Bank of Montreal 2008 Annual Report Download - page 81

MD&A
BMO Financial Group 191st Annual Report 2008 | 77
BMO’s primary high-level market risk measures are Market Value
Exposure (MVE) and Earnings Volatility (EV). The market value and
earnings volatility exposures at October 31, 2008 are summarized
in the following table.
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BMO incurs market risk in its trading and underwriting activities and
structural banking activities.
As part of our enterprise-wide risk management framework, we
employ extensive governance and management processes surrounding
market risk-taking activities. These include:
•oversight by senior governance committees, including Trading
Products Risk Committee (TPRC), Balance Sheet Management
Committee (BSMC), RMC and RRC;
•an Economic Capital plan process that incorporates market risk
measures (market value exposures, stress testing);
•process for the effective valuation of trading positions and
measurement of market risk;
•development of appropriate policies and corporate standards;
•a well-developed limit-setting and monitoring process;
•controls over processes and models used; and
•a framework of scenario and stress tests for worst-case events.
Portfolio Management
Total enterprise-wide outstanding credit exposures were $395 billion as
at October 31, 2008, comprised of $232 billion in Canada, $136 billion in
the United States and $27 billion in other jurisdictions.
BMO’s credit risk governance policies ensure that an acceptable
level of diversification is maintained at all times. The use of structural
industry risk factor limits ensures diversification of risk in the com-
mercial and corporate lending portfolios, and allows us to closely monitor
sectors where closer attention is appropriate. At year-end, our credit
assets consisted of a well-diversified portfolio comprised of millions
of clients, the majority of them consumers and small to medium-sized
businesses.
BMO employs a number of measures to mitigate and manage
credit risk. These measures include but are not limited to strong
underwriting standards, qualified professional risk managers, a robust
monitoring and review process, redistributing exposures, and buying
or selling insurance through guarantees or credit default swaps.
Credit portfolio quality is discussed on page 41. Note 4 on page 113
of the financial statements and Tables 11 to 19 on pages 96 to 99
provide details of BMO’s loan portfolio, impaired loans and provisions
and allowances for credit losses.
Collateral Management
The purpose of collateral for credit risk mitigation is to minimize losses
that could otherwise be incurred and to protect funds employed in credit
risk activities. Depending on the type of borrower, the assets available
and the structure and term of the credit requirements, collateral can take
various forms. Investment grade liquid securities are regularly pledged
in support of treasury counterparty facilities. For corporate and commer-
cial borrowers, collateral can take the form of pledges of the assets
of a business, such as accounts receivable, inventory, machinery and
real estate, or personal assets pledged in support of guarantees. On
an ongoing basis, collateral is subject to regular valuation, as prescribed
in the relevant governing procedures, which
incorporate set formulas
for certain asset types along with an assessment
of current economic and
market circumstances.
Allowance for Credit Losses
Across all loan portfolios, BMO employs a disciplined approach to
provisioning and loan loss evaluation, with prompt identification of
problem loans being a key risk management objective. BMO maintains
both specific and general allowances for credit losses, the sum of which
is sufficient to reduce the book value of credit assets to their estimated
realizable value. Specific allowances reduce the aggregate carrying
value of credit assets where there is evidence of deterioration in credit
quality. We maintain a general allowance in order to cover any impair-
ment 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 our regulator, OSFI.
The general allowance is reviewed on a quarterly basis and a number
of factors are considered when determining the appropriate level
of the general allowance. This includes a general allowance model
that applies historical expected and unexpected loss rates, based on
probabilities of default and loss given default factors, to current balances.
For business loans, these historical loss rates are associated with the
underlying risk rating of the borrower, which is assigned at the time of
loan origination, monitored on an ongoing basis and adjusted to reflect
changes in underlying credit risk. These loss rates are further refined
with regard to industry sectors and credit products. For consumer loans,
loss rates are based on historical loss experience for the different
portfolios. Model results are then considered along with the level of
the existing allowance and management’s judgment regarding portfolio
quality, business mix, and economic and credit market conditions.
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Market risk is the potential for a negative impact on the balance
sheet and/or income statement resulting from adverse changes in
the value of financial instruments as a result of changes in certain
market variables. These variables include interest rates, foreign
exchange rates, equity and commodity prices and their implied
volatilities, as well as credit spreads, credit migration and default.
Market Risk
Other
Government
Financial institutions
Service industries
Forest products
Utilities
Transportation
Oil and gas
Mining
Manufacturing
Communications
Agriculture
Wholesale trade
Retail trade
Residential mortgages
Credit cards
Personal loans
Home equity loans
Commercial mortgages
Commercial real estate
Construction
Gross Loans and Acceptances (excluding Reverse Repos)
Diversification by Industry
As at October 31, 2008