Bank of Montreal 2004 Annual Report Download - page 58

BMO Financial Group Annual Report 200454
MD&A
Management’s Discussion and Analysis
In general, investors in the commercial paper have recourse
only to the assets of the related VIE, unless we have provided
credit support for the investors or entered into a derivative
transaction involving the VIE.
We provide liquidity and credit support to these vehicles
either through backstop liquidity facilities or in the form of
let-
ters of credit and other guarantees. The total contractual amount
of this support was $27,019 million as at October 31, 2004, of
which only $400 million related to credit support. None of these
facilities were drawn upon as at year-end.
Derivatives contracts entered into with these vehicles enable
the vehicles to manage their exposures to interest and foreign
exchange rate fluctuations. The fair value of derivatives out-
standing with these VIEs recorded in our Consolidated Balance
Sheet was a derivative asset of $52 million as at October 31, 2004.
Interests in Bank Securitization Vehicles
Periodically, we sell loans to off-balance sheet entities or trusts,
either for capital management purposes or to obtain alternate
sources of funding. BMO recognizes in income the gains on
sales to the securitization vehicles as well as revenues paid to
us for servicing the loans sold. The impact of securitization
activities on our revenues and expenses is outlined in Note 7
on page 95 of the financial statements.
BMO has retained interests in these off-balance sheet entities,
as we are sometimes required to purchase subordinated inter-
ests or maintain cash deposits in the entities to serve as a source
of liquidity for the vehicle. Retained interests recorded as
assets in our Consolidated Balance Sheet as at October 31, 2004
were $39 million. In the event that there are defaults in the
vehicles, retained interests may not be recoverable and would
then be written down. During the year ended October 31, 2004,
we wrote down retained interests in securitization vehicles
by a total of $19 million.
In addition to retained interests, BMO has deferred purchase
price amounts of $143 million related to securitizations recorded
in our Consolidated Balance Sheet. This represents the amount
of gain on sales to securitization vehicles that has not been
received in cash. Further information on the impact of securiti-
zation activities on the Consolidated Balance Sheet is outlined
in Note 7 on page 95 of the financial statements.
We also provide liquidity 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 contractual
amount of standby letters of credit and guarantees, which is
included in other credit instruments in Note 5 on page 93 of the
financial statements, was $3,750 million as at October 31, 2004.
No amount was drawn upon at year-end.
Credit Investment Management Vehicles
Credit investment management vehicles provide investors
with investment opportunities in customized, diversified debt
portfolios in a variety of asset and rating classes. We earned
investment management fees of $31 million in 2004 for
managing these portfolios.
We hold an interest in High Grade Structured Investment
Vehicles (SIVs). Our exposure to loss relates to our investments
to sponsor these vehicles as well as derivative contracts we have
entered into with the vehicles. Our investment in SIVs was
$128 million as at October 31, 2004 and was recorded as invest-
ment securities in our Consolidated Balance Sheet. The fair
value of our derivative contracts outstanding with the SIVs
as at October 31, 2004 was recorded in our Consolidated
Balance Sheet as a derivative asset of $37 million. In order to
ensure that these vehicles receive an investment grade rating,
we provide liquidity support to the vehicles through standby
letters of credit and/or commitments to extend credit. The
total contractual amount of these standby letters of credit
and commitments to extend credit as at October 31, 2004 was
$200 million, which was included in other credit instruments
in Note 5 on page 93 of the financial statements. No amounts
were drawn upon at year-end.
Financial Instruments
As a financial institution, most of BMO’s balance sheet is
comprised of financial instruments and the majority of our net
income results from gains, losses, income and expenses related
to financial instruments. As a result, this MD&A is largely
concerned with how we use financial instruments to earn
income and manage risks.
Our use of financial instruments exposes us to credit
and counterparty risk and various market risks, including
equity price risk, interest rate risk and foreign currency risk.
A discussion of how we manage these and other risks as
well as structural interest rate sensitivities can be found in the
Enterprise-Wide Risk Management section on pages 58 to 67
of this MD&A
Further information on how we determine the fair value of
financial instruments is included in the Financial Instruments
Measured at Fair Value discussion in the Critical Accounting
Estimates section on the next page of the MD&A.