Bank of Montreal 2007 Annual Report Download - page 61

MD&A
BMO Financial Group 190th Annual Report 2007 57
Enterprise-Wide Capital Management
Capital Management Framework
Our capital management framework is designed to maintain an opti-
mum level of capital in a cost-effective structure that: meets our target
regulatory capital ratios; meets our internal assessment of required
capital; is consistent with our targeted credit ratings; underpins our
operating groups’ business strategies; and builds long-term shareholder
value. Our approach includes establishing limits, goals and performance
measures for the management of balance sheet positions, risk levels
and minimum capital amounts, as well as issuing and redeeming capital
instruments to obtain the most cost-effective capital structure possible.
The key elements of our capital management framework are approved
by the Board of Directors pursuant to its annual review of our capital
management corporate policy and capital plan. Actual capital adequacy
is monitored against the capital plan throughout the year and the
plan is updated accordingly.
For performance management and decision-making purposes,
we allocate capital to lines of business based primarily on the assess-
ment and measurement of the line’s economic capital requirements,
as outlined on page 66, and regulatory capital requirements. By allo-
cating capital to operating units and measuring their performance with
respect to the capital necessary to support the risks in their business,
we maximize our risk-adjusted return to shareholders. We also ensure
that we maintain a well-capitalized position to protect our stakeholders
from the risks inherent in our various businesses, while still allowing
the flexibility to deploy resources in the high-return, strategic growth
activities of our operating groups. Capital in excess of what we deter-
mine is necessary to support our line of business activities is held
in Corporate Services.
Our disciplined approach to capital management helps in delivering
on our long-standing commitment to enhancing shareholder value.
Regulatory Capital Review
Capital adequacy for Canadian banks is measured pursuant to guide-
lines issued by the Office of the Superintendent of Financial Institutions
Canada (OSFI), based on standards established by the Bank for
International Settlements.
Tier 1 capital represents more permanent forms of capital, and
primarily includes common shareholders’ equity, preferred shares
and innovative hybrid instruments less a deduction for goodwill and
excess intangible assets. Tier 1 capital increased $0.4 billion during
the year to $17.0 billion. The increase was primarily attributable to
growth in retained earnings, the impact of net capital issuances and
the reclassification of preferred shares of a subsidiary from Tier 2
to Tier 1 capital. These factors were partially offset by foreign exchange
adjustments due to the strengthening of the Canadian dollar.
Total capital includes Tier 1 and Tier 2 capital, net of certain
deductions. Tier 2 capital is primarily comprised of subordinated deben-
tures and the eligible portion of the general allowance for credit losses.
Tier 2 capital increased during the year primarily due to the issuance
of subordinated debentures. Table 20 on page 88 provides additional
details on the components of BMO’s capital.
Risk-weighted assets are determined by applying OSFI-prescribed
rules to on- and off-balance sheet exposures and to market risk expo-
sures related to our trading activities. Risk-weighted assets increased
$15.9 billion to $178.7 billion, due primarily to loan and market risk risk-
weighted asset growth in BMO Capital Markets. Market risk risk-weighted
assets increased in part due to the adoption of a more conservative
translation of certain of our trading and underwriting positions to risk-
weighted assets for regulatory capital purposes. Personal and Commercial
Banking risk-weighted assets were reduced by the execution of initiatives
to manage regulatory capital requirements on a cost-effective basis.
In 2008, we anticipate continued growth in risk-weighted assets and
deployment of capital to strategically advantaged businesses. Table 21
on page 88 provides a detailed breakdown of risk-weighted assets.
The Tier 1 Capital Ratio is our key measure of capital adequacy.
It decreased to 9.51% from 10.22% a year ago due to strong risk-
weighted asset growth, partially offset by growth in Tier 1 capital.
The ratio remains strong and was well above our policy in 2007
of maintaining a ratio of at least 8.0%. In 2008, our target is to maintain
a Tier 1 Capital Ratio of at least 8.0%.
Our Total Capital Ratio decreased to 11.74% from 11.76% a year ago.
The decrease in the ratio was driven by growth in risk-weighted assets
partially offset by a net issuance of subordinated debt and higher Tier 1
capital. Both our Tier 1 and Total Capital Ratios remain well above OSFI’s
stated minimum capital ratios of 7% and 10%, respectively, for a well-
capitalized financial institution.
As noted in the Provisions for Income Taxes section, BMO hedges
the foreign exchange risk arising from our net investment in our U.S.
operations by funding the net investment in U.S. dollars. This strategy
reduces the impact on BMO’s capital ratios of changes in foreign
exchange rates, as the effect of foreign currency adjustments to Tier 1
capital arising from an increase or decrease in the value of the
Canadian dollar is largely offset by the change in the Canadian dollar
equivalent of U.S. risk-weighted assets.
BMO’s assets-to-capital multiple increased to 17.2 from 16.1 in 2006,
due primarily to growth in loans and securities. The multiple remains
well below the maximum permitted by OSFI.
Capital Management Activities
As part of ongoing efforts to manage capital on a cost-effective basis,
BMO undertook a number of issuances and redemptions during 2007.
We issued $350 million of Class B Preferred shares, Series 13 and
$250 million of Series 14. We also issued $1.2 billion of Series D Medium-
Term Notes, Second Tranche. We issued $800 million of BMO Trust
Subordinated Notes –Series A by BMO Subordinated Notes Trust,
a closed-end trust wholly owned by BMO. These Notes are fully and
unconditionally guaranteed by BMO on a subordinated basis and
qualify as subordinated debt for regulatory purposes. We also redeemed
our $150 million Series 22 7.92% Debentures and our $200 million
Class B Preferred shares, Series 4, while our US$300 million 7.80%
Notes matured. Further details are provided in Notes 18 and 21
to the financial statements.
On August 31, 2007, we announced a new normal course issuer
bid, commencing September 6, 2007 and ending September 5, 2008,
under which we may repurchase for cancellation up to 25 million BMO
common shares, representing approximately 5% of our public float.
Under our previous 12-month normal course issuer bid, which expired
on September 5, 2007 and allowed for the repurchase for cancellation
of up to 15 million common shares, 8,087,400 shares were repurchased
at a total cost of $555.6 million. We increased the size of the share
repurchase program in 2007 to provide greater flexibility in the man-
agement of BMO’s capital levels.
The Tier 1 Capital Ratio, Total Capital Ratio and Assets-to-Capital
Multiple are the primary capital measures monitored by OSFI.
The Tier 1 Capital Ratio is defined as Tier 1 capital divided by
risk-weighted assets.
The Total Capital Ratio is defined as total capital divided by
risk-weighted assets.
The Assets-to-Capital Multiple is calculated by dividing total
assets, including specified off-balance sheet items net of other
specified deductions, by total capital.