Bank of Montreal 2008 Annual Report Download - page 117

Notes
BMO Financial Group 191st Annual Report 2008 | 113
Note 4: Loans, Customers’ Liability under Acceptances and Allowance for Credit Losses
We do not accrue interest income on loans classified as impaired,
and any interest income that is accrued and unpaid is reversed against
interest income.
Payments received on corporate and commercial loans that
have been classified as impaired are applied first to the recovery of
collection costs, principal and any previous write-offs or allowances,
and any amounts remaining are then recorded as interest income.
Payments received on impaired consumer instalment loans are applied
first to outstanding interest and then to the remaining principal.
A loan will be reclassified back to performing status when we
determine that there is reasonable assurance of full and timely repay-
ment of interest and principal in accordance with the terms and
conditions of the loan, and that none of the criteria for classification
of the loan as impaired continue to apply.
From time to time we restructure a loan due to the poor financial
condition of the borrower. If they are no longer considered impaired,
interest on these restructured loans is recorded on an accrual basis.
Allowance for Credit Losses
The allowance for credit losses recorded in our Consolidated Balance
Sheet is maintained at a level which we consider adequate to absorb
credit-related losses on our loans, customers’ liability under acceptances
and other credit instruments (as discussed in Note 5). The portion
related to other credit instruments is recorded in other liabilities in
our Consolidated Balance Sheet.
The allowance comprises the following two components:
Specific Allowances
These allowances are recorded for specific loans to reduce their book
value to the amount we expect to recover. We review our loans and
acceptances on an ongoing basis to assess whether any loans should
be classified as impaired and whether an allowance or write-off should
be recorded (other than consumer instalment and credit card loans,
which are written off when certain conditions exist, as discussed under
impaired loans). Our review of problem loans is conducted at least
quarterly by our account managers, who assess the ultimate collectibility
and estimated recoveries on a specific loan based on all events and
conditions that the manager believes are relevant to the condition of
the loan. This assessment is then reviewed and concurred with by an
independent credit officer.
To determine the amount we expect to recover from an impaired
loan, we use the value of the estimated future cash flows discounted
at the effective rate inherent in the loan. When the amounts and timing
of future cash flows cannot be estimated with reasonable reliability,
the expected recovery amount is estimated using either the fair value
of any security underlying the loan, net of expected costs of realization
and any amounts legally required to be paid to the borrower, or an
observable market price for the loan. Security can vary by type of loan
and may include cash, securities, real property, accounts receivable,
guarantees, inventory or other capital assets.
General Allowance
We maintain a general allowance in order to cover any impairment
in the existing portfolio that cannot yet be associated with specific loans.
Our approach to establishing and maintaining the general allowance
is based on the guideline issued by OSFI.
The general allowance is reviewed on a quarterly basis. A number
of factors are considered when determining the appropriate level of
the general allowance, including a general allowance model that applies
historical expected and unexpected loss rates to current balances
with sensitivity to risk ratings, industry sectors and credit products.
Model results are then considered along with the level of the existing
allowance, as well as management’s judgment regarding portfolio
quality, business mix, and economic and credit market conditions.
Change in Accounting Policy
On November 1, 2006, we adopted the CICA’s new accounting require-
ments for loans. The new rules require us to amortize deferred
loan origination costs using the effective interest method. We record
the amortization in interest, dividend and fee income, loans, over
the life of the resulting loan. Under the effective interest method, the
amount recognized varies over the life of the loan based on the principal
outstanding. Prior to November 1, 2006, an equal amount of loan
origination costs was recognized in each year over the life of the
resulting loan.
As at November 1, 2006, we adjusted our deferred loan origination
costs to reflect the balance that would have resulted if we had always
used the effective interest method to recognize loan origination costs.
The impact was a decrease in loans, residential mortgages of $87 million,
a decrease in future income tax liability of $30 million and a decrease
in retained earnings of $57 million.
Loans
Loans are recorded at amortized cost using the effective interest method
as described above. This method allocates interest income over the
expected term by applying the effective interest rate to the carrying
amount of the loan. The effective interest rate is defined as the
rate that exactly discounts estimated future cash receipts through
the expected life of the loan. The treatment of interest income for
impaired loans is described below.
Securities borrowed or purchased under resale agreements
represent the amounts we will receive as a result of our commitment
to resell securities that we have purchased back to the original seller,
on a specified date at a specified price. We account for these instru-
ments as loans.
Lending Fees
The accounting treatment for lending fees varies depending on the
transaction. Loan origination, restructuring and renegotiation fees are
recorded as interest income over the term of the loan. Commitment
fees are recorded as interest income over the term of the loan, unless
we believe the loan commitment will not be used. In the latter case,
commitment fees are recorded as lending fees over the commitment
period. Loan syndication fees are included in lending fees as the
syndication is completed, unless the yield on any loans we retain is less
than that of other comparable lenders involved in the financing. In the
latter case, an appropriate portion of the syndication fee is recorded as
interest income over the term of the loan.
Customers’ Liability under Acceptances
Acceptances represent a form of negotiable short-term debt that is
issued by our customers and which we guarantee for a fee. We have
offsetting claims, equal to the amount of the acceptances, against
our customers in the event of a call on these commitments. The amount
due under acceptances is recorded in other liabilities and our correspon-
ding claim is recorded as a loan in our Consolidated Balance Sheet.
Fees earned are recorded in lending fees in our Consolidated
Statement of Income.
Impaired Loans
We classify residential mortgages as impaired when payment is con-
tractually 90 days past due, or one year past due if guaranteed by
the Government of Canada. Credit card loans are classified as impaired
and immediately written off when principal or interest payments are
180 days past due. Consumer instalment loans, other personal loans and
some small business loans are classified as impaired when principal
or interest payments are 90 days past due, and are normally written
off when they are one year past due.
Corporate and commercial loans are classified as impaired when
we are no longer reasonably assured that principal or interest will be
collected on a timely basis, or when payments are 90 days past due,
or for fully secured loans, when payments are 180 days past due.