Bank of Montreal 2010 Annual Report Download - page 69

MD&A
Exposure to Other Select Financial Instruments,
including Collateralized Debt Obligations (CDOs)
The following table provides additional detail on select financial instru-
ments that are held in our trading and available-for-sale portfolios.
BMO’s portfolios containing CDOs and collateralized loan obligations
(CLOs) are in run-off mode, resulting in reduced exposures in 2010. Most
of our CDOs and CLOs are hedged with other large financial institutions.
Net CDO exposure was minimal at $13 million ($16 million in 2009), and
net CLO exposure was also minimal at $29 million ($125 million in 2009).
The differences between hedged investment amounts and the
carrying value of hedged investment amounts reflect mark-to-market
losses, which can be recovered through total return or credit default
swaps (CDSs). The underlying securities consist of a wide range of corpo-
rate assets. Approximately 15% of hedged investment amounts have
been hedged through swaps with a single financial institution rated A.
The value of BMO’s interest in those hedges is supported by collateral
held, with the exception of relatively modest amounts as permitted
under counterparty agreements. Another 60% of hedged investment
amounts relate to two counterparties rated AA– for which we have
recorded $94 million of gains on hedging contracts. The remaining 25%
relate to a counterparty in wind-down mode, for which no gains have
been recorded on hedging contracts.
Amounts in the table below exclude CDS protection purchased
from two credit derivative product company counterparties that has
a market value of US$68 million (before deduction of US$39 million
of credit valuation adjustments) and a corresponding US$1.5 billion CDO
notional value in CDS protection provided to other financial institutions
in our role as intermediary.
The credit rating of one of the credit derivative product company
counterparties is Ba1 and the subordinated notes of the other counter-
party are rated Caa1. The underlying security on the two exposures
consists of three pools of broadly diversified single-name corporate
and sovereign credits. Each of the pools has from 90 to 134 credits, of
which 62% to 83% are investment grade with first-loss protection that
ranges from 5.9% to 19.2% with a weighted average of 11.1% based on
notional value.
Exposures to Other Select Financial Instruments (Canadian $ in millions) (1)
Carrying Carrying
value of value of Cumulative
unhedged and Hedged hedged loss in value Cumulative Net losses
Tranche wrapped investment investment of hedged gain on on hedged
As at October 31, 2010 rating investments amounts amounts investments hedges investments
CDOs (2) B 13 Sundry securities
CCC or below 232 49 (183) 183 – Hedged with a financial institution rated A
13 232 49 (183) 183 –
CLOs AAA 306 284 (22) 22 Hedged with monolines rated AA–
A– to AA+ 602 560 (42) 42 Hedged with monolines rated AA–
A– to AA+ 370 341 (29) (29) No hedge gains recorded with monoline in wind-down mode
1,278 1,185 (93) 64 (29)
Residential MBS (3)
No subprime AAA 25 Mostly U.K. and Australian mortgages
U.S. subprime –
wrapped A– to AA+ 1 Wrapped with monoline rated AA–
CCC or below 7 Wrapped with monolines in wind-down mode or no longer rated
33
Commercial MBS AAA 3 European, U.K. and U.S. commercial real estate loans
A– to AA+ 88 Mostly Canadian commercial and multi-use residential loans
91
Asset-backed AAA 105 Mostly Canadian credit card receivables and auto loans
securities BBB– to BBB+ 143 Mostly Canadian credit card receivables and auto loans
248
(1) Most of the unhedged and wrapped investments were transferred to the available-for-sale
portfolio effective August 1, 2008.
(2) CDOs include indirect exposure to approximately $44 million of U.S. subprime residential
mortgages. As noted above, this exposure is hedged via total return swaps with a large
non-monoline financial institution.
(3) Amounts exclude BMO Life Assurance holdings of $32.8 million of residential MBS and
$230.9 million of commercial MBS.
U.S. Regulatory Developments
On July 21, 2010, U.S. President Obama signed into law the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the Dodd-Frank
Act). The Act is broad in scope and we are assessing the impact of
the legislation. The reforms include heightened consumer protection,
regulation of the over-the-counter (OTC) derivatives markets, restrictions
on proprietary trading by banks (referred to as the Volcker Rule),
imposition of heightened prudential standards and broader application
of leverage and risk-based capital requirements, greater supervision
of systemically significant payment, clearing or settlement systems,
restrictions on interchange fees, and the creation of a new financial
stability oversight council of regulators with the objective of increasing
stability by monitoring systemic risks posed by financial services
companies and their activities. Many aspects of the Dodd-Frank Act are
subject to rulemaking and will take effect over several years, making
it difficult to anticipate at this time the overall impact on us or the
financial services industry more generally. We anticipate an increase
in compliance costs and regulatory enforcement, and will be focused
on managing the impact, particularly on our U.S. business, of
regulatory changes given their complexity and breadth.
BMO Financial Group 193rd Annual Report 2010 67