Bank of Montreal 2004 Annual Report Download - page 105

BMO Financial Group Annual Report 2004 101
Notes
Derivative-Related Credit Risk
Over-the-counter derivative instruments are subject to credit risk.
Credit risk arises from the possibility that counterparties may
default on their obligations. The credit risk associated with deriv-
atives is normally a small fraction of the notional amount of the
derivative instrument. Derivative contracts generally expose us
to potential credit loss if changes in market rates affect a counter-
party’s position unfavourably and the counterparty defaults on
payment. Accordingly, the credit risk is represented by the positive
fair value of the derivative instrument. We strive to limit credit
risk by dealing with counterparties that we believe are creditworthy,
and we manage our credit risk for derivatives using the same
credit risk process that is applied to loans and other credit assets.
We also pursue opportunities to reduce our exposure to credit
losses on derivative instruments, including entering into master
netting agreements with counterparties. The credit risk associated
with favourable contracts is eliminated by master netting agree-
ments, to the extent that unfavourable contracts with the same
counterparty cannot be settled before favourable contracts.
Exchange-traded derivatives have no potential for credit exposure
as they are settled net with each exchange.
Terms used in the credit risk table below are as follows:
Replacement cost represents the cost of replacing all contracts
that have a positive fair value, using current market rates. It repre-
sents in effect the unrealized gains on our derivative instruments.
Replacement costs disclosed below represent the net of the asset
and liability to a specific counterparty where we have a legally
enforceable right to offset the amount owed to us with the amount
owed by us and we intend either to settle on a net basis or to
realize the asset and settle the liability simultaneously.
Credit risk equivalent represents the total replacement cost plus
an amount representing the potential future credit exposure, as
outlined in the Capital Adequacy Guideline of the Superintendent
of Financial Institutions Canada.
Risk-weighted balance represents the credit risk equivalent, weighted
based on the creditworthiness of the counterparty, as prescribed
by the Superintendent of Financial Institutions Canada.
(Canadian $ in millions) 2004 2003
Replacement Credit risk Risk-weighted Replacement Credit risk Risk-weighted
cost equivalent balance cost equivalent balance
Interest Rate Contracts
Swaps $ 11,092 $ 14,994 $ 3,541 $ 12,131 $ 15,685 $ 3,777
Forward rate agreements 106 196 40 99 147 29
Purchased options 1,556 1,941 441 1,879 2,273 541
Total interest rate contracts 12,754 17,131 4,022 14,109 18,105 4,347
Foreign Exchange Contracts
Cross-currency swaps 940 1,513 457 517 1,136 383
Cross-currency interest rate swaps 3,735 6,165 1,124 2,560 4,650 860
Forward foreign exchange contracts 2,043 3,275 951 2,310 3,611 1,027
Purchased options 145 224 80 469 759 202
Total foreign exchange contracts 6,863 11,177 2,612 5,856 10,156 2,472
Commodity Contracts
Swaps 3,514 6,941 2,673 988 2,762 1,107
Purchased options 2,047 4,006 1,361 423 1,270 556
Total commodity contracts 5,561 10,947 4,034 1,411 4,032 1,663
Equity Contracts 391 1,649 669 248 1,542 607
Credit Contracts 75 1,195 254 32 500 104
Total derivatives 25,644 42,099 11,591 21,656 34,335 9,193
Impact of master netting agreements (13,455) (18,352) (4,705) (11,512) (15,345) (3,690)
Total $ 12,189 $ 23,747 $ 6,886 $ 10,144 $ 18,990 $ 5,503
Included in the total derivatives are unrealized gains on hedging derivatives, which we include in the Consolidated Balance Sheet on an accrual rather than a mark-to-market basis. The excess of market
value over book value for these items was $333 million as at October 31, 2004 ($547 million in 2003). Total derivatives does not include exchange traded derivatives with a positive fair value of $137 million
as at October 31, 2004 ($107 million in 2003).
Transactions are conducted with counterparties in various geographic locations and industries. Set out below is the replacement
cost of contracts (before the impact of master netting agreements) from customers located in the following countries, based on country
of ultimate risk:
(Canadian $ in millions, except as noted) 2004 2003
Canada $ 7,611 30% $ 5,769 27%
United States 11,088 43 8,922 41
Other countries (1) 6,945 27 6,965 32
Total $ 25,644 100% $ 21,656 100%
(1) No other country represented 10% or more of our replacement cost in either 2004 or 2003.