Bank of Montreal 2004 Annual Report Download - page 101

BMO Financial Group Annual Report 2004 97
Notes
Under the new VIE guideline, the sellers’ interests in the
assets are excluded from the consideration of who is required
to consolidate the multi-seller conduits. Because of the fees
we earn, we expect to consolidate our customer securitization
vehicles on November 1, 2004. The impact of consolidation on our
Consolidated Balance Sheet will be an increase in cash resources
of $28 million, an increase in loans of $20,805 million, a decrease
in derivative assets of $51 million, an increase in other assets
of $25 million, an increase in other liabilities of $20,849 million,
a decrease in derivative liabilities of $1 million and a decrease
in opening retained earnings of $41 million. The impact on our
Consolidated Statement of Income in future years is not expected
to be significant. When we adopt these rules, we will not restate
prior period financial statements.
We have significant variable interests in certain other VIEs that
we are not required to consolidate. Our involvement with non-
consolidated VIEs is summarized as follows:
Bank Securitization Vehicles
We use bank securitization vehicles to securitize our loans either
for capital management purposes or to obtain alternate sources of
f unding. The structure of these vehicles limits the types of activities
they can undertake and the types of assets they can hold, and they
have limited decision-making authority. We are not required to con-
solidate our bank securitization vehicles under the CICA guideline.
More information on our rights and obligations related to these
vehicles can be found in Note 7. In addition to the interests described
in Note 7, we also provide liquidity support to our securitization
vehicles in the form of standby letters of credit and guarantees for
up to 75% of the asset value transferred. The total contract amount
of standby letters of credit and guarantees was $3,750 million as
at October 31, 2004. No amount was drawn at year end.
Credit Investment Management Vehicles
Credit investment management vehicles provide investment
opportunities in customized, diversified debt portfolios in a variety
of asset and rating classes. We earn investment management
fees for managing these portfolios. Until earlier this year, we had
two types of credit investment management vehicles: High Yield
Collateralized Bond Obligation Vehicles (“CBOs”) and High
Grade Structured Investment Vehicles (“SIVs”).
During the year, we sold our investment in the CBOs with minimal
impact on net income. We were also replaced as asset manager.
As a result, we no longer have interests in the CBOs.
We continue to hold our interest in the SIVs and act as asset
manager. Assets held by the SIVs totalled $19,502 million as at
October 31, 2004 ($17,651 million in 2003).
Our exposure to loss relates to our investments in these vehicles,
derivative contracts we have entered into with the vehicles and
the liquidity support we provide through standby letters of credit
and/or commitments to extend credit. Our investment in the SIVs,
which was recorded as investment securities on our Consolidated
Balance Sheet, was $128 million as at October 31, 2004 ($97 million
in 2003). The fair value of our derivative contracts outstanding
with the SIVs and recorded on our Consolidated Balance Sheet
was a derivative asset of $37 million as at October 31, 2004. The total
contract amount of letters of credit and commitments to extend
credit were $200 million as at October 31, 2004 ($208 million
in 2003); no amounts were drawn at year end. We are not required
to consolidate these SIVs under the CICA guideline.
Compensation Trusts
We have established trusts in order to administer our employee
share ownership plan. Under this plan, we match 50% of employees’
contributions when they choose to contribute a portion of
their gross salary toward the purchase of our common shares.
Our matching contributions are paid into trusts, which purchase
our shares on the open market for payment to employees once
employees are entitled to the shares under the terms of the plan.
We are not required to consolidate these compensation trusts
under the CICA guideline.
Other VIEs
We are involved with other entities that may potentially be VIEs.
This involvement can include, for example, acting as a derivatives
counterparty, liquidity provider, investor, fund manager or trustee.
These activities do not cause us to be exposed to a majority of
the expected losses of these VIEs or allow us to benefit from a
majority of their expected residual returns. As a result, we are
not required to consolidate these VIEs under the CICA guideline.
Transactions with these VIEs are conducted at market rates,
and individual credit or investment decisions are based upon the
analysis of the specific VIE, taking into consideration the quality
of underlying assets. We record and report these transactions in
the same manner as other transactions. For example, derivative
contracts are recorded in accordance with our derivatives account-
ing policy as outlined in Note 9. Liquidity facilities are described
in Note 6.
Note 9 Derivative Financial Instruments
Derivative financial instruments are contracts that require the
exchange of, or provide the opportunity to exchange, cash flows
determined by applying certain rates, indices or changes therein
to notional contract amounts. Derivative transactions are
conducted either directly between two counterparties in the
over-the-counter market or on regulated exchange markets.
Types of Derivatives
Swaps
Swaps are contractual agreements between two parties to exchange
a series of cash flows. The various swap agreements that we enter
into are as follows:
Interest rate swaps – counterparties generally exchange fixed
and floating rate interest payments based on a notional value in
a single currency.
Cross-currency swaps – fixed rate interest payments and principal
amounts are exchanged in different currencies.
Cross-currency interest rate swaps – fixed and floating rate
interest payments and principal amounts are exchanged in
different currencies.
Commodity swaps – counterparties generally exchange
fixed and floating rate payments based on a notional value of
a single commodity.
Equity swaps – counterparties exchange the return on an equity
security or group of equity securities.
Credit default swaps – one counterparty pays the other a fee in
exchange for that other counterparty making a payment if a credit
event occurs, such as bankruptcy or a credit rating change.
The main risks associated with these instruments are related
to the exposure to movements in interest rates, foreign exchange
rates, credit ratings, securities values or commodities prices,
as applicable, and the possible inability of counterparties to meet
the terms of the contracts.
Forwards and Futures
Forwards and futures are contractual agreements to either buy
or sell a specified amount of a currency, commodity or security
at a specific price and date in the future. Forwards are customized
contracts transacted in the over-the-counter market. Futures
are transacted in standardized amounts on regulated exchanges
and are subject to daily cash margining.
The main risks associated with these instruments arise from
the possible inability of over-the-counter counterparties to meet
the terms of the contracts and from movements in commodities
prices, securities values, interest rates and foreign exchange
rates, as applicable.