Bank of Montreal 2010 Annual Report Download - page 119

Notes
BMO Financial Group 193rd Annual Report 2010 117
Securities
Securities are divided into three types, each with a different purpose and
accounting treatment. The three types of securities we hold are as follows:
Trading securities are securities that we purchase for resale over a
short period of time. We report these securities at their fair value and
record the fair value changes and transaction costs in our Consolidated
Statement of Income in trading revenues.
Fair Value Option
Securities designated as trading under the fair value option are financial
instruments that may be accounted for at fair value, with changes
in fair value recorded in income provided they meet certain criteria.
Securities designated as trading under the fair value option must
have reliably measurable fair value and satisfy one of the following
criteria established by OSFI: (1) accounting for them at fair value
eliminates or significantly reduces an inconsistency in measurement
or recognition that would otherwise arise from measuring assets or
liabilities or recognizing the gains and losses on them on a different
basis, (2) the securities are part of a group of financial assets, financial
liabilities or both that is managed and its performance evaluated on
a fair value basis, in accordance with a documented risk management
or investment strategy, and is reported to key management personnel
on a fair value basis, or (3) the securities are hybrid financial instru-
ments with one or more embedded derivatives that would otherwise
be required to be bifurcated and accounted for separately from the
host contract. Financial instruments must be designated when they
are acquired, and the designation is irrevocable. These securities
would otherwise be accounted for as available-for-sale securities with
unrealized gains and losses recorded in other comprehensive income.
Securities held by our insurance subsidiaries that support our
insurance liabilities are designated as trading securities under the fair
value option. Since the actuarial calculation of insurance liabilities is
based on the fair value of the investments supporting them, electing
the fair value option for these investments better aligns the accounting
result with the way the portfolio is managed. The fair value of these
securities as at October 31, 2010 was $4,153 million ($3,167 million in
2009). The impact of recording these as trading securities was an increase
in non-interest revenue, insurance income of $298 million for the year
ended October 31, 2010 (increase of $415 million in 2009).
Available-for-sale securities consist of debt and equity securities
that may be sold in response to or in anticipation of changes in interest
rates and resulting prepayment risk, changes in foreign currency
risk, changes in funding sources or terms, or to meet liquidity needs.
Available-for-sale securities are measured at fair value with
unrealized gains and losses recorded in accumulated other comprehen-
sive income (loss) on available-for-sale securities in our Consolidated
Statement of Changes in Shareholders’ Equity until the security is
sold, or if an unrealized loss is considered other than temporary. Gains
and losses on disposal and other than temporary impairment losses
are recorded
in our Consolidated Statement of Income in securities gains
(losses), other
than trading. Interest income earned and dividends
received on available-for-sale securities are recorded in our Consolidated
Statement of Income in interest, dividend and fee income, securities.
We have not classified any of our securities as held-to-maturity.
Available-for-sale securities whose sale is restricted are recorded
at amortized cost.
Investments made by our insurance operations are classified as
available-for-sale or other securities, except for investments that support
the policy benefit liabilities on our insurance contracts, which are
designated as trading securities under the fair value option as discussed
above. Interest and other fee income on available-for-sale securities
is recognized when earned in our Consolidated Statement of Income
in non-interest revenue, insurance income.
Merchant banking investments, which are included in other securities in
our Consolidated Balance Sheet, are securities held by our merchant bank-
ing subsidiaries. These subsidiaries account for their investments at fair
value, with changes in fair value recorded in our Consolidated Statement
of Income in securities gains (losses), other than trading as they occur.
Transaction costs for non-trading securities are expensed.
We account for all of our securities transactions using settlement date
accounting on our Consolidated Balance Sheet. For securities classified
or designated as trading, changes in fair value between the trade date
and settlement date are recorded in net income. For available-for-sale
securities, changes in fair value between the trade date and settlement
date are recorded in other comprehensive income.
Impairment Review
We review available-for-sale securities and investments where we exert
significant influence, but not control, at each quarter end to identify
and evaluate investments that show indications of possible impairment.
An investment is considered impaired if its unrealized losses represent
impairment that is considered to be other than temporary.
In determining whether a loss is temporary, factors considered
include the extent of the unrealized loss, the length of time that the
security has been in an unrealized loss position, the financial condition
and near-term prospects of the issuer, and our intention or obligation to
sell the investment before any anticipated recovery. If the decline is con-
sidered not to be temporary, a write-down is recorded in our Consolidated
Statement of Income in securities gains (losses), other than trading.
For debt securities classified as available-for-sale, a previous
impairment loss is reversed through net income if an event occurs after
the impairment was recognized that can be objectively attributed to
an increase in fair value.
As at October 31, 2010, we had 118 available-for-sale securities
(250 in 2009) with unrealized losses totalling $25 million (unrealized
losses of $199 million in 2009). Of these available-for-sale securities,
54 have been in an unrealized loss position continuously for more than
one year (93 in 2009), amounting to an unrealized loss position of
$10 million (unrealized loss position of $74 million in 2009). Unrealized
losses on these instruments, excluding corporate equities, resulted
from changes in interest rates and not from deterioration in the credit-
worthiness of the issuers. We expect full recovery of principal and
interest payments from certain debt securities due to governmental
support and/or over-collateralization provided. The share prices and
valuations of many equity securities that we hold have also appreciated
from earlier levels. Based on these factors and our intention to
not sell these securities before any anticipated recovery, we have
determined that the unrealized losses are temporary in nature.
We did not own any securities issued by a single non-government entity
where the book value, as at October 31, 2010 or 2009, was greater than
10% of our shareholders’ equity.
Included in other securities are investments where we exert significant
influence, but not control, of $196 million and $613 million as at October 31,
2010 and 2009, respectively.
Fair Value Measurement
For traded securities, quoted market value is considered to be fair value.
Quoted market value is based on bid prices. For securities where market
quotes are not available, we use estimation techniques to determine fair
value. These estimation techniques include discounted cash flows, internal
models that utilize observable market data or comparisons with other
securities that are substantially the same. In limited circumstances, we
use internal models where the inputs are not based on observable market
data. Further discussion of fair value measurement is included in Note 29.