Bank of Montreal 2008 Annual Report Download - page 126

facilities of $5,849 million and undrawn facilities of $5,151 million as at
October 31, 2008. The fair value of derivative contracts outstanding with
the CB Trust was a derivative asset of $112 million as at October 31, 2008.
BMO Subordinated Notes Trust (“SN Trust”) was created in 2007 to
issue $800 million of BMO Trust Subordinated Notes –Series A. SN Trust
used the proceeds of the offering to purchase a senior deposit note from
the Bank. We are not required to consolidate SN Trust. See Note 18 for
further information related to SN Trust.
We also provide liquidity support amounting to $30 million to
SN Trust. As at October 31, 2008, $5 million of the amount provided had
been drawn ($5 million in 2007).
BMO Capital Trust (the “Trust”) was created to issue BMO Capital
Trust Securities (“BOaTS”). As at October 31, 2008, the Trust had assets
of $3,187 million ($3,140 million in 2007). The Trust is a VIE which we are
required to consolidate. Securities of $2.2 billion issued by the Trust are
reported as either non-controlling interest or capital trust securities in our
Consolidated Balance Sheet. Refer to Note 19 for more details on BOaTS.
Compensation Trusts
We have established trusts in order to administer our employee
share ownership plan. Under this plan, we match 50% of employees’
contributions when they choose to contribute a portion of their gross
salary toward the purchase of our common shares. Our matching
contributions are paid into trusts, which purchase our shares on the
open market for payment to employees once employees are entitled
to the shares under the terms of the plan. Total assets held by our
compensation trusts amounted to $618 million as at October 31, 2008
($825 million in 2007). We are not required to consolidate these compen-
sation trusts and we have no exposure to loss related to these trusts.
Other VIEs
We are involved with other entities that may potentially be VIEs.
This involvement can include, for example, acting as a derivatives
counterparty, liquidity provider, investor, fund manager or trustee.
These activities do not cause us to be exposed to a majority of the
expected losses of these VIEs or allow us to benefit from a majority
of their expected residual returns. As a result, we are not required
to consolidate these VIEs. Transactions with these VIEs are conducted
at market rates, and individual credit or investment decisions are based
upon the analysis of the specific VIE, taking into consideration the
quality of underlying assets. We record and report these transactions
in the same manner as other transactions. For example, derivative
contracts are recorded in accordance with our derivatives accounting
policy as outlined in Note 10. Liquidity facilities are described in Note 7.
Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
122 | BMO Financial Group 191st Annual Report 2008
Change in Accounting Policy
On November 1, 2006, we adopted the CICA’s new accounting require-
ments for hedging derivatives. The new rules require us to record all
our hedging derivatives at fair value. Prior to November 1, 2006,
we accounted for derivatives that qualified as accounting hedges
on an accrual basis.
The types of hedging relationships that qualify for hedge accounting
have not changed under the new rules. We will continue to designate
our hedges as either cash flow hedges or fair value hedges.
Changes in the fair value of hedging derivatives are either offset
in our Consolidated Statement of Income against the changes in the
fair value of the risk being hedged, or recorded in accumulated other
comprehensive income (loss) on cash flow hedges. If the change in
fair value of the derivative is not completely offset by the change in fair
value of the item it is hedging, the difference is recorded immediately
in our Consolidated Statement of Income.
Derivative Instruments
Derivative instruments are financial contracts that derive their value
from underlying changes in interest rates, foreign exchange rates or
other financial or commodity prices or indices.
Derivative instruments are either regulated exchange-traded
contracts or negotiated over-the-counter contracts. We use these
instruments for trading purposes, as well as to manage our exposures,
mainly to currency and interest rate fluctuations, as part of our
asset/liability management program.
Types of Derivatives
Swaps
Swaps are contractual agreements between two parties to exchange a
series of cash flows. The various swap agreements that we enter into
are as follows:
Interest rate swaps –counterparties generally exchange fixed
and floating rate interest payments based on a notional value in a
single currency.
Cross-currency swaps –fixed rate interest payments and principal
amounts are exchanged in different currencies.
Cross-currency interest rate swaps –fixed and floating rate interest
payments and principal amounts are exchanged in different currencies.
Commodity swaps –counterparties generally exchange fixed and
floating rate payments based on a notional value of a single commodity.
Equity swaps –counterparties exchange the return on an equity
security or a group of equity securities for the return based on a fixed
or floating interest rate or the return on another equity security or
a group of equity securities.
Credit default swaps –one counterparty pays the other a fee
in exchange for that other counterparty agreeing to make a payment
if a credit event occurs, such as bankruptcy or failure to pay.
Total return swaps –one counterparty agrees to pay or receive from
the other cash amounts based on changes in the value of a reference
asset or group of assets, including any returns such as interest earned
on these assets, in exchange for amounts that are based on prevailing
market funding rates.
T
he main risks associated with these instruments are related to
exposure to movements in interest rates, foreign exchange rates, credit
quality, securities values or commodities prices, as applicable, and the
possible inability of counterparties to meet the terms of the contracts.
Forwards and Futures
Forwards and futures are contractual agreements to either buy or sell
a specified amount of a currency, commodity, interest rate-sensitive
financial instrument or security at a specific price and date in the future.
Forwards are customized contracts transacted in the over-the-
counter market. Futures are transacted in standardized amounts on
regulated exchanges and are subject to daily cash margining.
The main risks associated with these instruments arise from the
possible inability of over-the-counter counterparties to meet the terms
of the contracts and from movements in commodities prices, securities
values, interest rates and foreign exchange rates, as applicable.
Options
Options are contractual agreements that convey to the buyer the right but
not the obligation to either buy or sell a specified amount of a currency,
commodity, interest-rate-sensitive financial instrument or security at a
fixed future date or at any time within a fixed future period.
For options written by us, we receive a premium from the purchaser
for accepting market risk.
For options purchased by us, we pay a premium for the right to
exercise the option. Since we have no obligation to exercise the option,
our primary exposure to risk is the potential credit risk if the writer
of an over-the-counter contract fails to meet the terms of the contract.
Note 10: Derivative Instruments