Bank of Montreal 2012 Annual Report Download - page 134

Notes
Note 4: Loans, Customers’ Liability under Acceptances
and Allowance for Credit Losses
Loans
Loans are recorded at amortized cost using the effective interest method
except for purchased loans, which are described in the Purchased Loans
section below. The effective interest method allocates interest income
over the expected term of the loan 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 to the net carrying amount of the
loan. The treatment of interest income for impaired loans is
described below.
We amortize deferred loan origination costs that are directly
attributable and incremental to the origination of a loan 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, loans, 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 commitment 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 corresponding
claim is recorded as a loan in our Consolidated Balance Sheet.
Fees earned are recorded in lending fees in our Consolidated
Statement of Income over the term of the acceptance.
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. Residential mortgages are written off
following a review on an individual loan basis that confirms all recovery
attempts have been exhausted. 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. For the purpose
of measuring the amount to be written off, the determination of the
recoverable amount includes an estimate of future recoveries.
Corporate and commercial loans are classified as impaired when
we are no longer reasonably assured that principal or interest will be
collected in its entirety on a timely basis. Generally, corporate and
commercial loans are considered impaired when payments are 90 days
past due, or for fully secured loans, when payments are 180 days past
due. Corporate and commercial loans are written off following a review
on an individual loan basis that confirms all recovery attempts have
been exhausted.
Once a loan is identified as impaired, we continue to recognize
interest income based on the original effective interest rate of the loan.
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.
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. The portion related to other credit
instruments is recorded in other liabilities in our Consolidated Balance
Sheet. As at October 31, 2012, there was $230 million in allowance for
credit losses related to other credit instruments included in other
liabilities ($228 million in 2011).
The allowance comprises the following two components:
Specific Allowance
These allowances are recorded for individually identified impaired 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 approved 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 loan’s original effective interest rate. The determination of
estimated future cash flows of a collateralized loan reflects the expected
realization of the underlying security net of expected costs and any
amounts legally required to be paid to the borrower. Security can vary
by type of loan and may include cash, securities, real property, accounts
receivable, guarantees, inventory or other capital assets.
Certain personal loans are individually identified as impaired;
however, the provision for personal loans is calculated on a pooled
basis, taking into account historical loss experience. In the periods
following the recognition of impairment, adjustments to the allowance
for these loans reflecting the time value of money are recognized and
presented as interest income.
Collective Allowance
We maintain a collective allowance (previously referred to as the
general allowance) in order to cover any impairment in the existing
portfolio that cannot yet be associated with loans that are individually
identified as impaired. Our approach to establishing and maintaining the
collective allowance is based on the guideline issued by OSFI. The
collective allowance is reviewed on a quarterly basis. For purposes of
calculating the collective allowance, we group loans on the basis of
similarities in credit risk characteristics. The collective allowance
methodology incorporates both quantitative and qualitative factors to
determine an appropriate level of the collective allowance.
BMO Financial Group 195th Annual Report 2012 131