Bank of Montreal 2012 Annual Report Download - page 145

Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We record interest that we pay or receive on these derivatives as
an adjustment to net interest income in our Consolidated Statement of
Income over the life of the hedge.
To the extent that changes in the fair value of the derivative offset
changes in the fair value of the hedged item, they are recorded in other
comprehensive income. The excess of the change in fair value of the
derivative that does not offset changes in the fair value of the hedged
item (the “ineffectiveness of the hedge”) is recorded directly in
non-interest revenue, other in our Consolidated Statement of Income.
For cash flow hedges that are discontinued before the end of the
original hedge term, the unrealized gain or loss recorded in other
comprehensive income is amortized to net interest income in our
Consolidated Statement of Income as the hedged item affects earnings.
If the hedged item is sold or settled, the entire unrealized gain or loss is
recognized in net interest income in our Consolidated Statement of
Income. The amount of unrealized gain that we expect to reclassify to
our Consolidated Statement of Income over the next 12 months is
$166 million ($123 million after tax). This will adjust the interest
recorded on assets and liabilities that were hedged.
Fair Value Hedges
Fair value hedges modify exposure to changes in a fixed rate
instrument’s fair value caused by changes in interest rates. These
hedges convert fixed rate assets and liabilities to floating rate. Our fair
value hedges include hedges of fixed rate securities, deposits and
subordinated debt.
We record interest receivable or payable on these derivatives as an
adjustment to net interest income in our Consolidated Statement of
Income over the life of the hedge.
For fair value hedges, not only is the hedging derivative recorded at
fair value but fixed rate assets and liabilities that are part of a hedging
relationship are adjusted for the changes in value of the risk being
hedged (“quasi fair value”). To the extent that the change in the fair
value of the derivative does not offset changes in the quasi fair value of
the hedged item (the “ineffectiveness of the hedge”), the net amount is
recorded directly in non-interest revenue, other in our Consolidated
Statement of Income.
For fair value hedges that are discontinued, we cease adjusting the
hedged item to quasi fair value. The quasi fair value adjustment of the
hedged item is then amortized as an adjustment to the net interest
income on the hedged item over its remaining term to maturity. If the
hedged item is sold or settled, any remaining quasi fair value
adjustment is included in the determination of the gain or loss on sale
or settlement. We did not hedge any commitments during the years
ended October 31, 2012 and 2011.
Net Investment Hedges
Net investment hedges mitigate our exposure to foreign currency
exchange rate fluctuations in our net investment in foreign operations.
Deposit liabilities denominated in foreign currencies are designated as
hedges of this exposure. The foreign currency translation on the net
investment in foreign operations and the corresponding hedging
instrument is recorded in net gain (loss) on translation of net foreign
operations in other comprehensive income. To the extent that the
hedging instrument is not effective, amounts are included in the
Consolidated Statement of Income in foreign exchange, other than
trading. There was no hedge ineffectiveness associated with net
investment hedges for the year ended October 31, 2012 (no
ineffectiveness in 2011). We use foreign currency deposits with a term
to maturity of zero to three months as hedging instruments in net
investment hedges, and the fair value of such deposits was
$6,867 million as at October 31, 2012 ($7,393 million in 2011).
Fair Value Hedging Relationships
The following table presents the impact of fair value hedges on our financial results.
(Canadian $ in millions) Pre-tax gains/(losses) recorded in income
Contract type
Amount of gain/(loss) on
hedging derivatives (1)
Quasi fair value
adjustment (2)
Hedge ineffectiveness recorded
in non-interest revenue – other
Interest rate contracts – 2012 42 (44) (2)
2011 245 (276) (31)
(1) Unrealized gains (losses) on hedging derivatives are recorded in Other Assets – Derivative
instruments or Other Liabilities – Derivative instruments in the Consolidated Balance Sheet.
(2) Unrealized gains (losses) on hedged items are recorded in Securities – Available for sale,
Subordinated Debt, and Deposits.
Cash Flow Hedging Relationships
The following table presents the impact of cash flow hedges on our financial results.
(Canadian $ in millions) Pre-tax gains/(losses) recorded in income
Contract type
Fair value change recorded in
other comprehensive income
Fair value change recorded in
non-interest revenue – other
Reclassification of gains (losses) on
hedges from other comprehensive
income to net interest income
Amortization of
spot/forward differential on
foreign exchange contracts
to interest expense
2012
Interest rate (44) 3 177 –
Foreign exchange (27) – – (32)
Total (71) 3 177 (32)
2011
Interest rate 345 8 98 –
Foreign exchange 120 – – (66)
Total 465 8 98 (66)
Embedded Derivatives
From time to time, we purchase or issue financial instruments
containing embedded derivatives. The embedded derivative is separated
from the host contract and carried at fair value if the economic
characteristics of the derivative are not closely related to those of the
host contract, the terms of the embedded derivative are the same as
those of a stand-alone derivative, and the combined contract is not held
for trading or designated at fair value. To the extent that we cannot
reliably identify and measure the embedded derivative, the entire
contract is carried at fair value, with changes in fair value reflected in
income. Embedded derivatives in certain of our equity linked notes are
accounted for separately from the host instrument.
142 BMO Financial Group 195th Annual Report 2012