Bank of Montreal 2004 Annual Report Download - page 60

BMO Financial Group Annual Report 200456
MD&A
Management’s Discussion and Analysis
The expected rate of return on plan assets is the management
estimate that most affects the calculation of pension expense.
Our expected rate of return on plan assets is determined based
on the plan’s target asset allocation and estimated rates of
return for each asset class. Estimated rates of return are based
on expected returns from fixed income securities, which take
into consideration bond yields. An equity risk premium is then
applied to estimate equity returns. Returns from other asset
classes are set to reflect the relative risks of these classes as
compared to fixed income and equity assets. With all other
assumptions held constant, a 1% decline in the expected rate of
return on assets would result in an increase in pension expense
for 2004 of approximately $31 million. The impact of changes
in expected rates of return on plan assets is not significant for
our other employee future benefits expense since the amount of
assets held in these plans is small.
Pension and other employee future benefits expense and
obligations are also sensitive to changes in discount rates. For our
Canadian plans, which represent 80% of our pension obligations,
we determine our discount rate at each year-end based on mar-
ket rates on high-quality debt instruments with cash flows that
match the timing and amount of expected benefit payments.
As a result of a decrease in long-term interest rates year
over year, we changed the discount rate to 6.0% from 6.25%
as at October 31, 2004. This change will increase our pension
and other employee future benefits expense by approximately
$5 million in 2005.
Additional information regarding our accounting for pen-
sions and other employee future benefits, including sensitivity
analysis for key assumptions, is included in Note 20 on page 111
of the financial statements.
Other Than Temporary Impairment
Investment securities that are carried at cost, amortized cost or
accounted for using the equity method are reviewed at each
quarter-end reporting period to determine whether the fair
value is below the current carrying value. When the fair value
of any of our investment securities has declined below its
carrying value, management is required to assess whether the
decline is other than temporary. In making this assessment,
we consider such factors as the type of investment, the length
of time and extent to which the fair value has been below the
carrying value, the financial condition and near-term prospects
of the issuer, and our intent and ability to hold the investment
long enough to allow for any anticipated recovery. The decision
to record a write-down, its amount and the period in which
it is recorded could change if management’s assessment of
the above factors were different. We do not record impairment
write-downs on debt securities when impairment is due to
changes in interest rates, since we expect to realize the full value
of the investments by holding them to maturity. The majority
of our investment securities are either issued or guaranteed by
Canadian and U.S. governments. For government securities
where the carrying value of the investment exceeds fair value,
total unrealized losses in 2004 were $24 million, of which
$7 million relates to securities on which the carrying value
exceeded fair value for 12 months or more. In most cases, these
unrealized losses resulted from increases in interest rates,
not from deterioration in the creditworthiness of the issuer.
We also have investments in corporate debt and equity secu-
rities, mortgage-backed securities and collateralized mortgage
obligations. Quoted market value is considered to be fair value
for actively traded securities. For privately issued securities,
and for thinly traded securities where market quotes are not
available, we use estimation techniques to determine fair value.
Estimation techniques used include discounted cash flows for
debt securities, and multiples of earnings or comparisons
with other securities that are substantially the same for equity
securities. For corporate debt and equity securities, mortgage-
backed securities and collateralized mortgage obligations
where the carrying value exceeds fair value and an impairment
write-down has not been recorded, total unrealized losses
in 2004 were $19 million, of which $2 million relates to
securities on which the carrying value has exceeded fair value
for 12 months or more.
Additional information regarding our accounting for
investment securities is included in Note 3 on page 88 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 Shareholders’
Equity. In determining our provision for income taxes, we
interpret tax legislation in a variety of jurisdictions and make
assumptions about the expected timing of the reversal of future
tax assets and liabilities. If our interpretations differ from
those of tax authorities or if the timing of reversals is not as
anticipated, our provision for income taxes could increase or
decrease in future periods. The amount of any such increase
or decrease cannot be reasonably estimated.
Additional information regarding our accounting for
income taxes is included in Note 21 on page 114 of the
financial statements.
Goodwill
Goodwill is assessed for impairment at least annually. This
assessment includes a comparison of the carrying value of
each group of businesses having goodwill to the fair value to
ensure that the fair value of the group of businesses is greater
than its carrying value. If carrying value exceeds fair value
for a group of businesses, a more detailed goodwill impairment
assessment would have to be undertaken. In determining fair
value, we use valuation models such as analysis of discounted
cash flows, price-to-earnings ratios and other multiples.
Management must exercise judgment and make assumptions
in determining fair value. These judgments and assumptions
may affect the fair value and any resulting impairment write-
down. At October 31, 2004, our estimated fair value of each
group of businesses was greater than the carrying value and, as
such, the fair value estimate for any of our groups of businesses
would have to decline by more than 20% before a detailed
impairment assessment would be triggered.
Additional information regarding the composition of
BMO’s goodwill is included in Note 12 on page 104 of the
financial statements.