Bank of Montreal 2013 Annual Report Download - page 138

Cash Flow Hedges
Cash flow hedges modify exposure to variability in cash flows for
variable rate interest bearing instruments and assets and liabilities
denominated in foreign currencies. Our cash flow hedges, which have a
maximum remaining term to maturity of eleven years, are hedges of
floating rate loans and deposits as well as assets and liabilities
denominated in foreign currencies.
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 $107
million ($79 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, 2013 and 2012.
Net Investment Hedges
Net investment hedges mitigate our exposure to foreign currency
exchange rate fluctuations related to our net investment in foreign
operations. Deposit liabilities denominated in foreign currencies are
designated as hedges of this exposure. The foreign currency translation
of our 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 years ended October 31, 2013 and 2012. 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 $7,547 million as at October 31, 2013
($6,867 million in 2012).
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
Amount of gain/(loss) on Quasi fair value Hedge ineffectiveness recorded
Contract type hedging derivatives (1) adjustment (2) in non-interest revenue – other
Interest rate contracts – 2013 (371) 360 (11)
2012 42 (44) (2)
2011 245 (276) (31)
(1) Unrealized gains (losses) on hedging derivatives are recorded in Other Assets – Derivative (2) Unrealized gains (losses) on hedged items are recorded in Securities – Available for sale,
instruments or Other Liabilities – Derivative instruments in the Consolidated Balance Sheet. Subordinated Debt and Deposits.
BMO Financial Group 196th Annual Report 2013 149
Notes