Bank of Montreal 1999 Annual Report Download - page 42

Capital Adequacy
36 Bank of Montreal Group of Companies 1999 Annual Report
Approach
We manage capital through prudent balance sheet management, while balancing the
needs and requirements of our shareholders, regulators and rating agencies. We take a
disciplined approach toward balance sheet management, which includes
monitoring
leveraged and RWA and undertaking securitizations as
discussed below. As a result,
capital management is closely aligned with our risk management strategy.
Management of our capital takes into account economic, regulatory and legal entity
requirements. Capital is managed at two levels
—
the consolidated Bank level and the
line of business level.
At the consolidated Bank level, total capital determines the amount of risk that we
can assume, subject to meeting regulatory and legal capital requirements. For inter-
nal management purposes our focus is on economic equity. At the line of business
level,
equity is managed on an economic basis, whereby it is allocated to support the
various risks associated with the activities of each line of business.
For additional information, refer to note 6 to the consolidated financial statements.
Securitization
What is securitization?
Securitizing assets involves selling financial assets to trusts or special-purpose vehicles that are
independent from us.
Why do we securitize?
Securitization serves as an effective balance sheet management tool by reducing or eliminating the
need to hold capital against risk-weighted assets, enabling capital to be reduced or redeployed to
alternative revenue-generating purposes. It also serves as an effective liquidity management tool by
diversifying funding sources.
The nature of securitization changes our role from that of lender to loan servicer, thereby removing
the loans from our balance sheet. Securitization also affects the manner in which our revenue and
provision for credit losses are reported in the Income Statement. Securitization revenue, which
is in the form of cash flows received from the trust, is recorded in other income, replacing the net
interest income, fee and commission revenue, and credit losses on loans that would normally be
reflected for the assets prior to securitization.
Credit losses are a component of the cash flows on the securitized portfolio, so our revenues may
be lower depending on the performance of the securitized receivables. However, our exposure to
credit losses on the securitized assets is contractually limited to the cash flows on that portfolio, and
any first loss protection we provide.
What have we securitized?
In 1999 we securitized $0.5 billion of NHA mortgage loans in addition to the $5.0 billion of uninsured
mortgage loans, $145 million of insured mortgage loans, $4.1 billion of commercial loans and
$0.5 billion of credit card receivables we securitized in 1998. We also securitized $2.0 billion of credit
card receivables in 1997. The impact of these securitizations on results is shown below.
How does this affect us?
($ millions except as noted)
As at October 31 1999 1998 1997
Reduced net interest revenue (234) (128) (17)
Increased other income 198 68 16
Reduced provision for credit losses 42 50 –
Impact on net income before tax 6(10) (1)
Improved Tier 1 Capital Ratio (basis points†) – 35 10
†Defined in the glossary on page 104.