Bank of Montreal 2004 Annual Report Download - page 55

BMO Financial Group Annual Report 2004 51
MD&A
Strategy and Approach
Our Capital Management Framework is designed to maintain
an optimum level of capital in a cost-effective structure that:
meets our target regulatory ratios; supports our internal assess-
ments of required capital; results in targeted credit ratings;
funds our selected operating group business strategies;
and builds long-term shareholder value. Our approach includes
establishing limits, goals and performance measures for man-
agement of balance sheet positions, risk levels and minimum
capital amounts, as well as issuing and redeeming capital
instruments to obtain the most cost-effective capital structure
possible. These are approved by the Board of Directors
pursuant to its annual review of our capital management
policy and capital plan.
At the consolidated enterprise level, our targeted capital
levels are set in support of our risk appetite, while still satisfy-
ing regulatory and legal requirements. At the line of business
level, performance measurement is assessed on allocated eco-
nomic capital, which is based primarily on the assessment and
measurement of capital at risk outlined on page 59. By allocating
capital internally we ensure that we maintain a well-capitalized
position to protect our stakeholders from the risks inherent
in our various businesses, while still allowing the flexibility to
deploy resources in high-return or strategic growth activities
of our operating groups in order to meet or exceed established
enterprise targets.
Generally, BMO generates earnings that are sufficient
to meet new capital requirements. As such, management’s
primary challenge is achieving the most cost-effective capital
structure, rather than procuring sufficient capital to fund
expansion initiatives.
Dividends are generally increased in line with long-term
trends in earnings per share growth, while sufficient earnings
are retained to support anticipated business growth, fund
strategic investments and provide continued support for depos-
itors. BMO’s policy is to achieve a dividend payout ratio of
35% to 45% of net income available to shareholders, over time.
Performance Review
Our common shareholders’ equity exceeded our assessment of
required capital by $2.3 billion, an increase of $1.6 billion from
a year ago. The increase was due to strong net income in 2004,
lower economic capital requirements due to our position in the
credit cycle, and refinements in the measurement of economic
capital. The components of regulatory capital and the measures
we monitor are outlined in Tables 20 and 21 on page 80.
The Tier 1 Capital Ratio rose to 9.81% from 9.55% a year ago.
Tier 1 capital, representing more permanent forms of capital,
increased $1,134 million during the year to $13,471 million, as
outlined in the table. Net income was the primary driver of
this increase. At year-end, we had $2,485 million of excess
Tier 1 capital relative to our minimum targeted Tier 1 Capital
Ratio of 8.0%.
Our Total Capital Ratio, which is defined as total capital
divided by risk-weighted assets, declined to 11.31% from 12.09%
a year ago. The decline related to an increase in risk-weighted
assets and the requirement to deduct certain significant invest-
ments, effective in 2004, primarily related to our insurance
subsidiaries. Both our Tier 1 and Total Capital Ratios remain
well above the minimum regulatory targets established by
our regulator of 7% and 10%, respectively.
Risk-weighted assets increased $8.2 billion during the year to
$137.3 billion, due primarily to strong mortgage and personal
loan growth in Personal and Commercial Client Group in both
Canada and the United States, as well as the acquisitions of
New Lenox State Bank and Lakeland Community Bank in
Illinois. In 2005, we anticipate continuing controlled growth in
risk-weighted assets and redeployment of capital to strategi-
cally advantaged businesses.
The assets-to-capital multiple is calculated by dividing total
assets, including specified off-balance sheet items net of other
specified deductions, by total capital. BMO’s assets-to-capital
The Tier 1 Capital Ratio is our key measure of capital adequacy. It is
defined as Tier 1 capital divided by risk-weighted assets.
Enterprise-Wide Capital Management
Other Liabilities
Other liabilities increased $4.8 billion to $74.4 billion. Accounts
payable, accrued interest and other items increased $2.2 billion.
Derivative-related liabilities increased $3.3 billion due to the
same factors that drove the increase in derivative-related assets.
Securities sold under repurchase agreements decreased $2.9 bil-
lion, but there was a related $2.2 billion increase in securities
sold but not yet purchased.
Subordinated Debt
Subordinated debt decreased $0.5 billion to $2.4 billion due to
a $400 million redemption and the lower Canadian/U.S. dollar
exchange rate.
Shareholders’ Equity
Shareholders’ equity increased $0.7 billion to $13.2 billion.
The increase was largely related to higher retained earnings.
The increase in retained earnings was curtailed by higher
income taxes related to gains on hedging our net investment
in foreign operations, principally our U.S. subsidiaries; this
is discussed further in the Provision for Income Taxes section
on page 33. As indicated below, we redeemed our $400 million
Class B Series 3 preferred shares and replaced this capital
with more cost-effective innovative Tier 1 capital, which
is reflected as non-controlling interest in subsidiaries in
other liabilities.
BMO’s Consolidated Statement of Changes in Shareholders’
Equity on page 85 provides a summary of items that increase or
reduce shareholders’ equity while Note 18 on page 108 provides
details on the components of and changes in share capital.
Details of our enterprise-wide capital management processes
and strategies can be found below.