Bank of Montreal 2013 Annual Report Download - page 168

Privately Issued Securities
Privately issued debt and equity securities are valued using recent
market transactions, where available. Otherwise, fair value is derived
from valuation models using a market or income approach. These
models consider various factors, including projected cash flows,
earnings, revenue and other third-party evidence as available. The fair
value of limited partnership investments is based upon net asset values
published by third-party fund managers.
Prices from brokers and multi-contributor pricing sources are
corroborated as part of our independent review process, which may
include using valuation techniques or obtaining consensus or composite
prices from other pricing services. We validate the estimates of fair
value by independently obtaining multiple quotes of external market
prices and input values. We review the approach taken by third-party
vendors to ensure that the vendor employs a valuation model which
maximizes the use of observable inputs such as benchmark yields, bid-
ask spreads, underlying collateral, weighted-average terms to maturity
and prepayment rate assumptions. Fair value estimates from internal
valuation techniques are verified, where possible, by reference to prices
obtained from third-party vendors.
Loans
In determining the fair value of our fixed rate and floating rate
performing loans and customers’ liability under acceptances, we
discount the remaining contractual cash flows, adjusted for estimated
prepayment, at market interest rates currently offered for loans with
similar terms.
The value of our loan balances determined using this approach is
further adjusted by a credit mark that represents an estimate of the
expected credit losses in our loan portfolio.
Derivative Instruments
A number of well-established valuation techniques are employed to
estimate fair value, including discounted cash flow analysis, the Black-
Scholes model, Monte Carlo simulation and other accepted market
models. These vetted models incorporate current market measures for
interest rates, currency exchange rates, equity and commodity prices
and indices, credit spreads, recovery rates, corresponding market
volatility levels, spot prices, correlation levels and other market-based
pricing factors. Option implied volatilities, an input into many valuation
models, are either obtained directly from market sources or calculated
from market prices. Multi-contributor pricing sources are used
wherever possible.
In determining the fair value of complex and customized
derivatives, we consider all reasonably available information, including
dealer and broker quotations, multi-contributor pricing sources and any
relevant observable market inputs. Our model calculates fair value based
on inputs specific to the type of contract, which may include stock
prices, correlation for multiple assets, interest rates, foreign exchange
rates, yield curves and volatilities.
We calculate a credit valuation adjustment (“CVA”) to recognize the
risk that any given derivative counterparty may not ultimately be able to
fulfill its obligations. The CVA is derived from market-observed credit
spreads or proxy credit spreads and our assessment of the net
counterparty credit risk exposure, taking into account credit mitigants
such as collateral, master netting arrangements and settlements
through clearing houses.
Deposits
In determining the fair value of our deposits, we incorporate the
following assumptions:
‰ For fixed rate, fixed maturity deposits, we discount the remaining
contractual cash flows for these deposits, adjusted for expected
redemptions, at market interest rates currently offered for deposits
with similar terms and risks.
‰ For fixed rate deposits with no defined maturities, we consider fair
value to equal book value, based on book value being equivalent to
the amount payable on the reporting date.
‰ For floating rate deposits, changes in interest rates have minimal
impact on fair value since deposits reprice to market frequently. On
that basis, fair value is assumed to equal book value.
A portion of our structured note liabilities that have coupons or
repayment terms linked to the performance of interest rates, foreign
currencies, commodities or equity securities have been designated at
fair value through profit or loss. The fair value of these structured notes
is estimated using internally vetted valuation models and incorporates
observable market prices for identical or comparable securities, and
other inputs such as interest rate yield curves, option volatilities and
foreign exchange rates, where appropriate. Where observable prices or
inputs are not available, management judgment is required to
determine the fair value by assessing other relevant sources of
information such as historical data and proxy information from similar
transactions.
Securities Sold But Not Yet Purchased
The fair value of these obligations is based on the fair value of the
underlying securities, which can include equity or debt securities. As
these obligations are fully collateralized, the method used to determine
fair value would be the same as that used for the relevant underlying
equity or debt securities.
Securities Borrowed or Purchased Under
Resale Agreements and Securities Lent
or Sold Under Repurchase Agreements
The fair value of these agreements is determined using a standard
discounted cash flow model. Inputs to the model include contractual
cash flows and collateral funding spreads.
Securitization Liabilities
The determination of the fair value of securitization liabilities, recorded
in other liabilities, is based on quoted market prices or quoted market
prices for similar financial instruments, where available. Where quoted
prices are not available, fair value is determined using valuation
techniques, which maximize the use of observable inputs and
assumptions such as discounted cash flows.
Subordinated Debt and Capital Trust Securities
The fair value of our subordinated debt and capital trust securities is
determined by referring to current market prices for similar instruments.
Set out in the following table are the amounts that would be reported if
all of our financial instrument assets and liabilities were reported at
their fair values. Certain assets and liabilities, including goodwill,
intangible assets and total equity, are not considered financial
instruments and are therefore not fair valued in the following table.
Notes
BMO Financial Group 196th Annual Report 2013 179