides guidance on the application of the standards set out in CICA Handbook Section 1590 “Subsidiaries” to certain entities defined as variable interest entities (“VIEs”). VIEs are entities in which equity investors do not have a controlling financial interest or the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by other parties. AcG-15 requires the consolidation of a VIE by its primary beneficiary, defined as the party that receives the majority of the expected residual returns and/or that absorbs the majority of the entity’s expected losses. The application of the provisions of AcG-15 on November 1, 2004 resulted in the consolidation of certain mutual funds in which the Bank has a significant investment and the consolidation of the VIE that leases the Bank’s head office building under a capital lease. The impact of the application of this standard was an increase in “Premises and equipment” of $84 million, “Securities” of $48 million, “Other assets” of $3 million, “Other liabilities” of $90 million, “Non-controlling interest” of $44 million, and “Retained earnings” of $1 million. Prior period consolidated financial statements have not been restated for this Guideline.
 
15(c)-12

The VIEs in which the Bank holds a significant variable interest but of which it is not the primary beneficiary under AcG-15 are described below. The maximum risk of loss arising from these variable interests is primarily the investments in these entities and the backstop liquidity facilities granted to them in the event of a market disruption and the fair value of the derivatives contracts concluded with these entities.

Securitization entities
The Bank carries out transactions in which certain assets such as mortgage loans, credit card receivables and personal loans are sold to entities that finance these purchases through the issuance of term bonds or commercial paper. These entities are qualified special purpose entities under CICA Accounting Guideline No. 12 “Transfers of Receivables” (AcG-12) and are therefore exempt from the consolidation requirements under AcG-15. Asset securitization operations are described in Note 3 to the consolidated financial statements. The Bank provides backstop liquidity facilities under a commercial paper conduit program. The details of these facilities are presented in Note 17 to the consolidated financial statements. Moreover, the Bank has concluded a derivative contract with one of these special purpose entities. The fair value of this derivative is presented on the Bank’s Consolidated Balance Sheet.

Multi-seller special purpose entities (SPEs)
The Bank administers a multi-seller SPE that purchases financial assets from clients and finances these purchases through the issuance of commercial paper. Clients use this multi-seller SPE to diversify their sources of financing and reduce financing costs while continuing to manage the financial assets and providing some first loss protection. The Bank does not have any ownership interest in this SPE and, under AcG-15, is not required to consolidate it. The Bank acts as a financial agent and trustee and provides administrative and transaction structuring services to this SPE. The Bank does not provide any credit protection; it does, however, provide backstop liquidity facilities under the commercial paper program. Note 17 to the consolidated financial statements provides information on these backstop liquidity facilities. The rights to collect fees for all services rendered to this SPE are variable interests. In order to meet the needs of investors, the Bank has concluded derivative contracts with this SPE, the fair value of which is presented on the Bank’s Consolidated Balance Sheet. The total assets of the SPE were $1.2 billion as at October 31, 2005.

The Bank also acts as a financial agent and administrator for three other trusts. These trusts issue and sell to purchasers fixed/adjustable rate debt securities backed by mortgage-backed securities, asset-backed securities, structured financial securities, synthetic corporate exposures and other securities. The Bank does not have any ownership position in these trusts and is not required to consolidate them under AcG-15. The rights to collect fees represent variable interests. The Bank concluded derivative contracts with some of these trusts the fair value of which is presented on the Bank’s Consolidated Balance Sheet. The total assets of these trusts were $3.9 billion as at October 31, 2005.

Investment funds
As part of its investment banking operations, the Bank invests in several limited liability partnerships and incorporated entities. These investment companies in turn invest in operating companies with a view to reselling these investments at a profit over the medium or long term. The Bank does not intervene in the operations of these entities; its only role is that of investor. The Bank is not required to consolidate these entities under AcG-15 as it does not absorb the majority of the expected losses and/or receive the majority of the expected residual returns of these entities. As at October 31, 2005, the recorded value of the Bank’s total investment was $144 million. The total assets of all these entities amounted to $2.6 billion. Moreover, the Bank has commitments to invest in these entities. These commitments are disclosed in Note 17 to the consolidated financial statements.

Investment companies
In January 2004, the CICA issued Accounting Guideline No. 18 “Investment Companies” (AcG-18). Under this Guideline, investment companies are required to account for all their investments at fair value, including investments that would otherwise be consolidated or accounted for using the equity method. AcG-18 sets out the criteria for determining whether a company is an investment company and also provides guidance on the circumstances in which the parent company of, or equity method investor in, an investment company should account for the investment company’s investments at fair value. The Bank applied the provisions of this Guideline prospectively as of November 1, 2004 and its impact is negligible.

2b. Recent Accounting Standards Pending Adoption
Financial Instruments - Recognition and Measurement, Hedges and Comprehensive Income
In January 2005, the CICA issued three new standards: “Financial Instruments - Recognition and Measurement,” “Hedges,” and “Comprehensive Income.” The main consequences of implementing these standards are described below.

All financial assets and liabilities will be carried at fair value in the Consolidated Balance Sheet, except for items classified in the following categories, which will be carried at amortized cost: loans and receivables, held-to-maturity securities and financial liabilities not held for trading. Realized and unrealized gains and losses on financial assets and liabilities that are held for trading will be recorded in the Consolidated Statement of Income. Unrealized gains and losses on financial assets that are available for sale will be recorded in other comprehensive income until realized, at which time they will be recorded in the Consolidated Statement of Income. All derivatives, including embedded derivatives that must be accounted for separately, will be recorded at fair value in the Consolidated Balance Sheet.
 
15(c)-13

For fair value hedges, changes in the fair value of the derivatives and corresponding changes in fair value of the hedged items attributed to the risk being hedged will be recognized in the Consolidated Statement of Income. For cash flow hedges, the effective portion of the changes in the fair values of the derivative instruments will be recorded in other comprehensive income until the hedged items are recognized in the Consolidated Statement of Income.

Other comprehensive income, which comprises the above items as well as unrealized exchange gains and losses on self-sustaining foreign operations (net of hedging activities), will be included as a separate component of the Consolidated Statement of Changes in Shareholders’ Equity. A new statement, “Statement of Comprehensive Income,” will be added to the Bank’s consolidated financial statements.

These new standards will apply to the Bank effective November 1, 2006. The impact of implementing these new standards on the Bank’s consolidated financial statements cannot yet be determined as it is dependent on the Bank’s unsettled positions and hedging strategies and on market volatility at the time of transition.

3 | Transfers of Receivables

Asset securitization
Mortgage loans
During 2005, the Bank securitized $2,130 million of guaranteed residential mortgage loans (2004: $1,527 million) through the creation of mortgage-backed securities. The Bank sold $1,844 million of these securities (2004: $1,527 million) and $10 million of mortgage-backed securities created in October 2001. Mortgage-backed securities created and unsold remain in the Consolidated Balance Sheet under “Securities - Investment account.” The Bank received net cash proceeds of $1,845 million (2004: $1,520 million) and retained the rights to the excess spread of $79 million (2004: $47 million) earned on the mortgage loans. The Bank also recorded a servicing liability of $11 million (2004: $9 million). A pre-tax gain of $59 million (2004: $31 million), net of transaction fees, was recognized in the Consolidated Statement of Income under “Securitization revenues.”

Personal loans
Since fiscal 2002, the Bank has sold fixed-rate personal loans on a revolving basis to a trust. A series of notes totaling $206 million issued by this trust in 2002 matured during fiscal 2005. The two remaining series of notes outstanding represent $309 million as at October 31, 2005.

Credit card receivables
Under a 1998 agreement, the Bank sells credit card receivables on a revolving basis to a trust. During 2005, the Bank sold an additional $800 million of its credit card receivables. The Bank received cash proceeds of $795 million and retained the rights to the excess spread of $21 million generated on the receivables, net of any credit losses. The Bank also recorded a servicing liability of approximately $4 million and recognized a pre-tax gain of approximately $12 million, net of transaction fees of $5 million. Following this sale and the maturity of certificates totaling $500 million during fiscal 2005 (maturity of $200 million in 2004), gross securitized credit card receivables outstanding increased from $900 million as at October 31, 2004 to $1.2 billion as at October 31, 2005.

Key assumptions
The key assumptions used to measure the fair value of retained interests as at the securitization date for transactions carried out during 2005 and 2004 were as follows:

   
Guaranteed
  
Credit card
  
Personal
  
     
mortgage loans
  
receivables
  
loans
  
       
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
                           
Weighted average term (months)
    
27.5
    
27.1
    
—
    
—
    
13.1
    
13.3
 
Payment rate
    
—
    
—
    
31.6
%
  
31.2
%
  
—
    
—
 
Prepayment rate
    
20.0
%
  
20.0
%
  
—
    
—
    
30.0
%
  
30.0
%
Excess spread, net of credit losses
    
1.8
 %  
1.3
%
  
10.4
%
  
10.3
%
  
1.3
%
  
1.8
%
Expected credit losses
    
—
    
—
    
3.5
%
  
3.4
%
  
1.7
%
  
1.2
%
Discount rate
    
3.3
%
  
3.9
%
  
17.0
%
 (1)
21.0
%
  
17.0
%
 (1)
21.0
%

(1) Since August 1, 2005 (previously 21%)
 
15(c)-14

The table below presents certain amounts recorded in the consolidated financial statements with respect to securitization operations:

       
Securitization revenues
  
Investment account securities
  
Other liabilities
  
   
Gains (losses)
          
Cash deposits
          
       
on sale of assets
  
Retained interests
  
at a trust
  
Servicing liability
  
        
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
                                   
Mortgage loans
                                  
-Guaranteed
    
59
    
31
    
125
    
99
    
—
    
—
    
19
    
16
  
-Other(1)
    
—
    
—
    
—
    
—
    
20
    
20
    
—
    
—
  
Credit card receivables
    
69
    
38
    
31
    
13
    
2
    
5
    
6
    
3
  
Personal loans
    
(1
)
  
(2
)
  
2
    
7
    
16
    
26
    
2
    
4
  
Total
    
127
    
67
    
158
    
119
    
38
    
51
    
27
    
23
  

(1) During 2000, the Bank sold uninsured mortgage loans on properties with five or more units to a trust.

The table below presents total securitized assets and certain credit data on securitized assets:

                     
2005
                
2004
  
   
Securitized
  
Impaired
  
Net credit
  
Securitized
  
Impaired
  
Net credit
  
       
assets
  
loans
  
losses
  
assets
  
loans
  
losses
  
                           
Mortgage loans
                          
-Guaranteed
    
4,395
(1)
  
—
    
—
    
3,520
(1)
  
—
    
—
  
-Other
    
186
    
—
    
—
    
293
 
  
—
    
—
  
Credit card receivables
    
1,200
    
7
    
41
    
900
    
4
    
40
  
Consumer loans(3)
    
—
    
—
    
—
    
—
    
—
    
1
  
Personal loans
    
222
(2)
  
1
    
6
    
515
    
3
    
8
  
Total
    
6,003
    
8
    
47
    
5,228
    
7
    
49
  

(1)  Includes $243 million of mortgage-backed securities created and unsold in 2005 (2004: $243 million). These securities are presented in the Consolidated Balance Sheet under “Securities - Investment account.”
(2)  The trust that holds personal loans also holds $87 million of mortgage-backed securities created by the Bank in 2005.
(3)  During 2001, the Bank sold consumer loans to a trust. The Bank terminated this program in March 2004. At that time, outstanding loans represented less than 10% of the portfolio originally sold.

The table below summarizes certain cash flows received from securitization vehicles:

   
Guaranteed
  
Credit card
  
Personal
  
      
mortgage loans
  
receivables
  
loans
  
       
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
                           
Proceeds from new securitizations
    
1,845
    
1,520
    
795
    
—
    
—
    
—
  
Proceeds collected and reinvested in revolving securitizations
    
—
    
—
    
3,092
    
3,273
    
268
    
377
  
Cash flows from retained interests in securitizations
    
60
    
55
    
81
    
64
    
16
    
27
  
 
 
15(c)-15

As at October 31, the sensitivity of the current fair value of these retained interests to immediate 10% and 20% adverse changes in key assumptions was as follows:

Sensitivity of key assumptions to adverse changes

   
Guaranteed
  
Credit card
  
Personal
  
Assumptions
  
mortgage loans
  
receivables
  
loans
  
            
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
                           
Prepayment rate
    
20.0
%
  
20.0
%
  
31.5
%
  
31.2
%
  
30.0
%
  
30.0
%
Impact on fair value of 10%
adverse change
  
 
$(3.4
)
 
$(2.6
)
 
$(2.2
)
 
$(0.9
)
 
$(0.0
)
 
$(0.2
)
Impact on fair value of 20%
adverse change
  
 
$(6.7
)
 
$(5.2
)
 
$(4.1
)
 
$(1.7
)
 
$(0.1
)
 
$(0.4
)
                                     
Excess spread, net of credit losses
    
1.6
%
  
1.5
%
  
10.4
%
  
10.3
%
  
1.3
%
  
1.8
%
Impact on fair value of 10%
adverse change
  
 
$(12.5
)
 
$(9.9
)
 
$(3.1
)
 
$(1.3
)
 
$(0.2
)
 
$(1.3
)
Impact on fair value of 20%
adverse change
  
 
$(25.1
)
 
$(19.7
)
 
$(6.3
)
 
$(2.7
)
 
$(0.5
)
 
$(2.6
)
                                       
Discount rate
    
3.8
%
  
4.2
%
  
17.0
%(1)
  
21.0
%
  
17.0
%(1)
  
21.0
%
Impact on fair value of 10%
adverse change
  
 
$(0.5
)
 
$(0.4
)
 
$(0.1
)
 
$(0.1
)
 
$(0.3
)
 
$(0.6
)
Impact on fair value of 20%
adverse change
  
 
$(0.9
)
 
$(0.8
)
 
$(0.2
)
 
$(0.1
)
 
$(0.6
)
 
$(1.1
)
                                       
Servicing
    
0.3
%
  
0.3
%
  
2.0
%
  
2.0
%
  
1.0
%
  
1.0
%
Impact on fair value of 10%
adverse change
  
 
$(1.9
)
 
$(1.6
)
 
$(0.6
)
 
$(0.3
)
 
$(0.2
)
 
$(0.4
)
Impact on fair value of 20%
adverse change
  
 
$(3.8
)
 
$(3.3
)
 
$(1.2
)
 
$(0.5
)
 
$(0.4
)
 
$(0.8
)

(1) Since August 1, 2005 (previously 21%)

These sensitivities are hypothetical and should be used with caution. Changes in fair value attributable to changes in assumptions generally cannot be extrapolated because the relationship between the change in the assumption and the change in fair value may not be linear. Changes affecting one factor may result in changes to another, which might magnify or counteract the sensitivities attributable to changes in assumptions.

Other transfers
Mortgage loans
During fiscal 2005, the Bank sold $431 million (2004: $131 million) of insured and uninsured mortgage loans to a mutual fund of the Bank. The Bank received net cash proceeds of $429 million (2004: $128 million) and recorded a pre-tax loss of $2 million (2004: $3 million) on the Consolidated Statement of Income under “Other income - Other.” Total outstanding insured and uninsured mortgage loans sold to this mutual fund represent $541 million as at October 31, 2005 ($208 million as at October 31, 2004).
 
15(c)-16

4 | Securities

Securities held are as follows:

   
Under
  
1 to
  
5 to
  
Over
  
No
  
2005
  
2004
  
           
1 year
  
5 years
  
10 years
  
10 years
  
maturity
  
Total
  
Total
  
Investment account
                              
Securities issued or guaranteed by
                              
Canada
                              
Unamortized cost
    
455
    
1,627
    
102
    
23
    
75
    
2,282
    
2,393
  
Provinces
                                            
Unamortized cost
    
98
    
48
    
172
    
68
    
—
    
386
    
150
  
Municipalities or school boards
                                            
Unamortized cost
    
—
    
—
    
34
    
—
    
—
    
34
    
2
  
U.S. Treasury and other U.S. agencies
                                            
Unamortized cost
    
38
    
969
    
—
    
—
    
—
    
1,007
    
263
  
Other debt securities
                                            
Unamortized cost
    
544
    
599
    
385
    
111
    
209
    
1,848
    
3,491
  
Equity securities
                                            
Cost
    
66
    
190
    
16
    
11
    
1,029
    
1,312
    
1,147
  
Total carrying value
   
1,201
    
3,433
    
709
    
213
    
1,313
    
6,869
    
7,446
  
Trading account
                                            
Securities issued or guaranteed by
                                            
Canada
    
5,058
    
1,962
    
660
    
340
    
—
    
8,020
    
8,231
  
Provinces
    
1,583
    
1,642
    
644
    
1,097
    
—
    
4,966
    
3,574
  
Municipalities or school boards
    
86
    
216
    
125
    
43
    
—
    
470
    
434
  
U.S. Treasury and other U.S. agencies
    
—
    
—
    
—
    
—
    
—
    
—
    
2,004
  
Other debt securities
    
1,087
    
3,230
    
897
    
827
    
—
    
6,041
    
2,776
  
Equity securities
    
3
    
15
    
1
    
—
    
6,667
    
6,686
    
3,542
  
         
7,817
    
7,065
    
2,327
    
2,307
    
6,667
    
26,183
    
20,561
  
Total carrying value of securities
                                                  
33,052
    
28,007
  

Gross unrealized gains (losses) are as follows:

         2005    2004  
       
Gross
  
Gross
          
Gross
  
Gross
      
   
Carrying
  
unrealized
  
unrealized
  
Fair
  
Carrying
  
unrealized
  
unrealized
  
Fair
  
      
Value
  
gains
  
losses
  
value
  
Value
  
gains
  
losses
  
value
  
                                   
Investment account
                                  
Securities issued or guaranteed by
                                  
Canada
    
2,282
    
26
    
(4
)
  
2,304
    
2,393
    
42
    
—
    
2,435
  
Provinces
    
386
    
8
    
(3
)
  
391
    
150
    
6
    
—
    
156
  
Municipalities or school boards
    
34
    
—
    
—
    
34
    
2
    
—
    
—
    
2
  
U.S. Treasury and other
                                                  
U.S. agencies
    
1,007
    
—
    
(14
)
  
993
    
263
    
2
    
—
    
265
  
Other debt securities
    
1,848
    
6
    
(11
)
  
1,843
    
3,491
    
24
    
(6
)
  
3,509
  
Equity securities
    
1,312
    
109
    
(43
)
  
1,378
    
1,147
    
83
    
(27
)
  
1,203
  
Total investment account
    
6,869
    
149
    
(75
)
  
6,943
    
7,446
    
157
    
(33
)
  
7,570
  
 
 
15(c)-17

5 | Loans and Impaired Loans

          
Term to maturity    
          
Impaired loans    
  
   
Less than
      
2-5
  
More than
  
Total gross
      
Specific
  
Net
  
          
1 year
  
1 year
  
years
  
5 years
  
amount
  
Gross
  
allowances
  
balance
  
                                   
October 31, 2005
                                  
Residential mortgage
   
9,803
    
1,904
    
3,814
    
156
    
15,677
    
10
    
2
    
8
  
Personal and credit card
   
8,782
    
534
    
419
    
61
    
9,796
    
35
    
18
    
17
  
Business and government
    
13,454
    
642
    
1,475
    
6,525
    
22,096
    
215
    
123
    
92
  
 
    
32 ,039
    
3,080
    
5,708
    
6,742
    
47,569
    
260
    
143
    
117
  
General allowance(1)
                                                                      
(308
)
Impaired loans, net of specific and general allowances
                                                                       
(191
)
                                                   
October 31, 2004
                                                  
Residential mortgage
   
8,959
    
2,370
    
3,907
    
264
    
15,500
    
4
    
2
    
2
  
Personal and credit card
   
6,818
    
517
    
431
    
59
    
7,825
    
31
    
17
    
14
  
Business and government
    
12,476
    
660
    
1,137
    
4,478
    
18,751
    
353
    
209
    
144
  
     
28,253
    
3,547
    
5,475
    
4,801
    
42,076
    
388
    
228
    
160
  
General allowance(1)
                                                                          
(350
)
Impaired loans, net of specific and general allowances
                                                                           
(190
)

(1) The general allowance for credit risk was created taking into account the Bank’s credit in its entirety.

6 | Allowance for Credit Losses

The changes made to allowances during the past two years are as follows:

   
Allocated
  
Unallocated
  
Country
          
   
Specific
  
general
  
general
  
risk
  
2005
  
       
allowances
  
allowance
  
allowance
  
allowance
  
Total
  
                       
Allowances at beginning
    
228
    
272
    
78
    
—
    
578
  
Provision for credit losses
    
75
    
(31
)
  
(11
)
  
—
    
33
  
Write-offs
    
(215
)
  
—
    
—
    
—
    
(215
)
Recoveries
    
55
    
—
    
—
    
—
    
55
  
Allowances at end
    
143
    
241
    
67
    
—
    
451
  

   
Allocated
 
Unallocated
 
Country
 
 
 
 
 
 
 
Specific
 
general
 
general
 
risk
 
2004
 
    
 
allowances
 
allowance
 
allowance
 
allowance
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
  
Allowances at beginning
    
206
    
300
    
105
    
19
    
630
  
Provision for credit losses
    
141
    
(28
)
  
(27
)
  
—
    
86
  
Write-offs
    
(178
)
  
—
    
—
    
(19
)
  
(197
)
Recoveries
    
59
    
—
    
—
    
—
    
59
  
Allowances at end
    
228
    
272
    
78
    
—
    
578
  


15(c)-18

7 | Premises and Equipment

           
2005
  
2004
  
           
Net
  
Net
  
       
Accumulated
  
carrying
  
carrying
  
          
Cost
  
amortization
  
value
  
value
  
                   
Land
    
18
    
—
    
18
    
8
  
Buildings
    
189
    
90
    
99
    
35
  
Equipment and furniture
    
565
    
433
    
132
    
123
  
Leasehold improvements
    
348
    
242
    
106
    
101
  
     
1,120
    
765
    
355
    
267
  
Amortization for the year recorded in the Consolidated Statement of Income
                
63
    
52
  

8 | Goodwill and Intangible Assets

The Bank performs an annual impairment test of goodwill and intangible assets with indefinite lives. No impairment loss was recorded in 2005 or 2004.

The change in the carrying value of goodwill is as follows:

   
Personal and
  
Wealth
  
Financial
      
          
Commercial
  
Management
  
Markets
  
Total
  
                   
Balance as at October 31, 2003
    
61
    
407
    
192
    
660
  
Acquisitions
    
—
    
1
    
—
    
1
  
Other
    
(12
)
  
13
    
—
    
1
  
Balance as at October 31, 2004
    
49
    
421
    
192
    
662
  
Acquisitions
    
—
    
—
    
—
    
—
  
Other
    
—
    
—
    
—
    
—
  
Balance as at October 31, 2005
    
49
    
421
    
192
    
662
  
 
Intangible assets are:
           
2005
  
2004
  
           
Net
  
Net
  
       
Accumulated
  
carrying
  
carrying
  
          
Cost
  
amortization
  
value
  
value
  
                   
Trademarks(1)
    
11
    
—
    
11
    
11
  
Management contracts(1)
    
160
    
—
    
160
    
160
  
Other
    
16
    
9
    
7
    
9
  
Total
    
187
    
9
    
178
    
180
  

(1) Not subject to amortization
 
15(c)-19

9 | Other Assets and Other Liabilities

        
Other assets
  
Other liabilities
  
          
2005
  
2004
  
2005
  
2004
  
                   
Interest and dividends receivable (payable)
    
322
    
333
    
(627
)
  
(692
)
Income taxes payable
    
—
    
—
    
(135
)
  
(129
)
Prepaid expenses and deferred amounts
    
386
    
378
    
—
    
—
  
Future income tax assets (liabilities) (Note 15)
    
137
    
100
    
(40
)
  
(31
)
Trade and other payables
    
—
    
—
    
(1,724
)
  
(1,946
)
Brokers’ client accounts
    
1,589
    
73
    
(1,562
)
  
(371
)
Investments in companies subject to significant influence
    
116
    
119
    
—
    
—
  
Accrued benefit asset (liability) (Note 12)
    
353
    
358
    
(105
)
  
(98
)
Insurance-related obligations
    
—
    
—
    
(82
)
  
(92
)
Subsidiaries’ debts to third parties
    
—
    
—
    
(768
)
  
(745
)
Accounts payable and deferred income
    
—
    
—
    
(301
)
  
(344
)
Other
    
361
    
438
    
(584
)
  
(787
)
         
3,264
    
1,799
    
(5,928
)
  
(5,235
)

10 | Deposits
 
       
Payable
  
Payable
          
   
Payable
  
after
  
on a fixed
  
2005
  
2004
  
      
on demand
  
notice
  
date
  
Total
  
Total
  
                       
Personal
    
2,258
    
9,600
    
14,527
    
26,385
    
24,008
  
Business and government
    
8,831
    
5,593
    
15,212
    
29,636
    
23,966
  
Deposit-taking institutions
    
1,625
    
44
    
4,287
    
5,956
    
5,458
  
         
12,714
    
15,237
    
34,026
    
61,977
    
53,432
  

11 | Subordinated Debentures and Non-Controlling Interest

Subordinated debentures
Subordinated debentures represent direct unsecured obligations, in the form of notes and debentures, to the Bank’s debt holders. The rights of the holders of the Bank’s notes and debentures are subordinate to the claims of depositors and certain other creditors. Approval from the Superintendent is required before the Bank can redeem its subordinated debentures in whole or in part.

During the fiscal year ended October 31, 2005, the Bank issued a total of $350 million of subordinated debentures under its Canadian Medium Term Note Program. The issue, Series 3 Medium Term Notes, matures in December 2019. Interest on this issue is payable semi-annually at a fixed rate of 4.926% until December 22, 2014, and thereafter, quarterly to maturity at a floating rate equal to the rate on three-month bankers’ acceptances plus 1.00%.

The Bank redeemed a subordinated debenture in the amount of $350 million, maturing June 7, 2010, at a rate of 6.90%. In October 2005, the Bank also converted a US $250 million debenture, maturing in November 2009, into deposit notes.
 
15(c)-20
 
               
Denominated in
          
Maturity date
  
Interest rate
  
Characteristics
  
foreign currency
  
2005
  
2004
  
                           
November
  
2009
    
7.75%  
 
  
Convertible into deposit notes at the Bank’s option
    
US 250
    
—
    
305
  
June
  
2010
    
6.90%(1)
)
  
Redeemable since June 7, 2005
         
—
    
350
  
October
  
2011
    
7.50%(2)
)
  
Redeemable since October 17, 2001
          
150
    
150
  
October
  
2012
    
6.25%(3)
)
  
Not redeemable prior to October 31, 2007
          
300
    
300
  
April
  
2014
    
5.70%(4)
)
  
Redeemable since April 16, 2004
          
250
    
250
  
December
  
2019
    
4.926%(5)
)
  
Not redeemable prior to December 22, 2014
          
350
    
—
  
February
  
2087
    
Floating(6)
)
  
Redeemable at the Bank’s option since February 28, 1993
    
US 44
    
52
    
53
  
Total
                                      
1,102
    
1,408
  

(1)
Bearing interest at a rate of 6.90% until June 7, 2005, and thereafter at an annual rate equal
 
to the 90-day acceptance rate plus 1%.
(2)
Bearing interest at a rate of 7.50% until October 17, 2006, and thereafter at an annual rate equal
 
to the 90-day acceptance rate plus 1%.
(3)
Bearing interest at a rate of 6.25% until October 31, 2007, and thereafter at an annual rate equal
 
to the 90-day acceptance rate plus 1%
(4)
Bearing interest at a rate of 5.70% until April 16, 2009, and thereafter at an annual rate equal
 
to the 90-day acceptance rate plus 1%.
(5)
Bearing interest at a rate of 4.926% until December 22, 2014, and thereafter at an annual rate equal
 
to the 90-day acceptance rate plus 1%.
(6)
Bearing interest at an annual rate of 1/8% above LIBOR.

The subordinated debenture maturities are as follows:

            
2006
    
—
  
2007
    
—
  
2008
    
—
  
2009
    
—
  
2010
    
—
  
2011 to 2015
    
700
  
2016 and thereafter
    
402
  
     
1,102
  
         
On November 2, 2005, the Bank issued $500 million of subordinated debentures that mature in 2020. Interest at the annual rate of 4.70% is payable semi-annually on May 2 and November 2 of each year.

Non-controlling interest

   
Denominated in
          
   
foreign currency
  
2005
  
2004
  
               
300,000 preferred shares, Series A, exchangeable, non-cumulative dividends, issued by NB Capital Corporation (1) 
    
US 300
    
355
    
365
  
Mutual funds consolidated in accordance with AcG-15
          
124
    
—
  
Other
              
8
    
5
  
Total
               
487
    
370
  

(1)
Annual dividend of 8.35% payable quarterly on March 31, June 30, September 30 and December 31. These preferred shares are non-voting shares, subordinated to common shares. They are redeemable at the issuer’s option as of September 3, 2007. The preferred shares, whose liquidation price is US $1,000 per share, are traded on the New York Stock Exchange in the form of depositary shares representing 1/40 of each share. Each preferred share shall automatically be exchanged for a new preferred share of the Bank if one of the following events occurs: i) the Bank defaults on the dividend payment for its first preferred shares; ii) the Bank’s Tier 1 capital ratio is less than 4% or the total capital ratio is less than 8%; or iii) at the request of the Superintendent, in accordance with Section 485(3) of the Bank Act.
 
 
15(c)-21

12 | Employee Future Benefits

The Bank offers defined benefit pension plans that cover substantially all salaried employees. These defined benefit plans are funded pension plans.

The effective dates of the most recent actuarial valuations and those of compulsory future valuations to ensure the funded status of these plans are:

   
Date of most recent
  
Date of compulsory
  
           
actuarial valuation
  
actuarial valuation
  
           
Employee pension plan
    
December 31, 2004
    
December 31, 2007
  
Pension plan for designated employees
    
December 31, 2004
    
December 31, 2007
  
Post-Retirement Allowance Program
    
December 31, 2004
    
December 31, 2006
  

The Bank’s employee pension plans provide for the payment of benefits based on length of service and final average earnings of the employees covered by the plans. The Bank also offers various complementary, contributory insurance plans to eligible current and retired employees, their spouses and their dependants. However, these benefit plans are not funded.

The following tables describe the Bank’s commitments and costs for these employee future benefits. The measurement date used is October 31 of each year.

Accrued benefit asset (liability)

   
Pension benefit plans
  
Other benefit plans
  
          
2005
  
2004
  
2005
  
2004
  
                   
Accrued benefit obligation
                  
Balance at beginning
    
1,480
    
1,305
    
116
    
104
  
Current service cost
    
37
    
31
    
4
    
4
  
Interest cost
    
95
    
89
    
8
    
7
  
Employee contributions
    
16
    
15
    
—
    
—
  
Benefits paid
    
(64
)
  
(56
)
  
(5
)
  
(5
)
Plan amendments
    
24
    
—
    
—
    
—
  
Actuarial losses
    
143
    
96
    
13
    
6
  
Balance at end
   
1,731
    
1,480
    
136
    
116
  
                           
Plan assets
                          
Fair value at beginning
   
1,478
    
1,366
    
—
    
—
  
Actual return on plan assets
    
162
    
104
    
—
    
—
  
Bank contributions
    
46
    
49
    
—
    
—
  
Employee contributions
    
16
    
15
    
—
    
—
  
Benefits paid
    
(64
)
  
(56
)
  
—
    
—
  
Fair value at end
    
1,638
    
1,478
    
—
    
—
  
                           
Funded status - plan deficit
    
(93
)
  
(3
)
  
(136
)
  
(116
)
Unamortized net actuarial losses
    
412
    
346
    
31
    
18
  
Unamortized past service costs
    
34
    
15
    
—
    
—
  
Accrued benefit asset (liability) at end
    
353
    
358
    
(105
)
  
(98
)

The accrued benefit asset (liability) is presented as follows in the Consolidated Balance Sheet:

   
Pension benefit plans
  
Other benefit plans
  
      
2005
  
2004
  
2005
  
2004
  
                   
Accrued benefit asset included in “Other assets”
    
353
    
358
    
—
    
—
  
Accrued benefit liability included in “Other liabilities”
    
—
    
—
    
(105
)
  
(98
)
Net amount recorded as at October 31
    
353
    
358
    
(105
)
  
(98
)
 
 
15(c)-22

Included in the above accrued benefit obligation and fair value of plan assets at year-end are the following amounts in respect of benefit plans with accrued benefit obligations in excess of plan assets:

         
2005
  
2004
  
           
Fair value of plan assets
    
1,541
    
1,390
  
Accrued benefit obligation
    
1,664
    
1,424
  
Funded status - plan deficit
    
(123
)
  
(34
)

As at October 31, plan assets consist of:

      
2005
%
  
2004
%
  
           
Asset category
          
Money market
    
7
    
5
  
Bonds
    
27
    
28
  
Equities
    
54
    
56
  
Other
    
12
    
11
  
     
100
    
100
  

Plan assets include investment securities issued by the Bank. As at October 31, 2005, these investments totaled $128 million (2004: $128 million).

In fiscal 2005, the Bank and its subsidiaries received close to $5 million (2004: $5 million) in management fees for related management, administration and custodial services.

Elements of defined benefit expense for the years ended October 31:

   
Pension benefit plans
  
Other benefit plans
  
        
2005
  
2004
  
2005
  
2004
  
                   
Current service cost
    
37
    
31
    
4
    
4
  
Interest cost
    
95
    
89
    
8
    
7
  
Actual return on plan assets
    
(162
)
  
(104
)
  
—
    
—
  
Actuarial losses on obligation
    
143
    
96
    
13
    
6
  
Plan amendments
    
24
    
—
    
—
    
—
  
Curtailment and settlement loss
    
—
    
2
    
—
    
—
  
Expense before adjustments to recognize the long-term nature of employee future benefits
    
137
    
114
    
25
    
17
  
                           
Difference between expected return and actual return on plan assets for year
    
59
    
5
    
—
    
—
  
Difference between actuarial gains recognized for year and actual actuarial gains on accrued benefit obligation for year
    
(125
)
  
(83
)
  
(12
)
  
(6
)
                           
Difference between amortization of past service costs for year and actual plan amendments for year
    
(20
)
  
2
    
—
    
—
  
Defined benefit expense
    
51
    
38
    
13
    
11
  
 

 
15(c)-23

The significant assumptions used by the Bank are as follows (weighted average):

   
Pension benefit plans
  
Other benefit plans
  
       
2005
  
2004
  
2005
  
2004
  
       %   %   %   %  
                   
Accrued benefit obligation as of October 31
                  
Discount rate
    
5.50
    
6.25
    
5.75
    
6.50
  
Rate of compensation increase
    
3.50
    
4.00
    
3.50
    
4.00
  
                           
Defined benefit expense for years ended October 31
                         
Discount rate
    
6.25
    
6.75
    
6.50
    
6.75
  
Expected long-term rate of return on plan assets
    
7.25
    
7.50
    
—
    
—
  
Rate of compensation increase
    
4.00
    
4.00
    
4.00
    
4.00
  
 
For measurement purposes, a 6.9% annual rate of increase (2004: 7.7%) in the per capita cost of covered healthcare benefits was assumed for 2005. The rate was assumed to decrease gradually to reach 5.9% in 2008 and remain at that level thereafter.

Sensitivity of key assumptions in 2005
       
Pension benefit plans
  
Change in obligation
  
Change in expense
  
           
Impact of a 0.25% change in the assumption regarding the discount rate
    
62
    
7
  
Impact of a 0.25% change in the assumption regarding the expected long-term rate of return on plan assets
    
—
    
4
  
Impact of a 0.25% change in the assumption regarding the rate of compensation increase
    
13
    
3
  
   
Other benefit plans
  
Change in obligation
  
Change in expense
  
           
Impact of a 0.25% change in the assumption regarding the discount rate
    
5
    
1
  
Impact of a 0.25% change in the assumption regarding the rate of compensation increase
    
—
    
—
  
Impact of a 1.00% increase in the expected healthcare cost trend rate
    
16
    
3
  
Impact of a 1.00% decrease in the expected healthcare cost trend rate
    
(14
)
  
(2
)

The sensitivity analysis presented in the above table must be used with caution given that the changes are hypothetical and the changes in each significant assumption may not be linear.

Cash payments for employee future benefits for the years ended October 31 are as follows:

       
2005
  
2004
  
           
Bank pension benefit plan contributions
    
46
    
49
  
Benefits paid under other benefit plans
    
5
    
5
  
 
 
15(c)-24

13 | Capital Stock

Authorized
 
First preferred shares
An unlimited number of shares, without par value, issuable for a maximum aggregate consideration of $1 billion.

Second preferred shares
15 million shares, without par value, issuable for a maximum aggregate consideration of $300 million.

Common shares
An unlimited number of shares, without par value, issuable for a maximum aggregate consideration of $3 billion.
 
 
      
 
      
2005
  
Shares outstanding and dividends declared
  
Number of
shares
  
Shares
$
  
$
  
Dividends
per share
  
First preferred shares
                  
Series 13
    
—
    
—
    
8
    
1.2000
  
Series 15
    
8,000,000
    
200
    
12
    
1.4625
  
Series 16
    
8,000,000
    
200
    
6
    
0.8089
  
Preferred shares and dividends
    
16,000,000
    
400
   
26
        
                           
Common shares at beginning
    
167,430,253
    
1,545
              
Issued pursuant to:
                          
Dividend Reinvestment and Share Purchase Plan
    
239,374
    
12
              
Stock Option Plan
    
1,773,463
    
46
              
Repurchase of common shares
    
(4,178,900
)
  
(39
)
            
Impact of shares purchased or sold for trading
    
70,712
    
1
                      
Common shares at end and dividends
    
165,334,902
    
1,565
   
286
    
1.7200
  
Total dividends
            
   
   
312
             
 
 
              
 
  
 
      
 
      
2004
  
Shares outstanding and dividends declared
  
Number of
shares
  
Shares
$
  
$
  
Dividends
per share
  
First preferred shares
                  
Series 13
    
7,000,000
    
175
    
11
    
1.6000
  
Series 15
    
8,000,000
    
200
    
12
    
1.4625
  
Preferred shares and dividends
    
15,000,000
    
375
    
23
        
                           
Common shares at beginning
    
174,619,903
    
1,583
              
Issued pursuant to:
                          
Dividend Reinvestment and Share Purchase Plan
    
286,745
    
12
              
Stock Option Plan
    
1,223,605
    
30
              
Repurchase of common shares
    
(8,700,000
)
  
(80
)
                    
Common shares at end and dividends
    
167,430,253
    
1,545
    
243
    
1.4200
  
Total dividends
                       
266
             
 
 
15(c)-25

Characteristics of first preferred shares (amounts in dollars)
 
Series 13
Redeemable in cash at the Bank’s option, subject to the prior approval of the Superintendent and upon notice of not more than 60 and not less than 30 days, i) on August 15, 2005 and on the last day of each period of five years plus one day thereafter (conversion date), in whole at any time or in part from time to time, at a price equal to $25.00 per share plus all declared and unpaid dividends at the date fixed for redemption and, ii) after August 15, 2005, other than on a conversion date, in whole but not in part, at a price equal to $25.50 per share, plus all declared and unpaid dividends at the date fixed for redemption; non-cumulative preferential dividends at a quarterly rate of $0.40 per share for the first five years and at a variable rate thereafter.

Series 15
Redeemable in cash at the Bank’s option, subject to the prior approval of the Superintendent, on or after May 15, 2008, in whole or in part, at a price equal to $26.00 per share if redeemed before May 15, 2009, at a price equal to $25.75 per share if redeemed during the 12-month period preceding May 15, 2010, at a price equal to $25.50 per share if redeemed during the 12-month period preceding May 15, 2011, at a price equal to $25.25 per share if redeemed during the 12-month period preceding May 15, 2012, and at a price equal to $25.00 per share if redeemed on or after May 15, 2012, plus, in all cases, all declared and unpaid dividends at the date fixed for redemption.

Series 16
Redeemable in cash at the Bank’s option, subject to the prior approval of the Superintendent, on or after May 15, 2010, in whole or in part, at a price equal to $26.00 per share if redeemed before May 15, 2011, at a price equal to $25.75 per share if redeemed during the 12-month period preceding May 15, 2012, at a price equal to $25.50 per share if redeemed during the 12-month period preceding May 15, 2013, at a price equal to $25.25 per share if redeemed during the 12-month period preceding May 15, 2014, and at a price equal to $25.00 per share if redeemed on or after May 15, 2014, plus, in all cases, all declared and unpaid dividends at the date fixed for redemption.

Issuance and redemption of preferred shares
On March 15, 2005, the Bank issued 8,000,000 first preferred shares with non-cumulative preferential dividends at a quarterly rate of $0.303125 per share, Series 16, for a consideration of $194 million, net of fees of $6 million.

On August 15, 2005, the Bank redeemed for cancellation all 7,000,000 first preferred shares with non-cumulative dividends, Series 13, at a price equal to $25.00 per share, plus $0.40 per share, representing all declared and unpaid dividends until the date of redemption.

Repurchase of common shares
On January 13, 2005, the Bank commenced a normal course issuer bid for the repurchase and cancellation of up to 8,400,000 common shares over a 12-month period ending no later than January 12, 2006. Purchases were made in the open market at market prices through the facilities of the Toronto Stock Exchange. Premiums paid above the average carrying value of the common shares were charged to retained earnings. As at October 31, 2005, the Bank completed the repurchase of 4,178,900 common shares at a cost of $224 million, which reduced common equity capital by $39 million and retained earnings by $185 million.

On December 8, 2003, the Bank commenced a normal course issuer bid for the repurchase of up to 8,700,000 common shares over a 12-month period ending no later than December 7, 2004. Purchases were made in the open market at market prices through the facilities of the Toronto Stock Exchange. Premiums paid above the average carrying value of the common shares were charged to retained earnings. As at October 31, 2004, the Bank had completed the repurchase of 8,700,000 common shares at a cost of $382 million, which reduced common equity capital by $80 million and retained earnings by $302 million.

Reserved common shares
As at October 31, 2005, 3,724,980 common shares were reserved under the Dividend Reinvestment and Share Purchase Plan and 14,395,655 common shares were reserved under the Stock Option Plan.

Restriction on the payment of dividends
The Bank is prohibited from declaring dividends on its common or preferred shares if there are reasonable grounds for believing that the Bank would, by so doing, be in contravention of the regulations of the Bank Act or the guidelines of the Superintendent with respect to capital adequacy and liquidity. In addition, the ability to pay common share dividends is restricted by the terms of the outstanding preferred shares pursuant to which the Bank may not pay dividends on its common shares without the approval of the holders of the outstanding preferred shares, unless all preferred share dividends have been declared and paid or set aside for payment.
 
15(c)-26

14 | Stock-Based Compensation

The Bank has five stock-based compensation plans.

The information below on the compensation expense with respect to the SAR Plan, the DSU Plan and the RSU Plan excludes the impact of hedging. Compensation expense for these plans, net of the impact of hedging, is negligible.

Stock Appreciation Rights (SAR) Plan
The Bank offers a Stock Appreciation Rights Plan to senior management and other key employees of the Bank and its subsidiaries (“designated employees”). Under the Plan, when designated employees exercise their SARs, they receive a cash amount equal to the difference between the market price of a common share of the Bank on the exercise date of the SAR and the exercise price of the SAR. The exercise price of each SAR awarded is equal to the closing market price of the stock on the day before the date of the award. SARs vest evenly over a four-year period and expire 10 years from the award date or, in certain circumstances set out in the Plan, within specified time limits. Compensation expense recognized for the year ended October 31, 2005 with respect to the Plan amounted to $12 million (2004: $15 million).
 
            
2005
          
2004
  
       
Weighted
      
Weighted
  
       
average
      
average
  
   
Number
  
exercise
  
Number
  
exercise
  
      
of SARs
  
price
  
of SARs
  
price
  
SAR Plan
                  
Outstanding at beginning
    
715,680
  
 
$18.59
    
1,269,640
  
 
$17.71
  
Awarded
    
9,800
  
 
$48.20
    
16,000
  
 
$41.00
  
Exercised
    
(340,320
)
 
$17.99
    
(566,310
)
 
$17.19
  
Cancelled
   
(6,850
)
 
$21.73
    
(3,650
)
 
$27.34
  
Outstanding at end
   
378,310
  
 
$19.84
    
715,680
  
 
$18.59
  
Exercisable at end
   
340,348
  
 
$17.80
    
668,649
  
 
$17.58
  
 
   
SARs
  
SARs
      
Exercise price
  
outstanding
  
exercisable
  
Expiry date
  
               
$13.50
    
26,000
    
26,000
    
December 2006
  
$24.50
    
600
    
600
    
December 2007
  
$17.35
    
292,010
    
292,010
    
December 2009
  
$24.90
    
10,350
    
10,350
    
December 2010
  
$28.01
    
10,450
    
4,663
    
December 2011
  
$30.95
    
14,000
    
3,625
    
December 2012
  
$41.00
    
15,100
    
3,100
    
December 2013
  
$48.20
    
9,800
    
—
    
December 2014
  
Total
    
378,310
    
340,348
    
 
  
 
Stock Option Plan
The Bank offers a Stock Option Plan to senior management and other key employees of the Bank and its subsidiaries (“designated employees”). Under the Bank’s Stock Option Plan, options are periodically awarded to designated employees. These options provide employees with the right to subscribe for common shares of the Bank at an exercise price equal to the market price of the Bank’s shares on the day before the date of the award. The options vest evenly over a four-year period and expire 10 years from the award date or, in certain circumstances set out in the Plan, within specified time limits. The maximum number of common shares that may be issued under the Stock Option Plan is 14,395,655 as at October 31, 2005. The maximum number of common shares reserved for a participant may not exceed 5% of the total number of Bank shares issued and outstanding. Each participant in the SAR Plan who is a resident of Canada may exchange each SAR held for a stock option governed by the Stock Option Plan at an exercise price representing the market value of a common share at closing on the day preceding the date the option is exchanged.
 
15(c)-27
 
            
2005
         
2004
  
       
Weighted
      
Weighted
  
       
average
      
average
  
   
Number
  
exercise
  
Number
  
exercise
  
      
of options
  
price
  
of options
  
price
  
                   
Stock Option Plan
                  
Outstanding at beginning
   
6,180,960
  
 
$30.20
    
6,134,765
  
 
$26.40
  
Awarded
    
1,468,260
  
 
$48.20
    
1,376,900
  
 
$41.00
  
Exercised
    
(1,760,263
)
 
$25.69
    
(1,240,055
)
 
$23.39
  
Cancelled
   
(274,987
)
 
$41.59
    
(90,650
)
 
$30.04
  
Outstanding at end
   
5,613,970
  
 
$35.76
    
6,180,960
  
 
$30.20
  
Exercisable at end
   
2,192,403
  
 
$28.90
    
2,826,403
  
 
$25.72
  

   
Options
  
Options
  
 
  
Exercise price
  
outstanding
  
exercisable
  
Expiry date
  
               
$11.00
    
3,300
    
3,300
    
December 2005
  
$13.50
    
23,775
    
23,775
    
December 2006
  
$25.20
    
166,000
    
166,000
    
December 2007
  
$25.20
    
236,500
    
236,500
    
December 2008
  
$24.90
    
427,695
    
427,695
    
December 2010
  
$28.01
    
1,024,740
    
602,136
    
December 2011
  
$30.95
    
1,162,013
    
468,676
    
December 2012
  
$41.00
    
1,238,037
    
264,321
    
December 2013
  
$48.20
    
1,331,910
    
—
    
December 2014
  
Total
    
5,613,970
    
2,192,403
    
 
  

The fair value on the award date of options awarded in 2005 was estimated at $9.70 (2004: $9.10) using the Black-Scholes model. The following assumptions were used: i) a risk-free interest rate of 4.05% (2004: 4.37%), ii) an expected life of options of 6 years (2004: 6 years), iii) an expected volatility of 27% (2004: 27%), and iv) an expected dividend yield of 5.00% (2004: 5.00%).

The compensation expense recorded for these stock options was $6 million for the year ended October 31, 2005 (2004: $5 million). The offsetting entry was credited to contributed surplus.

Deferred Stock Unit Plan for Officers
The Deferred Stock Unit (DSU) Plan for Officers is for certain members of senior management and other key employees of the Bank and its subsidiaries. A total of 216,775 DSUs were outstanding as at October 31, 2005 (2004: 252,212). Compensation expense recognized for 2005 with respect to the Plan was $6 million (2004: $6 million).

Restricted Stock Unit Plan
The Restricted Stock Unit (RSU) Plan is for Bank officers designated as eligible persons by a committee or the Board of Directors of the Bank, provided they are employees of the Bank or of one of its subsidiaries. As at October 31, 2005, a total of 67,181 RSUs were outstanding. Compensation expense recognized for 2005, the first year of the Plan, with respect to the Plan was $4 million.

Employee Share Ownership Plan
Under the Bank’s Employee Share Ownership Plan, employees who meet the eligibility criteria can contribute up to 8% of their annual gross salary by way of payroll deductions. The Bank matches 25% of the employee contribution amount, to a maximum of $1,500 per annum. Bank contributions vest to the employee after one year of continuous participation in the Plan. Subsequent contributions vest immediately. The Bank’s contributions, amounting to $4 million in 2005 (2004: $4 million), were charged to “Salaries and staff benefits” when paid.
 
15(c)-28

15 | Income Taxes

The Bank’s income taxes for the years ended October 31 in the consolidated financial statements are as follows:

        
2005
  
2004
  
Consolidated Statement of Income
          
Income taxes
    
291
    
318
  
               
Consolidated Statement of Changes in Shareholders’ Equity
              
Income taxes related to
              
Share issuance and other expenses
    
(2
)
  
—
  
Dividends on preferred shares, Series 13, 15 and 16
    
—
    
1
  
Unrealized foreign currency translation adjustments
    
13
    
31
  
        
11
    
32
  
          
302
    
350
  
Income taxes were as follows:
              
Current income taxes
    
333
    
300
  
Future income taxes relating to the inception and reversal of temporary differences
    
(31
)
  
50
  
Income taxes
    
302
    
350
  

The temporary differences and carryforwards resulting in future income tax assets and liabilities are as follows:

          
2005
  
2004
  
           
Future income tax assets
          
Allowance for credit losses and other liabilities
    
313
    
294
  
Accrued benefit liability - Other benefit plans
    
34
    
30
  
        
347
    
324
  
Future income tax liabilities
              
Premises and equipment
    
(20
)
  
(20
)
Securitization
    
(42
)
  
(30
)
Accrued benefit asset - Pension benefit plans
    
(111
)
  
(108
)
Other
    
(77
)
  
(97
)
        
(250
)
  
(255
)
Net balance of future income tax assets
    
97
    
69
  
Future income tax assets
    
137
    
100
  
Future income tax liabilities
    
(40
)
  
(31
)
        
97
    
69
  

Reconciliation of the Bank’s income tax rate for the years ended October 31 is as follows:
   
2005
  
2004
  
      
$
  
%
  
$
  
%
  
                   
Income before income taxes and non-controlling interest
    
1,171
    
100.0
    
1,071
    
100.0
  
Income taxes at Canadian statutory income tax rate
    
392
    
33.5
    
364
    
34.0
  
Reduction in income tax rate due to:
                          
Tax-exempt income from securities, mainly dividends from Canadian corporations
    
(58
)
  
(4.9
)
  
(40
)
  
(3.7
)
Rates applicable to subsidiaries abroad
    
(41
)
  
(3.5
)
  
(32
)
  
(3.0
)
Other items
    
(2
)
  
(0.2
)
  
26
    
2.4
  
         
(101
)
  
(8.6
)
  
(46
)
  
(4.3
)
Income taxes and effective income tax rate
    
291
    
24.9
    
318
    
29.7
  


15(c)-29

16 | Earnings per Share

Diluted net earnings per common share are calculated based on net income less dividends on preferred shares divided by the average number of common shares outstanding.

         
2005
  
2004
  
           
Net income
    
855
    
725
  
Dividends on preferred shares
    
(26
)
  
(23
)
Net income available to common shareholders - basic and diluted
    
829
    
702
  
               
Average number of common shares outstanding (thousands)
              
Average basic number of common shares outstanding
    
166,382
    
170,918
  
Adjustment to number of common shares
              
Stock options
    
2,582
    
2,358
  
Average diluted number of common shares outstanding
    
168,964
    
173,276
  
Earnings per share - basic
  
$
4.98
  
$
4.10
  
Earnings per share - diluted
  
$
4.90
  
$
4.05
  

17 | Guarantees, Commitments and Contingent Liabilities

Guarantees
CICA Accounting Guideline No. 14 “Disclosure of Guarantees” (AcG-14) defines a guarantee as a contract (including an indemnity) that contingently requires the guarantor to make payments (either in cash, financial instruments, other assets or shares of the entity, or provision of services) to the beneficiary due to (a) changes in interest rate, security or commodity price, foreign exchange rate, index or other variable, including the occurrence or non-occurrence of a specified event, that is related to an asset, a liability or an equity security of the beneficiary of the guarantee, (b) failure of a third party to perform under a contractual agreement or (c) failure of a third party to pay its indebtedness when due.

The maximum potential future payments for significant guarantees issued by the Bank and in effect as at October 31, are presented in the following table:

        
2005
  
2004
  
           
Letters of guarantee
    
1,313
    
1,225
  
Backstop liquidity facilities
   
1,519
    
1,378
  
Derivatives
   
1,850
    
385
  
Securities lending
   
1,023
    
761
  
Other indemnification agreements
   
226
    
230
  
Other guarantee
   
23
    
22
  
Total
    
5,954
    
4,001
  

Letters of guarantee
In the normal course of business, the Bank issues letters of guarantee. These letters of guarantee represent irrevocable commitments that the Bank will make payments in the event that a client cannot meet its financial obligations to third parties. The Bank’s policy for requiring collateral security with respect to letters of guarantee is similar to that for loans. Generally, the term of these letters of guarantee is less than two years. The general allowance for credit losses covers all credit risks including those relating to letters of guarantee.

Backstop liquidity facilities
The Bank provides backstop liquidity facilities under asset-backed commercial paper conduit programs administered by it further to securitization operations. The Bank also administers a multi-seller conduit that buys various financial assets from clients and finances these purchases by issuing asset-backed commercial paper. The Bank provides backstop liquidity facilities to some multi-seller conduits, including the one administered by the Bank.

The backstop liquidity facilities may only be drawn upon if, after market disruption, the conduit was unable to access the commercial paper market. These guarantees have a duration of less than one year and are renewable periodically. The terms of the backstop liquidity facilities do not require the Bank to advance money to the conduit in the event of a bankruptcy or to fund non-performing or defaulted assets. None of the backstop liquidity facilities provided by the Bank have been drawn upon to date and no amount has been accrued in the Consolidated Balance Sheet with respect to these backstop liquidity facilities.
 
15(c)-30

Derivatives
In the normal course of business, the Bank enters into written put options to meet the needs of its clients and for its own risk management and trading activities. Put options are contractual agreements where the Bank conveys to the purchaser the right, but not the obligation, to sell to the Bank by or before a predetermined date, a specific amount of currency, commodity or financial instrument, at a price agreed to when the option is sold. Written put options that qualify as a guarantee under AcG-14 include primarily over-the-counter currency options with companies other than financial institutions and over-the-counter stock options when it is probable that the counterparty holds the underlying securities. Most of the terms of these options vary according to the contracts, but do not exceed two years. As at October 31, 2005, the Bank recorded a liability of $26 million in the Consolidated Balance Sheet with respect to these written put options (2004: $3 million), representing the fair value of these options.

Securities lending
Under securities lending agreements the Bank has entered into with certain clients who have entrusted it with the safekeeping of their securities, the Bank lends their securities to third parties and indemnifies its clients in the event of loss. In order to protect itself against any contingent loss, the Bank obtains, as security from the borrower, a cash amount or highly liquid marketable securities with a fair value greater than that of the securities loaned. No amount has been accrued in the Consolidated Balance Sheet with respect to potential indemnities resulting from these securities lending agreements.

Other indemnification agreements
In the normal course of business, including securitization activities and discontinuance of operations and activities, the Bank enters into numerous contractual agreements. Under these agreements, the Bank undertakes to compensate the counterparty for costs incurred as a result of litigation, changes in laws and regulations (including tax legislation), claims with respect to past performance, incorrect representations or the non-performance of certain restrictive covenants. Moreover, as a member of a securities transfer network and pursuant to the membership agreement and the regulations governing the operation of the network, the Bank granted a movable hypothec to the network that can be used in the event another member fails to meet its contractual obligations. The nature of certain of these commitments prevents the Bank from estimating the maximum potential liability it may be required to pay. The duration of these agreements is stipulated in each contract. The maximum potential future payments that the Bank is able to estimate is presented in the previous table and their duration does not exceed four years. No amount has been accrued in the Consolidated Balance Sheet with respect to these agreements.

Other guarantee
Pursuant to a mutual guarantee agreement required by a regulatory authority, a subsidiary of the Bank has agreed to guarantee all commitments, debts and liabilities of a company subject to significant influence to the maximum of its regulatory capital. This guarantee expires on the date the investment in the company subject to significant influence is sold, or sooner if deemed appropriate by the regulatory authority. To date, this guarantee remains undrawn and no amount has been accrued in the Consolidated Balance Sheet with respect to the agreement.

Commitments
As at October 31, 2005, minimum commitments under leases, contracts for outsourced information technology services and other leasing agreements are as follows:

       
Service
  
Equipment
      
       
Premises
  
contracts
  
and furniture
  
Total
  
                   
2006
    
102
    
189
    
7
    
298
  
2007
     94    
184
    
7
    
285
  
2008
    
87
    
172
    
4
    
263
  
2009
    
81
    
163
    
2
    
246
  
2010
    
76
    
163
    
1
    
240
  
2011 and thereafter
    
410
    
230
    
—
    
640
  
     
850
    
1,101
    
21
    
1,972
  
 
 
15(c)-31

Pledged assets
In the normal course of business, the Bank pledges securities and other assets as collateral for various liabilities it contracts. A breakdown of assets pledged as collateral is provided below.

As at October 31
  
2005
  
2004
  
           
Assets pledged to:
          
- Bank of Canada
    
25
    
25
  
- Direct clearing organizations
    
2,480
    
2,812
  
Assets pledged in relation to:
              
- Derivative transactions
    
538
    
544
  
- Borrowing, securities lending and securities sold under repurchase agreements
    
13,264
    
12,016
  
- Other
    
221
    
643
  
Total
    
16,528
    
16,040
  

Credit instruments
In the normal course of business, the Bank enters into various off-balance sheet commitments. The credit instruments used to meet the financing needs of its clients represent the maximum amount of additional credit the Bank could be obligated to extend if the commitments were fully drawn.

As at October 31
  
2005
  
2004
  
           
Letters of guarantee(1)
    
1,313
    
1,225
  
Documentary letters of credit(2)
    
110
    
102
  
Credit card loans(3)
    
5,331
    
4,882
  
Commitments to extend credit(3)
              
Original term of one year or less
    
6,589
    
6,756
  
Original term of more than one year
    
11,074
    
10,346
  

(1)
See “Letters of guarantee” on page 105.
(2)
Documentary letters of credit are documents issued by the Bank and used in international trade to enable a third party to draw drafts on the Bank up to an amount established under specific terms and conditions; these instruments are collateralized by the delivery of the goods they represent.
(3)
Credit card loans and commitments to extend credit represent the undrawn portions of credit authorizations granted in the form of loans, acceptances, letters of guarantee and documentary letters of credit. The Bank is required at all times to make the undrawn portion of the authorization available, subject to certain conditions.

Other commitments
The Bank acts as an investor in investment banking activities by entering into agreements to finance external private equity funds and investments in equity and debt securities at market value at the time the agreements are signed. In connection with these activities, the Bank had commitments to invest up to $721 million as at October 31, 2005 (2004: $747 million).

Litigation
In the normal course of business, the Bank is engaged in various legal proceedings, most of which are related to lending activities and arise when the Bank takes measures to collect delinquent loans. Recently, motions for authorization to institute class action suits were filed against various financial institutions, including the Bank, contesting, among other things, certain transaction fees. The subsidiary National Bank Financial is also engaged in various legal proceedings in the normal course of business. Most of these proceedings concern services to individual investors and may relate to the suitability of investments. In the opinion of Management, based on past experience, the related aggregate potential liability will not have a material impact on the Bank’s financial position.

18 | Derivative Financial Instruments

Derivative financial instruments are financial contracts whose value is derived from an underlying interest rate, exchange rate, or equity, commodity or credit instrument or index. The Bank uses these instruments to accommodate the needs of its clients and for its own risk management and trading activities.

The main types of derivative financial instruments used are as follows:

Foreign exchange forward contracts and futures
Foreign exchange forward contracts and futures are contractual obligations to buy or deliver a specific amount of currency, interest, commodities or financial instruments on a specific future date at a specified price. Foreign exchange forward contracts are tailor-made agreements transacted in the over-the-counter market. Futures are traded on organized exchanges and are subject to daily cash margining.
 
15(c)-32

Swaps
Swaps are specific transactions in which two parties agree to exchange cash flows. The Bank uses the following types of swap contracts:

Cross currency swaps are transactions in which counterparties exchange fixed rate interest payments and principal payments in different currencies.

Interest rate swaps are transactions in which counterparties exchange fixed and floating rate interest payments, based on the notional principal value in the same currency.

Commodity swaps are transactions in which counterparties exchange fixed and floating rate payments, based on the notional principal value of a single product.

Equity swaps are transactions in which counterparties agree to exchange the return on one equity or group of equities for a payment based on a benchmark interest rate.

Credit default swaps are transactions in which one of the counterparties agrees to pay interest expenses to the other counterparty so that it can make a payment if a credit event occurs.

Options
Options are agreements between two parties in which the writer of the option conveys to the buyer the right, but not the obligation, to buy or to sell, at or by a predetermined date, at any time prior to a predetermined expiry date, a specific amount of currency, commodities or financial instruments at a price agreed to when the option is arranged. The writer receives a premium for selling this instrument.
 
15(c)-33

Notional principal amounts
Notional principal amounts, which are off-balance sheet items, represent the set underlying principal of a derivative instrument and serve as a reference for currency and interest rates and stock market prices to determine the amount of cash flows to be exchanged. Notional principal amounts are presented in the table below.

     
Remaining term to maturity
                 
2005
2004
  
                       
Contracts
  
Contracts
    
                       
held for
  
held for
    
   
Within
  
3 to 12
  
1 to 5
  
Over
  
Total
 
trading
  
non-trading
Total
  
      
3 months
  
months
  
years
  
5 years
  
contracts
  
purposes
  
purposes
contracts
  
Foreign exchange contracts
                                  
OTC contracts
                                  
Forwards
    
4,852
    
1,423
    
512
    
—
    
6,787
    
6,760
    
27
    
6,306
  
Swaps
    
35,272
    
10,230
    
4,582
    
1,060
    
51,144
    
45,141
    
6,003
    
29,559
  
Options purchased
    
4,478
    
2,606
    
349
    
—
    
7,433
    
7,433
    
—
    
5,514
  
Options written
    
3,321
    
3,263
    
258
    
—
    
6,842
    
6,842
    
—
    
5,284
  
Total
    
47,923
    
17,522
    
5,701
    
1,060
    
72,206
    
66,176
    
6,030
    
46,663
  
Exchange-traded contracts
                                                  
Futures
                                                  
Long positions
    
27
    
—
    
—
    
—
    
27
    
27
    
—
    
90
  
Short positions
    
88
    
2
    
—
    
—
    
90
    
90
    
—
    
62
  
Options purchased
    
30
    
—
    
—
    
—
    
30
    
30
    
—
    
30
  
Options written
    
20
    
—
    
—
    
—
    
20
    
20
    
—
    
1
  
Total
    
165
    
2
    
—
    
—
    
167
    
167
    
—
    
183
  
Interest rate contracts
                                                  
OTC contracts
                                                  
Forward rate agreements
    
1,248
    
7,534
    
300
    
—
    
9,082
    
9,082
    
—
    
7,033
  
Swaps
    
43,650
    
21,885
    
49,287
    
8,312
    
123,134
    
99,794
    
23,340
    
116,761
  
Options purchased
    
10,300
    
15,375
    
3,100
    
1,949
    
30,724
    
30,724
    
—
    
13,157
  
Options written
    
11,905
    
19,793
    
3,967
    
2,579
    
38,244
    
38,244
    
—
    
13,566
  
Total
    
67,103
    
64,587
    
56,654
    
12,840
    
201,184
    
177,844
    
23,340
    
150,517
  
Exchange-traded contracts
                                                  
Futures
                                                  
Long positions
    
3,890
    
491
    
812
    
—
    
5,193
    
5,193
    
—
    
12,316
  
Short positions
    
3,840
    
4,273
    
1,557
    
—
    
9,670
    
9,670
    
—
    
21,670
  
Options purchased
    
37,747
    
16,492
    
1,046
    
—
    
55,285
    
55,285
    
—
    
21,748
  
Options written
    
25,859
    
2,261
    
1,518
    
—
    
29,638
    
29,638
    
—
    
21,002
  
Total
    
71,336
    
23,517
    
4,933
    
—
    
99,786
    
99,786
    
—
    
76,736
  
Equity, commodity and credit derivative contracts
                                                  
OTC contracts
                                                  
Forwards
    
19
    
28
    
334
    
72
    
453
    
453
    
—
    
107
  
Swaps
    
4,850
    
2,839
    
2,133
    
827
    
10,649
    
10,639
    
10
    
13,166
  
Options purchased
    
1,212
    
558
    
3,939
    
2,686
    
8,395
    
8,395
    
—
    
1,635
  
Options written
    
1,003
    
600
    
189
    
108
    
1,900
    
1,900
    
—
    
1,405
  
Total
    
7,084
    
4,025
    
6,595
    
3,693
    
21,397
    
21,387
    
10
    
16,313
  
Exchange-traded contracts
                                                  
Futures
                                                  
Long positions
    
286
    
112
    
42
    
1
    
441
    
441
    
—
    
94
  
Short positions
    
1,395
    
31
    
—
    
—
    
1,426
    
1,426
    
—
    
755
  
Options purchased
    
3,294
    
998
    
183
    
—
    
4,475
    
3,966
    
509
    
391
  
Options written
    
1,795
    
923
    
101
    
—
    
2,819
    
2,310
    
509
    
111
  
Total
    
6,770
    
2,064
    
326
    
1
    
9,161
    
8,143
    
1,018
    
1,351
  
                                                   
Total 2005
    
200,381
    
111,717
    
74,209
    
17,594
    
403,901
    
373,503
    
30,398
    
291,763
  
Total 2004
    
126,636
    
106,504
    
49,987
    
8,636
    
291,763
    
265,174
    
26,589
        

Credit risk
Credit risk on derivative financial instruments is the risk of a financial loss occurring as a result of a counterparty failing to honour its contractual obligations to the Bank. The current replacement cost, which is the positive fair value of all outstanding derivative financial instruments, represents the Bank’s maximum credit derivative exposure. The credit equivalent amount is calculated by taking into account the current replacement cost of all outstanding contracts in a gain position, potential future exposure and the impact of master netting agreements. The risk-weighted amount is the credit equivalent amount multiplied by the counterparty risk factors prescribed by the Superintendent. The Bank negotiates master netting agreements with counterparties with which it has significant credit risk exposure resulting from derivative transactions. Such agreements provide for the simultaneous close-out and settling of all transactions with a counterparty in the event of default. Some of these agreements also provide for the exchange of collateral between parties where the fair value of the outstanding transactions between the parties exceeds an agreed threshold.
 
15(c)-34

As at October 31, credit risk exposure on the derivatives portfolio is as follows:

                                            
2005
          
2004
  
   
Current replacement cost
          
Current replacement cost
          
       
Trading(1)
  
Non-
trading
 
Total
  
Credit
equiv-
alent
  
Risk-
weighted
amount
  
Trading(1)
  
Non-
trading
  
Total
  
Credit
equiv-
alent
  
Risk-
weighted
amount
  
                                           
Interest rate contracts
    
439
    
218
    
657
    
1,134
    
223
    
743
    
376
    
1,119
    
1,443
    
281
  
Foreign exchange contracts
    
800
    
38
    
838
    
1,744
    
433
    
1,111
    
23
    
1,134
    
1,619
    
354
  
Equity, commodity and credit derivative contracts
    
1,021
    
7
    
1,028
    
2,628
    
664
    
841
    
4
    
845
    
2,048
    
504
  
     
2,260
    
263
    
2,523
    
5,506
    
1,320
    
2,695
    
403
    
3,098
    
5,110
    
1,139
  
Impact of master netting agreements
    
(1,080
)
  
(124
)
  
(1,204
)
  
(2,566
)
  
(572
)
  
(1,560
)
  
—
    
(1,560
)
  
(2,394
)
  
(535
)
        
1,180
    
139
    
1,319
    
2,940
    
748
    
1,135
    
403
    
1,538
    
2,716
    
604
  

(1)
Excluding, in accordance with the guidelines of the Office of the Superintendent of Financial Institutions Canada, exchange-traded instruments and forward contracts with an original maturity of 14 days. The total positive fair value of these excluded contracts amounted to $130 million as at October 31, 2005 (2004: $40 million).

Fair value
The fair value of derivatives is determined before factoring in the impact of master netting agreements. When available, market prices are used to determine the fair value of derivatives. Otherwise, fair value is determined using pricing models that incorporate current market prices and the contractual prices of the underlying instruments, the time value of money, yield curves and volatility factors. If necessary, fair value is adjusted to take into account market, model and credit risks, as well as the related costs.
 
15(c)-35

As at October 31, fair values are as follows:

       
2005
          
2004
      
(millions of dollars)
  
Positive
  
Negative
  
Net
  
Positive
  
Negative
  
Net
  
                           
Contracts held for trading purposes
                          
Interest rate contracts
                          
Forwards
    
7
    
8
    
(1
)
  
6
    
7
    
(1
)
Swaps
    
391
    
355
    
36
    
675
    
501
    
174
  
Options
    
52
    
46
    
6
    
72
    
65
    
7
  
Total
    
450
    
409
    
41
    
753
    
573
    
180
  
                                       
Foreign exchange contracts
                                     
Forwards
    
29
    
83
    
(54
)
  
54
    
143
    
(89
)
Swaps
    
681
    
445
    
236
    
971
    
603
    
368
  
Options
    
109
    
118
    
(9
)
  
102
    
157
    
(55
)
Total
    
819
    
646
    
173
    
1,127
    
903
    
224
  
                                       
Equity, commodity and credit derivative contracts
                                      
Forwards
    
64
    
119
    
(55
)
  
24
    
171
    
(147
)
Swaps
    
783
    
492
    
291
    
615
    
475
    
140
  
Options
    
274
    
180
    
94
    
216
    
264
    
(48
)
Total
    
1,121
    
791
    
330
    
855
    
910
    
(55
)
Total contracts held for trading purposes
   
2,390
    
1,846
    
544
    
2,735
    
2,386
    
349
  
                                       
Contracts held for non-trading purposes
                                      
Interest rate contracts
                                      
Forwards
    
—
    
—
    
—
    
—
    
—
    
—
  
Swaps
    
218
    
94
    
124
    
374
    
183
    
191
  
Options
    
—
    
—
    
—
    
2
    
—
    
2
  
Total
    
218
    
94
    
124
    
376
    
183
    
193
  
                                       
Foreign exchange contracts
                                     
Forwards
    
—
    
—
    
—
    
—
    
—
    
—
  
Swaps
    
38
    
52
    
(14
)
  
23
    
50
    
(27
)
Options
    
—
    
—
    
—
    
—
    
—
    
—
  
Total
    
38
    
52
    
(14
)
  
23
    
50
    
(27
)
                                       
Equity, commodity and credit derivative contracts
                                      
Forwards
    
—
    
—
    
—
    
—
    
—
    
—
  
Swaps
    
—
    
—
    
—
    
—
    
—
    
—
  
Options
    
7
    
4
    
3
    
4
    
1
    
3
  
Total
    
7
    
4
    
3
    
4
    
1
    
3
  
Total contracts held for non-trading purposes
    
263
    
150
    
113
    
403
    
234
    
169
  
                                       
Total fair value
   
2,653
    
1,996
    
657
    
3,138
    
2,620
    
518
  
Impact of master netting agreements
    
(1,217
)
  
(1,217
)
  
—
    
(1,577
)
  
(1,577
)
  
—
  
     
1,436
    
779
    
657
    
1,561
    
1,043
    
518
  
 
 
15(c)-36

As at October 31, credit risk exposure on the derivatives portfolio is as follows:

          
2005
  
2004
  
                   
   
Replacement
  
Credit
  
Replacement
  
Credit
  
         
cost
  
equivalent
  
cost
  
equivalent
  
                   
OECD governments(1)
   
23
    
446
    
13
    
625
  
OECD banks(1)
   
1,675
    
1,654
    
2,545
    
1,473
  
Other
    
825
    
840
    
540
    
618
  
Total
    
2,523
    
2,940
    
3,098
    
2,716
  

(1)
Organisation for Economic Co-operation and Development

19 | Geographic Distribution of Earning Assets by Ultimate Risk
 
   
2005
  
2004
  
           
$
  
%
  
$
  
%
  
                   
North America
                  
Canada
    
76,690
    
78.8
    
63,103
    
85.4
  
United States
    
11,184
    
11.5
    
6,111
    
8.3
  
              
87,874
    
90.3
    
69,214
    
93.7
  
Europe
                          
United Kingdom
    
5,552
    
5.7
    
1,087
    
1.5
  
Germany
    
102
    
0.1
    
244
    
0.3
  
Other
    
2,500
    
2.6
    
2,048
    
2.8
  
        
8,154
    
8.4
    
3,379
    
4.6
  
Asia and Pacific
    
1,029
    
1.1
    
612
    
0.8
  
Latin America and Caribbean
   
230
    
0.2
    
627
    
0.9
  
Middle East and Africa
    
22
    
—
    
30
    
—
  
Earning assets as at September 30
   
97,309
    
100.0
    
73,862
    
100.0
  
Other assets as at September 30
    
11,514
          
9,483
        
Net change in assets in October
    
(1,225
)
        
5,152
        
Total assets as at October 31
    
107,598
          
88,497
        

Earning assets are those which bear interest. Consequently, they do not include cash, cheques and other items in the clearing process (net value), customers’ liability under acceptances, premises and equipment, and other assets. The Bank’s earning assets as at September 30 were distributed according to location of ultimate risk, i.e., the geographic location of the borrower or, if applicable, the guarantor. Earning assets are calculated net of any allowance for credit losses. There is no material concentration of credit risk in any given operating segment.
 
15(c)-37

20 | Interest Rate Sensitivity Position
 
The Bank offers a range of financial products for which the cash flows are sensitive to interest rate fluctuations. Interest rate risk arises from on- and off-balance sheet cash flow mismatches. The degree of exposure is based on the size and direction of interest rate movements and on the maturity of the mismatched positions. Analyzing interest rate sensitivity gaps is one of the techniques used by the Bank to manage interest rate risk.

The table below illustrates the sensitivity of the Bank’s Consolidated Balance Sheet to interest rate fluctuations as at October 31.

                       
Non-
          
   
Floating
  
Within
  
3 to 12
  
1 to 5
  
Over
  
interest
  
2005
  
2004
  
        
rate
  
3 months
  
months
  
years
  
5 years
  
sensitive
  
Total
  
Total
  
                                   
Assets
                                  
Cash
   
—
    
—
    
—
    
—
    
—
    
227
    
227
    
481
  
Deposits with financial institutions
    
371
    
5,944
    
1,803
    
—
    
—
    
1,969
    
10,087
    
5,296
  
Effective yield
          
1.8
%
  
1.8
%
  
—
%
  
—
%
                  
Securities
    
1
    
3,900
    
5,579
    
9,650
    
5,409
    
8,513
    
33,052
    
28,007
  
Effective yield
          
3.2
%
  
3.2
%
  
3.9
%
  
4.6
%
                  
Loans
    
527
    
32,739
    
5,796
    
8,788
    
223
    
6,068
    
54,141
    
45,994
  
Effective yield
          
3.5
%
  
5.0
%
  
5.3
%
  
6.5
%
                  
Other assets
    
—
    
—
    
—
    
—
    
—
    
10,091
    
10,091
    
8,719
  
         
899
    
42,583
    
13,178
    
18,438
    
5,632
    
26,868
    
107,598
    
88,497
  
                                                   
Liabilities and shareholders’ equity
                                                  
Deposits
    
4,376
    
28,431
    
8,133
    
15,996
    
1,164
    
3,877
    
61,977
    
53,432
  
Effective yield
          
2.9
%
  
3.2
%
  
3.7
%
  
4.6
%
                  
Other debt(1)
    
—
    
12,920
    
2,225
    
3,686
    
4,286
    
5,302
    
28,419
    
18,386
  
Effective yield
          
2.4
%
  
3.0
%
  
3.8
%
  
4.6
%
                  
Subordinated debentures
    
—
    
—
    
202
    
550
    
350
    
—
    
1,102
    
1,408
  
Effective yield
          
-
%
  
4.6
%
  
6.0
%
  
4.9
%
                  
Acceptances and
                                                 
other liabilities
    
1,595
    
13
    
71
    
226
    
82
    
9,516
    
11,503
    
11,067
  
Shareholders’ equity
    
—
    
—
    
—
    
400
    
—
    
4,197
    
4,597
    
4,204
  
          
5,971
    
41,364
    
10,631
    
20,858
    
5,882
    
22,892
    
107,598
    
88,497
  
                                                   
On-balance sheet gap
    
(5,072
)
  
1,219
    
2,547
    
(2,420
)
  
(250
)
  
3,976
    
—
    
—
  
Derivative financial instruments
    
—
    
(18,914
)
  
11,146
    
6,139
    
1,629
    
—
    
—
    
—
  
Total
    
(5,072
)
  
(17,695
)
  
13,693
    
3,719
    
1,379
    
3,976
    
—
    
—
  
Position in Canadian dollars
                                                  
On-balance sheet total
    
(7,392
)
  
6,449
    
1,995
    
(5,269
)
  
(954
)
  
3,564
    
(1,607
)
  
61
  
Derivative financial instruments
    
—
    
(15,628
)
  
5,788
    
6,593
    
1,662
    
—
    
(1,585
)
  
(301
)
Total
    
(7,392
)
  
(9,179
)
  
7,783
    
1,324
    
708
    
3,564
    
(3,192
)
  
(240
)
Position in foreign currency
                                                  
On-balance sheet total
    
2,320
    
(5,230
)
  
551
    
2,849
    
705
    
412
    
1,607
    
(61
)
Derivative financial instruments
    
—
    
(3,286
)
  
5,359
    
(454
)
  
(34
)
  
—
    
1,585
    
301
  
Total
    
2,320
    
(8,516
)
  
5,910
    
2,395
    
671
    
412
    
3,192
    
240
  
Total 2005
    
(5,072
)
  
(17,695
)
  
13,693
    
3,719
    
1,379
    
3,976
    
—
    
—
  
Total 2004
    
843
    
(31,765
)
  
17,922
    
15,419
    
1,574
    
(3,993
)
  
—
    
—
  

(1)
Obligations related to securities sold short and securities sold under repurchase agreements.

The effective yield represents the weighted average effective yield based on the earlier of contractual repricing and maturity dates.
 
15(c)-38

21 | Fair Value of Financial Instruments

The following table presents the fair value of balance sheet financial instruments, except for instruments whose fair value is estimated to approximate their carrying value. This fair value is determined using the valuation methods and assumptions described below. The fair values of derivative financial instruments are not included in the table and are presented separately in Note 18.

Fair value represents the amount for which a financial instrument could be exchanged in an arm’s length transaction between willing parties under no compulsion to act and is best evidenced by a quoted market price. If no quoted market prices are available, the fair values presented are estimates derived using present value or other valuation techniques and may not be indicative of the net realizable value.

The fair values disclosed exclude the values of assets and liabilities that are not considered financial instruments such as premises and equipment. Due to the judgment used in applying a wide range of acceptable valuation techniques and estimations in calculating fair value amounts, fair values are not necessarily comparable among financial institutions. The calculation of estimated fair values is based on market conditions at a specific point in time and may not be reflective of future fair values.
 
              
2005
                
2004
          
                           
       
Favourable
          
Favourable
      
Carrying
  
Fair
  
(unfavourable)
  
Carrying
  
Fair
  
(unfavourable)
      
value
  
value
  
variance
  
value
  
value
  
variance
            
                           
Assets
                          
Securities
    
33,052
    
33,126
    
74
    
28,007
    
28,131
    
124
  
Loans
    
47,118
    
47,205
    
87
    
41,498
    
41,700
    
202
  
                                       
Liabilities
                                      
Deposits
    
61,977
    
62,051
    
(74
)
  
53,432
    
53,682
    
(250
)
Subordinated debentures
    
1,102
    
1,131
    
(29
)
  
1,408
    
1,496
    
(88
)

Valuation methods and assumptions
 
Securities
 
The fair value of securities is presented in Note 4 to the consolidated financial statements. It is based on quoted market prices. If quoted market prices are not available, fair value is estimated using the quoted market prices of similar securities.

Loans
The fair value of floating-rate loans is assumed to approximate their carrying value. The fair value of other loans is estimated based on a discounted cash flows calculation that uses market interest rates currently charged for similar new loans as at the balance sheet date applied to expected maturity amounts (adjusted for any prepayments).

Deposits
The fair value of fixed-rate deposits is determined by discounting the contractual cash flows using market interest rates currently offered for deposits with the same remaining terms to maturity. The fair value of deposits with no stated maturity is assumed to approximate their carrying value.

Subordinated debentures
The fair value of subordinated debentures is determined by discounting the contractual cash flows using market interest rates currently offered for similar financial instruments with the same remaining term to maturity.

22 | Related Party Transactions

The Bank grants loans to its directors and officers under various conditions. As of August 31, the balance of loans granted is:
      
2005
  
2004
  
           
Mortgage loans
    
2
    
3
  
Other loans
    
61
    
71
  

Since January 1, 2003, loans to eligible officers have been granted under the same conditions as those applicable to loans granted to any other employee of the Bank. The principal conditions are as follows: the employee must meet the same credit requirements as a client; mortgage loans are granted at the market rate less 2%; personal loans and credit card advances bear interest at the client rate divided by 2; and personal lines of credit bear interest at the Canadian prime rate less 3%, but never lower than Canadian prime divided by 2.
 
15(c)-39

For personal loans, credit card advances and personal lines of credit, employees may not borrow more than 50% of their annual salary at the reduced rate. The Canadian prime rate is applied to the remainder.

Loans granted to officers before January 1, 2003 are administered according to the conditions previously in effect, for a transitional period ending December 31, 2005. These conditions are as follows: loans to directors are granted under market conditions for similar risks; residential mortgage loans to officers are granted at the market rate divided by 3 for the first $50,000 and at the lower of the market rate divided by 3 and the market rate less 5% for the remainder; and other loans granted to officers, mainly personal lines of credit, bear interest at the prime rate divided by 2 for the first $10,000 to $20,000 and at the lower of prime less 3% and prime divided by 2 for the remainder, to an aggregate maximum of 50% of the officer’s annual salary.

23 | Segment Disclosures

The Bank carries out its activities in three reportable segments, defined below. The other operating activities are grouped for presentation purposes. Each reportable segment is distinguished by services offered, type of client and marketing strategy. The operations of each of the Bank’s reportable segments are summarized below.

Personal and Commercial
The Personal and Commercial segment comprises the branch network, intermediary services, credit cards, insurance, commercial banking services and real estate.

Wealth Management
The Wealth Management segment comprises full-service retail brokerage, direct brokerage, mutual funds, trust services and portfolio management.

Financial Markets
The Financial Markets segment encompasses corporate financing and lending, treasury operations, including asset and liability management for the Bank, and corporate brokerage.

Other
This heading comprises securitization transactions, certain non-recurring items, and the unallocated portion of centralized services.

The accounting policies are the same as those presented in the note on accounting policies (Note 1), with the exception of the net interest income, other income and income taxes of the operating segments, which are presented on a taxable equivalent basis. Taxable equivalent basis is a calculation method that consists in grossing up certain tax-exempt income by the amount of income tax that would have been otherwise payable. The impact of these adjustments is reversed under the “Other” heading. Head office expenses are allocated to each operating segment and disclosed in the segmented results. The Bank assesses performance based on net income. Intersegment revenues are recognized at the exchange amount. Segment assets correspond to average assets directly used in segment operations.
 
15(c)-40

Results by business segment

   
Personal and
  
Wealth
  
Financial
                  
      
Commercial
  
Management
  
Markets
  
Other
   Total  
       
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
                                           
Net interest income(1)
    
1,302
    
1,251
    
101
    
94
    
318
    
256
    
(284
)
  
(238
)
  
1,437
    
1,363
  
Other income(1)
    
749
    
714
    
706
    
649
    
671
    
728
    
140
    
91
    
2,266
    
2,182
  
Total revenues
    
2,051
    
1,965
    
807
    
743
    
989
    
984
    
(144
)
  
(147
)
  
3,703
    
3,545
  
Operating expenses
    
1,254
    
1,218
    
619
    
581
    
595
    
543
    
31
    
46
    
2,499
    
2,388
  
Contribution
    
797
    
747
    
188
    
162
    
394
    
441
    
(175
)
  
(193
)
  
1,204
    
1,157
  
Provision for credit losses
    
117
    
137
    
—
    
—
    
8
    
51
    
(92
)
  
(102
)
  
33
    
86
  
Income before income taxes and non-controlling interest
    
680
    
610
    
188
    
162
    
386
    
390
    
(83
)
  
(91
)
  
1,171
    
1,071
  
Income taxes(1)
    
227
    
218
    
70
    
58
    
135
    
145
    
(141
)
  
(103
)
  
291
    
318
  
Non-controlling interest
    
—
    
—
    
3
    
4
    
1
    
—
    
21
    
24
    
25
    
28
  
Net income (net loss)
    
453
    
392
    
115
    
100
    
250
    
245
    
37
    
(12
)
  
855
    
725
  
Average assets
    
43,956
    
40,511
    
882
    
834
    
51,809
    
42,367
    
(5,745
)
  
(5,040
)
  
90,902
    
78,672
  

(1)
Net interest income was grossed up by $90 million (2004: $61 million) and other income by $60 million (2004: $47 million) to bring the tax-exempt income earned on certain securities in line with the income earned on other financial instruments. An equivalent amount was added to income taxes. The effect of these adjustments is reversed under the “Other” heading.

Results by geographic segment
Total revenues are allocated based on the country in which the client conducts business. More than 95.7% (2004: 93.8%) of revenues are concentrated in Canada.

24 | Reconciliation of Canadian and United States Generally Accepted Accounting Principles
 
The consolidated financial statements of the Bank were prepared in accordance with Canadian GAAP. The principal differences on net income and on the Consolidated Balance Sheet resulting from the application of U.S. GAAP are presented below. Under U.S. GAAP, a Consolidated Statement of Comprehensive Income is also required.

       
Restated
  
         
2005
  
2004
  
           
Net income per Canadian GAAP
    
855
    
725
  
Charge for other-than-temporary impairment
    
(4
)
  
—
  
Investment account securities
    
72
    
(2
)
Sale of premises - FIN 46R
    
—
    
(2
)
Mutual funds - FIN 46R
    
—
    
14
  
Loan securitization
    
—
    
6
  
Derivatives and hedging
    
(9
)
  
(68
)
Income tax effect on above items
    
(19
)
  
19
  
Net income per U.S. GAAP
    
895
    
692
  
               
Net earnings per common share - U.S. GAAP
              
Basic
  
 
$5.22
  
 
$3.91
  
Diluted
  
 
$5.15
  
 
$3.86
  
 
 
15(c)-41

Consolidated Statement of Comprehensive Income

       
Restated
  
         
2005
  
2004
  
           
Net income per U.S. GAAP
    
895
    
692
  
Other comprehensive income
              
Change in unrealized gains and losses on securities available for sale, net of income tax savings of $30 (2004: $5)
    
(59
)
  
(6
)
Change in gains and losses on derivatives designated as cash flow hedges, net of income tax savings of $19 (2004: $12)
    
(43
)
  
(27
)
Minimum pension liability adjustment, net of income taxes (2004: $2)
   
—
    
4
  
Change in unrealized foreign currency translation adjustments, net of income taxes of $13 (2004: $31)
    
(16
)
  
(16
)
Comprehensive income
    
777
    
647
  

Consolidated Condensed Balance Sheet

       
 
              
Restated
  
           
2005
          
2004
  
   
Canadian
      
U.S.
      
Canadian
  
U.S.
  
         
GAAP
  
Variation
  
GAAP
  
GAAP
  
Variation
  
GAAP
  
                           
Assets
                          
Cash and deposits with financial institutions
    
10,314
    
(29
)
  
10,285
    
5,777
    
2
    
5,779
  
Securities
                                      
Investment account - available for sale
    
6,869
    
74
    
6,943
    
7,446
    
172
    
7,618
  
Trading account
    
26,183
    
634
    
26,817
    
20,561
    
297
    
20,858
  
Securities purchased under reverse repurchase agreements
    
7,023
    
—
    
7,023
    
4,496
    
—
    
4,496
  
Loans
    
47,118
    
—
    
47,118
    
41,498
    
—
    
41,498
  
Premises and equipment
    
355
    
—
    
355
    
267
    
84
    
351
  
Goodwill
    
662
    
22
    
684
    
662
    
22
    
684
  
Other assets
    
9,074
    
1,419
    
10,493
    
7,790
    
(773
)
  
7,017
  
Total assets
    
107,598
    
2,120
    
109,718
    
88,497
    
(196
)
  
88,301
  
                                       
Liabilities
                                      
Deposits
    
61,977
    
10
    
61,987
    
53,432
    
40
    
53,472
  
Other liabilities
    
39,435
    
1,934
    
41,369
    
29,083
    
(564
)
  
28,519
  
Subordinated debentures
   
1,102
    
55
    
1,157
    
1,408
    
96
    
1,504
  
Non-controlling interest
    
487
    
—
    
487
    
370
    
44
    
414
  
Total liabilities
    
103,001
    
1,999
    
105,000
    
84,293
    
(384
)
  
83,909
  
                                       
Shareholders’ equity
                                      
Preferred shares
    
400
    
—
    
400
    
375
    
—
    
375
  
Common shares
    
1,565
    
24
    
1,589
    
1,545
    
24
    
1,569
  
Contributed surplus
    
13
    
—
    
13
    
7
    
—
    
7
  
Unrealized foreign currency translation adjustments
    
(26
)
  
26
    
—
    
(10
)
  
10
    
—
  
Retained earnings
    
2,645
    
33
    
2,678
    
2,287
    
(2
)
  
2,285
  
Accumulated other comprehensive income
    
—
    
38
    
38
    
—
    
156
    
156
  
Total shareholders’ equity
   
4,597
    
121
    
4,718
    
4,204
    
188
    
4,392
  
Total liabilities and shareholders’ equity
    
107,598
    
2,120
    
109,718
    
88,497
    
(196
)
  
88,301
  

Restatement
In 2005, the Bank concluded that in 2004, although it had satisfied all hedge accounting criteria under SFAS No. 133 for certain of its derivative financial instruments, a $47 million expense (before income taxes) was not recorded for U.S. GAAP purposes.

Consequently, the Bank restated income and balance sheet items in accordance with U.S. GAAP. The impact of this restatement was a decrease in net income of $31 million (pre-tax income of $47 million), a decline in basic and diluted earnings per share of $0.17, an increase in other comprehensive income of $33 million and other assets of $1 million, a decrease in investment account securities available for sale of $4 million, an increase in deposits of $40 million, a decline in subordinated debentures of $35 million and other liabilities of $10 million and an increase in shareholders’ equity of $2 million.
 
15(c)-42

Impairment charge
Under Canadian GAAP, unless compelling evidence is provided to indicate otherwise, a decrease in the value of an investment is considered an other-than-temporary impairment when the carrying value exceeds the market value for a prolonged period. The factors indicative of an impairment that is other than temporary under Canadian GAAP differ from those under U.S. GAAP as regards the period during which the carrying value may exceed the market value before it must be concluded that the decrease in value is an other-than-temporary impairment. In comparison to Canadian GAAP, the period under U.S. GAAP is significantly shorter. Lastly, under U.S. GAAP, when there has been a loss in value of an investment that is other than a temporary decline, the investment should be written down to fair value, based on market prices.

Investment account securities
Under U.S. GAAP, investment account securities are separated into two categories: securities available for sale (recognized in the Consolidated Balance Sheet at fair value) and securities held to maturity (carried in the Consolidated Balance Sheet at unamortized cost). Unrealized gains and losses on securities available for sale, net of income taxes, are presented separately in “Accumulated other comprehensive income” under “Shareholders’ equity,” while the change in unrealized gains and losses, net of income taxes, is recorded in the Consolidated Statement of Comprehensive Income. Under U.S. GAAP, the Bank records substantially all investment account securities as available for sale.

Under Canadian GAAP, unrealized foreign currency translation gains and losses for monetary investment account securities are presented in the Consolidated Statement of Income. Under U.S. GAAP, this translation adjustment must be presented in the Consolidated Statement of Comprehensive Income, net of income taxes, and is an integral part of the variation in fair value of investment account securities available for sale described above.

Furthermore, under U.S. GAAP, all obligations related to securities sold short must be recorded at fair value as liabilities, and any changes in fair value must be accounted for in the Consolidated Statement of Income. Under Canadian GAAP, securities sold short that are used in hedging relationships are recorded at unamortized cost. Gains and losses realized on these securities are included in the Consolidated Statement of Income concurrently with the gains and losses on the hedged items.

Sale of premises
Under Canadian GAAP, the head office building leases are considered a sales-type lease followed by an operating lease as a lessee. Under U.S. GAAP (SFAS No. 98 “Accounting for Leases”), in order for a lease to be accounted for as a sales-type lease, title of property must be transferred at the end of the lease term; therefore, the two leases must be accounted for as operating leases. Consequently, the building remains on the balance sheet, and the proceeds received are recorded as a liability. In addition, under FASB Interpretation No. 46 (FIN 46R), “Consolidation of Variable Interest Entities,” applicable to quarters ending after March 15, 2004, the Bank, as the primary beneficiary, has consolidated, as at October 31, 2004, the VIE that leases the head office building under a capital lease. The Canadian standard, AcG-15, is harmonized with FIN 46R. Under Canadian GAAP, the Bank was not required to consolidate the VIE that leases the head office building prior to the adoption of AcG-15 on November 1, 2004.

Mutual funds
Under U.S. GAAP (FIN 46R), in 2004 and 2005 the Bank consolidated certain mutual funds it manages because, by virtue of its investments in these funds, the Bank is deemed to be the primary beneficiary. Under Canadian GAAP, the Bank was not required to consolidate these mutual funds prior to the adoption of AcG-15 on November 1, 2004.

Derivative financial instruments
Under Canadian GAAP, derivatives used in sales or trading activities as well as instruments that do not qualify for hedge accounting are recorded on the Consolidated Balance Sheet at fair value.

Under the U.S. standard, all derivatives are recognized at fair value on the Consolidated Balance Sheet as an asset or liability. The Canadian and U.S. accounting treatments for derivatives held for sale or trading are therefore the same.

However, the Canadian and U.S. accounting treatments for derivatives held for hedging purposes differ. In accordance with the U.S. standard, changes in the fair value of derivatives designated as fair value hedges are recorded in income and are generally offset by changes in the fair value of the hedged items attributable to the hedged risk. With respect to derivatives designated as cash flow hedges, the effective portion of the changes in fair value is recorded as a separate component of comprehensive income in the Consolidated Statement of Comprehensive Income and is reclassified in the Consolidated Statement of Income in the period or periods during which the hedged items are recognized in the Consolidated Statement of Income. The ineffective portion of the changes in fair value of a hedging item is always recognized in the Consolidated Statement of Income.
 
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Minimum pension liability
Under U.S. GAAP (SFAS No. 87 “Employers’ Accounting for Pensions”), if the accrued benefit obligation, without salary projections, exceeds the fair value of the assets of a pension plan, a liability (minimum pension liability) equivalent to the difference must be recorded in the consolidated balance sheet. Recognition of an additional liability is required where the accrued benefit obligation, without salary projections, exceeds the fair value of the pension plan assets, and a net accrued benefit asset is recognized in the consolidated balance sheet. If an additional liability is recognized, an amount is recognized as an intangible asset, up to the amount of unamortized prior service cost, with any excess recorded, net of income taxes, under “Other comprehensive income.” No amount has been recorded in 2004 and 2005.

Goodwill
In 1999, the value of the shares issued by the Bank as part of the acquisition of First Marathon was based on the market price of the shares over a reasonable period of time before and after the acquisition date, as required by Canadian GAAP in effect before July 1, 2001. Under U.S. GAAP, the value of these shares would have been based on their market price over a reasonable period of time before and after the date the terms of the acquisition were agreed to and announced. Had the Bank followed U.S. GAAP, goodwill and common shares would have increased.

Securities lending
Under U.S. GAAP (FASB Interpretation No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”), non-cash collateral received for securities lending transactions is recorded as assets in the Consolidated Balance Sheet with a corresponding obligation if the contracts allow the entity to sell them or give them again as collateral. Under Canadian GAAP, non-cash collateral received for these transactions is not recorded in the Consolidated Balance Sheet.

Joint venture
Under U.S. GAAP, investments in joint ventures are accounted for using the equity method whereas under Canadian GAAP, these investments are recorded using proportionate consolidation. If U.S. GAAP had been applied, other liabilities, other assets and cash would have decreased and the investment in the joint venture would have increased; there would have been no impact on net income.

Accounting for client trades - brokerage activities
Under Canadian GAAP, securities trades for which the Bank acts as agent for its brokerage clients are recorded on a trade date basis in the Consolidated Balance Sheet. Under U.S. GAAP, these trades must be recorded on the settlement date in the Consolidated Balance Sheet. Prior year comparative figures have been reclassified to conform with the presentation adopted in 2005.
 
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