Bank of Montreal 2015 Annual Report Download - page 179

Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 26: Commitments, Guarantees, Pledged Assets, Provisions and Contingent Liabilities
In the normal course of business, we enter into a variety of contracts under which we may be required to make payments to reimburse the
counterparty for a loss if a third party does not perform according to the terms of a contract or does not make payments when due under the terms
of a debt instrument, and contracts under which we provide indirect guarantees of the indebtedness of another party all of which are considered
guarantees.
Guarantees that qualify as derivatives are accounted for in accordance with the policy for derivative instruments (see Note 8). For guarantees
that do not qualify as derivatives, the liability is initially recorded at fair value, which is generally the fee received. Subsequently, guarantees are
recorded at the higher of the initial fair value, less amortization to recognize any fee income earned over the period, and the best estimate of the
amount required to settle the obligation. Any change in the liability is reported in our Consolidated Statement of Income.
In addition, we enter into a variety of commitments, including off-balance sheet credit instruments such as backstop liquidity facilities, securities
lending, letters of credit, credit default swaps and commitments to extend credit, as a method of meeting the financial needs of our customers. These
commitments include contracts where we may be required to make payments to a counterparty, based on changes in the value of an asset, liability
or equity security that the counterparty holds, due to changes in an underlying interest rate, foreign exchange rate or other variable. The contractual
amount of our commitments represents our maximum undiscounted potential exposure, before possible recoveries under recourse and collateral
provisions. Collateral requirements for these instruments are consistent with collateral requirements for loans.
A large majority of these commitments expire without being drawn upon. As a result, the total contractual amounts may not be representative of
the funding likely to be required for these commitments.
We strive to limit credit risk by dealing only with counterparties that we believe are creditworthy, and we manage our credit risk for other credit
instruments using the same credit risk process that is applied to loans and other credit assets.
The maximum amount payable related to our various commitments is as follows:
(Canadian $ in millions) 2015 2014
Financial Guarantees
Standby letters of credit (1) 15,351 13,949
Credit default swaps (2) (3) 9,385 11,983
Other Credit Instruments
Backstop liquidity facilities (4) 5,528 5,501
Securities lending 6,081 5,269
Documentary and commercial letters of credit 1,101 1,111
Commitments to extend credit (5) 101,173 78,817
Other commitments 3,586 2,261
Total 142,205 118,891
(1) As at October 31, 2015, we recognized $35 million ($50 million in 2014) in other liabilities.
(2) As at October 31, 2015, $8,000 million of the credit default swaps outstanding relates to our credit protection vehicle and will mature within one year.
(3) The fair value of the related derivative liabilities included in our Consolidated Balance Sheet was $48 million as at October 31, 2015 ($124 million in 2014).
(4) As at October 31, 2015, $53 million was outstanding from backstop liquidity facilities ($53 million in 2014) and was recognized in other liabilities.
(5) Commitments to extend credit exclude personal lines of credit and credit cards that are unconditionally cancellable at our discretion.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Financial Guarantees
Standby letters of credit represent our obligation to make payments to third parties on behalf of customers if they are unable to make the required
payments or meet other contractual requirements. The majority have a term of one year or less. Collateral requirements for standby letters of credit
and guarantees are consistent with our collateral requirements for loans. Standby letters of credit and guarantees include our guarantee of a
subsidiary’s debt directly provided to a third party.
Written credit default swaps require us to compensate a counterparty following the occurrence of a credit event in relation to a specified
reference obligation, such as a bond or a loan. The terms of these contracts range from less than one year to 10 years. Refer to Note 8 for details.
Other Credit Instruments
Backstop liquidity facilities are provided to asset-backed commercial paper (“ABCP”) programs administered by either us or third parties as an
alternative source of financing in the event that such programs are unable to access ABCP markets or when predetermined performance measures of
the financial assets held by these programs are not met. The terms of the backstop liquidity facilities do not require us to advance money to these
programs in the event of bankruptcy of the borrower. The facilities’ terms are generally no longer than one year, but can be several years.
We lend eligible customers’ securities to third party borrowers who have been evaluated for credit risk using the same credit risk process that is
applied to loans and other credit assets. In connection with these activities, we provide an indemnification to clients against losses resulting from the
failure of the borrower to return loaned securities when due. All borrowings are fully collateralized with cash or marketable securities. As securities
are loaned, we require borrowers to maintain collateral which is equal to or in excess of 100% of the fair value of the securities borrowed. The
collateral is revalued on a daily basis.
Documentary and commercial letters of credit represent our agreement to honour drafts presented by a third party upon completion of specific
activities.
Commitments to extend credit represent our commitment to our customers to grant them credit in the form of loans or other financings for
specific amounts and maturities, subject to their meeting certain conditions.
As a participant in merchant banking activities, we enter into commitments to fund external private equity funds and investments in equity and
debt securities at market value at the time the commitments are drawn. In addition, we act as underwriter for certain new issuances under which we
alone or together with a syndicate of financial institutions purchase the new issue for resale to investors.
192 BMO Financial Group 198th Annual Report 2015