Bank of Montreal 2013 Annual Report Download - page 61

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Impairment of Securities
We have investments in securities issued or guaranteed by Canadian,
U.S. and other governments, corporate debt and equity securities,
mortgage-backed securities and collateralized mortgage obligations,
which are classified as either available-for-sale securities, held-to-
maturity or other securities. We review held-to-maturity, available-for-
sale and other securities at each quarter-end reporting period to identify
and evaluate investments that show indications of possible impairment.
An investment is considered impaired if there is objective evidence that
the estimated future cash flows will be reduced and the impact can be
reliably measured. We consider evidence such as delinquency or default,
bankruptcy, restructuring or the absence of an active market. The deci-
sion to record a write-down, its amount and the period in which it is
recorded could change if management’s assessment of those factors
were different. We do not record impairment write-downs on debt
securities when impairment is due to changes in market rates, if future
contractual cash flows associated with the debt security are still
expected to be recovered.
At the end of 2013, there were total unrealized losses of
$96 million on securities for which cost exceeded fair value and an
impairment write-down had not been recorded. Of this amount,
$5 million related to securities for which cost had exceeded fair value
for 12 months or more. These unrealized losses resulted from increases
in market interest rates and not from deterioration in the creditworthi-
ness of the issuer.
Additional information regarding our accounting for available-for-
sale securities, held-to-maturity securities and other securities and the
determination of fair value is included in Note 3 on page 134 of the
financial statements.
Income Taxes
The provision for income taxes is calculated based on the expected tax
treatment of transactions recorded in our Consolidated Statements of
Income or Changes in Equity. In determining the provision for income
taxes, we interpret tax legislation in a variety of jurisdictions and make
assumptions about the expected timing of the reversal of deferred tax
assets and liabilities. If our interpretations differ from those of tax author-
ities or if the timing of reversals is not as expected, our provision for
income taxes could increase or decrease in future periods. The amount of
any such increase or decrease cannot be reasonably estimated.
Public discussions concerning U.S. legislation suggest that it is
possible that corporate income tax rates may be reduced during BMO’s
fiscal year ending October 31, 2014. If corporate tax rates were to be
reduced, this would result in a reduction of the deferred tax asset and a
charge to the provision for income taxes. A 1% reduction in the U.S.
federal corporate tax rate from 35% to 34% would result in a decrease
in our deferred tax asset of approximately $60 million and a
corresponding reduction in net income. As deferred tax assets are
deducted from BMO’s CET1 ratio or capitalized as a risk-weighted asset,
any such decrease in deferred tax assets will wholly or partly offset the
deterioration in our CET1 ratio which would otherwise result from such
reduced net income. Any reduction in the U.S. federal corporate tax rate
would be expected to increase net income from our U.S. operations in
future periods.
Additional information regarding our accounting for income taxes is
included in Note 24 on page 171 of the financial statements.
Goodwill and Intangible Assets
Goodwill is assessed for impairment at least annually. This assessment
includes a comparison of the carrying value and the recoverable amount
of each business unit to verify that the recoverable amount of the
business unit is greater than its carrying value. If the carrying value
were to exceed the recoverable amount of the business unit, a more
detailed goodwill impairment assessment would have to be undertaken.
The recoverable amount of an asset is the higher of its fair value less
costs to sell and its value in use.
Fair value less costs to sell was used to perform the impairment
test in 2013 and 2012. In determining fair value less costs to sell, we
employ a discounted cash flow model, consistent with that used when
we acquire businesses. This model is dependent on assumptions related
to revenue growth, discount rates, synergies achieved on acquisition
and the availability of comparable acquisition data. Changes in each of
these assumptions would affect the determination of fair value for each
of the business units in a different manner. Management must exercise
judgment and make assumptions in determining fair value, and differ-
ences in judgments and assumptions could affect the determination of
fair value and any resulting impairment write-down. At October 31,
2013, the estimated fair value of each of our business units was greater
than its carrying value.
Intangible assets are amortized to income on either a straight-line
or an accelerated basis over a period not exceeding 15 years, depending
on the nature of the asset. There are no intangible assets with indefinite
lives. We test intangible assets for impairment when circumstances
indicate the carrying value may not be recoverable. No such impairment
was identified for the years ended October 31, 2013 and 2012.
Additional information regarding the composition of goodwill and
intangible assets is included in Note 13 on page 156 of the financial
statements.
Insurance-Related Liabilities
Insurance claims and policy benefit liabilities represent current claims
and estimates for future insurance policy benefits. Liabilities for life
insurance contracts are determined using the Canadian Asset Liability
Method, which incorporates best-estimate assumptions for mortality,
morbidity, policy lapses, surrenders, future investment yields, policy
dividends, administration costs and margins for adverse deviation. These
assumptions are reviewed at least annually and updated to reflect actual
experience and market conditions. The most significant impact on the
valuation of a liability results from a change in the assumption for future
investment yields. Future investment yields may be sensitive to varia-
tions in reinvestment interest rates and accordingly may affect the
valuation of policy benefit liabilities. If the assumed yield were to
increase by one percentage point, net income would increase by
approximately $81 million. A reduction of one percentage point would
lower net income by approximately $66 million.
Contingent Liabilities
BMO and its subsidiaries are involved in various legal actions in the
ordinary course of business.
Provisions are recorded at the best estimate of the amount required
to settle the obligation related to these legal actions as at the balance
sheet date, taking into account the risks and uncertainties surrounding
the obligation. Management and internal and external experts are
involved in estimating any amounts required. The actual costs of
resolving these claims may be substantially higher or lower than the
amount of the provisions.
Additional information regarding provisions is provided in Note 28
on page 177 of the financial statements.
Caution
This Critical Accounting Estimates section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
72 BMO Financial Group 196th Annual Report 2013