Bank of Montreal 2015 Annual Report Download - page 164

Notes
Quantitative Information about Level 3 Fair Value Measurements
The table below presents the fair values of our significant Level 3 financial instruments, the valuation techniques used to determine their fair values
and the value ranges of significant unobservable inputs used in the valuations.
Reporting line in fair
value hierarchy table
Fair value
of assets
Significant
unobservable inputs
Range of input values (1)
As at October 31, 2015
(Canadian $ in millions, except as noted) Valuation techniques Low High
Securities
Private equity (2) Corporate equity 1,251 Net Asset Value
EV/EBITDA
Net Asset Value
Multiple
na
5.5x
na
10.1x
Collateralized loan obligations securities (3) Corporate debt 249 Discounted Cash Flow Model Yield/Discount Margin 1.50% 1.50%
Merchant banking securities Other 364 Net Asset Value
EV/EBITDA
Net Asset Value
Multiple
na
4.5x
na
8.7x
(1) The low and high input values represent the actual highest and lowest level of inputs used to value a group of financial instruments in a particular product category. These input ranges do not reflect
the level of input uncertainty, but are affected by the specific underlying instruments within the product category. The input ranges will therefore vary from period to period based on the
characteristics of the underlying instruments held at each balance sheet date.
(2) Included in private equity is $627 million of Federal Reserve Bank and U.S. Federal Home Loan Bank shares that we hold to meet regulatory requirements. These shares are carried at cost, which is
deemed to approximate fair value since these shares are not traded in the market.
(3) Includes both trading and available-for-sale instruments.
na – not applicable
Significant Unobservable Inputs in Level 3 Instrument Valuations
Net Asset Value
Net asset value represents the estimated value of a security based on valuations received from the investment or fund manager. The valuation of
certain private equity securities is based on the economic benefit derived from our investment.
EV/EBITDA Multiple
The fair value of private equity and merchant banking investments is derived by calculating an enterprise value (“EV”) using the EV/EBITDA multiple
and then proceeding through a waterfall of the company’s capital structure to determine the value of the assets or securities we hold. The EV/EBITDA
multiple is determined using judgment in considering factors such as multiples for comparable listed companies, recent transactions and company-
specific factors, as well as liquidity discounts that account for the lack of active trading in these assets and securities.
Yield/Discount Margin
A financial instrument’s yield is the interest rate used to discount future cash flows in a valuation model. An increase in the yield, in isolation, would
result in a decrease in the related fair value measurement. The discount margin is the difference between a debt instrument’s yield and a benchmark
instrument’s yield. Benchmark instruments have high credit quality ratings and similar maturities and are often government bonds. The discount
margin for an instrument forms part of the yield used in a discounted cash flow calculation. Generally, an increase in the discount margin will result in
a decrease in fair value.
Sensitivity Analysis of Level 3 Instruments
Sensitivity analysis at October 31, 2015, for securities which represent greater than 10% of Level 3 instruments, is provided below.
Within Level 3 trading securities is corporate debt of $239 million related to securities which are hedged with credit default swaps that are also
considered to be Level 3 instruments. As at October 31, 2015, the derivative assets and derivative liabilities were valued at $1 million and $nil,
respectively. We determine the valuation of these derivatives and the related securities based on market-standard models we use to model the
specific collateral composition and cash flow structure of the related deal. As at October 31, 2015, the impact of assuming a 10 basis point increase or
decrease in the discount margin would be a $0.2 million decrease or increase in fair value, respectively.
We have not applied another reasonably possible alternative assumption to the significant Level 3 categories of private equity investments and
merchant banking securities, as the net asset values are provided by the investment or fund managers.
Significant Transfers
Our policy is to record transfers of assets and liabilities between fair value hierarchy levels at their fair values as at the end of each reporting period,
consistent with the date of the determination of fair value. Transfers between the various fair value hierarchy levels reflect changes in the availability
of quoted market prices or observable market inputs that result from changing market conditions. The following is a discussion of the significant
transfers between Level 1, Level 2 and Level 3 balances for the year ended October 31, 2015.
During the year ended October 31, 2015, $158 million of trading securities and $122 million of available-for-sale securities were transferred from
Level 1 to Level 2 due to reduced observability of the inputs used to value these securities. During the year ended October 31, 2015, $90 million of
trading securities and $180 million of available-for-sale securities were transferred from Level 2 to Level 1 due to increased availability of quoted
prices in active markets.
BMO Financial Group 198th Annual Report 2015 177