Bank of Montreal 2007 Annual Report Download - page 63

MD&A
BMO Financial Group 190th Annual Report 2007 59
Off-Balance Sheet Arrangements
BMO enters into a number of off-balance sheet arrangements in the
normal course of operations. The discussion that follows addresses
the more significant types of off-balance sheet arrangements.
Credit Instruments
In order to meet the financial needs of our clients, we use a variety
of off-balance sheet credit instruments. These include guarantees and
standby letters of credit, which represent our obligation to make pay-
ments to third parties on behalf of a customer if the customer is unable
to make the required payments or meet other contractual require-
ments. We also engage in securities lending where we lend either our
securities or our customers’ securities to third parties. This exposes us
to credit risk, as a third party may not return the securities as agreed.
We also write documentary and commercial letters of credit, which
represent our agreement to honour drafts presented by a third party
upon completion of specified activities. Commitments to extend credit
are off-balance sheet arrangements that represent our commitment
to customers to grant them credit in the form of loans or other
financings for specific amounts and maturities, subject to meeting
certain conditions.
There are a large number of credit instruments outstanding at any
time. Our customers are broadly diversified and we do not anticipate
events or conditions that would lead a significant number of our custo-
mers to fail to perform in accordance with the terms of the contracts.
We use our credit adjudication process in deciding whether to enter into
these arrangements, just as we do when extending credit in the form
of a loan. We monitor off-balance sheet instruments to ensure that
there are no undue concentrations in any geographic region or industry.
The maximum amount payable by BMO in relation to these
credit instruments was approximately $110 billion at October 31, 2007
($110 billion at October 31, 2006). However, this amount is not repre-
sentative of our likely credit exposure or liquidity requirements for these
instruments as it does not take into account any amounts that could
possibly be recovered under recourse or collateralization provisions.
In addition, a large majority of these commitments expire without being
drawn upon. Further information on these instruments can be found
in Note 5 on page 103 of the financial statements.
Securities lending commitments are generally short-term in nature
and subject to recall on a demand basis. For all other credit commit-
ments outlined above, in the absence of an event that triggers a default,
early termination by BMO may result in breach of contract.
Derivatives
On November 1, 2006, we adopted the CICA’s new accounting require-
ments for hedging derivatives. The new rules require us to record
all of our hedging derivatives in our Consolidated Balance Sheet at
fair value (see Note 9, Change in Accounting Policy on page 108). Prior
to November 1, 2006, we accounted for derivatives that qualified as
accounting hedges on an accrual basis, and our interest rate hedging
derivatives represented off-balance sheet items. The fair value of our
hedging derivatives was $77 million of assets and $127 million of liabilities
as at October 31, 2006. Under the new rules, these hedging derivatives
are now recorded at fair value in our Consolidated Balance Sheet.
Variable Interest Entities (VIEs)
Customer Securitization Vehicles
Customer securitization vehicles (referred to as bank-sponsored multi-
seller conduits) assist our customers with the securitization of their
assets to provide them with alternate sources of funding. These vehicles
provide clients with access to financing in the commercial paper markets
by allowing them to sell their assets into these vehicles, which then
issue commercial paper to investors to fund the purchases. In almost
all cases, the sellers continue to service the transferred assets and
are first to absorb any losses on the assets. We earn fees for providing
services related to the securitizations, including liquidity, distribution
and financial arrangement fees for supporting the ongoing operations
of the vehicles. These fees totalled approximately $80 million in 2007
and $99 million in 2006.
In general, investors in the commercial paper have recourse
only to the assets of the related VIE. Our exposure to losses relates to
our investment in commercial paper issued by the vehicles, derivative
contracts we have entered into with the vehicles and the liquidity
support we provide through standby letters of credit and commitments
to extend credit. We use our credit adjudication process in deciding
whether to enter into these agreements just as we do when extending
credit in the form of a loan. During the year we changed the nature of
liquidity lines offered to certain of our Canadian customer securitization
vehicles to global style liquidity lines, which have objective criteria
for determining when they can be drawn upon. Previously, we offered
market disruption liquidity lines, which had more subjective criteria.
The total contractual amount of the Canadian support was $20,756 mil-
lion at October 31, 2007 ($20,237 million in 2006). The total contractual
amount of the U.S. support was $10,719 million at October 31, 2007
($12,366 million in 2006). Included in the U.S. support in 2006 was
$634 million related to a credit facility that has been terminated.
None of these facilities were drawn upon at year-end.
As at October 31, 2007, BMO held $5,564 million of commercial
paper issued by these vehicles ($448 million at October 31, 2006).
BMO sometimes enters into derivatives contracts with these vehi-
cles to enable them to manage their exposures to interest rate and
foreign exchange rate fluctuations. The fair value of such contracts at
October 31, 2007 was $20 million, which was recorded as a derivative
liability in our Consolidated Balance Sheet (derivative liability of
$5 million at October 31, 2006).
The level of our ownership of ABCP in two of the vehicles
causes us to be exposed to the majority of any expected gains
or losses and, as such, the vehicles have been consolidated. Included
in our Consolidated Balance Sheet at October 31, 2007 were assets
of $311 million classified as other assets and commercial paper of
$65 million classified as a deposit liability.
In the event we chose to or were required to terminate our rela-
tionship with a customer securitization vehicle, we would be obligated
to hold any associated derivatives until their maturity. We would no
longer receive fees for providing services relating to the securitizations,
as previously described.
Structured Finance Vehicles
We facilitate development of investment products by third parties
including mutual funds, unit investment trusts and other investment
funds that are sold to retail investors. We enter into derivative contracts
with these funds to provide the investors their desired exposure and
hedge our exposure from these derivatives by investing in other funds.
We also sponsor VIEs that provide investors access to debt portfolios
through the issuance of commercial paper. We consolidate those VIEs
where our interests expose us to a majority of the expected losses
or residual returns, or both. Assets held by the VIEs in which we have
a significant variable interest but we do not consolidate totalled
$2,365 million as at October 31, 2007 ($762 million in 2006). Our expo-
sure to loss from VIEs related to this activity is limited to the amount
of our investment, which totalled $553 million as at October 31, 2007
($216 million in 2006).
In the event we chose to terminate our relationship with these
vehicles, we would be required to settle any associated derivatives
at their fair value.