Bank of Montreal 2010 Annual Report Download - page 165

Notes
BMO Financial Group 193rd Annual Report 2010 163
The sensitivity analysis for the structured product is performed on an aggre-
gate basis and is described as part of the discussion on derivatives below.
Within Level 3 trading securities are mortgage-backed securities
and collateralized mortgage obligations of $211 million. We determined
the fair value of these securities based on expected discounted cash flows.
The significant inputs for the valuation model include market yields
and spread assumptions. The determination of market yields has the most
significant impact on the valuation of these securities. The impact of
assuming a 50 basis point increase or decrease in the market yield would
result in a change in fair value of $(4) million and $5 million, respectively.
Within Level 3 available-for-sale corporate debt securities is a
deferred purchase price amount of $633 million related to our off-balance
sheet securitization activities. We have determined the valuation of the
deferred purchase price (excess spread) based on expected future cash
flows. The significant inputs for the valuation model include interest rate,
weighted-average prepayment rate, weighted-average maturity, expected
credit losses and weighted-average discount rate. The determination
of interest rates has the most significant impact on the valuation of the
deferred purchase price. Sensitivity analysis for the deferred purchase
price is included in Note 8.
Within Level 3 derivative assets and derivative liabilities was
$377 million and $51 million related to the mark-to-market of credit
default swaps and total return swaps on the above noted trading
securities, respectively. We have determined the fair value of the structured
product (securities and derivatives together), based on a model with
observable and unobservable inputs. The discount margin of the under lying
securities has the most significant impact on the valuation. The impact of
Changes in Level 3 Fair Value Measurements
The table below presents a reconciliation of all changes in Level 3 financial instruments for the year ended October 31, 2010, including realized
and unrealized gains (losses) included in earnings and other comprehensive income.
For the year ended October 31, 2010 (Canadian $ in millions)
Change in fair value
Included
in other Fair value
Balance, compre- Transfers Transfers as at Unrealized
October 31, Included in hensive into out of October 31, gains
2009 earnings income Purchases Sales Maturities
(1) Level 3 Level 3 2010 (losses) (2)
Trading Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies 49 (7) – – (42) – – – – –
Mortgage-backed securities and
collateralized mortgage obligations 204 34 – 8 (3) (32) – – 211 20
Corporate debt 1,476 (17) – 96 – (1) 14 (210) 1,358 10
Total trading securities 1,729 10 – 104 (45) (33) 14 (210) 1,569 30
Available-for-Sale Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies 86 2 (16) – (52) – – – 20 –
Mortgage-backed securities and
collateralized mortgage obligations 39 1 – – – (20) – – 20 1
Corporate debt 1,960 (281) 31 244 (156) (252) 13 (59) 1,500 45
Corporate equity 311 (4) (18) 78 (2) (2) 6 – 369 –
Total available-for-sale securities 2,396 (282) (3) 322 (210) (274) 19 (59) 1,909 46
Derivative Assets
Interest rate contracts 1 20 – 196 – – – – 217 217
Equity contracts 11 (34) – 31 – – – – 8 8
Credit default swaps 567 (53) – 3 – (357) – – 160 160
Total derivative assets 579 (67) – 230 – (357) – – 385 385
Derivative Liabilities
Interest rate contracts 73 – – – – (25) – – 48 48
Equity contracts 97 (57) – 31 – – – – 71 71
Credit default swaps 3 – – – – – – – 3 3
Total derivative liabilities 173 (57) – 31 – (25) – – 122 122
assuming a 10 basis point increase or decrease in that spread would result
in a change in fair value of $(4) million and $4 million, respectively.
Signifi cant Transfers
Transfers are made between the various fair value hierarchy levels
due to changes in the availability of quoted market prices or observable
market inputs due to changing market conditions. The following is
a discussion of the significant transfers between Level 1, Level 2 and
Level 3 balances for the years ended October 31, 2010 and 2009.
During the year ended October 31, 2010, a portion of the asset-
backed commercial paper issued by the conduits known as the Montreal
Accord were transferred from Level 3 to Level 2 within corporate debt
trading securities because we are now valuing the notes based on broker
quotes rather than internal models due to increased broker/dealer trading
of these securities, resulting in improved liquidity. In addition, certain
available-for-sale corporate debt securities that were previously valued
using observable market information were transferred from Level 2 to
Level 1 as values for these securities became available in active markets.
During the year ended October 31, 2009, the mid-term notes and
associated total return swap related to our credit protection vehicle
were transferred from Level 3 to Level 2 as there was improved liquidity
in the inputs to our model and greater transparency of fair value as
a result of our hedging transactions. Also in 2009, $23 million of trading
securities, corporate debt were transferred from Level 1 to Level 3
as the securities were no longer quoted in an active market subsequent
to the issuer’s bankruptcy protection filing. As at October 31, 2010,
management valued these securities using discounted estimated
recoverable amounts.
(1) Includes cash settlement of derivative assets and derivative liabilities.
(2) Unrealized gains or losses on trading securities, derivative assets and derivative liabilities
still held on October 31, 2010 are included in earnings in the year. For available-for-sale
securities, the unrealized gains or losses on securities still held on October 31, 2010 are included
in Accumulated Other Comprehensive Income.
Certain comparative figures have been reclassified to conform with the current year’s presentation.