Bank of Montreal 2010 Annual Report Download - page 122

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Notes
120 BMO Financial Group 193rd Annual Report 2010
Change in Accounting Policy
During August 2009, the CICA issued amendments to Handbook
section 3855 “Financial Instruments – Recognition and Measurement”
on the classification and measurement of financial assets. For details of
the impact of our adoption of this new standard, see Note 3.
Loans
Loans are recorded at amortized cost using the effective interest method.
This method allocates interest income over the expected term by
applying the effective interest rate to the carrying amount of the loan.
The effective interest rate is defined as the rate that exactly discounts
estimated future cash receipts through the expected term of the loan.
The treatment of interest income for impaired loans is described below.
We amortize deferred loan origination costs using the effective
interest method. We record the amortization as a reduction to interest,
dividend and fee income, loans, over the term of the resulting loan.
Under the effective interest method, the amount recognized in interest,
dividend and fee income varies over the term of the loan based on
the principal outstanding.
Securities Borrowed or Purchased Under Resale Agreements
Securities borrowed or purchased under resale agreements represent the
amounts we will receive as a result of our commitment to resell securities
that we have purchased back to the original seller, on a specified date at
a specified price. We account for these instruments as if they were loans.
Lending Fees
The accounting treatment for lending fees varies depending on the
transaction. Some loan origination, restructuring and renegotiation
fees are recorded as interest income over the term of the loan, while
other lending fees to a certain threshold are taken into income at the
time of loan origination. Commitment fees are recorded as interest
income over the term of the loan, unless we believe the loan commit-
ment will not be used. In the latter case, commitment fees are recorded
as lending fees over the commitment period. Loan syndication fees are
included in lending fees as the syndication is completed, unless the yield
on any loans we retain is less than that of other comparable lenders
involved in the financing. In the latter case, an appropriate portion of the
syndication fee is recorded as interest income over the term of the loan.
Customers’ Liability under Acceptances
Acceptances represent a form of negotiable short-term debt that is
issued by our customers and which we guarantee for a fee. We have
offsetting claims, equal to the amount of the acceptances, against
our customers in the event of a call on these commitments. The amount
due under acceptances is recorded in other liabilities and our corre-
sponding claim is recorded as a loan in our Consolidated Balance Sheet.
Fees earned are recorded in lending fees in our Consolidated
Statement of Income.
Impaired Loans
We classify residential mortgages as impaired when payment is contractually
90 days past due, or one year past due if guaranteed by the Government of
Canada. Credit card loans are classified as impaired and immediately written
off when principal or interest payments are 180 days past due. Consumer
instalment loans, other personal loans and some small business loans are
classified as impaired when principal or interest payments are 90 days past
due, and are normally written off when they are one year past due.
Corporate and commercial loans are classified as impaired when
we are no longer reasonably assured that principal or interest will be
collected on a timely basis, or when payments are 90 days past due, or
for fully secured loans, when payments are 180 days past due.
We do not accrue interest income on loans classified as impaired,
and any interest income that is accrued and unpaid is reversed against
interest income.
Payments received on corporate and commercial loans that have
been classified as impaired are applied first to the recovery of collection
costs, principal and any previous write-offs or allowances, and any
amounts remaining are then recorded as interest income. Payments
received on impaired consumer instalment loans are applied first to
outstanding interest and then to the remaining principal.
A loan will be reclassified back to performing status when we
determine that there is reasonable assurance of full and timely
repayment of interest and principal in accordance with the terms and
conditions of the loan, and that none of the criteria for classification
of the loan as impaired continue to apply.
From time to time we restructure loans, classified as impaired,
due to the poor financial condition of the borrower. If they are no longer
considered impaired, interest on these restructured loans is recorded
on an accrual basis.
Allowance for Credit Losses
The allowance for credit losses recorded in our Consolidated Balance
Sheet is maintained at a level that we consider adequate to absorb
credit-related losses on our loans, customers’ liability under acceptances
and other credit instruments (as discussed in Note 5). The portion
related to other credit instruments is recorded in other liabilities in
our Consolidated Balance Sheet.
The allowance comprises the following two components:
Specific Allowances
These allowances are recorded for specific loans to reduce their book value
to the amount we expect to recover. We review our loans and acceptances
on an ongoing basis to assess whether any loans should be classified
as impaired and whether an allowance or write-off should be recorded
(other than credit card loans, which are classified as impaired and
written off when principal or interest payments are 180 days past due,
as discussed under impaired loans). Our review of problem loans is
conducted at least quarterly by our account managers, each of whom
assesses the ultimate collectability and estimated recoveries for a specific
loan based on all events and conditions that the manager believes are
relevant to the condition of the loan. This assessment is then reviewed
and concurred with by an independent credit officer.
To determine the amount we expect to recover from an impaired
loan, we use the value of the estimated future cash flows discounted
at the effective rate inherent in the loan. When the amounts and timing
of future cash flows cannot be estimated with reasonable reliability,
the expected recovery amount is estimated using either the fair value of
any security underlying the loan, net of expected costs of realization and
any amounts legally required to be paid to the borrower, or an observ-
able market price for the loan. Security can vary by type of loan and may
include cash, securities, real property, accounts receivable, guarantees,
inventory or other capital assets. For personal loans that are not
individually assessed, specific provisions are calculated on a pooled
basis, taking into account historical loss experience.
General Allowance
We maintain a general allowance in order to cover any impairment
in the existing portfolio that cannot yet be associated with specific loans.
Our approach to establishing and maintaining the general allowance
is based on the guideline issued by OSFI.
The general allowance is reviewed on a quarterly basis. A number
of factors are considered when determining the appropriate level of
the general allowance, including a general allowance model that applies
historical expected and unexpected loss rates to current balances
with sensitivity to risk ratings, industry sectors and credit products.
Model results are then considered along with the level of the existing
allowance, as well as management’s judgment regarding portfolio
quality, business mix, and economic and credit market conditions.
Provision for Credit Losses
Changes in the value of our loan portfolio due to credit-related losses or
recoveries of amounts previously provided for or written off are included
in the provision for credit losses in our Consolidated Statement of Income.
Note 4: Loans, Customers’ Liability under Acceptances
and Allowance for Credit Losses