Bank of Montreal 2008 Annual Report Download - page 114

Securities
Securities are divided into three types, each with a different purpose and
accounting treatment. The three types of securities we hold are as follows:
Trading securities are securities that we purchase for resale over
a short period of time. We report these securities at their market value
and record the mark-to-market adjustments and any gains or losses
on the sale of these securities in our Consolidated Statement of Income
in trading revenues (losses).
Available-for-sale securities consist of debt and equity securities.
Available-for-sale securities include securities that may be sold in
response to or in anticipation of changes in interest rates and resulting
prepayment risk, changes in foreign currency risk, changes in funding
sources or terms, or to meet liquidity needs.
Merchant banking investments are securities held by our
merchant banking subsidiaries. These subsidiaries account for their
investments at fair value, with changes in fair value recorded
in our Consolidated Statement of Income in securities gains (losses),
other than trading as they occur.
Merchant banking investments are classified as other securities
in our Consolidated Balance Sheet.
Impairment Review
We review available-for-sale securities and investments where we exert
significant influence, but not control, at each quarter end to identify
and evaluate investments that show indications of possible impairment.
An investment is considered impaired if its unrealized losses represent
impairment that is considered to be other than temporary.
In determining whether a loss is temporary, factors considered
include the extent of the unrealized loss, the length of time that the
security has been in an unrealized loss position, the financial condition
and near-term prospects of the issuer, and our ability and intent
to hold the investment for a period of time sufficient to allow for
any anticipated recovery. If the decline is considered to be other than
temporary, a write-down is recorded in our Consolidated Statement
of Income in securities gains (losses), other than trading.
As at October 31, 2008, we had available-for-sale securities
with unrealized losses of $352 million (unrealized losses of $48 million
in 2007). The majority of unrealized losses resulted from increases in
market interest rates and not from deterioration in the creditworthiness
of the issuers. Management has determined that the unrealized losses
are temporary in nature.
We did not own any securities issued by a single non-government entity
where the book value, as at October 31, 2008 or 2007, was greater than
10% of our shareholders’ equity.
Included in other securities are investments where we exert significant
influence, but not control, of $995 million and $962 million as at
October 31, 2008 and 2007, respectively.
Fair Value Measurement
For traded securities, quoted market value is considered to be fair
value. Quoted market value is based on bid prices, where available.
For securities where market quotes are not available, we use estimation
techniques to determine fair value. These estimation techniques
include discounted cash flows, internal models that utilize observable
market data or comparisons with other securities that are substantially
the same.
In limited circumstances, we use internal models where the inputs
arenotbasedonobservablemarketdata.Sensitivity analysis for the
most significant items valued using internal models without observable
inputs is described below.
Within available-for-sale securities as at October 31, 2008 was
$625 million of Apex Trust (“Apex”) mid-term notes (“MTNs”) with a
face value of $815 million (see Note 9). The valuation of these MTNs has
been determined by management based on expected discounted cash
flows. The determination of the discount rate used in the discounted
cash flow model has the most significant impact on the valuation of the
MTNs and is impacted by changes in credit spreads and the ratings of
the underlying credit default swaps. The impact of assuming the discount
rate increased or decreased by 50 basis points would result in a change
in fair value of $(14) million and $14 million, respectively. The impact on
income for the year ended October 31, 2008 related to changes in the
fair value of our investment in Apex MTNs was a charge of $190 million
before tax.
A third party holds its exposure to the Apex MTNs through a
total return swap with us. The valuations of this swap and the related
underlying MTNs have been determined by management based on
expected discounted cash flows. The determination of the discount rate
used in the discounted cash flow model has the most significant impact
on the valuation of the swap and underlying securities and is impacted
by changes in credit spreads and the ratings of the underlying credit
default swaps. The impact of assuming the discount rate increased or
decreased by 50 basis points would result in a change in fair value of
$(7) million and $8 million, respectively. The impact on income for the
year ended October 31, 2008 related to changes in the fair value of the
swap and underlying MTNs was a charge of $120 million before tax.
Within available-for-sale securities as at October 31, 2008 was
$187 million of third-party asset-backed commercial paper (“ABCP”)
with a face value of $325 million. The valuation of this ABCP has been
determined by management based on expected discounted cash
flows and expectations of the probability of restructuring the vehicles
in accordance with the Montreal Accord versus the liquidation value.
The determination of the discount rate used in the discounted cash flow
model has the most significant impact on the valuation of the ABCP
andisimpactedbychangesincreditspreadsandtheexpectedrating
of the new notes. The impact of assuming the discount rate increased
or decreased by 50 basis points would result in a change in fair
value
of $(5) million and $5 million, respectively. This third-party ABCP
was transferred from trading to available-for-sale securities in accordance
with the change in accounting policy decribed above. For the year
ended October 31, 2008, $14 million before tax was recorded in Other
Comprehensive Income and for the nine months ended July 31, 2008
$70 million before tax was recorded in income related to declines
in the fair value of this investment.
Within derivative assets and derivative liabilities as at Octo-
ber 31, 2008 was $1,250 million and $52 million, respectively, related
to the mark-to-market of credit default swaps and total return swaps
on structured products. The valuation of these derivatives has been
determined by management based on estimates of current market
spreads for similar structured products. The impact of assuming
a 10 basis point increase or decrease in that spread would result in
a change in fair value of $(10) million and $10 million, respectively.
The impact on net income for the year ended October 31, 2008
related to changes in the fair value of these derivatives was a loss
of $43 million before tax.
Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
110 | BMO Financial Group 191st Annual Report 2008