Bank of Montreal 1998 Annual Report Download - page 52

44
BANK OF MONTREAL GROUP OF COMPANIES
HOW SPECIFIC RISKS ARE MEASURED AND MANAGED:
This section describes how we manage specific risks, including the means by which we
measure them, starting with credit risk.
CREDIT RISK
Approach:
Our focus on a broadly diversified portfolio results in lending relationships with millions of
different clients, the majority of which are consumers and small to medium-sized businesses.
Credit risk management of such a broad client base requires a combination of a high degree
of personal accountability, clear delegation of decision-making authority and disciplined
portfolio management. Customer relationship managers, who are skilled lenders, evaluate
credit transactions for commercial loans. We monitor performance and price credit trans-
actions commensurate with risk using Risk Adjusted Return on Capital (RAROC†) among
other methodologies. RAROC is applied to all large commercial transactions and draws on
multiple external market data inputs for measurement purposes, such as stock exchange
filings and credit ratings.
Our commitment to diversifying the risks within the loan and investment portfolios is
integral to effective credit risk management, particularly in the corporate and institutional
portfolios, where concentration of risk can be a more significant issue.
Management stresses the prompt recognition of problem accounts and the transfer of mate-
rial
cases to a group of specialists skilled in managing such accounts. All problem accounts
are subject to a formal quarterly review. Our independent internal audit group reviews
management processes to ensure that line functions adhere to established credit policies.
These processes enable us to maintain a loan portfolio that is well diversified by size and
risk category throughout individual, commercial, corporate, institutional, industrial and
geographic markets.
Consistent with the general principles stated above, during 1998 we began implementing a
redesign of lending activities as part of a broader initiative to further enhance our risk manage-
ment processes. The steps taken to date have separated three key elements of the credit process
for large corporate lending activity, namely transaction origination, distribution (sales and
syndications), and portfolio management activity. The availability and increasing reliability
of technological tools in the portfolio management process have enabled us to refocus
the work-flows so that more time and attention are given to higher-risk situations. Also,
individual lenders can readily approve low-risk situations.
The largest components of our overall loan portfolio are as follows:
Commercial, Corporate and Institutional Loan Portfolio (39.3% of Total Assets in 1998
versus 34.3% in 1997)
Securities purchased under resale agreements (reverse repos†) and loans to financial institu-
tions represented 42.3% of the overall commercial loan portfolio in 1998, increased from
38.4% at October 31, 1997. The remainder of the portfolio was broadly diversified across
Canada and the U.S. Midwest, by industry, industry sub-sector and client relationship, with
a broad range of borrower type and size. Manufacturing and service industries are by their
nature diversified among many industry sub-sectors.
Individual Portfolio (22.6% of Total Assets in 1998 versus 24.1% in 1997)
Mortgages continue to be the predominant lending product in the loans to individuals port-
folio, representing 66.4% of total loans to individuals. Credit card assets represent only 0.4%
of our total assets as a result of our card securitizations ($2.5 billion to date) in Canada and
the sale of our U.S. card business to Partners First. The individual portfolio is inherently
diverse, which helps to mitigate loan loss volatility. Loan loss experience on this portfolio is
more predictable and tends to follow the economic cycle. Transaction decisions are also
subject to automated methodologies, which enable consistency, reliability and efficiency in
decision-making.
ENTERPRISE-WIDE RISK MANAGEMENT
STRATEGY:
To maintain a well-diversified
asset portfolio regardless of the
economic environment and to
earn a return appropriate to the
risk profile of the portfolio.
MEASURES:
We use two primary measures
to monitor our success in
managing the credit risk in
our loan portfolio:
■The provisioning ratio is the
most accurate indicator of
underlying asset quality over
the long term, and represents
the base level of provisions
necessary to cover losses in
the lending portfolios. This
ratio is calculated as the annual
provision for credit losses (PCL)
as a percentage of average
loans and acceptances (collec-
tively referred to as loans).
■Gross impaired loans as a
percentage of equity plus
the allowance for credit losses
(allowance) measures the
financial condition of our port-
folio by comparing the volume
of impaired loans to the level
of capital and reserves avail-
able to absorb loan losses.
MARKET DIVERSIFICATION
(% of loan portfolio)
0.2
36.4
63.4
Commercial, corporate
& institutional
Designated lesser-developed
countries
Individuals
GEOGRAPHICAL
DIVERSIFICATION
(% of loan portfolio)
8.1
35.5
55.9
Canada
United States
Other countries
Mexico
0.5
†Defined in the Glossary on page 92