Bank of Montreal 2008 Annual Report Download - page 68

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
64 | BMO Financial Group 191st Annual Report 200864 | BMO Financial Group 191st Annual Report 2008
The assets of two of the conduits consist of Canadian residential mort-
gages and the third holds Canadian credit card loans transferred from
BMO. BMO’s investment in the asset-backed commercial paper (ABCP)
of conduits that hold residential mortgages totalled $0.5 billion at
October 31, 2008 ($0.4 billion in 2007). No losses have been recorded on
these investments. We have provided $5.1 billion in liquidity facilities to
the two conduits that hold residential mortgages and no amounts
were drawn against these facilities at October 31, 2008. We have not
provided liquidity facilities to the conduit that holds credit card loans.
Further information on the impact of securitization activities on the
Consolidated Balance Sheet is outlined in Note 8 on page 118 of the
financial statements.
Canadian Customer Securitization Vehicles
The six customer securitization vehicles we sponsor in Canada 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
realized losses on the assets.
In general, investors in the commercial paper have recourse only
to the assets of the related vehicle. 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 backstop liquidity facilities. 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.
BMO sometimes enters into derivative contracts with these
vehicles to enable them to manage their exposures to interest rate and
foreign exchange rate fluctuations. The fair value of such contracts at
October 31, 2008 was $55 million, which was recorded as a derivative
asset in our Consolidated Balance Sheet (derivative liability of $20 mil-
lion in 2007).
BMO consolidates the accounts of two of the six customer
securitization vehicles, as the majority of the gains or losses of those
vehicles are expected to accrue to BMO. One of the vehicles holds
notes of another conduit that are rated R-1 (low) by DBRS and
has $65 million of assets. The other vehicle is a conduit whose
notes are rated R-1 (mid) by DBRS and has $200 million of assets.
Their combined assets include $8 million of mortgage loans with
subprime characteristics, $66 million of mortgage loans with Alt-A
characteristics and $13 million of small commercial mortgage loans.
No losses have been recorded on BMO’s exposure to these vehicles.
BMO’s investment in the asset-backed commercial paper
(ABCP) of the four non-consolidated conduits totalled $2.1 billion at
October 31, 2008 ($5.6 billion in 2007). No losses have been recorded
on these investments.
BMO provided liquidity support facilities to the four non-consolidated
conduits totalling $11.0 billion at October 31, 2008 ($20.8 billion in
2007). This amount comprised part of other credit instruments outlined
in Note 5 on page 115 of the financial statements. All of these facilities
remain undrawn. The assets of each of these vehicles consist primarily
of high-quality, diversified pools of Canadian auto receivables and
Canadian residential mortgages. These asset classes together comprise
67% to 92% of the assets of the four conduits. The mortgages in
the conduits include $111 million of Canadian residential mortgage
loans with subprime characteristics, $948 million of Canadian residential
mortgage loans with Alt-A characteristics and $233 million of small
commercial mortgage loans. There are no collateralized debt obligations
(CDOs) and no exposure to monoline insurers in these conduits.
In the event we choose to or are required to terminate our
relationship 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.
U.S. Customer Securitization Conduit
BMO provided committed liquidity support facilities of US$8.2 billion
to our ABCP U.S. multi-seller conduit at October 31, 2008 (US$11.5 billion
in 2007). The conduit provides funding to diversified pools of portfolios
through 91 individual securitization transactions with an average facility
size of US$90 million. At present, the size of the pools ranges from
US$1.9 million to US$450 million. The ten largest pools comprise 33%
of the portfolio. Committed amounts comprise a wide range of asset
classes, including mid-market corporate loans (24%), commercial real
estate loans and leases (13%), auto loans and leases (12%), corporate
loans (12%), consumer instalment loans (8%) and equipment loans
and leases (8%). Residential mortgages comprise 2.5% of the portfolio,
of which 0.3% are classified as subprime or Alt-A.
Approximately 60% of the conduit’s commitments have been rated
by Moody’s or S&P, and all of those are rated A or higher. Approximately
$1.5 billion of the commitments are insured by monolines, primarily
MBIA and Ambac, the ratings of which, while recently downgraded
to Baa1 by Moody’s and AA by S&P, have no impact on the performance
of the underlying assets. None of the insurance guarantees involve
mortgages or asset-backed securities/structured-finance CDOs. All of the
underlying transactions are performing in accordance with their terms
and conditions.
The conduit had US$6.5 billion of commercial paper outstanding
at October 31, 2008, down from US$8.3 billion in 2007. The ABCP of the
conduit is rated A1 by S&P and P1 by Moody’s. BMO has not invested
in the conduit’s ABCP. Outstanding commercial paper has consistently
been purchased by third-party investors, notwithstanding market
disruptions, and pricing levels are in line with those of top-tier ABCP
conduits in the United States.
In the first half of this fiscal year, as a result of the deterioration
in credit conditions and in accordance with the terms of the supporting
liquidity agreements, BMO directly funded three commercial accounts
that have exposure to the U.S. housing sector totalling US$851 million.
The net book value of the three accounts was reduced to US$296 million
at October 31, 2008, having been lowered by payments and loss
provisions. The credit quality of two of the accounts began to deteriorate
and specific provisions have been taken in response. BMO’s provision
for credit losses reflects US$327 million related to these accounts
in 2008. In the fourth quarter of 2008, we noted some deterioration
in certain of the conduit’s portfolios; however, all of them were
performing at that time.
BMO is also a counterparty to derivative contracts with the conduit
that are used to manage its exposure to interest rates. The fair value
of derivative contracts outstanding with the conduit and recorded in our
Consolidated Balance Sheet was a derivative asset of $1 million as at
October 31, 2008 ($nil in 2007). BMO is not required to consolidate the
conduit, as the conduit has issued an expected-loss note. The holder
of the note consolidates the conduit as the noteholder is exposed to the
majority of expected losses.
In the event we choose or are required to terminate our relation-
ship with the conduit, we would be required to settle any associated
derivative contracts at their fair value and would no longer receive fees
for the administration of the conduit.