Bank of Montreal 2010 Annual Report Download - page 74

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
record these market-related amounts directly in equity or defer them
on our balance sheet and amortize amounts in excess of 10% of our plan
assets or benefit liability balances to pension expense over a period
of approximately 12 years. We currently follow the second alternative.
We have not yet finalized our decision on which alternative to elect for
the accounting of market-related amounts. Additional information on
our pension and other employee future benefits is included in Note 23
on page 149 of the financial statements.
On transition to IFRS, we can either recalculate pension expense
back to inception of the plans as though we had always applied the IFRS
pension requirements or, alternatively, record market-related amounts
that exist on November 1, 2010 directly in retained earnings (fresh
start method).
Should the bank elect the fresh start method, the result would
be a reduction in retained earnings of approximately $1,200 million, a
decrease in other assets of approximately $1,600 million and a decrease
in other liabilities of approximately $400 million on November 1, 2010,
the beginning of our comparative year. This would result in approxi-
mately a 65 basis point reduction in our Tier 1 Capital Ratio, which would
be phased in over five quarters as permitted under OSFI’s IFRS advisory.
Adopting this alternative would also result in reduced pension expense
in future years since any deferred losses that exist on October 31, 2010
would not be amortized to pension expense.
We have not yet finalized our decision on whether to elect the
fresh start method as permitted under IFRS.
Asset Securitization
We have substantially completed our assessment of certain of our signif-
icant asset securitization programs and whether the loans and mortgages
sold through these programs qualify for off-balance sheet treatment
under IFRS. The assessment included our Canadian credit card loans and
Canadian mortgage loans sold to the bank’s securitization vehicles and
to the Canada Mortgage Bond program, a third-party securitization
program. We assessed whether the loans and mortgages qualify for off-
balance sheet treatment based on the transfer of the risks and rewards,
as determined under the derecognition criteria contained in the IFRS
financial instruments standard (IAS 39). Based on the analysis completed
to date, our preliminary conclusion is that the loans or mortgages sold
under these securitization programs will not qualify for off-balance sheet
recognition under IFRS. Under Canadian GAAP, the mortgages and loans
sold through these programs are removed from our balance sheet.
Additional information on our asset securitization vehicles is included
in Note 8 on page 126 of the financial statements.
If the securitized assets sold to the securitization vehicles noted
in the preceding paragraph were to be recognized on the bank’s balance
sheet, assets and liabilities would increase by approximately $18 billion
and opening retained earnings would be reduced by less than $100 mil lion
on November 1, 2010, the beginning of our comparative year. The reduc-
tion in retained earnings primarily represents the reversal of the gain
on sale previously recognized in earnings. The interest and fees collected
from customers, net of the yield paid to investors in the securitization
vehicle, would be recorded in net interest income using the effective
interest rate method over the term of the securiti zation and credit losses
associated with loans and mortgages would be recorded in the provision
for credit losses. The reduction in retained earnings would result in less
than a 5 basis point reduction in our Tier 1 Capital Ratio, which would be
phased in over five quarters, as permitted under OSFI’s IFRS advisory.
We expect to complete our assessment of the asset securitization
activity associated with selling the bank’s Canadian mortgage loans to
certain other third-party asset securitization programs in the first and
second quarters of 2011.
The IASB’s project to revise the accounting requirements for securi-
tization activities is currently on hold. We do not expect the existing
accounting requirements impacting asset securitization to change prior
to the bank’s transition to IFRS in 2012.
Consolidation
We have substantially completed our assessment of whether we are
required to consolidate our credit protection vehicle and our structured
investment vehicles when we transition to IFRS. We assessed the con-
solidation requirement based on whether the bank would in substance
control the vehicles, as determined under the criteria contained in the
IFRS consolidated and separate financial statements standard (IAS 27)
and, where appropriate, SIC-12 (an interpretation of IAS 27). Our analysis
considered whether the activities of the vehicles are conducted on
behalf of the bank, the bank’s exposure to the risks and benefits, its
decision-making powers over the vehicles, and whether these consider-
ations demonstrate that the bank, in substance, controls the vehicles
and therefore must consolidate them.
Information on these vehicles, including total assets, our exposure
to loss and our assessment of the consolidation requirement under
Canadian GAAP, is included in Note 9 on page 128 of the financial
statements.
Credit Protection Vehicle – Based on the analysis completed to date, our
preliminary conclusion is that the bank would be required to consolidate
this vehicle, as our analysis indicates that the bank, in substance,
controls this vehicle, based on the definition of control under IFRS.
Under Canadian GAAP, we are not required to consolidate this vehicle.
Consolidation of this vehicle would impact the bank’s balance
sheet, increasing assets and liabilities by approximately $500 million on
November 1, 2010, the beginning of our comparative year. Our estimate
incorporates the elections permitted under IFRS to fair value certain
assets and liabilities of the credit protection vehicle, with changes in
the fair value recorded in income as they occur. We do not expect any
significant volatility in the bank’s net income under IFRS as a result of
the fair value election, unless there is a significant downturn in market
conditions, as any changes in the fair value of the assets and liabilities
will largely offset each other as a result of the hedges the bank has put
in place. The risk of volatility in net income will be reduced over time as
the CDS contracts held by the vehicle mature. Based on their notional
values, the contracts will expire as follows: 24% in fiscal 2012, 40% in
fiscal 2013, 6% in fiscal 2014 and 30% in fiscal 2016.
Structured Investment Vehicles (SIVs) – Based on the analysis completed
to date, our preliminary conclusion is that the bank would be required to
consolidate the SIVs, as our analysis indicates that the bank, in substance,
controls the SIVs, based on the definition of control under IFRS. Under
Canadian GAAP, we are not required to consolidate the SIVs.
Consolidation of the SIVs would increase assets and liabilities on
the bank’s balance sheet by approximately $200 million on November 1,
2010, the beginning of our comparative year. This represents the amount
by which the assets of the SIVs exceed the amount drawn on the loan
facility the bank has made available to the SIVs as of November 1, 2010.
Our estimate incorporates the election permitted under IFRS to fair
value the assets and liabilities of the SIVs, with changes in the fair value
recorded in income as they occur. We do not expect any significant
volatility in the bank’s net income under IFRS as a result of the fair value
election, unless there is a significant downturn in market conditions,
as any changes in the fair value of the assets should be largely offset by
changes in the fair value of the capital notes. The risk of volatility in net
income will be reduced over time as the assets held by the vehicles
mature. Based on their par value, we expect that 47% of the assets will
mature by the end of fiscal 2012, 14% in fiscal 2013, 10% in fiscal 2014,
12% in 2015 and 17% between 2016 and 2028.
The risk-weighted assets of the vehicles noted above are already
included in the current determination of the bank’s risk-weighted assets.
In addition, we do not expect the consolidation of these vehicles would
result in any significant adjustment to opening retained earnings. As a
result, we do not expect that consolidating any of these vehicles would
have a significant impact on the calculation of our Tier 1 Capital Ratio.
72 BMO Financial Group 193rd Annual Report 2010