Bank of Montreal 2008 Annual Report Download - page 66

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
62 | BMO Financial Group 191st Annual Report 200862 | BMO Financial Group 191st Annual Report 2008
Financial Instruments in the Difficult Credit Environment
At the request of the G7 finance ministers and central bank governors,
The Financial Stability Forum issued a report in April 2008 on enhancing
market and institutional resilience. Among its recommendations,
it encouraged enhanced disclosure related to financial instruments
that markets now consider to carry higher risk. We have expanded
our discussion of certain financial instruments in keeping with
these developments.
Caution
Given the uncertainty in the capital markets environment, our capital
market instruments could experience further valuation gains and losses
due to changes in market value.
This section, Financial Instruments in the Difficult Credit Environ-
ment, contains forward-looking statements. Please see the Caution
Regarding Forward-Looking Statements on page 30.
Subprime First Mortgage Loans
In the United States, subprime loans are typically considered to be
those made to borrowers with credit bureau scores of 620 or less.
We do not originate subprime mortgages through a subprime mortgage
program in the United States; however, we make loans available in
the United States to individuals with credit scores below 620 as part
of our lending requirements under the Community Reinvestment Act.
We also occasionally lend to parties with credit scores below 620
when there are other strong qualification criteria. As a result, we have
US$0.25 billion of first mortgage loans outstanding that had subprime
characteristics at the date of authorization. Of this, US$5.4 million or
2.14% was 90 days or more in arrears at October 31, 2008. This compares
with a rate of 0.94% for BMO’s total U.S. first mortgage loan portfolio.
In Canada, BMO does not have any subprime mortgage programs,
nor do we purchase subprime mortgage loans from third-party
lenders. BMO mortgage lending decisions incorporate a full assessment
of the customer and loan structure. Credit score is only one component of
the adjudication process and consequently, we do not categorize loans
based upon credit scores alone. There is a nominal amount of subprime
mortgage loans held in certain BMO-sponsored Canadian conduits
that hold third-party assets, as described in the discussion of those
conduits that follows.
We also had net exposure of US$159 million at October 31, 2008
to a business that buys distressed mortgages (including subprime
mortgages) at a discounted price. This exposure is one of the three
accounts discussed in the BMO-Sponsored Securitization Conduits
section that follows.
Alt-A First Mortgage Loans
In the United States, Alt-A loans are generally considered to be loans
for which borrower qualifications are subject to limited verification.
The U.S. loan portfolio had two loan programs that met this definition –
our Easy Doc and No Doc programs. Loans under the No Doc program,
which comprise most of the exposure in this class, required minimum
credit bureau scores of 660 and maximum loan-to-value ratios of 80%
(90% with private mortgage insurance). Due to these lending require-
ments, the credit quality of our Alt-A portfolio is strong and the loans
have performed well. Our direct Alt-A loans totalled US$1.6 billion
at October 31, 2008. Of this, US$10 million or 0.62% was 90 days or
more in arrears. This compares with a rate of 0.94% for BMO’s total
U.S. first mortgage loan portfolio. We discontinued the Easy Doc
and No Doc programs in the third quarter of 2008.
Outstanding Shares and Securities Convertible
into Common Shares
Number of shares
Dividends declared per share
As at November 19, 2008 or dollar amount 2008 2007 2006
Common shares 506,053,000 $ 2.80 $ 2.71 $ 2.26
Class B Preferred shares
Series 5 $ 200,000,000 $ 1.33 $ 1.33 $ 1.33
Series 13 $ 350,000,000 $ 1.13 $0.96 –
Series 14 $ 250,000,000 $ 1.48 ––
Series 15 $ 250,000,000 $ 0.94 ––
Series 16 $ 300,000,000 $ 0.55 ––
Convertible into common shares:
Class B Preferred shares (1)
Series 4 (2) –$– $ 0.91 $ 1.20
Series 6 (3) $ 250,000,000 $ 1.19 $ 1.19 $ 1.19
Series 10 US$ 300,000,000 US$ 1.49 US$ 1.49 US$ 1.49
Stock options
–vested 14,325,000
–nonvested 5,724,000
(1) Convertible preferred shares may be exchanged for common shares in future years on a
pro-rata basis based on 95% of the average trading price of common shares for the 20 days
ending four days prior to the exchange date.
(2) Redeemed in August 2007.
(3) Redeemed on November 25, 2008.
Note 21 on page 135 of the financial statements includes details on share capital.
Dividends
BMO’s target dividend payout range is 45% to 55% of net income
available to common shareholders, the highest among Canada’s major
banks. The target is reflective of our confidence in our continued
ability to grow earnings and our strong capital position. Dividends are
generally increased in line with long-term trends in earnings per share
growth, while sufficient earnings are retained to support anticipated
business growth, fund strategic investments and provide continued
support for depositors.
Dividends declared per common share in 2008 totalled $2.80,
up 3.3% from $2.71 in 2007. Dividends declared in 2008 represent 74.0%
of net income available to common shareholders, above our target
dividend payout range of 45% to 55%. At year-end, BMO’s common
shares provided a 6.51% annual dividend yield based on the closing
share price. On November 25, 2008, BMO’s Board of Directors declared a
quarterly dividend on common shares of $0.70 per share, unchanged
from the prior quarter.
Until we have a better understanding of the likely length and
extent of the current economic slowdown, we do not anticipate
increasing common share dividends. We believe the current dividend
rate is appropriate, based on BMO’s earning power, and we continue
to focus on improving our core business performance to return the
dividend payout ratio to our target range.
Eligible Dividends Designation
For the purposes of the Income Tax Act (Canada) and any similar
provincial and territorial legislation, BMO designates all dividends paid
on both its common and preferred shares after December 31, 2005,
and all dividends (including deemed dividends) paid thereafter, as
“eligible dividends” unless BMO indicates otherwise.