Bank of Montreal 2013 Annual Report Download - page 133

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Liquidity and Funding Risk
Liquidity and funding risk is the potential for loss if we are unable to
meet financial commitments in a timely manner at reasonable prices as
they fall due. It is our policy to ensure that sufficient liquid assets and
funding capacity are available to meet financial commitments, including
liabilities to depositors and suppliers, and lending, investment and
pledging commitments, even in times of stress. Managing liquidity and
funding risk is essential to maintaining both depositor confidence and
stability in earnings.
Our liquidity and funding risk management practices and key
measures are outlined in the text presented in a blue-tinted font in the
Enterprise-Wide Risk Management section of Management’s Discussion
and Analysis on pages 92 to 94 of this report.
Note 7: Guarantees
In the normal course of business, we enter into a variety of guarantees.
Guarantees include contracts where we may be required to make
payments to a counterparty, based on changes in the value of an asset,
liability or equity security that the counterparty holds, due to changes in
an underlying interest rate, foreign exchange rate or other variable. In
addition, contracts under which we may be required to make payments
to reimburse the counterparty for a loss if a third party does not perform
according to the terms of a contract or does not make payments when
due under the terms of a debt instrument, and contracts under which
we provide indirect guarantees of the indebtedness of another party,
are considered guarantees.
Guarantees that qualify as derivatives are accounted for in
accordance with the policy for derivative instruments (see Note 10). For
guarantees that do not qualify as a derivative, the liability is initially
recorded at fair value, which is generally the fee to be received.
Subsequently, guarantees are recorded at the higher of the initial fair
value, less amortization to recognize any fee income earned over the
period, and the best estimate of the amount required to settle the
obligation. Any increase in the liability is reported in the Consolidated
Statement of Income.
The most significant guarantees are as follows:
Standby Letters of Credit and Guarantees
Standby letters of credit and guarantees represent our obligation to
make payments to third parties on behalf of another party if that party
is unable to make the required payments or meet other contractual
requirements. The maximum amount payable under standby letters of
credit and guarantees totalled $13,470 million as at October 31, 2013
($11,851 million in 2012). The majority have a term of one year or less.
Collateral requirements for standby letters of credit and guarantees are
consistent with our collateral requirements for loans. A large majority of
these commitments expire without being drawn upon. As a result, the
total contractual amounts may not be representative of the funding
likely to be required for these commitments.
As at October 31, 2013, $41 million ($29 million in 2012) was
included in other liabilities related to guaranteed parties that were
unable to meet their obligations to a third party (see Note 4). No other
amount was included in our Consolidated Balance Sheet as at
October 31, 2013 and 2012 related to these standby letters of credit and
guarantees.
Backstop and Other Liquidity Facilities
Backstop liquidity facilities are provided to asset-backed commercial
paper (“ABCP”) programs administered by either us or third parties as an
alternative source of financing in the event that such programs are
unable to access ABCP markets or when predetermined performance
measures of the financial assets owned by these programs are not met.
The terms of the backstop liquidity facilities do not require us to
advance money to these programs in the event of bankruptcy of the
borrower. The facilities’ terms are generally no longer than one year, but
can be several years.
The maximum amount payable under these backstop and other
liquidity facilities totalled $4,512 million as at October 31, 2013
($4,467 million in 2012). As at October 31, 2013, $145 million was
outstanding from facilities drawn in accordance with the terms of the
backstop liquidity facilities ($107 million in 2012).
Credit Enhancement Facilities
Where warranted, we provide partial credit enhancement facilities to
transactions within ABCP programs administered by either us or third
parties. Credit enhancement facilities are included in backstop liquidity
facilities.
Senior Funding Facility
In addition to our investment in the notes subject to the Montreal
Accord, we have provided a senior loan facility of $232 million as at
October 31, 2013 ($295 million in 2012). No amounts were drawn as at
October 31, 2013 and 2012.
Derivatives
Certain of our derivative instruments meet the accounting definition of a
guarantee when they require the issuer to make payments to reimburse
the holder for a loss incurred because a debtor fails to make payment
when due under the terms of a debt instrument. In order to reduce our
exposure to these derivatives, we enter into contracts that hedge the
related risks.
Written credit default swaps require us to compensate a
counterparty following the occurrence of a credit event in relation to a
specified reference obligation, such as a bond or a loan. The maximum
amount payable under credit default swaps is equal to their notional
amount of $13,288 million as at October 31, 2013 ($24,126 million in
2012). The terms of these contracts range from less than one year to 10
years. The fair value of the related derivative liabilities included in
derivative instruments in our Consolidated Balance Sheet was
$102 million as at October 31, 2013 ($156 million in 2012).
Exchange and Clearinghouse Guarantees
We are a member of several securities and futures exchanges and
clearinghouses. Membership in certain of these organizations may
require us to pay a pro rata share of the losses incurred by the
organization in the event of default of another member. Such
obligations vary with different organizations. These obligations may be
limited to members who dealt with the defaulting member, an amount
related to our contribution to a member’s guarantee fund, or an amount
specified in the membership agreement. It is difficult to estimate our
maximum exposure under these membership agreements, since this
would require an assessment of future claims that may be made against
us that have not yet occurred. Based on historical experience, we expect
the risk of loss to be remote.
Indemnification Agreements
In the normal course of operations, we enter into various agreements
that provide general indemnifications. These indemnifications typically
occur in connection with sales of assets, securities offerings, service
contracts, membership agreements, clearing arrangements, derivatives
contracts and leasing transactions. We also have a securities lending
business that lends securities owned by clients to borrowers who have
been evaluated for credit risk using the same credit risk process that is
applied to loans and other credit assets. In connection with these
Notes
144 BMO Financial Group 196th Annual Report 2013