Bank of Montreal 2004 Annual Report Download - page 59

BMO Financial Group Annual Report 2004 55
MD&A
Critical Accounting Estimates
The Notes to our October 31, 2004 consolidated financial
statements outline BMO’s significant accounting estimates.
The accounting estimates discussed below are considered
particularly important, as they require significant judgments by
management. BMO has established detailed policies and control
procedures that are intended to ensure these judgments are well
controlled, independently reviewed and consistently applied
from period to period. We believe that our estimates for deter-
mining the valuation of our assets and liabilities are appropriate.
Allowance for Credit Losses
The allowance for credit losses adjusts the value of credit
assets to reflect their estimated realizable value. In assessing
their estimated realizable value, we must rely on estimates
and exercise judgment regarding matters for which the ulti-
mate outcome is unknown. These include economic factors,
developments affecting companies in particular industries
and specific issues with respect to single borrowers. Changes
in circumstances may cause future assessments of credit risk to
be materially different from current assessments, which could
require an increase or decrease in the allowance for credit losses.
One of our key balance sheet measures is the provision for
credit losses as a percentage of average net loans and accept-
ances (including securities purchased under resale
agreements). Over the past 10 years, the ratio has ranged from
a high of 0.66% in 2001 to the current low of (0.07%). This
ratio varies based on changes in the economy and credit con-
ditions. Our provision for credit losses would range from a
provision of $1,030 million to a net recovery of $103 million
if we applied these ratios to average net loans and acceptances
(including securities purchased under resale agreements)
in 2004. Our provision for credit losses recorded for the year
ended October 31, 2004 was a net recovery of $103 million.
Additional information on the process and methodology for
determining the allowance for credit losses can be found in
the discussion of credit risk on pages 60 and 61 as well as in
Note 4 on page 93 of the financial statements.
Financial Instruments Measured at Fair Value
BMO records trading securities as well as trading derivatives
at their fair value. Fair value represents our estimate of the
proceeds we would receive, or would have to pay in the case
of a derivative liability, in a current transaction between
willing parties.
BMO’s trading securities, derivative assets and derivative
liabilities are valued as follows:
Derivative financial
instruments
Trading
securities Asset Liability
Valued using quoted market prices 98% 10% 16%
Valued using internal models*2% 90% 84%
Total 100% 100% 100%
*Almost all models are based on observable market data.
The fair value of most trading securities and exchange-traded
derivatives is based on quoted market prices. Most over-the-
counter instruments are valued using models that utilize
observable market data. For example, the fair value of interest
rate swaps is determined using yield curves developed from
observable market interest rates.
Additional information concerning our method of deter-
mining fair value is included in Note 3 on page 88, Note 9 on
page 97 and Note 26 on page 119 of the financial statements.
Accounting for Securitizations
When loans are securitized, we record a gain or loss on sale.
In determining the gain or loss, management must estimate the
net present value of expected future cash flows by relying on
estimates of the amount of interest and fees that will be col-
lected on the securitized assets, the yield to be paid to investors,
the portion of the securitized assets that will be repaid before
their scheduled maturity, expected credit losses, the fair
value cost of servicing, and the rate at which to discount these
estimated future cash flows. Actual cash flows may differ
significantly from those estimated by management. If manage-
ment’s estimate of future cash flows were different, our gains
on securitization recognized in income would also be different.
The rate used to discount expected future cash flows is the
estimate that most affects the gain on securitization. A 10%
decrease in interest rates would have resulted in a decrease of
less than $10 million in the amount of the deferred purchase
price recorded in our Consolidated Balance Sheet.
Additional information concerning accounting for securi-
tizations, including sensitivity analysis for key assumptions,
is included in Note 7 on page 95 of the financial statements.
Pensions and Other Employee Future Benefits
Our pensions and other employee future benefits expense is
calculated by our actuaries based on assumptions determined by
management. If actual experience differs from the assumptions
used by management, our pension and other employee future
benefits expense could increase or decrease in future years
as a result.
Accounting Estimates and Policies