Bank of Montreal 2008 Annual Report Download - page 74

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
70 | BMO Financial Group 191st Annual Report 2008
We use a qualitative estimation process to determine whether
an entity is a VIE and whether BMO holds a variable interest in that VIE.
We also use a variety of complex estimation processes involving
qualitative and quantitative factors to calculate and analyze a VIE’s
expected losses and its expected residual returns. These processes
involve estimating the future cash flows and performance of the VIE,
analyzing the variability of those cash flows and allocating the losses
and returns among the identified parties holding variable interests.
These processes enable us to identify the party that is exposed to the
majority of the VIE’s expected losses, expected residual returns, or both,
and thus which party should consolidate the entity.
We are required to reconsider if consolidation is required when
our obligation to absorb expected losses or residual returns increases.
If there is a change in events that leads to BMO absorbing the
majority of the expected losses or residual returns BMO would be
required to consolidate the VIE as of the date of the change.
With respect to Apex, reconsideration events would include
BMO purchasing additional Notes, granting additional liquidity facilities,
an increase to the loan amount extended by BMO beyond what is
contemplated under the existing credit lending facilities, or guaranteeing
repayment on Notes held by third parties. Each of these reconsideration
events could result in BMO absorbing additional expected losses or
residual returns. It is not expected that such reconsideration events will
occur in the near future. The issuance of an expected loss note by Apex
would also be considered a reconsideration event but would not likely
result in BMO absorbing additional expected losses or residual returns.
If the total return swap held by a third party is terminated, another third
party would have to be found to absorb the exposure to the underlying
Notes, otherwise BMO would be required to consolidate Apex.
With respect to Links and Parkland, reconsideration events
include a purchase or sale by BMO of capital notes, provision of additional
lending facilities, an increase to the loan amount extended by BMO
beyond what is contemplated under the existing credit lending facilities,
asset for capital note exchanges and provision of a guarantee by BMO
to compensate note holders for realized losses. The reconsideration
event
that is most likely to occur is an increase in our lending facilities.
If we were to provide an increase in our lending facilities prior to
July 2009, we would not expect to consolidate at that time based
on our current assessment of our exposure to expected losses.
A reconsideration event for our Canadian multi-seller conduits
includes the purchase or sale by BMO of asset-backed commercial
paper (ABCP) issued by the conduits and the granting of additional
liquidity facilities or credit enhancement. Since BMO regularly purchases
and sells ABCP issued by our Canadian multi-seller conduits, we con-
tinually monitor expected losses to ensure they do not approach
consolidation thresholds.
A reconsideration event for our U.S. multi-seller conduit includes
the purchase or sale by BMO of ABCP issued by the conduit, the
addition of new programs and the granting of additional liquidity facilities
or credit enhancement. Repayment of the expected loss note would
also be a reconsideration event and a third party would have to be found
to absorb the majority of the expected losses otherwise BMO would
be required to consolidate. We monitor BMO’s exposure to expected
losses as reconsideration events occur and increase the expected
loss note so that consolidation is not required.
Additional information concerning BMO’s involvement with variable
interest entities is included on pages 63 to 66 as well as in Note 9 on
page 120 of the financial statements.
Pensions and Other Employee Future Benefits
BMO’s pensions and other employee future benefits expense is calculated
by our actuaries using assumptions determined by management.
If actual experience differs from the assumptions used, pension and
other employee future benefits expense could increase or decrease
in future years. The expected rate of return on plan assets is the man-
agement estimate that most affects the calculation of pension expense.
Our expected rate of return on plan assets is determined using the
plan’s target asset allocation and estimated rates of return for each asset
class. Estimated rates of return are based on expected returns from
fixed income securities, which take into consideration bond yields.
An equity risk premium is then applied to estimate expected equity
returns. Expected returns from other asset classes are established
to reflect the risks of these asset classes relative to fixed income and
equity assets. With all other assumptions held constant, a 1 percentage
point decline in the expected rate of return on plan assets would
result in an increase in pension expense for 2009 of approximately
$45 million. The impact of changes in expected rates of return
on plan assets is not significant for our other employee future benefits
expense since only small amounts of assets are held in these plans.
Pension and other employee future benefits expense and
obligations are also sensitive to changes in discount rates. For our
Canadian plans, which currently represent 82% of BMO’s pension
obligations, we determine a discount rate at each year-end using market
rates applicable to high-quality debt instruments with cash flows that
match the timing and amount of expected benefit payments.
Additional information regarding our accounting for pensions
and other employee future benefits, including sensitivity analysis
for key assumptions, is included in Note 24 on page 139 of the
financial state
ments.
Other Than Temporary Impairment
We review available-for-sale and other securities at each quarter-end
reporting period 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 making this assessment, we consider
such factors as the type of investment, the length of time and extent
to which the fair value has been below the cost, the financial condition
and near-term prospects of the issuer, and our intent and ability to
hold the investment long enough to allow for any anticipated recovery.
The decision to record a write-down, its amount and the period in
which it is recorded could change if management’s assessment of those
factors were different. We do not record impairment write-downs on
debt securities when impairment is due to changes in market interest
rates, since we expect to realize the full value of these investments
by holding them until they recover in value or to maturity.
We also have investments in securities issued or guaranteed by
Canadian or U.S. governments, corporate debt and equity securities,
mortgage-backed securities and collateralized mortgage obligations.
Quoted market value is considered to be fair value for actively traded
securities. At the end of 2008, there were total unrealized losses of
$352 million on securities on which the cost exceeded fair value
and an impairment write-down had not been recorded. Of this amount,
$7 million related to securities for which the cost had exceeded fair
value for 12 months or more. These unrealized losses resulted from
increases in market interest rates and not from deterioration in the
creditworthiness of the issuer.
Additional information regarding our accounting for available-for-
sale securities and other securities and the determination of fair value
is included in Note 3 on page 109 of the financial statements.