BANK OF MONTREAL - Annual Report - Management's Discussion & Analysis
Dec 17, 2009 (PR Newswire Europe via COMTEX) --
Company: Bank of Montreal (BMO)
Management's Discussion and Analysis
BMO's President & Chief Executive Officer and Chief Financial Officer have
signed a statement outlining management's responsibility for financial
information in this Annual Report. The statement, which can be found on page
108, also explains the roles of the Audit Committee and Board of Directors in
respect of financial information in the Annual Report. Management's Discussion
and Analysis (MD&A) comments on BMO's operations and financial condition for
the years ended October 31, 2009 and 2008. The MD&A should be read in
conjunction with our consolidated financial statements for the year ended
October 31, 2009. The MD&A commentary is as of November 24, 2009, except for
peer group comparisons, which are as of December 8, 2009. Unless otherwise
indicated, all amounts are stated in Canadian dollars and have been derived
from financial statements prepared in accordance with Canadian generally
accepted accounting principles (GAAP). Certain prior year data has been
reclassified to conform with the current year's presentation, including
restatements arising from transfers of certain businesses between operating
groups.
Index
28 Financial Performance and Condition at a Glance provides a snapshot of our results on 11 key financial performance
and condition measures used by management to monitor performance relative to our peer groups.
30 Who We Are provides an overview of BMO Financial Group, explains the links between our objectives and our overall
vision, presents key performance data and outlines "Reasons to invest in BMO."
31 Enterprise-Wide Strategy outlines our enterprise-wide strategy and the context in which it is developed, as well
as our progress in relation to our strategic priorities.
32 Caution Regarding Forward-Looking Statements advises readers about the limitations and inherent risks and
uncertainties of forward-looking information.
32 Factors That May Affect Future Results outlines certain industry and company-specific factors that investors
should consider when assessing BMO's earnings prospects.
34 Economic Developments includes commentary on the impact of economic developments on our businesses in 2009 and
expectations for the Canadian and U.S. economies in 2010.
Value Measures reviews financial performance on the four key measures that assess or most directly influence
shareholder return.
35 Total Shareholder Return
36 Earnings per Share Growth
37 Return on Equity
37 Net Economic Profit Growth
38 2009 Financial Performance Review provides a detailed review of BMO's consolidated financial performance by major
income statement category. It also includes a summary of notable items affecting results and the impact of
business acquisitions and changes in foreign exchange rates.
Operating Group Review outlines the strategies of our operating groups, the paths they choose to differentiate
their businesses and the major business risks they face, along with their strengths, competencies and key value
drivers. It also includes a summary of their achievements in 2009, their priorities for 2010 and a review of their
financial performance for the year.
46 Summary
47 Personal and Commercial Banking
48 Personal and Commercial Banking Canada
51 Personal and Commercial Banking U.S.
54 Private Client Group
57 BMO Capital Markets
60 Corporate Services, including Technology and Operations
Financial Condition Review discusses our assets and liabilities by major balance sheet category. It reviews our
capital adequacy and our approach to ensuring we optimize our capital position to support our business strategies
and maximize returns to our shareholders. It also discusses off-balance sheet arrangements and financial
instruments.
60 Summary Balance Sheet
62 Enterprise-Wide Capital Management
65 Select Financial Instruments
70 Off-Balance Sheet Arrangements
Accounting Matters and Disclosure and Internal Control reviews critical accounting estimates and changes in
accounting policies in 2009 and for future periods. It also discusses our evaluation of disclosure controls and
procedures and internal control over financial reporting.
71 Critical Accounting Estimates
73 Changes in Accounting Policies in 2009
73 Future Changes in Accounting Policies
74 Disclosure Controls and Procedures and Internal Control over Financial Reporting
74 Pre-Approval of Shareholders' Auditors' Services and Fees
75 Enterprise-Wide Risk Management outlines our approach to managing the key financial risks and other related
risks we face.
91 Non-GAAP Measures includes explanations of non-GAAP measures and their reconciliation to their GAAP
counterparts.
91 Review of Fourth Quarter Performance, Quarterly Earnings Trends and 2008 Financial Performance Review provide
commentary on results for relevant periods other than fiscal 2009.
96 Supplemental Information presents many useful financial tables and provides more historical detail.
Regulatory Filings
Our continuous disclosure materials, including our interim filings, annual MD&A, audited consolidated financial
statements, Annual Information Form and Notice of Annual Meeting of Shareholders & Proxy Circular, are available
on our website at www.bmo.com, on the Canadian Securities Administrators' website at www.sedar.com and on the
EDGAR section of the SEC's website at www.sec.gov. BMO's President and Chief Executive Officer and Chief
Financial Officer each certify the appropriateness and fairness of BMO's annual and interim consolidated
financial statements and MD&A and Annual Information Form, and the effectiveness of BMO's disclosure controls
and procedures and internal control over financial reporting.
27 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Financial Performance and Condition at a Glance
Our Performance (Note 1) Peer Group Performance
Five-Year Total Five-Year TSR (%)
Shareholder Return (TSR)
- BMO shareholders have earned an - The Canadian peer group average
average annual return of 1.8% over annual five-year TSR was 7.2%. The
the past five years. one-year TSR was 22.0% as equity
markets were strong in the second
half of the year.
- The one-year TSR in 2009 was a
strong 25.1%, outpacing the broader
market indices in both Canada and the - The North American peer group
United States. average annual five-year TSR of
-1.0% and one-year TSR of -18.7%
were significantly below the
Canadian averages as U.S. banks
were more severely affected by
credit losses and the difficult
capital markets environment.
See page 35.
Earnings per Share (EPS) Growth EPS Growth (%)
- EPS fell 18.1% to $3.08 in 2009. - The Canadian peer group average
EPS increased 9.6% after having
decreased 41% in 2008. The average
was skewed by one bank's return to
- There were increased provisions for profitability after recording a
credit losses, higher income taxes large loss in 2008. The EPS of all
and more shares outstanding. other Canadian banks in the peer
group increased by less than the
average.
- Personal and Commercial Banking
Canada (P&C Canada) and BMO Capital
Markets achieved strong growth in net - EPS growth for the North
income. American peer group was -80%, as
five of our U.S. peers recorded
losses.
See page 36.
Return on Equity (ROE) ROE (%)
- ROE, at 9.9%, was good in the - The Canadian peer group average
context of the economic environment, ROE of 11.3% was in line with the
having been reduced primarily by our average return in 2008. ROE fell
stronger capital position as well as for most of the peer group but the
lower earnings. average was raised by the
above-mentioned bank's return to
profitability.
- The bank chose to grow common
shareholders' equity by almost $1.5
billion to increase investor and - ROE for the North American peer
depositor confidence and provide us group was low at 1.8%, as ROE for
with financial flexibility. each of our U.S. peers was less
than BMO's and five banks reported
negative returns.
See page 37.
Net Economic Profit (NEP) Growth NEP Growth (%)
- NEP, a measure of added economic - The Canadian peer group average
value, fell, reflecting lower ROE. NEP growth was -11.1%, with five
of our peers posting reduced NEP.
All the Canadian banks bolstered
their capital levels in the year.
- NEP growth for the North
American peer group was -391%.
Twelve of the 14 banks in the
group posted reduced NEP, with
some incurring very large
reductions.
See page 37.
Revenue Growth Revenue Growth (%)
- Revenue increased $859 million or - Revenue growth for the Canadian
8.4% to a strong $11.1 billion in peer group averaged a strong
2009. 27.8%.
- There was strong growth in P&C - Both retail and wholesale
Canada and BMO Capital Markets added banking contributed to growth in
more than $1 billion of revenue, 2009, in contrast to 2008 when the
rising 42%. group average was a 10.8% decrease
due to low wholesale banking
revenues.
- Corporate Services revenue
decreased, largely due to market
conditions. - Revenue growth for the North
American peer group was 30.4%, a
strong rebound from its
performance in 2008.
See page 40.
Productivity Ratio Productivity Ratio (%)
(Expense-to-Revenue Ratio)
- The productivity ratio was 66.7% - The Canadian peer group average
and improved 90 basis points from productivity ratio was 63.7%,
2008. Similarly, the cash improving from 71.4% in 2008 due
productivity ratio improved 80 basis to strong revenue growth.
points to 66.3%.
- The average productivity ratio
- The improvement was due to strong for the North American peer group
revenue growth combined with was 65.9%, a level that is worse
effective expense management. than the average of our Canadian
peers.
See page 44.
Note 1. Results stated on a cash Certain BMO and peer group prior
basis as well as NEP are non-GAAP year data has been restated to
measures. Please see page 91 for a conform with the current year's
discussion of the use of non-GAAP basis of presentation.
measures.
Results are as at or for the years
ended October 31 for Canadian
banks and as at or for the years
ended September 30 for U.S. banks.
28 BMO Financial Group 192nd Annual Report 2008
Our Performance Peer Group Performance
Credit Losses Provision for Credit
Losses as a % of Average
Net Loans and Acceptances
- The provision for credit - The Canadian peer group average
losses (PCL) was $1,603 PCL represented 90 basis points of
million, comprised of average net loans and acceptances,
$1,543 million of specific up from 48 basis points in 2008.
provisions and a $60
million increase in the
general allowance.
- PCL as a percentage of - The North American peer
average net loans and group average PCL was 235
acceptances was 88 basis basis points, as U.S. banks
points, remaining elevated continued to be severely
in line with impaired affected by deterioration
loans. in the real estate market
and broader economy.
See pages 43 and 80.
Impaired Loans Gross Impaired Loans and
Acceptances as a % of
Equity and Allowances for
Credit Losses
- Gross impaired loans and - GIL for the Canadian
acceptances (GIL) were peer group were 69% higher
$3,297 million, up from than last year and
$2,387 million in 2008, represented 10.8% of
and represented 14.1% of equity and allowances for
equity and allowances for credit losses, up from
credit losses, compared 7.5% last year.
with 11.3% a year ago.
- GIL for the U.S. banks
- Formations of new again rose sharply,
impaired loans and raising GIL as a
acceptances, a key driver percentage of equity and
of provisions for credit allowances for credit
losses, were $2,690 losses for the North
million, up 7% from $2,506 American peer group to
million in 2008, primarily 14.2%, a level above the
reflecting exposures to average of the Canadian
the real estate, peer group.
manufacturing and
financial services
sectors.
See pages 43 and 80.
Cash and Cash and
Securities-to-Total Securities-to-Total Assets
Assets (%)
- The cash and - The cash and
securities-to-total assets securities-to-total assets
ratio increased to 31.9% ratio for the Canadian
from 29.1% in 2008, peer group of 31.0%
reflecting a strong increased from 27.8% in
liquidity position. 2008. The increase raised
the average ratio to a
level that is in line with
historic averages.
- Liquidity remains sound
and continues to be
supported by our large
base of customer deposits - The North American peer
and our strong capital group average ratio was
position. 27.2% in 2009, a level
that is below the average
of our Canadian peers.
See page 86.
Capital Adequacy Capital Adequacy
- The Tier 1 Capital Ratio - The Canadian peer group
was strong at 12.24%, average Tier 1 Capital
compared with 9.77% in Ratio was 11.78% in 2009,
2008. up from 9.52% in 2008, as
banks chose to bolster
their capital levels.
- The Total Capital Ratio
was 14.87%, compared with
12.17% in 2008. - The basis for computing
capital adequacy ratios is
not comparable in Canada
and the United States.
- BMO's tangible common
equity to risk-weighted
assets ratio was a strong
9.21%, up from 7.47% in
2008.
See page 62.
Credit Rating
- BMO's credit ratings, as - The Canadian peer group median credit ratings
assessed by four major ratings were unchanged in 2009 with no change in the
agencies, were unchanged in ratings of any of the individual Canadian banks.
2009. All four ratings are Each of the median Canadian peer group ratings is
considered high-grade and high considered high-grade and high quality.
quality.
- The North American peer group median credit
- Moody's placed BMO's rating ratings as assessed by two of the ratings agencies
under review for possible were slightly lower than the median of the Canadian
downgrade during the fourth peer group, as economic conditions were more severe
quarter. in the United States.
See page 87.
The Canadian peer group
averages are based on the
performance of Canada's
six largest banks: BMO
Financial Group, Canadian
Imperial Bank of Commerce,
National Bank of Canada,
RBC Financial Group,
Scotiabank and TD Bank
Financial Group. The North
American peer group
averages are based on the
performance of 14 of the
largest banks in North
America. It includes the
Canadian peer group,
except National Bank of
Canada, as well as BT&T
Corporation, Fifth Third
Bancorp, Key Corp., Bank
of New York Mellon, The
PNC Financial Services
Group Inc., Regions
Financial, SunTrust Banks
Inc., U.S. Bancorp, and
Wells Fargo and Company.
The North American peer
group was redefined in
2009. Prior year averages
have not been restated.
29 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Who We Are
Established in 1817 as Bank of Montreal, BMO Financial Group is a highly
diversified North American financial services provider. With total assets of
$388 billion and more than 36,000 employees, BMO provides a broad range of
retail banking, wealth management and investment banking products and
solutions. We serve clients across Canada through our Canadian retail arm, BMO
Bank of Montreal, and through our wealth management businesses, BMO Nesbitt
Burns, BMO InvestorLine, BMO Insurance and BMO Harris Private Banking. BMO
Capital Markets, our North American investment and corporate banking division,
provides a full suite of financial products and services to our North American
and international clients. In the United States, BMO serves clients through
Chicago-based Harris, an integrated financial services organization that
provides more than one million personal and business clients with banking,
lending, investing, financial planning, trust administration, portfolio
management, family office and wealth transfer services. BMO Financial Group
comprises three operating groups: Personal and Commercial Banking, Private
Client Group and BMO Capital Markets.
Our Financial Objectives
BMO's vision, guiding principle and medium-term financial objectives for
certain important performance measures are set out below. We believe that we
will maximize total shareholder return and meet our medium-term financial
objectives by aligning our operations with and executing on our strategic
priorities, as outlined on the following page.
BMO's business planning process is rigorous and considers the prevailing
economic conditions, our customers' evolving needs and the opportunities
available across our lines of business. It includes clear and direct
accountability for annual performance that is measured against internal and
external benchmarks and progress towards our strategic priorities.
Our medium-term financial objectives of increasing earnings per share (EPS) by
an average of 10% per year over time, earning an average annual return on
equity (ROE) of 17% to 20% over time and maintaining strong regulatory capital
ratios are key guideposts as we execute against our strategic priorities. Our
operating philosophy is to increase revenues at rates higher than general
economic growth rates, while limiting expense growth to achieve average annual
cash operating leverage (defined as the difference between the revenue and
cash-based expense growth rates) of at least two percentage points over time.
In managing our operations, we balance current profitability with the need to
invest for future growth.
Our Vision
To be the bank that defines great customer experience.
Our Guiding Principle
We aim to maximize total shareholder return and balance our commitments to
financial performance, our customers, our employees, the environment and the
communities where we live and work.
Our Medium-Term Financial Objectives
Over time, increase EPS by an average of 10% per year, earn average annual ROE
of between 17% and 20%, achieve average annual cash operating leverage of at
least two percentage points, and maintain a strong regulatory capital
position.
Reasons to Invest in BMO
- Clear growth strategy
- Strong financial position
- Proactive risk management
- Commitment to stakeholders
As at or for the periods ended October 31, 2009
(%, except as noted) 1-year 5-year 10-year
Compound annual total shareholder return 25.1 1.8 10.0
Compound growth in annual EPS (18.1) (6.9) 2.8
Average annual ROE 9.9 17.0 16.0
Compound growth in annual dividends declared per share - 12.0 11.5
Dividend yield at October 31, 2009 5.6 na na
Price-to-earnings multiple 16.3 na na
Market value/book value (per share) 1.57 na na
Tier 1 Capital Ratio 12.24 na na
na - not applicable
The section above, Our Financial Objectives, as well as Enterprise-Wide
Strategy and Economic Developments, two sections that follow, contain certain
forward-looking statements. By their nature, forward-looking statements
require us to make assumptions and are subject to inherent risks and
uncertainties. Please refer to the Caution Regarding Forward-Looking
Statements on page 32 of this Annual Report for a discussion of such risks and
uncertainties and the material factors and assumptions related to the
statements set forth in such sections.
30 BMO Financial Group 192nd Annual Report 2009
Enterprise-Wide Strategy
Our Vision
To be the bank that defines great customer experience.
Our Guiding Principle
We aim to maximize total shareholder return and balance our commitments to
financial performance, our customers, our employees, the environment and the
communities where we live and work.
Our Strategy in Context
The recent challenges faced by financial services companies around the world
underscore the importance of a strong retail deposit base. We expect that new
opportunities will emerge as some monoline and international competitors
retreat from the market.
We believe our strategy of creating a differentiated customer experience,
rooted in providing clarity for our customers and focusing on the productivity
of our sales force and distribution network, equips us with clear competitive
advantages.
Shifts in demographics and growth in demand for advisory services provide a
number of attractive opportunities for growth in wealth management. A strong
brand, a focus on the client experience, deep capabilities and a full range of
client offerings position us to take advantage of these opportunities to grow
and outperform the market.
Delivering strong, stable returns in today's capital markets requires
increased focus on core clients and building on areas of competitive strength,
supported by a strong risk management framework.
Our Strategic Priorities and Progress
Maximize earnings growth across all North American personal and commercial
banking businesses, focusing on industry-leading customer experience and sales
force productivity.
- Achieved solid progress in improving our financial performance with increased core revenues, margins and net income.
- In Canada, we realized improvements in our personal banking net promoter score and improved market share in personal
deposits and commercial lending.
- In the United States, we improved commercial banking market share and our personal and commercial banking net
promoter scores.
- Introduced a number of offers that help bring clarity to financial decisions, including the Smart Saver Account and
BMO SmartSteps. We also simplified and enhanced our entire suite of credit cards.
- Continued to invest in our sales and distribution network, by building and redeveloping branches, starting
construction of a new integrated customer contact centre and investing in improved online capabilities.
- Refined our performance management system to ensure that we motivate and reward employees based on targets that
clearly deliver improved financial performance and customer loyalty.
Accelerate the growth of our wealth management business by providing our
clients with exceptional advice emphasizing retirement and financial planning.
- Acquired BMO Life Assurance Company (formerly AIG Life Insurance Company of Canada), strengthening our competitive
position in the wealth management market.
- Continued to develop more robust financial planning and investment advisor tools to enhance our planning-based client
experience and improve sales force efficiency.
- Became the first bank in Canada to offer a Registered Disability Savings Plan, enabling clients with disabilities to
improve their long-term financial security.
- Launched proprietary exchange traded funds, low-cost investment products that offer our clients the primary building
blocks of a well-diversified investment portfolio.
- Increased retirement and financial planning training across our sales force to continue to add value for our clients
and drive business results.
Deliver strong, stable returns in our capital markets business by providing
highly targeted solutions to our core clients, everywhere we compete, from a
single integrated platform.
- Continued to increase our focus on core clients by deepening sector capabilities and enhancing product and service
capabilities.
- Achieved solid earnings growth in 2009, led by our Trading Products business.
- Reduced earnings volatility and effectively managed off-balance sheet exposures through maintaining a diversified,
dynamic portfolio of strong businesses.
- Integrated debt advisory, origination and structuring activities across BMO Capital Markets into a single Debt
Capital Markets group.
- Strengthened and broadened our oversight of trading activities in partnership with Risk Management.
Grow our business in select global markets to meet our customers' expanding needs.
- Received approval from the China Bank Regulatory Commission to formally prepare for incorporation.
- BMO Capital Markets concentrated on sectors where we have a differentiated and competitive position that is either
global (Metals & Mining) or North American (Energy, Food & Consumer).
Sustain a culture that focuses on customers, high performance and our people.
- Renewed our learning and leadership development programs at BMO's Institute for Learning to support BMO's focus on
customers, talent and performance.
- Continued the development of our industry-leading talent management program and rolled out our Employee Promise - our
promise to our current and prospective employees - consistent with our customer brand and corporate values.
- Significantly advanced our risk management practices, organizational structure, capabilities and risk culture with
the continuation of the Enterprise Risk Management Evolution program.
- Increased productivity and effectiveness of technology and operations through a focus on high-quality service
delivery and continued unit cost reductions.
31 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Caution Regarding Forward-Looking Statements
Bank of Montreal's public communications often include written or oral
forward-looking statements. Statements of this type are included in this
Annual Report, and may be included in other filings with Canadian securities
regulators or the U.S. Securities and Exchange Commission, or in other
communications. All such statements are made pursuant to the "safe harbor"
provisions of, and are intended to be forward-looking statements under, the
United States Private Securities Litigation Reform Act of 1995 and any
applicable Canadian securities legislation. Forward-looking statements may
involve, but are not limited to, comments with respect to our objectives and
priorities for 2010 and beyond, our strategies or future actions, our targets,
expectations for our financial condition or share price, and the results of or
outlook for our operations or for the Canadian and U.S. economies.
By their nature, forward-looking statements require us to make assumptions and
are subject to inherent risks and uncertainties. There is significant risk
that predictions, forecasts, conclusions or projections will not prove to be
accurate, that our assumptions may not be correct and that actual results may
differ materially from such predictions, forecasts, conclusions or
projections. We caution readers of this Annual Report not to place undue
reliance on our forward-looking statements as a number of factors could cause
actual future results, conditions, actions or events to differ materially from
the targets, expectations, estimates or intentions expressed in the
forward-looking statements.
The future outcomes that relate to forward-looking statements may be
influenced by many factors, including but not limited to: general economic and
market conditions in the countries in which we operate; weak capital and/or
credit markets; interest rate and currency value fluctuations; changes in
monetary policy; the degree of competition in the geographic and business
areas in which we operate; changes in laws or in supervisory expectations or
requirements; judicial or regulatory proceedings; the accuracy and
completeness of the information we obtain with respect to our customers and
counterparties; our ability to execute our strategic plans and to complete and
integrate acquisitions; critical accounting estimates; operational and
infrastructure risks; general political conditions; global capital markets
activities; the possible effects on our business of war or terrorist
activities; disease or illness that affects local, national or international
economies; disruptions to public infrastructure, such as transportation,
communications, power or water supply; and technological changes.
We caution that the foregoing list is not exhaustive of all possible factors.
Other factors could adversely affect our results. For more information, please
see the discussion below, which outlines in detail certain key factors that
may affect Bank of Montreal's future results. When relying on forward-looking
statements to make decisions with respect to Bank of Montreal, investors and
others should carefully consider these factors, as well as other uncertainties
and potential events, and the inherent uncertainty of forward-looking
statements. Bank of Montreal does not undertake to update any forward-looking
statements, whether written or oral, that may be made from time to time by the
organization or on its behalf, except as required by law. The forward-looking
information contained in this document is presented for the purpose of
assisting our shareholders in understanding our financial position as at and
for the periods ended on the dates presented, as well as our strategic
priorities and objectives, and may not be appropriate for other purposes.
Assumptions about the level of asset sales, expected asset sale prices, net
funding cost, credit quality and risk of default and losses on default of the
underlying assets of the structured investment vehicles were material factors
we considered when establishing our expectations regarding the structured
investment vehicles discussed in this document, including the amount to be
drawn under the BMO liquidity facilities, whether consolidation will be
required and the expectation that the first-loss protection provided by the
subordinate capital notes will exceed future losses. Key assumptions included
that assets would continue to be sold with a view to reducing the size of the
structured investment vehicles, under various asset price scenarios, and that
the level of defaults and losses will be consistent with the credit quality of
the underlying assets and our current expectations regarding continuing
difficult market conditions.
Assumptions about the level of defaults and losses on defaults were material
factors we considered when establishing our expectations of the future
performance of the transactions that Apex Trust has entered into. Key
assumptions included that the level of defaults and losses on defaults would
be consistent with historical experience. Material factors that were taken
into account when establishing our expectations of the future risk of credit
losses in Apex Trust and risk of loss to BMO included industry diversification
in the portfolio, initial credit quality by portfolio, the first-loss
protection incorporated into the structure and the hedges that BMO has entered
into.
Assumptions about the performance of the Canadian and U.S. economies in 2010
and how that will affect our businesses were material factors we considered
when setting our strategic priorities and objectives, and our outlook for our
businesses. Key assumptions included that the Canadian and U.S. economies will
grow moderately in 2010, and that interest rates will remain low. We also
assumed that housing markets will strengthen in Canada and the United States.
We assumed that capital markets will improve somewhat and that the Canadian
dollar will strengthen modestly relative to the U.S. dollar. In determining
our expectations for economic growth, both broadly and in the financial
services sector, we primarily consider historical economic data provided by
the Canadian and U.S. governments and their agencies.
Factors That May Affect Future Results
As noted in the above Caution Regarding Forward-Looking Statements, all
forward-looking statements and information, by their nature, are subject to
inherent risks and uncertainties, both general and specific, which may cause
our actual results to differ materially from the expectations expressed in any
forward-looking statements. Some of these risks and uncertainties are
discussed in this section.
General Economic and Market Conditions in the Countries in which We Conduct
Business
We conduct business in Canada, the United States and other countries. Factors
such as interest rates, foreign exchange rates, consumer spending, business
investment, government spending, the health of capital markets, the rate of
inflation and the threat of terrorism affect the business and economic
environments in which we operate. Therefore, the amount of business we conduct
in a specific geographic region and its local economic and business conditions
may have an effect on our revenues and earnings. For example, a regional
economic decline may result in an increase in credit losses, a decrease in
loan growth and reduced capital markets activity.
Currency Rates
The Canadian dollar equivalents of our revenues and expenses denominated in
currencies other than the Canadian dollar are subject to fluctuations in the
value of the Canadian dollar relative to such currencies. Such fluctuations
may affect our overall business and financial results. Our most significant
exposure is to fluctuations in the value of the Canadian dollar relative to
the U.S. dollar due to the size of our operations in the United States.
Increases in the value of the Canadian dollar relative to the U.S. dollar have
affected our results in years prior to 2009. The U.S. dollar was stronger, on
average, in 2009 than in 2008. It strengthened appreciably in the first half
of the year and weakened appreciably in the latter half. An appreciation of
the Canadian dollar relative to the U.S. dollar would decrease the translated
value of U.S.-dollar-denominated revenues, expenses and earnings. Refer to the
Foreign Exchange section on page 39 and the discussion of Market Risk on pages
82 to 86 for a more complete discussion of our foreign exchange risk
exposures.
32 BMO Financial Group 192nd Annual Report 2009
Monetary Policy
Bond and money market expectations about inflation and central bank monetary
policy have an impact on the level of interest rates. Changes in market
expectations and monetary policy are difficult to anticipate and predict.
Fluctuations in interest rates that result from these changes can have an
impact on our earnings. Refer to the Market Risk section on pages 82 to 86 for
a more complete discussion of our interest rate risk exposures.
Level of Competition
The level of competition among financial services companies is high.
Furthermore, non-financial companies have been increasingly offering services
traditionally provided by banks. Customer loyalty and retention can be
influenced by a number of factors, including service levels, prices for
products or services, our reputation and the actions of our competitors.
Changes in these factors or a loss of market share could adversely affect our
earnings.
Changes in Laws, Regulations and Approach to Supervision
Regulations are in place to protect our clients, investors and the public
interest. Changes in laws and regulations, including how they are interpreted
and enforced, could adversely affect our earnings by allowing more competition
for our products and services and by increasing the costs of compliance.
Changes in regulations and approaches to supervision could also affect the
levels of capital and liquidity we choose to maintain. In addition, our
failure to comply with laws and regulations could result in sanctions and
financial penalties that could adversely affect our reputation and earnings.
Judicial or Regulatory Judgments and Legal and Regulatory Proceedings
We take reasonable measures to ensure compliance with the laws and regulations
of the jurisdictions in which we conduct business. However, there can be no
assurance that we will always be in compliance or be deemed to be in
compliance. As a result, it is possible that we could be subject to a judicial
or regulatory judgment or decision which results in fines, damages or other
costs that would have a negative impact on earnings and damage our reputation.
We are also subject to litigation arising in the ordinary course of our
business. The unfavourable resolution of any litigation could have a material
adverse effect on our financial results. Damage to our reputation could also
result, harming our future business prospects. Information about legal and
regulatory matters we currently face is provided in Note 29 on page 156 of the
financial statements.
Accuracy and Completeness of Customer and Counterparty Information
When deciding to extend credit or enter into other transactions with customers
and counterparties, we may rely on information provided by or on behalf of
those customers and counterparties, including audited financial statements and
other financial information. We also may rely on representations made by
customers and counterparties that the information they provide is accurate and
complete. Our financial results could be adversely affected if the financial
statements or other financial information provided by customers and
counterparties is materially misleading.
Execution of Strategic Plans
Our financial performance is influenced by our ability to execute strategic
plans developed by management. If these strategic plans do not meet with
success or if there is a change in these strategic plans, our earnings could
grow at a slower pace or decline.
Acquisitions
We perform thorough due diligence before completing an acquisition. However,
it is possible that we might make an acquisition that does not subsequently
perform in line with our financial or strategic objectives. Changes in the
competitive and economic environment as well as other factors may lower
revenues, while higher than anticipated integration costs and failure to
realize expected cost savings could also adversely affect our earnings after
an acquisition. Our post-acquisition performance is also contingent on
retaining the clients and key employees of acquired companies, and there can
be no assurance that we will always succeed in doing so.
Critical Accounting Estimates
We prepare our financial statements in accordance with Canadian generally
accepted accounting principles (GAAP). The application of GAAP requires that
management make significant judgments and estimates that can affect when
certain assets, liabilities, revenues and expenses are recorded in our
financial statements and their recorded values. In making these judgments and
estimates, we rely on the best information available at the time. However, it
is possible that circumstances may change or new information may become
available. Our financial results would be affected in the period in which any
new circumstances or information became apparent, and the amount of the impact
could be significant. More information is included in the discussion of
Critical Accounting Estimates on page 71.
Operational and Infrastructure Risks
We are exposed to many of the operational risks that affect all large
corporations. Such risks include the risk of fraud by employees or others,
unauthorized transactions by employees, and operational or human error. We
also face the risk that computer or telecommunications systems could fail,
despite our efforts to maintain these systems in good working order. Given the
high volume of transactions we process on a daily basis, certain errors may be
repeated or compounded before they are discovered and rectified. Shortcomings
or failures of our internal processes, employees or systems, including any of
our financial, accounting or other data processing systems, could lead to
financial loss and damage to our reputation. In addition, despite the
contingency plans we have in place, our ability to conduct business may be
adversely affected by a disruption in the infrastructure that supports our
operations and the communities in which we do business, including disruption
caused by pandemics or terrorist acts.
Other Factors
Other factors beyond our control that may affect our future results are noted
in the Caution Regarding Forward-Looking Statements on page 32. Additional
risks, including credit and counterparty, market, liquidity and funding,
insurance, operational, business, model, strategic, reputation and
environmental risks, are discussed in the Enterprise-Wide Risk Management
section starting on page 75.
We caution that the preceding discussion of factors that may affect future
results is not exhaustive. When relying on forward-looking statements to make
decisions with respect to BMO, investors and others should carefully consider
these factors, as well as other uncertainties, potential events and industry
and company-specific factors that may adversely affect future results. We do
not undertake to update any forward-looking statements, whether written or
oral, that may be made from time to time by us or on our behalf, except as
required by law.
33 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Economic Developments
Canadian and U.S. Economic and Financial Services Developments in 2009
The Canadian economy contracted sharply in the first half of 2009, as exports,
business investment and residential construction declined significantly in the
context of the global recession. However, growth resumed in the second half of
the year as a result of record-low interest rates, expansive fiscal policy and
the global recovery. Consumer confidence and spending have moved higher amid
moderating job losses, resulting in improved levels of demand for personal
credit. In response to increased affordability, home sales and prices have
reversed last year's declines, keeping mortgage growth strong. However, growth
in business investment and credit remains weak because of low rates of
capacity utilization and uncertainty about the economic recovery. Deposit
growth accelerated sharply as investors moved funds out of riskier assets and
households increased their savings rate. Inflation reached a 56-year low in
the summer, reflecting previous sharp declines in energy prices, the slack in
the economy and a strong Canadian dollar. This low inflation environment
allowed the Bank of Canada to reduce overnight lending rates to a record-low
25 basis points in an effort to stimulate demand.
The U.S. economy also contracted sharply in the first half of 2009 as a result
of steep declines in business investment, residential construction and
exports, and continued weakness in consumer spending. However, the longest
recession in seven decades likely ended this summer, with growth resuming in
response to aggressive monetary and fiscal stimulus and improving global
demand. As well, the credit market environment, which worsened early in the
year, improved dramatically in the spring and summer in response to a number
of government support programs for the financial sector. Although credit
remains restrained and growth in personal and business loans remains weak, the
cost of borrowing has declined sharply since early this year. As a result of
tax incentives and unprecedented levels of affordability, the housing market
slump of the past three years appears to have ended. The Federal Reserve
reduced interest rates again at the start of our fiscal year and has
subsequently held its target rate near zero, while further expanding its
liquidity provisions to support the economy.
Economic and Financial Services Outlook for 2010
The Canadian economy is expected to grow moderately in 2010, supported by low
interest rates, government spending and a healthier global economic climate.
Consumer and business spending will likely strengthen, supporting demand for
credit. Housing activity should remain firm, buoying demand for residential
mortgages. However, exports will likely be restrained by the strong currency
and soft U.S. demand. The Bank of Canada is expected to begin raising interest
rates in the summer. The Canadian dollar is expected to strengthen further
relative to the U.S. dollar, supported by rising commodity prices.
The U.S. economy is also expected to grow moderately in 2010, as the housing
market recovers and credit conditions ease. Demand for business credit and
residential mortgages should improve through the year, although personal
spending and credit will be constrained by large household debts and lingering
high unemployment. Given the subdued inflation environment, the Federal
Reserve is not expected to raise interest rates until the second half of 2010.
Capital markets are expected to continue strengthening as the economy recovers
and business confidence improves.
34 BMO Financial Group 192nd Annual Report 2009
Value Measures
Highlights
- Total shareholder return (TSR) - Low equity valuations in 2008 have reduced the average annual return to 1.8% over
the past five years. Our one-year TSR in 2009 was a strong 25.1%, much better than comparable indices.
- Earnings per share (EPS) growth - EPS fell 18% from 2008 in difficult market conditions, due primarily to increased
provisions for credit losses, higher income taxes and an increase in the number of shares outstanding as we chose to
bolster capital levels.
- Net income was down 10% but reached $1.8 billion in a challenging year. Results were lower than 2008 as Corporate
Services recorded reduced revenues and higher provisions for credit losses. P&C Canada and BMO Capital Markets
recorded strong net income, with results up appreciably from 2008.
- Return on equity (ROE) was 9.9% in 2009, compared with 13.0% in 2008. The reduction was primarily attributable to
increased common and preferred shares, as well as lower net income.
- We maintained our dividend payments at $2.80 per common share in 2009. Dividends paid over five-year and ten-year
periods have increased at average annual compound rates of 13.3% and 11.7%, respectively.
Total Shareholder Return
The five-year average annual TSR is a key measure of shareholder value and is
the most important of our financial performance and condition measures, since
it assesses our success in achieving our guiding principle of maximizing
return to shareholders. Over the past five years, shareholders have earned an
average annual TSR of 1.8% on their investment in BMO common shares. Low
valuations in the difficult equity market conditions of 2008 were the major
contributor to the low average return. The five-year average annual return was
lower than the 6.9% average annual return for the S&P/TSX Composite Total
Return Index, but higher than the negative 0.2% return for the S&P/TSX
Financial Services Total Return Index and the 0.3% return for the S&P 500
Total Return Index. The one-year return was strong, at 25.1%, and was
significantly above the returns of the comparable indices.
The table below summarizes dividends paid on BMO common shares over the past
five years and the movements in BMO's share price. An investment of $1,000 in
Bank of Montreal common shares made at the beginning of fiscal 2005 would have
been worth $1,093 at October 31, 2009, assuming reinvestment of dividends, for
a total return of 9.3%. We maintained our dividend payments at $0.70 per
common share in each quarter of 2009, consistent with 2008. Dividends paid
over five-year and ten-year periods have increased at average annual compound
rates of 13.3% and 11.7%, respectively.
The average annual TSR of 1.8% for the most recent five-year period increased
from the 0.9% average annual return for the five years ended October 31, 2008.
The averages are affected by the one-year TSRs included in the calculations.
Page 28 provides further comment on total shareholder return and includes peer
group comparisons.
The five-year average annual total shareholder return (TSR) represents the
average annual total return earned on an investment in BMO common shares made
at the beginning of a five-year period. The return includes the change in
share price and assumes that dividends received were reinvested in additional
common shares. The one-year TSR also assumes that dividends were reinvested in
shares.
Total Shareholder Return
Five-year
For the year ended October 31 2009 2008 2007 2006 2005 CAGR(1)
Closing market price per common
share ($) 50.06 43.02 63.00 69.45 57.81 (2.8)%
Dividends paid ($ per share) 2.80 2.80 2.63 2.13 1.80 13.3
Dividends paid (%) (2) 6.5 4.4 3.8 3.7 3.1
Increase (decrease) in share
price (%) 16.4 (31.7) (9.3) 20.1 0.5
Total annual shareholder return
(%) 25.1 (27.9) (5.8) 24.1 3.7
Total annual shareholder return assumes reinvestment of quarterly dividends
and therefore does not equal the sum of dividend and share price returns in
the table.
(1) Compound annual growth rate (CAGR).
(2) As a percentage of the closing market price in the prior year.
35 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Earnings per Share Growth
The year-over-year percentage change in earnings per share (EPS) is our key
measure for analyzing earnings growth. All references to EPS are to diluted
EPS, unless indicated otherwise.
Earnings per share (EPS) is calculated by dividing net income, after deduction
of preferred dividends, by the average number of common shares outstanding.
Diluted EPS, which is our basis for measuring performance, adjusts for
possible conversions of financial instruments into common shares if those
conversions would reduce EPS, and is more fully explained in Note 26 on page
153 of the financial statements.
EPS was $3.08, down $0.68 or 18% from $3.76 in 2008. Certain notable items
affected results in 2009 and 2008, reducing EPS by $0.88 in 2009 and $0.84 in
2008. We also recorded elevated provisions for credit losses in both 2009 and
2008 and higher income taxes in 2009.
Our five-year compound average annual EPS growth rate was -6.9%, well below
our medium-term target of 10% because of low earnings in 2009 and an increase
in the number of common and preferred shares outstanding as we chose to
bolster capital levels in the difficult economic environment.
The notable items that reduced net income by $474 million or $0.88 per share
in 2009 were:
- charges for certain trading activities and valuation adjustments related to the deterioration in capital markets of
$521 million ($355 million after tax and $0.66 per share) recorded in BMO Capital Markets;
- severance costs of $118 million ($80 million after tax and $0.15 per share) recorded in Corporate Services; and
- an increase in the general allowance for credit losses of $60 million ($39 million after tax and $0.07 per share)
recorded in Corporate Services.
In 2008, the notable items that reduced net income by $426 million or $0.84
per share were:
- charges for certain trading activities and valuation adjustments related to the deterioration in capital markets of
$388 million ($260 million after tax and $0.51 per share) recorded in BMO Capital Markets; and
- an increase in the general allowance for credit losses of $260 million ($166 million after tax and $0.33 per share)
recorded in Corporate Services.
We chose to redefine notable items in 2009 as it became apparent that certain
items could more appropriately be considered typical of our ongoing business
activities. As such, amounts related to notable items detailed for 2008 differ
from the amounts reported a year ago. Notable items are detailed on page 38.
Net income was $1,787 million in 2009, down $191 million or 10% from $1,978
million a year ago. As explained above, net income was reduced in both 2009
and 2008 by certain notable items and by elevated provisions for credit
losses. Revenue growth was strong, outpacing expense growth. However, earnings
were lowered by the elevated provisions for credit losses and less favourable
income taxes. Specific provisions for credit losses increased $473 million
($318 million after tax) and total provisions for credit losses increased $273
million ($184 million after tax). Notable items lowered net income in 2009 by
$48 million more than in 2008, despite the smaller increase in the general
allowance for credit losses. Revenues in 2009 increased $859 million or 8% to
a strong $11,064 million, notwithstanding the capital markets charges and the
difficult economic environment. Non-interest expense increased $487 million or
7%. The effective income tax rate was lower in 2008 as we recorded $160
million of recoveries of prior years' income taxes and earned a higher
proportion of income from lower-tax-rate jurisdictions.
Personal and Commercial Banking results in 2009 marked a fifth consecutive
year of solid net income, and BMO Capital Markets net income was up 49% after
having increased 70% in 2008.
Personal and Commercial Banking (P&C) net income rose $196 million or 15% from
a year ago to $1,501 million. The P&C group combines our two retail and
business banking operating segments, Personal and Commercial Banking Canada
(P&C Canada) and Personal and Commercial Banking U.S. (P&C U.S.). P&C Canada net
income rose by $183 million or 15% to $1,392 million. The improvement was
attributable to volume-driven revenue growth and improved net interest margin.
P&C Canada results are discussed in the operating group review on page 48. P&C
U.S. net income increased $13 million or 14% to $109 million, but decreased $1
million or 1% to $94 million on a U.S. dollar basis. Results a year ago
reflected a gain on the Visa Inc. initial public offering while results in the
current year were lowered by the increased impact of impaired loans. There was
strong deposit growth and reduced expenses. P&C U.S. results are discussed in
the operating group review on page 51.
Private Client Group (PCG) net income decreased $71 million or 16% to $381
million. The decrease was largely attributable to reduced revenue in our
brokerage and mutual fund businesses. PCG results are discussed in the
operating group review on page 54. BMO Capital Markets (BMO CM) net income
increased $349 million or 49% to $1,060 million as revenues increased 42% with
a comparatively low 7% increase in expenses. Trading performance was strong,
as we capitalized on market opportunities, and corporate banking revenues
improved. BMO CM results are discussed in the operating group review on page
57.
Corporate Services net loss increased $665 million to $1,155 million due to
reduced revenues, higher provisions for credit losses recorded in Corporate
Services under BMO's expected loss provisioning methodology, which is
explained in the operating group review on page 60, and higher severance costs
and income taxes.
Revenue increased $859 million or 8% to $11,064 million. The stronger U.S.
dollar added $363 million to revenue growth and business acquisitions added
$171 million. P&C Canada revenue increased $385 million or 8% and BMO Capital
Markets revenue increased by more than $1 billion or 42%. Corporate Services
revenue was lower than in 2008.
36 BMO Financial Group 192nd Annual Report 2009
Provisions for credit losses totalled $1,603 million, consisting of $1,543
million of specific provisions and a $60 million increase in the general
allowance for credit losses. In 2008, provisions for credit losses totalled
$1,330 million, consisting of $1,070 million of specific provisions and a
$260 million increase in the general allowance. The provision for credit losses
is discussed further on page 43.
Non-interest expense increased $487 million or 7% to $7,381 million.
Non-interest expense is discussed further on page 44.
Return on Equity
Return on equity (ROE) is another key value measure. ROE was 9.9% in 2009,
compared with 13.0% in 2008. The reduction was primarily attributable to
increased common and preferred shares, as well as lower net income. Common
shareholders' equity increased almost $1.5 billion or 9.1% from the end of
2008 as we decided to strengthen equity and associated capital ratios to
support investors' and depositors' confidence and provide operational
flexibility during the year. Average common shareholders' equity increased
$2.3 billion. Preferred share dividends increased $47 million or 64%,
contributing to reduced ROE. Through fiscal 2008, BMO had achieved an ROE of
13% or better for the previous 19 years, the only bank in our North American
peer group to have done so. As in 2008, our ROE compared favourably with our
global peers. Our ROE was low in the first half of 2009 but increased to 12.1%
in the third quarter and 14.0% in the fourth quarter. Our medium-term
objective is to achieve an average annual ROE of 17% to 20%, over time. Table
3 on page 97 includes ROE statistics for the past 10 years. Page 28 provides
further comment on ROE and includes peer group comparisons.
Return on common shareholders' equity (ROE)
is calculated as net income, less preferred dividends, as a percentage of
average common shareholders' equity. Common shareholders' equity is comprised
of common share capital, contributed surplus, accumulated other comprehensive
income (loss) and retained earnings.
Net Economic Profit Growth
The last of our four key value measures is net economic profit (NEP) growth.
NEP was a loss of $68 million, down from a profit of $405 million in the prior
year. The decrease was attributable to a reduction in earnings and a
significantly higher charge for capital as a result of our decision to
increase shareholders' equity. Earnings available to common shareholders were
slightly lower than the charge for capital, determined using a 10.5% rate for
cost of capital. Page 28 provides further comment on NEP growth and includes
peer group comparisons.
Net economic profit (NEP)
represents cash net income available to common shareholders, less a charge for
capital. NEP is an effective measure of economic value added. NEP is a
non-GAAP measure. See page 91.
Net Economic Profit ($ millions, except as noted)
For the year ended October 31 2009 2008 2007 2006 2005
Net income available to common
shareholders 1,667 1,905 2,088 2,633 2,366
After-tax impact of the amortization
of acquisition-related intangible
assets 35 35 38 36 74
Cash net income available to common
shareholders 1,702 1,940 2,126 2,669 2,440
Charge for capital* (1,770) (1,535) (1,523) (1,439) (1,325)
Net economic profit (68) 405 603 1,230 1,115
Net economic profit growth (%) (117) (33) (51) 10 -
*Charge for capital
Average common shareholders' equity 16,865 14,612 14,506 13,703 12,577
Cost of capital (%) 10.5 10.5 10.5 10.5 10.5
Charge for capital (1,770) (1,535) (1,523) (1,439) (1,325)
37 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
2009 Financial Performance Review
This section provides a review of our enterprise financial performance for
2009 that focuses on the Consolidated Statement of Income included in our
consolidated financial statements, which begin on page 110. A review of our
operating groups' strategies and performance follows the enterprise review. A
summary of the enterprise financial performance for 2008 is outlined on page
95.
Highlights
- Revenue increased $859 million or 8% in 2009 to a strong $11.1 billion, reflecting the benefit of our
diversified business mix as some of our businesses faced challenging conditions.
- Revenue growth in P&C Canada was primarily attributable to volume growth in most products and an improved net
interest margin. BMO Capital Markets revenues rose by more than $1 billion or 42% in 2009 due to increases in
trading revenues and corporate banking revenues and the effects of the stronger U.S. dollar.
- The provision for credit losses increased to $1,603 million from $1,330 million in 2008. Specific provisions
were up $473 million to $1,543 million and there was a $60 million increase in the general allowance, compared
with a $260 million increase a year ago. Credit market conditions remain challenging.
- Non-interest expense increased 7% in 2009, with approximately two-thirds of the increase attributable to the
stronger U.S. dollar and acquired businesses.
- The effective income tax rate was 10.5%, compared with a recovery rate of 3.6% in 2009. The tax rate in 2008
was lowered by recoveries of prior years' income taxes and proportionately higher income from lower-tax-rate
jurisdictions.
Notable Items
We chose to redefine notable items in 2009 as it became apparent that certain
items could more appropriately be considered typical of our ongoing business
activities. As such, amounts related to notable items detailed for 2008 and
2007 differ from the amounts reported a year ago.
We have designated certain charges as notable items to assist in discussing
their impact on our financial results. These items reduced net income by $474
million in 2009, $426 million in 2008 and $637 million in 2007, as set out in
the adjacent table. Charges in 2009, 2008 and 2007 include amounts related to
BMO's investment in Apex Trust, a Canadian credit protection vehicle. In the
latter half of 2009, we put in place hedges that reduced BMO's risk exposure
on Apex to levels that are not expected to expose BMO to significant loss.
In 2009, revenue was reduced by charges of $521 million related to Apex. These
charges reduced trading non-interest revenues by $344 million and securities
gains by $177 million.
In 2008, revenue was reduced by charges of $388 million in respect of the
capital markets environment, including charges of $230 million related to Apex
and $158 million in respect of exiting positions related to the monoline
insurer ACA Financial Guarantee Corporation. These charges reduced trading
non-interest revenues by $258 million and securities gains by $130 million.
In 2007, revenue was reduced by charges of $947 million, comprised of charges
of $852 million related to commodities losses and $95 million related to the
deterioration in the capital markets environment, including $80 million
related to Apex. These charges reduced trading non-interest revenue by $935
million and trading net interest income by $12 million.
Further details on the effects of notable items can be found on page 36.
Notable Items
($ millions) 2009 2008 2007
Charges related to deterioration in capital markets environment 521 388 95
Related income taxes 166 128 34
Net impact of charges related to deterioration in capital markets
environment (a) 355 260 61
Commodities losses - - 852
Performance-based compensation - - (120)
Related income taxes - - 292
Net impact of commodities losses (b) - - 440
Increase in general allowance 60 260 50
Related income taxes 21 94 17
Net impact of increase in general allowance (c) 39 166 33
Severance costs 118 - -
Related income taxes 38 - -
Net impact of severance costs (d) 80 - -
Restructuring charge (1) - - 159
Related income taxes - - 56
Net impact of restructuring (e) - - 103
Total reduction in net income (a + b + c + d + e) 474 426 637
(1) Modest recoveries of restructuring charges of $10 million in 2009
and $8 million in 2008 have been excluded from notable items.
38 BMO Financial Group 192nd Annual Report 2009
Foreign Exchange
The U.S. dollar was weaker at October 31, 2009 than at October 31, 2008 and
assets and liabilities are translated at year-end rates. However, the average
exchange rate over the course of 2009 is used for translation of revenues and
expenses and the U.S. dollar strengthened on this basis. The Canadian dollar
equivalents of BMO's U.S.-dollar-denominated net income, revenues, expenses,
income taxes and provision for credit losses in 2009 were increased relative
to the preceding year by the strengthening of the U.S. dollar. The adjacent
table indicates average Canadian/U.S. dollar exchange rates in 2009, 2008 and
2007 and the impact of higher average rates. At October 31, 2009, the Canadian
dollar traded at $1.0819 per U.S. dollar.
At the start of each quarter, BMO decides whether to enter into hedging
transactions that are designed to partially offset the pre-tax effects of
exchange rate fluctuations in the quarter on our expected
U.S.-dollar-denominated net income for that quarter. As such, these activities
partially mitigate the impact of exchange rate fluctuations, but only within
that quarter. As a result, the sum of the hedging gains/losses for the four
quarters in a year is not directly comparable to the impact of year-over-year
exchange rate fluctuations on earnings for the year. Hedging transactions
resulted in an after-tax loss of $1 million in 2009 ($11 million loss in
2008).
The gain or loss from hedging transactions in future periods will be
determined by both future exchange rate fluctuations and the amount of the
underlying future hedging transactions, since the transactions are entered
into each quarter in relation to expected U.S.-dollar-denominated net income
for the next three months. The effect of exchange rate fluctuations on our net
investment in foreign operations is discussed in the Provision for Income
Taxes section on page 45.
Effects of Changes in Exchange Rates on BMO's Results
2009 vs. 2008 vs.
($ millions, except as noted) 2008 2007
Canadian/U.S. dollar exchange rate (average)
2009 1.165
2008 1.032 1.032
2007 1.093
Increased (reduced) net interest income 246 (48)
Increased (reduced) non-interest revenue 117 (15)
Increased (reduced) revenues 363 (63)
Reduced (increased) expenses (216) 93
Reduced (increased) provision for credit losses (125) 28
Reduced (increased) income taxes 24 (6)
Increased net income 46 52
BMO's U.S.-dollar-denominated results are affected, favourably or
unfavourably, by movements in the Canadian/U.S. dollar exchange rate. Rate
movements affect future results measured in Canadian dollars and the impact on
results is a function of the periods in which revenues, expenses and
provisions for credit losses arise. If future results are consistent with the
range of results for the past three years, each one cent decrease in the
Canadian/U.S. dollar exchange rate, expressed in terms of how many Canadian
dollars one U.S. dollar buys, would be expected to change net income before
income taxes by between $9 million and -$5 million. An increase of one cent
would have the opposite effect.
Impact of Business Acquisitions
BMO Financial Group has selectively acquired a number of businesses. These
acquisitions increase revenues and expenses, affecting year-over-year
comparisons of operating results. The adjacent table outlines acquisitions by
operating group and their impact on BMO's revenues, expenses and net income
for fiscal 2009 relative to fiscal 2008 and fiscal 2008 relative to fiscal
2007, to assist in analyzing changes in results.
In respect of fiscal 2009 results relative to fiscal 2008, for the
acquisitions completed in fiscal 2009, the incremental effects are the
revenues and expenses of those businesses that are included in results for
fiscal 2009. For the acquisitions completed in fiscal 2008, the incremental
effects on results for 2009 relate to the inclusion of 12 months of results in
2009 and a lesser number of months in 2008.
In respect of fiscal 2008 results relative to fiscal 2007, for the
acquisitions completed in fiscal 2008, the incremental effects are the
revenues and expenses of those businesses that are included in results for
fiscal 2008. For the acquisitions completed in fiscal 2007, the incremental
effects on results for 2008 relate to the inclusion of 12 months of results in
2008 and a lesser number of months in 2007.
Subsequent to the year end, we announced that we had reached definitive
agreements to acquire Paloma Securities L.L.C. and the Diners Club North
American franchise, as described in Note 12 on page 137 of the financial
statements.
Impact of Business Acquisitions on Year-over-Year Comparisons* ($ millions)
Increase (decrease) in:
Business acquired/sold Revenue Expense Net income
Personal and Commercial Banking
Incremental effects on results for: 2009 36 36 (1)
2008 51 46 (1)
Merchants and Manufacturers Bancorporation, Inc.
Acquired February 2008 for $135 million
Ozaukee Bank
Acquired February 2008 for $180 million
First National Bank & Trust
Acquired January 2007 for $345 million
bcpbank Canada
Acquired December 2006 for $41 million
Private Client Group
Incremental effects on results for: 2009 64 41 16
2008 11 12 (1)
Stoker Ostler Wealth Advisors, Inc.
Acquired September 2009 for $12 million
AIG Life Insurance Company of Canada (BMO Life Assurance)
Acquired April 2009 for $330 million
Pyrford International plc
Acquired December 2007 for $47 million
BMO Capital Markets
Incremental effects on results for: 2009 71 50 13
2008 14 16 (1)
Griffin, Kubik, Stephens & Thompson, Inc.
Acquired May 2008 for $31 million
BMO Financial Group
Incremental effects on results for: 2009 171 127 28
2008 76 74 (3)
Purchases of businesses for $342 million in 2009 and for $393 million in 2008
*The impact excludes integration costs.
39 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Revenue
Revenue increased $859 million or 8% in 2009 to a strong $11,064 million.
Revenue was reduced by charges of $521 million in 2009 and $388 million in
2008 related to the impact of the capital markets environment. There was solid
revenue growth in each of the operating groups except Private Client Group and
Corporate Services. The stronger U.S. dollar increased overall revenue growth
by $363 million or 3.5 percentage points, while the net impact of acquired
businesses increased growth by $171 million or 1.7 percentage points.
BMO analyzes revenue at the consolidated level based on GAAP revenues
reflected in the financial statements rather than on a taxable equivalent
basis (teb), consistent with our Canadian peer group. Like many banks, we
continue to analyze revenue on a teb basis at the operating group level. The
teb adjustments for fiscal 2009 totalled $189 million, down from $195 million
in 2008.
P&C Canada revenue increased $385 million or 8%. The segment's revenue growth
was driven by volume growth in most products and an improved net interest
margin. P&C U.S. revenue increased US$14 million or 2%. Excluding the US$38
million gain on the sale of a portion of our investment in Visa on its initial
public offering in 2008 and the US$29 million increase in the impact of
impaired loans, revenue increased US$81 million or 9%, reflecting strong
deposit growth, a full year of results for our Wisconsin acquisitions and
higher gains on the sale of mortgages. Private Client Group revenue decreased
$134 million or 6%. The decrease was primarily due to lower fee-based revenue
in our brokerage and mutual fund businesses and lower net interest income due
to spread compression on deposit balances in our brokerage businesses. BMO
Capital Markets revenue increased $1,026 million or 42%, even though charges
for notable items were $133 million higher than in 2008. Revenue growth was
largely driven by significantly higher trading revenue, improved corporate
banking revenues and underwriting fees and the stronger U.S. dollar. Corporate
Services revenues were significantly lower due to market conditions.
Taxable equivalent basis (teb) Revenues of operating groups reflected in our
MD&A are presented on a taxable equivalent basis (teb). The teb adjustment
increases GAAP revenues and the provision for income taxes by an amount that
would increase revenues on certain tax-exempt securities to a level that would
incur tax at the statutory rate, to facilitate comparisons.
Net interest income is comprised of earnings on assets, such as loans and
securities, including interest and dividend income and BMO's share of income
from investments accounted for using the equity method of accounting, less
interest expense paid on liabilities, such as deposits. Net interest margin is
the ratio of net interest income to earning assets, expressed as a percentage
or in basis points.
Revenue ($ millions)
For the year ended October 31 2009 2008 2007 2006 2005
Net interest income 5,570 5,072 4,829 4,732 4,776
Year-over-year growth (%) 9.8 5.0 2.0 (0.9) (0.5)
Non-interest revenue 5,494 5,133 4,520 5,253 5,063
Year-over-year growth (%) 7.0 13.6 (14.0) 3.8 11.2
Total revenue 11,064 10,205 9,349 9,985 9,839
Year-over-year growth (%) 8.4 9.2 (6.4) 1.5 5.2
Net Interest Income
Net interest income for the year was $5,570 million, an increase of $498
million or 10% from 2008. The net effect of businesses acquired increased net
interest income by $33 million, while the impact of the stronger U.S. dollar
increased net interest income by $246 million. The bank's average earning
assets increased $15 billion. BMO's overall net interest margin was up 8 basis
points in 2009 due to the impact of securitization of low-margin mortgages and
deposit growth outpacing loan growth in P&C Canada. There were also wider
spreads in corporate lending and interest-rate-sensitive businesses, as well
as increased trading net interest income in BMO Capital Markets. These
increases were offset in large part by reduced net interest income in
Corporate Services. The main drivers of BMO's overall net interest margin are
the individual group margins, changes in the magnitude of each operating
group's assets and changes in net interest income in Corporate Services.
Change in Net Interest Income, Average Earning Assets and Net Interest Margin
Net interest income (teb) Average earning assets Net interest margin
(in basis points)
($ millions) Change ($ millions) Change
For the year
ended October 31 2009 2008 $ % 2009 2008 $ % 2009 2008 Change
P&C Canada 3,738 3,436 302 9 119,313 120,999 (1,686) (1) 313 284 29
P&C U.S. 892 748 144 19 28,594 24,913 3,681 15 312 300 12
Personal and Commercial
Banking (P&C) 4,630 4,184 446 11 147,907 145,912 1,995 1 313 287 26
Private
Client Group 353 376 (23) (6) 10,567 7,855 2,712 35 334 478 (144)
BMO
Capital Markets 1,798 1,207 591 49 179,372 176,080 3,292 2 100 69 31
Corporate
Services,
including
Technology
and Operations (1,211) (695) (516) (74) 4,002 (3,044) 7,046 +100 nm nm nm
Total BMO (1) 5,570 5,072 498 10 341,848 326,803 15,045 5 163 155 8
(1) Total BMO net interest margin is stated on a GAAP basis. The operating groups net
interest margins are stated on a teb basis.
nm - not meaningful
40 BMO Financial Group 192nd Annual Report 2009
P&C Canada recorded a solid increase in net interest income. Volume growth
remained strong in all major product categories except mortgages. Net interest
margin increased 29 basis points. Approximately half of the increase was due
to securitizing low-margin mortgages, while the remainder was primarily
attributable to deposit growth outpacing loan growth and actions taken to
mitigate the impact of long-term funding costs. In P&C U.S., the impact of
strong deposit growth was partly offset by higher levels of impaired loans.
The contribution to total growth in net interest income was improved by the
stronger U.S. dollar.
Private Client Group net interest income decreased primarily due to lower
deposit balances in our brokerage businesses. The group's net interest margin
decreased 144 basis points, with approximately half the decrease due to the
acquisition of BMO Life Assurance, which increased assets with no change to
net interest income. The remaining decrease was due mainly to lower deposit
income in the brokerage businesses, driven by lower spreads in the low
interest rate environment.
BMO Capital Markets net interest income increased $591 million or 49%.
Revenues from interest-rate-sensitive businesses were higher and trading and
corporate banking net interest income also increased. The group's average
earning assets increased $3 billion. There were increases in corporate lending
assets partially offset by a reduction in trading assets. The group's net
interest margin was higher due to wider spreads in corporate lending and
interest-rate-sensitive businesses, as well as increased trading net interest
income.
Corporate Services net interest income was lower due to the negative carry on
certain asset-liability interest rate positions as a result of changes in
market interest rates, the impact of funding activities that were undertaken
to enhance our strong liquidity position, and credit card securitizations
completed in 2008. Corporate Services net interest income improved in each
quarter subsequent to the first quarter of 2009, due in part to management
actions and more stable market conditions.
Table 9 on page 100 and Table 10 on page 101 provide further details on net
interest income and net interest margin.
Non-Interest Revenue
Non-interest revenue, which comprises all revenues other than net interest
income, was $5,494 million in 2009, an increase of $361 million or 7% from
2008. Higher charges in respect of notable items reduced revenue by $133
million from 2008 and year-over-year growth by two percentage points. The net
impact of acquired businesses increased 2009 non-interest revenue by $138
million, while the impact of the stronger U.S. dollar increased non-interest
revenue by $117 million.
Securities commissions and fees decreased $132 million or 12%. These fees
consist largely of full-service and online brokerage commissions within
Private Client Group, which account for about two-thirds of the total, and
institutional equity trading commissions within BMO Capital Markets. The
decrease was due to reductions in client trading volumes, as well as
competitive pricing pressures. Equity market valuations improved in the latter
half of the year.
Deposit and payment service charges increased $64 million or 8%, largely due
to volume growth. P&C Canada, P&C U.S. and BMO Capital Markets each accounted
for about a third of the growth.
Trading revenues are discussed in the trading-related revenues section that
follows.
Lending fees increased $127 million or 30% due to higher volumes.
Card fees decreased $170 million to $121 million. The decrease reflects
reductions related to increased securitization activity over the course of
2008, offset in part by the effects of increased cards transactions.
Investment management and custodial fees increased $5 million or 1% despite
weak equity markets.
Mutual fund revenues declined $122 million or 21%, building on the slowdown in
growth that began in the fourth quarter of 2008. Fees were again affected by
reduced managed asset values in the difficult market conditions. Asset levels
improved in the latter half of the year.
Non-Interest Revenue ($ millions)
Change from 2008
For the year ended October 31 2009 2008 2007 $ %
Securities commissions and fees 973 1,105 1,145 (132) (12)
Deposit and payment service
charges 820 756 728 64 8
Trading revenues 723 546 (487) 177 32
Lending fees 556 429 406 127 30
Card fees 121 291 107 (170) (58)
Investment management and
custodial fees 344 339 322 5 1
Mutual fund revenues 467 589 576 (122) (21)
Securitization revenues 929 513 296 416 81
Underwriting and advisory fees 397 353 528 44 12
Securities gains (losses), other
than trading (354) (315) 247 (39) (12)
Foreign exchange, other than
trading 53 80 132 (27) (34)
Insurance income 295 237 246 58 24
Other 170 210 274 (40) (19)
Total 5,494 5,133 4,520 361 7
Securitization revenues increased $416 million or 81% to $929 million. The
increase was attributable to $298 million from securitizing credit card loans
and $118 million from securitizing residential mortgages. Revenues included
gains of $98 million on the sale of loans for new securitizations, down $38
million from 2008, and gains of $602 million on sales of loans to revolving
securitization vehicles, up $318 million from 2008. The securitization of
assets results in the recognition of less interest income ($689 million less
in 2009), reduced credit card fees ($489 million less in 2009) and lower
provisions for credit losses ($172 million less in 2009). As such, securitizations
decreased pre-tax income by approximately $77 million in 2009. We securitize
loans for capital management purposes and to obtain alternate sources of funding.
We securitized $6.8 billion of residential mortgage loans in 2009 and $8.5 billion
in 2008. We securitized $3.2 billion of credit card loans in 2008. Securitization
revenues are detailed in Note 8 on page 125 of the financial statements.
41 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Underwriting and advisory fees were $44 million or 12% higher than in 2008.
Equity and debt underwriting fees increased as corporate clients strengthened
their balance sheets and improved liquidity. These increases were partially
offset by lower merger and acquisition fees.
Securities losses increased $39 million to a net loss of $354 million in 2009.
The notable items discussed on page 38 include charges of $177 million related
to the deterioration in the capital markets environment that were recorded in
securities gains (losses). Similar charges of $130 million were recorded in
2008. The charges in 2009 related to Apex. The charges in 2008 related to Apex
and to exiting positions related to monoline insurer ACA Financial Guarantee
Corporation.
Income from foreign exchange, other than trading, decreased $27 million or
34%.
Insurance income increased $58 million or 24%, which was entirely accounted
for by the BMO Life Assurance acquisition.
Other revenue includes various sundry amounts and fell $40 million or 19%.
Table 7 on page 98 provides further details on revenue and revenue growth.
Trading-Related Revenues
Trading-related revenues are dependent on, among other things, the volume of
activities undertaken for clients who enter into transactions with BMO to
mitigate their risks or to invest. BMO earns a spread or profit on the net sum
of its client positions by profitably neutralizing, within prescribed limits,
the overall risk of the net positions. BMO also assumes proprietary positions
with the goal of earning trading profits.
Although the North American economy was in recession for much of the year, our
trading-related revenues were strong in 2009 due to our focus on clients and
successfully taking advantage of market opportunities presented by high levels
of market volatility. The capital markets environment was extremely unsettled
in 2008 and the first half of 2009, having been affected by significantly
diminished business and investor confidence that reduced liquidity in the
marketplace, widened credit spreads and resulted in significant reductions in
both fixed-income and equity valuations. The Notable Items section on page 38
outlines charges related to difficulties in the capital markets environment
that reduced trading revenue by $344 million and total revenue by $521 million
in 2009. It outlines comparable charges in 2008 that reduced trading revenue
by $258 million and total revenue by $388 million. The section also refers
readers to the Select Financial Instruments section, which starts on page 65
and provides detailed information on certain instruments that markets had come
to regard as carrying higher risk.
Trading-related revenues include net interest income and non-interest revenue
earned from on and off-balance sheet positions undertaken for trading
purposes. The management of these positions typically includes marking them to
market on a daily basis. Trading revenues include income (expense) and gains
(losses) from both cash instruments and interest rate, foreign exchange
(including spot positions), equity, commodity and credit derivative contracts.
Trading-Related Interest and Non-Interest Revenues ($ millions)
Change from 2008
For the year ended October 31 2009 2008 2007 $ %
Interest rates 467 176 15 291 +100
Foreign exchange 362 379 273 (17) (4)
Equities 351 110 189 241 +100
Commodities 79 (18) (852) 97 +100
Other (168) 18 42 (186) (+100)
Total 1,091 665 (333) 426 64
Reported as:
Net interest income 368 119 154 249 +100
Non-interest revenue - trading revenues
(losses) 723 546 (487) 177 32
Total 1,091 665 (333) 426 64
In 2007, we recorded charges of $947 million that reduced trading-related
revenues, including $852 million of losses in our commodities trading
business. On November 18, 2008, a number of proceedings were commenced by
securities, commodities, banking and law enforcement authorities against
certain parties that were involved in activities related to the 2007
commodities trading losses. BMO is not a party to these proceedings.
Trading-related revenues increased $426 million from 2008. Interest rate
trading revenues were significantly higher in 2009 and were very volatile
during the year. There were relatively weak revenues in the first half of the
year and very strong revenues in the third quarter, due to very attractive
market opportunities and, in part, to lower trading valuation adjustments.
Equities trading revenues were also strong and appreciably higher than a year
ago, while foreign exchange revenues remained high, in line with results a
year ago. Foreign exchange trading revenues decreased in the latter half of
2009 due to narrowing spreads and increased liquidity. Equity trading revenues
were also stronger at the start of the year. Other trading revenues were
affected by the impact of hedging exposures in our structural balance sheet
position and securitization-related hedges.
The Market Risk section on page 82 provides more information on trading-related
revenues.
42 BMO Financial Group 192nd Annual Report 2009
Provision for Credit Losses
Credit conditions remained difficult through 2009, with indications of
stabilization appearing in the latter half of the year as a number of economic
developments increased confidence that the current recession was unlikely to
worsen.
BMO recorded a $1,603 million provision for credit losses in 2009, consisting
of $1,543 million of specific provisions and a $60 million increase in the
general allowance for credit losses. These amounts compare to the $1,330
million provision recorded in 2008, comprised of specific provisions of $1,070
million and a $260 million increase in the general allowance. The 2009
increase in the general allowance was primarily due to credit deterioration
within the loans portfolio and the weak economic environment.
As illustrated in the adjoining table, specific provisions for credit losses
during the year were higher than in prior periods. The 2009 specific
provisions included a $41 million one-time increase related to a change in
provisioning for the consumer loan portfolio in Canada, while provisions a
year ago included $336 million related to two corporate loans associated with
the U.S. housing market. An increase in provisions in our consumer book is
consistent with the current economic challenges. Although the U.S. portfolio
is exhibiting relatively more stress than the Canadian portfolio, it has
continued to perform better than our U.S. peer group's portfolios.
The most significant factor influencing both provisions for credit losses and
write-offs is the level of formations of new impaired loans - identified as
additions to impaired loans and acceptances in the adjacent Changes in Gross
Impaired Loans and Acceptances table. As with specific provisions and
consistent with a year ago, impaired loan formations were well above the low
levels of 2007 and 2006, totalling $2,690 million in 2009, up from $2,506
million in 2008. On a geographic basis, the United States accounted for the
majority of the 2009 formations, while real estate, manufacturing and
financial services were the industry sectors making the largest contributions
to formations in the year.
BMO's credit portfolio continued to be affected by the economic environment,
which resulted in downward migration in the risk ratings of some exposures.
This downward migration results in increased probability of default.
Accordingly, gross impaired loans increased to $3,297 million from $2,387
million in 2008. Factors contributing to the change are outlined in the
accompanying table.
In 2009, sales of gross impaired loans totalled $97 million, with related
reversals and recoveries of $9 million. This compares with sales of $16
million and related reversals and recoveries of $3 million in 2008.
The total allowance for credit losses increased $155 million in 2009 to $1,902
million, comprised of a specific allowance of $596 million and a general
allowance of $1,306 million.
The general allowance is maintained to cover impairment in the existing credit
portfolio that cannot yet be associated with specific loans, and is assessed
on a quarterly basis. The allowance decreased $15 million from the prior
fiscal year, the impact of a weaker U.S. dollar being partially offset by the
$60 million general provision recorded during the year. The general allowance
remains adequate and, as at October 31, 2009, represented 0.91% of credit
risk-weighted assets.
Overall BMO's loan book continues to be comprised primarily of the more stable
consumer and commercial portfolios that represented 80% of the loan portfolio
at year-end, improving from 73.8% in 2008 mainly due to reduced corporate
loans. The consumer loans portfolio represents 53.9% of the portfolio, up from
49.0% in 2008, with approximately 87.7% of the portfolio secured. The
corporate and commercial portfolio represents 46.1% of the portfolio, down
from 51.0% in 2008. We continue to monitor industry sectors that we consider
to be of most concern in the current economic conditions, including the real
estate, manufacturing and forest products sectors. BMO's exposure to these
sectors remains within acceptable limits.
Credit risk management is discussed further on page 80. Note 4 on page 119 of
the financial statements and Tables 11 to 19 on pages 102 to 105 provide
details of BMO's loan portfolio, impaired loans and provisions and allowances
for credit losses.
Provision for (Recovery of) Credit Losses (PCL)
($ millions, except as noted)
For the year ended October 31 2009 2008 2007 2006 2005 2004 2003
New specific provisions 1,765 1,242 460 410 407 510 846
Reversals of previous
allowances (77) (58) (66) (87) (121) (312) (303)
Recoveries of prior
write-offs (145) (114) (91) (112) (67) (131) (88)
Specific provisions for
credit losses 1,543 1,070 303 211 219 67 455
Increase in (reduction of)
general allowance 60 260 50 (35) (40) (170) -
Provision for (recovery of)
credit losses 1,603 1,330 353 176 179 (103) 455
PCL as a % of average net
loans and acceptances (%) 0.88 0.76 0.21 0.11 0.13 (0.08) 0.36
Changes in Gross Impaired Loans (GIL) and Acceptances
($ millions, except as noted)
For the year ended October 31 2009 2008 2007 2006 2005 2004 2003
GIL, beginning of year 2,387 720 666 804 1,119 1,918 2,337
Additions to impaired loans
and acceptances 2,690 2,506 588 420 423 607 1,303
Reductions in impaired loans
and acceptances (1) (288) 131 (143) (220) (319) (936) (1,156)
Write-offs (1,492) (970) (391) (338) (419) (470) (566)
GIL, end of year 3,297 2,387 720 666 804 1,119 1,918
GIL as a % of gross loans and
acceptances (excluding repos)
(%) 1.94 1.26 0.44 0.41 0.55 0.83 1.51
(1) Includes the impact of foreign exchange and write-offs of consumer loans
included in additions to impaired loans in the period.
Caution
This Provision for Credit Losses section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
43 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Non-Interest Expense
Non-interest expense increased $487 million or 7.1% to $7,381 million in 2009.
The factors contributing to the increase are set out in the adjacent
Contribution to Non-Interest Expense Growth table. Notable items in 2009
included severance costs that increased non-interest expense by $118 million
(1.7%).
As explained on page 39, the net effect of businesses acquired in 2009 and
2008 increased expenses in 2009 relative to 2008 by $127 million (1.8%). As
further explained on page 39, the stronger U.S. dollar increased costs in 2009
by $216 million (3.1%).
Higher performance-based compensation costs increased expenses by $41 million
(0.6%). A reduction in these costs in Private Client Group partially offset
increases in all other groups.
The dollar and percentage changes in expenses by category are outlined in the
adjacent Non-Interest Expense table. Table 8 on page 99 provides more detail
on expenses and expense growth.
Other employee compensation expense, which includes salaries and employee
benefits, was $368 million or 14% higher than in 2008. Approximately one-third
of this increase was due to the $118 million of severance costs, one-third to
higher benefit costs and the remainder to business acquisitions in P&C U.S.
and Private Client Group and the stronger U.S. dollar. Benefit costs were
raised by higher pension costs. Staffing levels were reduced in 2009 by 900
full-time equivalent staff or 2.4% to 36,173 full-time equivalent staff at
October 31, 2009 as a result of expense management efforts.
Premises and equipment costs increased $40 million or 3%, primarily due to
branch renovations and acquisition costs.
Other expenses rose $20 million or 1%. A $77 million increase in deposit
insurance premium costs was partially offset by reductions in travel and
business initiative costs.
Productivity
The productivity ratio (expense-to-revenue ratio) improved by 90 basis points
to 66.7% in 2009. BMO's overall ratio in any year is affected by the revenues
in each of the operating groups and Corporate Services. The productivity ratio
of each group over the years has typically been quite different because of the
nature of their businesses as well as the external environment.
P&C's productivity ratio improved to 58.4% from 60.3%. P&C Canada is BMO's
largest operating segment, and its productivity ratio of 54.0% improved by 210
basis points from last year, after having deteriorated by 70 basis points in
2008. The productivity ratio in P&C U.S. improved by 200 basis points despite
difficult market conditions as costs were reduced on a U.S. dollar basis. The
productivity ratio for Private Client Group in 2009 deteriorated by 500 basis
points to 76.4%, reflecting reduced revenue in the context of weaker equity
markets. BMO Capital Markets' productivity ratio improved a substantial 1,770
basis points due to extremely strong revenue growth. Excluding the notable
items that affected results in both 2009 and 2008, BMO's productivity ratio
improved by 240 basis points to 62.7%.
BMO's cash productivity ratio was 66.3%, an 80 basis point improvement from
67.1% in 2008, notwithstanding higher amounts related to notable items charged
to revenue and expense in 2009.
Examples of initiatives to enhance productivity are outlined in the 2009
Review of Operating Groups Performance, which starts on page 46. Our
medium-term goal, over time, is to achieve average annual cash operating
leverage of at least 2%, increasing revenues by an average of at least two
percentage points more than the rate of cash-based expense growth. We aim to
achieve operating leverage by driving revenues through an increased customer
focus and ongoing expense management, working to create greater efficiency and
effectiveness in all support functions, groups and business processes that
support the front line.
The productivity ratio (or expense-to-revenue ratio) is our key measure of
productivity. It is calculated as non-interest expense divided by total
revenues (on a taxable equivalent basis in the operating groups), expressed as
a percentage. The cash productivity ratio is calculated in the same manner,
after removing the amortization of intangible assets from non-interest
expenses. See page 91.
Contribution to Non-Interest Expense Growth (%)
For the year ended October 31 2009 2008 2007
Businesses acquired 1.8 1.1 0.7
Severance costs 1.7 - -
Restructuring charge - (2.5) 2.5
Currency translation effect 3.1 (1.4) (0.9)
Performance-based compensation 0.6 0.3 (0.7)
Other factors (0.1) 6.9 2.3
Total non-interest expense growth 7.1 4.4 3.9
Non-Interest Expense ($ millions)
Change from 2008
For the year ended October 31 2009 2008 2007 $ %
Performance-based
compensation 1,338 1,297 1,275 41 3
Other employee compensation 3,047 2,679 2,550 368 14
Total employee compensation 4,385 3,976 3,825 409 10
Premises and equipment 1,281 1,241 1,161 40 3
Restructuring charge (10) (8) 159 (2) (25)
Other 1,522 1,502 1,268 20 1
Amortization of intangible
assets 203 183 188 20 11
Total 7,381 6,894 6,601 487 7
Caution
This Non-Interest Expense section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
44 BMO Financial Group 192nd Annual Report 2009
Provision for Income Taxes
The provision for income taxes reflected in the Consolidated Statement of
Income is based upon transactions recorded in income, regardless of when such
transactions are subject to taxation by tax authorities, with the exception of
the repatriation of retained earnings from foreign subsidiaries, as outlined
in Note 25 on page 152 of the financial statements.
Management assesses BMO's consolidated results and associated provisions for
income taxes on a GAAP basis. We assess the performance of the operating
groups and associated income taxes on a taxable equivalent basis and report
accordingly.
The provision for income taxes was $217 million in 2009, compared with a
recovery of income taxes of $71 million in 2008. The effective tax rate in
2009 was a tax expense rate of 10.5%, compared with a recovery rate of 3.6% in
2008. Results included a recovery of prior years' income taxes of $160 million
in 2008. The higher effective tax rate in 2009 is mainly attributable to a
lower recovery of prior years' income taxes and a lower proportion of income
from lower-tax-rate jurisdictions.
BMO hedges the foreign exchange risk arising from its investments in U.S.
operations by funding the investments in U.S. dollars. Under this program, the
gain or loss on hedging and the unrealized gain or loss on translation of
investments in U.S. operations are charged or credited to shareholders' equity.
For income tax purposes, the gain or loss on the hedging activities attracts an
income tax charge or credit in the current period, which is charged or credited
to shareholders' equity, while the associated unrealized gain or loss on the
investments in U.S. operations does not attract income taxes until the
investments are liquidated. The income tax charge/benefit arising from a hedging
gain/loss is a function of the fluctuations in exchange rates from period to
period. Hedging of the investments in U.S. operations has given rise to income
tax expense in shareholders' equity of $382 million for the year, compared with
a recovery of $881 million in 2008. Refer to the Consolidated Statement of
Changes in Shareholders' Equity on page 112 of the financial statements for
further details.
Table 8 on page 99 details the $581 million of total net government levies and
income tax expense incurred by BMO in 2009. The increase from $309 million in
2008 was primarily due to higher income tax expense.
Transactions with Related Parties
In the ordinary course of business, we provide banking services to our
directors and executives and their affiliated entities, joint ventures and
equity-accounted investees on the same terms that we offer to our customers. A
select suite of customer loan and mortgage products is offered to our
employees at rates normally accorded to our preferred customers. We also offer
employees a fee-based subsidy on annual credit card fees.
Stock options and deferred share units granted to directors and preferred rate
loan agreements for executives, relating to transfers we initiate, are
discussed in Note 28 on page 156 of the financial statements.
45 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
2009 Review of Operating Groups' Performance
This section includes an analysis of the financial results of our operating
groups and descriptions of their businesses, strategies, strengths,
challenges, key value drivers, achievements and outlooks.
Personal and Commercial Banking (P&C) (pages 47 to 53)
Net income was $1,501 million in 2009, an increase of $196 million or 15% from
2008.
Private Client Group (PCG) (pages 54 to 56)
Net income was $381 million in 2009, a decrease of $71 million or 16% from
2008.
BMO Capital Markets (BMO CM) (pages 57 to 59)
Net income was $1,060 million in 2009, an increase of $349 million or 49% from
2008.
Corporate Services, including Technology and Operations (page 60) The net loss
was $1,155 million in 2009, compared with a net loss of $490 million in 2008.
Allocation of Results
The basis for the allocation of results geographically and among operating
groups is outlined in Note 27 on page 154 of the financial statements. Certain
prior-year data has been restated, as explained on page 27. See the following
page for further information on the allocation of results.
Contributions to Revenue, Expenses, Net Income and Average Assets by Operating
Group and by Location
($ millions, except as noted)
Corporate Services,
Personal and Commercial Private BMO including
Banking Client Group Capital Markets Technology and Operations
For the year ended
October 31 2009 2008 2007 2009 2008 2007 2009 2008 2007 2009 2008 2007
Operating Groups Relative Contribution to BMO's Performance (%)
Revenue 57.8 57.5 59.3 18.2 21.0 23.1 31.3 23.9 21.1 (7.3) (2.4) (3.5)
Expenses 50.6 51.3 49.4 20.8 22.2 22.7 25.4 25.4 23.9 3.2 1.1 4.0
Net income 84.0 66.0 59.3 21.3 22.9 24.8 59.3 35.9 19.6 (64.6) (24.8) (3.7)
Average
assets 35.4 38.3 39.4 2.6 2.2 2.1 59.1 58.8 57.4 2.9 0.7 1.1
Total Revenue
Canada 5,263 4,878 4,633 1,597 1,764 1,747 1,414 1,180 1,402 (560) (211) (324)
United
States 1,133 990 908 241 219 264 1,766 1,213 492 (320) (130) (152)
Other
countries - - - 174 163 151 286 47 75 70 92 153
6,396 5,868 5,541 2,012 2,146 2,162 3,466 2,440 1,969 (810) (249) (323)
Total Expenses
Canada 2,843 2,736 2,568 1,260 1,257 1,228 893 883 741 234 135 251
United
States 895 802 693 254 237 265 851 740 688 (11) (69) 10
Other
countries - - - 22 37 8 131 128 146 9 8 3
3,738 3,538 3,261 1,536 1,531 1,501 1,875 1,751 1,575 232 74 264
Net Income
Canada 1,392 1,209 1,148 222 331 336 367 422 527 (420) 46 (68)
United
States 109 96 116 (9) (10) - 552 292 (71) (762) (562) (109)
Other
countries - - - 168 131 192 141 (3) (39) 27 26 99
1,501 1,305 1,264 381 452 528 1,060 711 417 (1,155) (490) (78)
Average Assets
Canada 124,313 125,343 118,712 8,332 5,827 4,822 128,687 105,454 94,125 5,317 (129) (1,087)
United
States 30,894 26,924 23,477 2,811 2,385 2,299 101,361 97,054 80,580 7,412 2,897 4,794
Other
countries - - - 451 446 421 28,926 31,365 32,379 44 43 53
155,207 152,267 142,189 11,594 8,658 7,542 258,974 233,873 207,084 12,773 2,811 3,760
Total
Consolidated
For the year ended
October 31 2009 2008 2007
Operating Groups Relative Contribution
to BMO's Performance (%)
Revenue 100 100 100
Expenses 100 100 100
Net income 100 100 100
Average
assets 100 100 100
Total Revenue
Canada 7,714 7,611 7,458
United
States 2,820 2,292 1,512
Other
countries 530 302 379
11,064 10,205 9,349
Total Expenses
Canada 5,230 5,011 4,788
United
States 1,989 1,710 1,656
Other
countries 162 173 157
7,381 6,894 6,601
Net Income
Canada 1,561 2,008 1,943
United
States (110) (184) (64)
Other
countries 336 154 252
1,787 1,978 2,131
Average Assets
Canada 266,649 236,495 216,572
United
States 142,478 129,260 111,150
Other
countries 29,421 31,854 32,853
438,548 397,609 360,575
46 BMO Financial Group 192nd Annual Report 2009
BMO employs a methodology for segmented reporting purposes whereby expected
credit losses are charged to the operating groups quarterly based on their
share of expected credit losses. The difference between quarterly charges
based on expected losses and required quarterly provisions based on actual
losses is charged to Corporate Services. The operating group results are
presented on an expected credit loss basis.
The actual specific provision for credit losses for P&C was $1,105 million,
comprised of $488 million in P&C Canada and $617 million in P&C U.S., compared
with $519 million, $344 million and $175 million, respectively, for the 2008
fiscal year. For Private Client Group, the actual specific provision for credit
losses for 2009 was $30 million, compared with $6 million in 2008 and, for
BMO Capital Markets, the actual specific provision for credit losses for 2009
was $408 million, compared with $545 million in 2008.
BMO analyzes consolidated revenues on a GAAP basis. However, like many banks,
BMO analyzes revenue of its operating groups and associated ratios computed
using revenue on a taxable equivalent basis (teb). This basis includes an
adjustment that increases GAAP revenues and the GAAP provision for income
taxes by an amount that would raise revenues on certain tax-exempt securities
to a level equivalent to amounts that would incur tax at the statutory rate.
The offset to the group teb adjustments is reflected in Corporate Services
revenues and income tax provisions.
In 2009, we implemented Basel II equity allocations at the operating group level,
and applied the allocations retroactive to 2008. Group returns on equity for years
prior to 2008 are no longer comparable to returns on equity computed in later years.
Personal and Commercial Banking (Canadian $ in millions, except as noted)
P&C P&C Canada
Change Change
As at or for from from
the year Fiscal Fiscal Fiscal 2008 Fiscal Fiscal Fiscal 2008
ended October 31 2009 2008 2007 $ % 2009 2008 2007 $ %
Net interest
income (teb) 4,630 4,184 4,049 446 11 3,738 3,436 3,319 302 9
Non-interest revenue 1,766 1,684 1,492 82 5 1,525 1,442 1,314 83 6
Total revenue (teb) 6,396 5,868 5,541 528 9 5,263 4,878 4,633 385 8
Provision for
credit losses 455 384 357 71 18 387 341 322 46 13
Non-interest expense 3,738 3,538 3,261 200 6 2,843 2,736 2,568 107 4
Income before income
taxes
and non-controlling
interest in
subsidiaries 2,203 1,946 1,923 257 13 2,033 1,801 1,743 232 13
Income taxes (teb) 702 641 659 61 10 641 592 595 49 9
Net income 1,501 1,305 1,264 196 15 1,392 1,209 1,148 183 15
Amortization of
acquisition-related
intangible assets
(after tax) 31 30 33 1 5 3 2 8 1 55
Cash net income 1,532 1,335 1,297 197 15 1,395 1,211 1,156 184 15
Net economic profit 853 731 602 112 17
Return on equity (%) 23.9 23.7 19.8 0.2
Cash return on
equity (%) 24.4 24.3 20.3 0.1
Cash operating
leverage (%) 3.3 (2.8) 0.3 nm 4.1 (1.5) 0.7 nm
Productivity ratio
(teb) (%) 58.4 60.3 58.9 (1.9) 54.0 56.1 55.4 (2.1)
Cash productivity
ratio (teb) (%) 57.8 59.7 58.1 (1.9) 53.9 56.1 55.3 (2.2)
Net interest margin
on earning assets (%) 3.13 2.87 2.97 0.26 3.13 2.84 2.89 0.29
Average common
equity 6,095 5,292 6,193 803 15
Average earning
assets 147,907 145,912 136,449 1,995 1 119,313 120,999 114,791 (1,686) (1)
Average loans and
acceptances 145,122 144,067 136,907 1,055 1 120,588 122,156 116,033 (1,568) (1)
Average deposits 120,407 105,729 100,815 14,678 14 96,430 86,464 82,029 9,966 12
Assets under
administration 35,544 37,122 33,258 (1,578) (4) 24,513 23,502 14,160 1,011 4
Full-time
equivalent staff 19,733 20,665 20,257 (932) (5) 16,031 16,517 16,697 (486) (3)
P&C U.S.
Change
As at or for from
the year Fiscal Fiscal Fiscal 2008
ended October 31 2009 2008 2007 $ %
Net interest
income (teb) 892 748 730 144 19
Non-interest revenue 241 242 178 (1) (1)
Total revenue (teb) 1,133 990 908 143 14
Provision for
credit losses 68 43 35 25 57
Non-interest expense 895 802 693 93 12
Income before income
taxes
and non-controlling
interest in
subsidiaries 170 145 180 25 17
Income taxes (teb) 61 49 64 12 22
Net income 109 96 116 13 14
Amortization of
acquisition-related
intangible assets
(after tax) 28 28 25 - -
Cash net income 137 124 141 13 11
Net economic profit
Return on equity (%)
Cash return on
equity (%)
Cash operating
leverage (%) 2.2 (7.0) (1.7) nm
Productivity ratio
(teb) (%) 79.0 81.0 76.3 (2.0)
Cash productivity
ratio (teb) (%) 76.0 77.5 72.8 (1.5)
Net interest margin
on earning assets (%) 3.12 3.00 3.37 0.12
Average common
equity
Average earning
assets 28,594 24,913 21,658 3,681 15
Average loans and
acceptances 24,534 21,911 20,874 2,623 12
Average deposits 23,977 19,265 18,786 4,712 24
Assets under
administration 11,031 13,620 19,098 (2,589) (19)
Full-time
equivalent staff 3,702 4,148 3,560 (446) (11)
nm - not meaningful
P&C U.S. Selected Financial Data (US$ in millions)
As at or for the
year ended October 31
Total revenue 973 959 833 14 2
Non-interest
expense 769 773 634 (4) (1)
Net income 94 95 107 (1) (1)
Cash net income 118 121 130 (3) (2)
Average earning
assets 24,504 24,103 19,855 401 2
Average loans and
acceptances 21,017 21,203 19,136 (186) (1)
Average deposits 20,596 18,657 17,218 1,939 10
47 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Personal and Commercial Banking Canada
We promise our customers a great experience and the clarity they are looking
for to help them make the right financial decisions. Collaborating with our
colleagues across the enterprise, we offer a full range of products and
services to more than seven million customers. These include solutions for
everyday banking, financing, investing, credit cards and creditor insurance,
as well as a full suite of integrated commercial and capital markets products
and financial advisory services. We're building our presence and making it
easier for customers to do business with us through an integrated national
network of BMO Bank of Montreal branches, telephone banking, online banking
and automated banking machines, along with the expertise of our mortgage
specialists and financial planners.
"We are delivering strong results by differentiating our business from
our competitors, with a clear focus on one vision and one brand promise
that both start with the customer."
Frank Techar
President and Chief Executive Officer Personal and Commercial Banking
Canada
Strengths and Value Drivers
- Strong competitive position in commercial banking, reflected in our number two ranking in market share for business
loans of $5 million and below.
- Comprehensive range of everyday banking offers combined with our industry-leading AIR MILES(R)A customer loyalty
program.
- Effective credit risk management practices that provide our customers with consistent and reliable access to
financing solutions in all economic conditions.
- Rigorous performance management system, encompassing planning, tracking, assessment and coaching.
Challenges
- Uncertainty regarding the pace of economic recovery is expected to affect demand for some products and services.
- Increased pace of change and innovation provides customers with easy access to an expanding array of products and
services from both old and new competitors.
- Strong competition for deposit accounts is reducing deposit margins.
- Demand continues to grow for resources to meet regulatory, compliance, information security and fraud management
requirements.
Our Lines of Business
Personal Banking provides financial solutions for everyday banking, financing,
investing and creditor insurance needs. We serve approximately 20% of Canadian
households. Our national integrated multi-channel sales and distribution
network offers customers convenience and choice in meeting their banking
needs.
Commercial Banking provides our small business, medium-sized enterprise and
mid-market banking clients with a broad range of banking products and
services. We offer a full suite of integrated commercial and capital markets
products and financial advisory services.
Cards and Payments Services provides flexible, secure payment options to our
customers. We are one of the largest MasterCard(R)A issuers in Canada.
Our Strategies
We aim to succeed in the Canadian market through the quality and consistency
of our customer experience and through the productivity of our sales and
distribution network.
Our Path to Differentiation
- Excel at sales leadership and performance management.
- Leverage customer insights to develop offers and drive marketing program results.
- Focus investments and allocate resources to capitalize on the highest-value sales and distribution opportunities.
- Redesign core processes and leverage technology to improve the customer experience, free up front-line capacity and
reduce operating costs.
- Build best-in-class human resources capabilities and develop strong line leaders.
Key Performance Metrics and Drivers 2009 2008 2007
Personal banking revenue ($ millions) 2,478 2,427 2,340
Personal loan growth (%) (1) 4.2 5.2 4.1
Personal deposit growth (%) 13.6 4.9 1.2
Commercial banking revenue ($ millions) 1,531 1,377 1,383
Commercial loan growth (%) (1) 1.6 9.7 8.1
Commercial deposit growth (%) 7.3 6.4 10.4
Cards revenue ($ millions) 1,254 1,074 910
Cards loan growth (%) 7.0 13.8 12.0
Operating leverage (%) 4.0 (1.2) 0.7
Revenue growth (%) 7.9 5.3 3.3
Net income growth (%) 15.1 5.3 5.7
Employee engagement index (%) (2) 75 73 75
(1) Includes current consumer loans and mortgages, acceptances and securitized loans.
(2) Source: BMO Annual Employee Survey, conducted by Burke Inc., an independent research company.
Caution
This Personal and Commercial Banking Canada section contains forward-looking
statements. Please see the Caution Regarding Forward-Looking Statements.
48 BMO Financial Group 192nd Annual Report 2009
2009 Group Objectives and Achievements
Continue to enhance the customer experience and create a differentiated
position in the Canadian market.
- We've created a customer-focused mindset across the organization. Our employees are aligned behind one vision and one
brand promise, both centred on providing our customers with a great experience. We're hiring employees who have a
predisposition for delivering great customer service and we have invested in new sales and training programs for
front-line employees to differentiate us from our competitors.
Leverage improvements in our performance management system to deliver stronger
revenue growth and greater customer loyalty.
- Revenue grew by 8% to a record $5.3 billion and customer loyalty improved. We've continued to rigorously measure our
performance to deliver stronger results and improve customer loyalty. We refined our performance management system to
ensure that we motivate and reward employees based on targets that clearly deliver improved financial performance and
customer loyalty. We also increased differentiation in pay based on performance, and we used new productivity
insights in our planning and resource allocation.
Launch attractive and compelling new offerings that drive results.
- We continue to identify what customers want and need, and we're bringing new offers to the market faster. Based on
customer insights, we introduced a number of offers that deliver on our brand promise to bring clarity to financial
decisions, including the Smart Saver Account, the Tax Free Savings Account, BMO SmartSteps, BMO FirstHome Essentials
and BMO Business Essentials. We were the first bank in Canada to offer a Registered Disability Savings Plan. We also
simplified and enhanced our entire suite of credit card products to deliver more rewards and make it easier for
customers to choose a credit card that meets their needs.
- On November 24, 2009, we announced an agreement to purchase the Diners Club North American franchise. The acquisition
will provide our customers with access to a premier card program for employee travel and entertainment expenses.
Improve productivity of our sales and distribution network.
- We continued to invest in our sales and distribution network, building 12 new branches and redeveloping 20 others.
- We are building a new integrated customer contact centre in the Greater Toronto Area that is scheduled to open in
November 2010.
- We continued investing in improved online capabilities, providing our customers with more information and making it
easier for them to manage their finances.
Redesign core processes and technologies to achieve a high-quality customer
experience, create capacity for customer-facing employees and reduce costs.
- We redesigned our account opening process to enhance the consistency and quality of the customer experience.
- We improved various branch processes to free up employee capacity, including automating a number of activities and
moving other functions to the back office.
- We streamlined branch reports, which reduced our consumption of paper by 10 million sheets annually.
2010 Group Objectives
- Continue to enhance the customer experience and create a differentiated position in the Canadian market.
- Leverage improvements in our performance management system to deliver stronger revenue growth and greater customer
loyalty.
- Launch attractive and compelling new offers that drive results.
- Improve productivity of our sales and distribution network.
- Redesign core processes and technologies to achieve a high-quality customer experience, create capacity for
customer-facing employees and reduce costs.
49 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Canadian Business Environment and Outlook
The recession that began in Canada in late 2008 continued into the first half
of 2009. Economic activity, on balance, was stronger in Canada than in the
United States, in part because Canada's banks and housing markets proved more
stable than those in the United States. Residential mortgage balance growth
slowed in 2009, although residential real estate market conditions improved as
a result of low mortgage rates, greater affordability and government stimulus.
Personal deposit growth was strong, reflecting increased savings by cautious
households and a substantial shift in assets from equity mutual funds to
deposits and money markets, particularly in the first half of the year. In
commercial banking, deposit growth was also strong, possibly reflecting
decisions to maintain liquidity in the context of weak cash flows resulting
from the economic downturn. Commercial loan growth slowed sharply in 2009,
reflecting a pullback in business investment, following very strong growth
over the past three years.
Looking forward to 2010, we anticipate that the recent economic recovery will
strengthen moderately. Despite an improving economy, financial product
performance will likely reflect the effects of the recession. In personal
banking, deposit growth is expected to be dampened by relatively slow growth
in personal income and a redeployment of deposits into equities and
longer-term mutual funds. Housing sales are expected to remain healthy but
increase at a more moderate pace and, as a result, growth in residential
mortgage balances is expected to slow again in 2010. In commercial banking,
demand for non-residential mortgages and business loans will likely remain
weak in the first half of the year, with conditions improving in the second
half. Business deposit growth is also expected to slow in 2010 as cash flows
will likely remain below normal.
P&C Canada Financial Results
P&C Canada net income was $1,392 million, up $183 million or 15% from a year
ago.
Revenue increased $385 million or 8% to $5,263 million, driven by volume
growth in most products and improved net interest margin. Net interest margin
was 3.13%, 29 basis points higher than in the prior year. The increase was
largely driven by the securitization of low-margin mortgages, the impact of
deposit growth outpacing loan growth and prime rates that were favourable
relative to bankers' acceptances rates.
In our personal banking business, revenue increased $51 million or 2%. The
increase was driven by volume growth in personal loans and personal deposits,
improved net interest margin and higher activity fees, partially offset by
reductions in revenue from securitizations and mutual fund products.
In our commercial banking segment, revenue increased $154 million or 11%. The
increase was attributable to volume growth in deposits, improved net interest
margin and higher activity fees.
Cards and payment services revenue increased $180 million or 17%. The increase
was attributable to balance growth, an improvement in spread and higher
payment services revenue.
Non-interest expense was $2,843 million, up $107 million or 3.9% from 2008 due
to increases in employee benefits costs, performance-based compensation, and
occupancy and payment services costs, partially offset by lower business
initiative spending and cost savings resulting from staff reductions. Our cash
productivity ratio improved 220 basis points to 53.9%, as revenue growth
outpaced expense growth.
In 2009, the term investments business was moved to P&C Canada where it is
better aligned with P&C's retail product strategy. At the same time, all of
BMO's insurance businesses now operate within Private Client Group. All prior
periods have been restated to reflect this transfer.
50 BMO Financial Group 192nd Annual Report 2009
Personal and Commercial Banking U.S.
"We're here to help." We serve more than 1.2 million customers, working
together with Harris and BMO businesses in select U.S. Midwest markets to
bring clarity to our customers' financial decision-making and help them manage
their financial affairs. Through our integrated distribution network of 280
branches, our award-winning call centre, our online banking platform and more
than 650 automated banking machines, we provide excellent service to our
customers. We also play an active role in their local communities.
"We are actively and consistently focused on delivering a
great customer experience, differentiating Harris in our
markets and enabling profitable growth."
Ellen Costello
President and Chief Executive Officer,
Personal and Commercial Banking
U.S. and Harris Financial Corp.
Strengths and Value Drivers
- A rich heritage of more than 125 years in the U.S. Midwest with the established Harris brand and a commitment to
service excellence as demonstrated by our strong customer loyalty scores.
- A comprehensive and increasingly integrated distribution network, ranked in the top three for deposit share in most
markets where we compete.
- Strong working relationships with our key partners in Private Client Group and BMO Capital Markets, with the
opportunity to leverage the capabilities and scale of BMO Financial Group.
Challenges
- The economic outlook remains difficult, though showing signs of improvement, with expectations for loan demand
indicating a modest recovery in 2010.
- Regulatory oversight is increasingly rigorous with expectations of additional regulation and compliance
requirements.
- FDIC base premiums have been fully reinstated at increasing levels after more than a decade of no/low premiums.
- Chicago-area market dynamics remain competitive, as banks compete aggressively on pricing of both loans and deposits
to maintain and increase market share.
Our Lines of Business
P&C U.S. offers a full range of products and services to consumers and
businesses, including deposit and investment services, mortgages, consumer
credit, business lending, cash management and other banking services.
Our Strategies
- Transform the capabilities and economics of our sales and distribution network to respond to evolving customer
behaviours and expectations.
- Partner with Private Client Group to capture untapped wealth management opportunities within our customer base.
- Pursue a proactive advisory-based approach that fosters broader customer relationships and improves productivity and
returns in our commercial business.
- Drive growth across our banking distribution network through an intense focus on growing our customer base and core
deposits. Continue to pursue merger and acquisition opportunities, de novo branch expansion, new product offerings
and expanded channel capabilities.
- Promote individual and team productivity through role clarity, performance measurement, results-based compensation,
rigorous performance management and proactive talent renewal.
Our Path to Differentiation
- A customer-focused culture centred on understanding and responding to our customers' most important financial needs.
- A one-team mindset that brings the entire organization's capabilities to our customers.
- Effective sales management and leadership that drive our sales and service employees to excel.
- A disciplined, transparent performance management system that supports our business objectives, motivates employees
and rewards top performance.
- A strong brand signifying strength, stability and helpfulness.
Key Performance Metrics and Drivers 2009 2008 2007
Average US$ loan growth (%) (1) (0.9) 10.8 11.4
Average US$ deposit growth (%) 10.4 8.4 8.4
Cash operating leverage (US$) (%) 1.6 (7.0) (1.6)
Number of branches 280 281 232
Employee engagement index (2) 74 74 72
Retail Net Promoter Score (3) 44 42 41
(1) Based on current loans.
(2) Source: BMO Annual Employee Survey, conducted by Burke Inc., an independent research company.
(3) A measure of the strength of customer loyalty.
Caution
This Personal and Commercial Banking U.S. section contains forward-looking
statements. Please see the Caution Regarding Forward-Looking Statements.
51 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
2009 Group Objectives and Achievements
Improve financial performance by growing revenue and effectively managing
costs.
- On a U.S. dollar basis, excluding the impact of impaired loans, Visa gains and charges, and acquisition integration
and severance:
- Revenue grew 9% (2% on an as-reported basis).
- Net income grew 15% (-0.6% on an as-reported basis).
- The cash productivity ratio improved 190 basis points to 70.2% (150 basis points on an as-reported basis).
- Increased deposits by US$1.9 billion or 10%, with retail core deposit growth of US$0.2 billion, compared with a
reduction of US$0.5 billion in 2008.
- Continued focus on expense control including active workforce management, with a reduction of more than 11% of our
workforce.
Continue to leverage our leadership position in the Chicago area and increase
our presence and visibility in all other markets where we compete.
- Harris increased its share of voice, a measure of marketing visibility, from 3% in 2008 to 10% in 2009, building on
the success of the "We're Here to Help" positioning in our markets.
- Harris maintained its number two rank for retail deposit market share in the Chicago metropolitan market, growing 7%,
while larger banks lost market share. This growth resulted from our focused and integrated customer development and
sales efforts, complemented by our active community involvement.
Deliver a differentiated customer experience that fosters customer advocacy,
as measured by our retail Net Promoter Score.
- Our U.S. retail banking customer loyalty scores remain strong while competitor loyalty scores have decreased. Our
U.S. retail Net Promoter Score was 44 in 2009, an increase of 2 points from 2008.
2010 Group Objectives
- Maintain strong customer loyalty.
- Improve financial performance by growing revenue and effectively managing costs.
- Optimize our integrated distribution network and build our base of core households through organic expansion.
- Capitalize on our leadership position in the Chicago area and increase our presence and visibility in all other
markets where we compete.
52 BMO Financial Group 192nd Annual Report 2009
U.S. Business Environment and Outlook
Chicago's financial services marketplace remains one of the most fragmented in
the United States, with more than 240 deposit-taking institutions. Harris and
the two other largest banks in the Chicago area have together held 25% to 37%
of the personal and commercial deposit market since 1997. The Chicago area
remains a highly contested market because of the growth opportunities
presented by this fragmentation. Competitors are attempting to capture market
share through acquisitions, aggressive pricing and continuous investment in
their brands. The competitive dynamic has shifted with further consolidation
of the market following both regulator-initiated acquisitions (J.P. Morgan
Chase's acquisition of Washington Mutual, PNC's acquisition of National City
and MB Financial's acquisition of Corus deposits and branches) and
bank-initiated acquisitions (Bank of America's acquisition of LaSalle Bank).
We expect the local Chicago economy to show a modest improvement in 2010,
consistent with the broader U.S. economy. Weak home prices will likely
continue to dampen demand for home equity loans, but low interest rates should
increase demand for residential mortgages. Consumer spending remained weak in
2009 but is expected to increase moderately in 2010.
In 2010, we plan to continue to grow organically, building on our current
platform by capitalizing on the current market disruption. We will strive to
improve our financial performance by focusing on revenue growth and
effectively managing costs. By building our business around committed customer
relationships, we will continue to enhance our reputation as a strong, stable
and customer-focused bank.
P&C U.S. Financial Results
P&C U.S. net income was $109 million in 2009, a $13 million or 14% increase
from 2008. On a U.S. dollar basis, net income decreased $1 million or 1% to
$94 million. The impact of impaired loans reduced net income by US$46 million
in 2009 compared with US$22 million last year. Revenue increased US$14 million
or 2%. Non-interest expense decreased US$4 million or 1%.
Cash net income was US$162 million on a basis that adjusts for the impact of
impaired loans, integration costs, the Visa litigation accrual and the partial
sale of our investment in Visa in 2008, increasing US$13 million or 9%
compared to last year.
On a similarly-adjusted basis, revenue increased US$81 million or 9%,
reflecting strong deposit volume growth, a full year of results for our
Wisconsin acquisitions (US$33 million) and increased gains on the sale of
mortgages.
On a similarly-adjusted basis, expenses increased US$38 million or 5%,
reflecting a full year of results for our Wisconsin acquisitions (US$26
million).
The P&C U.S. cash productivity ratio improved by 150 basis points to 76.0%.
Excluding the impact of the Visa litigation accrual and the partial sale of
our investment, as well as impaired loans, severance costs and acquisition
integration costs, the cash productivity ratio was 70.2%.
53 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Private Client Group
Private Client Group (PCG) serves a full range of client segments, from
mainstream to ultra-high net worth, as well as select institutional markets,
with a broad offering of wealth management products and solutions. Operating
under the BMO brand in Canada and Harris in the United States, PCG's portfolio
in Canada includes full-service brokerage and online brokerage, as well as
insurance, and in both Canada and the United States includes private banking
and investment products.
"We are helping our clients reach their goals by providing
clarity on financial matters, creating innovative
solutions and delivering financial and retirement planning
expertise."
Gilles Ouellette
President and Chief Executive Officer Private Client Group
Strengths and Value Drivers
- A planning and advice-based approach that integrates investments, insurance, specialized wealth management and core
banking solutions.
- Brand prestige, recognition and trust.
- Strong national presence in Canada, as well as strategic positioning in the Chicago area and select high-growth U.S.
wealth management markets.
- Access to BMO's broad client base and distribution network in Canada and the United States.
- A culture of innovation focused on achieving competitive advantage.
Challenges
- A volatile equity market environment with record-low interest rates and continued uncertainty about the pace of
economic recovery.
- Eroded consumer confidence in market opportunities.
- Increased regulatory demands requiring proactive engagement and oversight.
- Competition for top talent.
Our Lines of Business
Full-Service Investing offers comprehensive investment and wealth advisory
services in Canada through BMO Nesbitt Burns(R)*. We are defining great client
experience by leveraging our financial planning capabilities, our broad range
of internal and external partnerships and the quality of our products to
deliver complete client-focused solutions.
Online Brokerage operates as BMO InvestorLine(R) in Canada. We are focused on
providing a superior client experience by understanding and anticipating our
clients' needs, and we offer a range of tools to help self-directed investors
plan, research and manage investing decisions in their own way. We are
building on our innovative and comprehensive set of services to acquire new
clients and increase investing activity among existing clients.
North American Private Banking operates as BMO Harris Private Banking in
Canada and Harris Private Bank(R)aEUR in the United States. As trusted advisors, we
deliver a planning and advice-based value proposition to high net worth and
ultra-high net worth clients, offering a comprehensive range of services, from
individual to team-based wealth management strategies.
Our Strategies
We aim to be the wealth management solutions provider that defines great
client experience, helping our clients accumulate, protect and grow their
assets. Our core strategy is to redefine a great wealth management client
experience that is anchored in financial and retirement planning by:
- Providing clarity on complex financial matters and delivering best-in-class solutions to our clients.
- Building a culture of innovation.
- Continuing to invest selectively to create incremental value.
- Enhancing productivity and simplifying processes and products.
Our Path to Differentiation
- Deliver a great client experience and simplify complex financial matters.
- Attract, develop and retain superior talent.
- Collaborate effectively within PCG and across BMO Financial Group.
Key Performance Metrics and Drivers 2009 2008 2007
Increase (decrease) in assets under management (%) 5.0 (16.2) 9.0
Increase (decrease) in assets under management and assets under
administration (%) 7.5 (13.7) 8.0
Increase in full-time employees (%) 1.7 3.9 4.1
Employee engagement index (%) (1) 74 75 76
Performance measures exclude the impact of businesses sold or transferred and
the impact of changes in the Canadian/U.S. dollar exchange rate.
(1) Source: BMO Annual Employee Survey, conducted by Burke Inc., an independent research company.
Investment Products includes BMO Mutual Funds, BMO Guardian Funds, BMO
Exchange Traded Funds (ETF) and BMO Asset ManagementTM. In our Funds and ETF
businesses, we help our clients build a confident future by providing wealth
management advice and innovative investment solutions across a range of
channels, with a particular focus on the retirement market. BMO Asset
Management is our centre of excellence in investment management in Canada, the
United States and Europe.
Insurance operates as BMO Insurance in Canada. We are focused on becoming the
market leader in simple and compelling insurance solutions as part of PCG's
complete wealth management offering, reinforcing our strength in retirement
planning. Products and services include creditor insurance, life insurance and
annuity, and other wealth management products.
Caution
This Private Client Group section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
54 BMO Financial Group 192nd Annual Report 2009
2009 Group Objectives and Achievements
Innovate within sales channels and enhance products and solutions to satisfy
clients' needs.
- We acquired BMO Life Assurance Company (formerly AIG Life Insurance Company of Canada), adding 300 new employees and
400,000 clients. We also consolidated our insurance operations within PCG to strengthen strategic alignment and
address client needs under a single brand.
- We launched a family of exchange traded funds, low-cost investment products that offer our clients the primary
building blocks of a well-diversified investment portfolio.
- We were the first bank in Canada to offer a Registered Disability Savings Plan, enabling clients with disabilities to
improve their long-term financial security.
- We continued to strengthen BMO InvestorLine's capabilities with improved online client tools and better information.
A record of continuous improvement is one factor that underlies The Globe and Mail ranking BMO InvestorLine best of
the bank-owned brokerages in its 2009 online brokerage rankings.
- We continue to be recognized for the products and services we offer our clients through BMO Mutual Funds. For the
third consecutive year, we ranked first in the Canadian mutual fund industry for best overall customer service in
both official languages (Dalbar Inc.). Four BMO funds won Canadian Investment Awards and the BMO Dividend Fund was
recognized as the best Canadian Dividend and Equity Income fund over ten years (Lipper Inc.).
- We increased our commitment to Asia. All our BMO Asia businesses have been consolidated under a new management team
in expanded Beijing offices, and China's banking regulator has given BMO approval to formally prepare for
incorporation in China. Incorporation will allow the bank to accept deposits in local currency, sell investment
products and provide other standard banking services.
Satisfy our clients' needs by continuing our high level of internal
collaboration and referrals.
- We increased referral volumes across BMO and Harris, evidence of our customers' trust during turbulent times.
- We launched the Employee Referral Opportunity Line to match identified client needs with the appropriate BMO product,
service or channel.
Expand our sales force and improve its productivity to drive revenue growth.
- We continued to develop more robust Financial Planning and Investment Advisor tools to enhance our planning-based
client experience and improve sales force efficiency.
- We increased retirement training across our sales force and established key performance metrics on retirement
planning to ensure we remain competitive in this important market, add value for our clients and drive business
results.
2010 Group Objectives
- Continue to differentiate by delivering a great client experience that is anchored in financial and retirement
planning.
- Innovate in the design and delivery of our products and services.
- Maintain our high level of internal collaboration and continue to leverage the full range of our wealth management
businesses to better meet client needs.
55 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Private Client Group Business Environment and Outlook
The Canadian and U.S. economies contracted sharply and stock markets weakened
through the first half of fiscal 2009. Economic conditions improved modestly
in the second half of the year as a result of record-low interest rates,
expansive fiscal policy and the early stages of a global recovery. The overall
investment climate was unfavourable for most of the year. This translated into
a decline in client assets and an increase in cash holdings as clients waited
for markets to stabilize. The low interest rate environment put pressure on
net interest income for much of the year. The Canadian economy is expected to
grow moderately in 2010, supported by low interest rates, government spending
and a healthier global economic climate. The Bank of Canada is expected to
begin raising interest rates in the summer. The Canadian dollar is expected to
strengthen further relative to the U.S. dollar, supported by rising commodity prices.
The U.S. economy is also expected to grow moderately in 2010, as the housing market
recovers and credit conditions ease. Given the subdued inflation environment, the
Federal Reserve is not expected to raise interest rates until the second half of 2010.
Capital markets in both countries are expected to continue strengthening as the
economy recovers and business confidence rises, leading to improvements in
asset levels. The low interest rate environment will continue to put pressure
on net interest income. Despite the recent market volatility, the North
American wealth management industry remains attractive as strong industry
growth rates are expected over the long term with high net worth and
retirement segments becoming increasingly significant.
Private Client Group Financial Results
Private Client Group net income decreased $71 million or 16% in 2009 from the
previous year, reflective of challenging equity markets and a low interest
rate environment. Results in the current year were reduced by a $17 million
($11 million after tax) charge associated with the decision to purchase
certain holdings from our U.S. clients, but also reflected a $23 million
recovery of prior years' income taxes in our insurance business. Results in
fiscal 2008 were affected by a $31 million ($19 million after tax) charge
related to the decision to purchase certain holdings from our U.S. clients.
In 2009, all of BMO's insurance businesses were brought together within
Private Client Group to align with our wealth management strategy and
consolidate our insurance capabilities and skill sets. The term investment
business is now included within P&C Canada. All comparative figures have been
restated to reflect the insurance and term investment business transfers.
Net income was comprised of $170 million from insurance and $211 million from
PCG excluding insurance, compared with $123 million and $329 million,
respectively, in 2008. The BMO Life Assurance acquisition completed in the
second quarter added revenues of $64 million, expenses of $41 million and net
income of $16 million in fiscal 2009. Revenue of $2,012 million decreased $134
million or 6%. The decrease was primarily due to lower revenue in our
brokerage businesses and lower fee-based revenue in our mutual fund
businesses, partially offset by increased insurance revenues. Challenging
equity market conditions for most of the year lowered the group's assets under
management and administration. Lower net interest income was primarily due to
spread compression on deposit balances in our brokerage businesses. The
stronger U.S. dollar increased revenue by $27 million or 1.3%. Non-interest
expense increased $5 million or 0.3%. The stronger U.S. dollar increased
expenses by $27 million or 1.7% and the acquisition of BMO Life Assurance
added expenses of $41 million. These increases were partially offset by
reductions in revenue-based costs, in line with lower non-interest revenue,
and the success of active expense management. U.S. operations recorded a net
loss of US$7 million in 2009 compared with a net loss of US$6 million in 2008.
Adjusted for the charges related to purchasing certain holdings from U.S.
clients in both years, net income decreased US$7 million, reflecting the
impact of challenging equity markets.
Private Client Group (Canadian $ in millions, except as noted)
Reported Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Net interest income (teb) 353 376 345 (23) (6)
Non-interest revenue 1,659 1,770 1,817 (111) (6)
Total revenue (teb) 2,012 2,146 2,162 (134) (6)
Provision for credit losses 5 4 3 1 37
Non-interest expense 1,536 1,531 1,501 5 -
Income before income taxes 471 611 658 (140) (23)
Income taxes (teb) 90 159 130 (69) (44)
Net income 381 452 528 (71) (16)
Amortization of acquisition-related
intangible assets (after tax) 4 4 4 - -
Cash net income 385 456 532 (71) (15)
Net economic profit 255 333 376 (78) (23)
Return on equity (%) 31.3 40.2 36.8 (8.9)
Cash return on equity (teb) (%) 31.6 40.6 37.1 (9.0)
Cash operating leverage (%) (6.6) (2.9) 2.1 nm
Productivity ratio (teb) (%) 76.4 71.4 69.4 5.0
Cash productivity ratio (teb) (%) 76.2 71.1 69.1 5.1
Net interest margin on
earning assets (%) 3.34 4.78 5.15 (1.44)
Average earning assets 10,567 7,855 6,708 2,712 35
Average loans and acceptances 7,454 6,726 5,637 728 11
Average deposits 14,605 11,382 9,240 3,223 28
Assets under administration 139,446 131,289 139,060 8,157 6
Assets under management 99,128 99,428 106,174 (300) -
Full-time equivalent staff 4,632 4,553 4,384 79 2
nm - not meaningful
U.S. Business Selected Financial Data (US$ in millions)
Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Total revenue 208 217 243 (9) (4)
Non-interest expense 218 230 243 (12) (5)
Net income (7) (6) - (1) (11)
Average earning assets 2,251 2,142 1,945 109 5
Average loans and acceptances 2,106 2,120 1,903 (14) (1)
Average deposits 1,196 1,155 1,128 41 4
56 BMO Financial Group 192nd Annual Report 2009
BMO Capital Markets
BMO Capital Markets provides a full range of products and services to help
corporate, institutional and government clients achieve their ambitions. From
27 offices on five continents, including 14 in North America, BMO Capital
Markets draws on expertise in areas including equity and debt underwriting,
corporate lending and project financing, mergers and acquisitions advisory
services, merchant banking, securitization, treasury and market risk
management, foreign exchange, derivatives, debt and equity research and
institutional sales and trading.
"Our performance and our progress on executing our
strategy in fiscal 2009 demonstrate that we can rise to
the market challenges, focus on execution and, most
importantly, deliver results."
Tom Milroy
Chief Executive Officer
BMO Capital Markets
Strengths and Value Drivers
- Diversified, dynamic portfolio of businesses that supports our well-established franchise.
- North American expertise that provides an integrated cross-border market experience.
- Expertise and leadership in targeted sectors and products.
- Top-tier equity research, sales and trading capabilities.
- Significant investment and corporate banking presence in Canada and the United States.
Challenges
- Ongoing market volatility and a dynamic market environment.
- Highly competitive landscape in the United States and in international markets as financial
institutions rebound from the recession and the distress in global credit markets in the first
half of 2009.
Our Lines of Business
Investment and Corporate Banking services include strategic advice on mergers
and acquisitions, restructurings and recapitalizations, as well as valuation
and fairness opinions. We provide capital-raising services through debt and
equity underwriting as well as a full range of loan and debt products, balance
sheet management solutions and treasury management services. In support of our
clients' international business activities, we offer trade finance and risk
mitigation services. We also provide a wide range of banking and other
operating services to international and domestic financial institutions.
Trading Products services include sales, trading and research activities. We
offer integrated debt, foreign exchange, interest rate, credit, equity,
securitization and commodities solutions to institutional, commercial and
retail clients. In addition, we supply efficient funding and liquidity
management to BMO Financial Group and its clients, as well as new product
development, proprietary trading and origination.
Our Strategies
- Increase focus on core clients by leveraging areas of strength at a national, North American and global level.
- Better serve clients by creating a more integrated capital markets business.
- Maintain a diversified, dynamic portfolio of businesses focused on meeting the evolving needs of our core clients.
- Continue to optimize our businesses to generate appropriate risk-adjusted returns.
- Continue to build strong risk management capabilities through solid internal partnerships and enhanced risk
transparency.
Our Path to Differentiation
- Serve a broad range of both Canadian and U.S. issuer and investor client needs with an integrated capital markets
offering.
- Offer a successful, stable and trustworthy North American universal banking model.
- Leverage selected capabilities in targeted sectors and products to be a leading competitor in the North American and
global markets.
- Provide nimble and responsive execution with an ability to react quickly to evolving markets and client needs.
Key Performance Metrics and Drivers 2009 2008 2007
Trading Products revenue ($ millions) 1,982 1,017 272
Investment and Corporate Banking and other revenue ($ millions) 1,484 1,423 1,697
Equity underwriting participation (deals) (1) 226 140 276
Debt underwriting participation (deals) (1) 115 121 110
Average loans and acceptances ($ billions) (2) 44.0 39.4 31.3
Canadian equity research ranking (3) #1 #1 #1
(1) Canadian corporate issuers in North America.
(2) Based on current loans.
(3) Brendan Wood International survey.
Caution
This BMO Capital Markets section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
57 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
2009 Group Objectives and Achievements
Increase our focus on core profitable clients.
- Concentrated on sectors where we have a differentiated and competitive position that is either global (Metals &
Mining) or North American (Energy, Food & Consumer).
- Expanded Metals & Mining investment banking coverage into coal and industrial mineral sectors.
- Expanded and upgraded our analyst coverage in the Mining, Energy and Technology sectors.
Optimize our capital.
- Continued to invest in our core businesses while downsizing or exiting a number of non-core businesses, ensuring
appropriate allocation of capital within our target risk-return profiles.
Improve our risk-return profile.
- Significantly reduced off-balance sheet exposures.
- Continued to enhance our risk management capabilities and the solid partnerships developed through our Risk
Evolution program.
Improve our return on equity while securing our future growth.
- Expanded our European institutional sales team to strengthen our ability to distribute Canadian and U.S. equities in
Europe.
- Expanded our public finance capability to capitalize on opportunities in the U.S. municipal bond business. BMO now
ranks second in the United States in underwriting taxable municipal bonds and advanced to 12th in the general
municipal bond market.
- Our return on equity was 16.4%, greatly improved from 11.4% a year ago.
Other Achievements
- Expanded our talent and enhanced our capabilities, particularly in the United States, while keeping overall
headcount relatively unchanged.
- Ranked as the top Equity Research Group in Canada for the 29th consecutive year in the Brendan Wood International
Survey of Institutional Investors.
- Our equity research team placed first in the 2009 Thomson Reuters StarMine Canadian Analyst Awards. BMO Capital
Markets won the award for top broker by collecting 17 individual analyst awards.
- Greenwich Associates ranked our Canadian fixed income team first in overall market share, overall market penetration
and research quality in its 2009 client survey.
- Received the Best FX Bank Canadian dollar award from FX Week in addition to being named European CEO magazine's Best
Foreign Exchange Bank - Canada 2009.
- Participated in 237 corporate and government debt transactions that raised $140 billion. Raised $49 billion through
participation in 226 equity transactions.
- Advised on 38 completed mergers and acquisitions in North America valued at $15 billion.
2010 Group Objectives
- Increase focus on core profi table clients.
- Better serve clients by creating a more integrated capital markets business.
- Maintain a diversified, dynamic portfolio of businesses to meet the evolving needs of core clients.
- Continue to optimize our businesses to generate appropriate risk-adjusted returns.
- Continue to build strong risk management capabilities through solid internal partnerships and enhanced risk
transparency.
58 BMO Financial Group 192nd Annual Report 2009
BMO Capital Markets Business Environment and Outlook
Fiscal 2009 saw very strong results in BMO Capital Markets. Although the North
American economy was in recession for a large part of the year, we benefited
from focusing on our clients as well as taking advantage of opportunities
presented by high levels of market volatility and uncertainty. Our
interest-rate-sensitive businesses and foreign exchange trading businesses
benefited from more favourable market conditions. Corporate banking revenue
improved significantly from the previous year due to wider spreads, despite
reduced levels of lending assets. Conditions were mixed for our investment
banking businesses. Equity underwriting revenues grew considerably as
corporate clients sought to strengthen their capital positions. In contrast,
mergers and acquisitions activity decreased this year due to lower activity in
the marketplace. Our overall performance in 2009 reflected the strength and
resilience of our core businesses.
Looking forward, we expect a modest economic recovery in both Canada and the
United States in 2010. Aggressive fiscal and monetary policies appear to have
ended the recession, although we expect that the recovery will be subdued due
to U.S. consumer de-leveraging and continued weakness in the U.S. commercial
real estate market. However, capital market conditions should continue to
improve, which will benefit our fee-based businesses. Also, equity markets
have recovered about half of their recessionary losses and with the current
economic outlook of sustained growth, low inflation and low interest rates,
equity markets should continue to improve, especially given the large amounts
of liquidity on the sidelines. Our focus in 2010 will be to deliver strong
returns on equity with stable, high-quality earnings. Growth in fiscal 2010
will depend on the performance of financial and commodity markets, as well as
general economic activity and business confidence.
BMO Capital Markets Financial Results
BMO Capital Markets net income increased $349 million to $1,060 million, as
revenues increased 42% with a comparatively low 7% increase in expenses.
Results in 2009 were affected by charges of $521 million ($355 million after
tax) related to the capital markets environment. Results in 2008 were affected
by charges of $388 million ($260 million after tax). Revenue increased $1,026
million to $3,466 million. The stronger U.S. dollar increased revenue by $243
million. Revenue growth was attributable to strong trading performance as we
capitalized on market opportunities, and to improved corporate banking
revenues as we benefited from our continued focus on client relationships.
Non-interest revenue increased $435 million or 35% over the prior year, driven
by significantly higher trading revenue and increases in lending and
underwriting fees. Equity underwriting fees reflected corporate clients'
increased demand for capital.
Net interest income increased $591 million or 49%. Trading net interest income
increased significantly, as did corporate banking net interest income, due to
wider spreads. Corporate banking revenues increased despite a reduction in
assets due to repayments during the year. Revenues from our
interest-rate-sensitive businesses were also higher than in the prior year due
to favourable market spreads. Net interest margin was significantly higher due
to increased trading net interest income and improved corporate lending
spreads.
The provision for credit losses was $170 million, compared with $117 million
in 2008, as expected losses were higher due to the deterioration in credit
markets.
Non-interest expense increased $124 million to $1,875 million, primarily due
to increased employee costs and higher allocated costs. Included in employee
costs were higher variable compensation costs consistent with improved
business performance. Severance costs of $29 million ($19 million after tax)
were comparable with a year earlier. The stronger U.S. dollar increased
expenses by $83 million.
The group's productivity ratio improved considerably from 71.8% to 54.1%
largely due to the increase in revenue in 2009.
Net income taxes increased from 2008 as the prior year's results included $115
million of recoveries of prior years' income taxes.
Net income from U.S. operations improved by US$190 million to US$464 million
due to significantly higher trading revenue and increased corporate banking
revenue.
BMO Capital Markets (Canadian $ in millions, except as noted)
Reported Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Net interest income (teb) 1,798 1,207 974 591 49
Non-interest revenue 1,668 1,233 995 435 35
Total revenue (teb) 3,466 2,440 1,969 1,026 42
Provision for credit losses 170 117 77 53 45
Non-interest expense 1,875 1,751 1,575 124 7
Income before income taxes 1,421 572 317 849 +100
Income taxes (recovery) (teb) 361 (139) (100) 500 +100
Net income 1,060 711 417 349 49
Amortization of acquisition-related
intangible assets (after tax) 1 1 - - -
Cash net income 1,061 712 417 349 49
Net economic profit 359 55 (141) 304 +100
Return on equity (%) 16.4 11.4 7.7 5.0
Cash return on equity (%) 16.4 11.5 7.7 4.9
Cash operating leverage (%) 34.9 12.7 (26.9) nm
Productivity ratio (teb) (%) 54.1 71.8 80.0 (17.7)
Cash productivity ratio (teb) (%) 54.1 71.7 80.0 (17.6)
Net interest margin on
earning assets (%) 1.00 0.69 0.60 0.31
Average common equity 6,136 5,830 4,972 306 5
Average earning assets 179,372 176,080 162,309 3,292 2
Average loans and acceptances 43,985 39,442 31,275 4,543 12
Average deposits 91,207 105,984 94,019 (14,777) (14)
Assets under administration 63,762 90,188 57,590 (26,426) (29)
Assets under management 6,969 9,294 23,233 (2,325) (25)
Full-time equivalent staff 2,362 2,467 2,365 (105) (4)
nm - not meaningful
U.S. Business Selected Financial Data (US$ in millions)
Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Total revenue 1,505 1,167 491 338 29
Non-interest expense 733 721 635 12 2
Net income 464 274 (44) 190 69
Average earning assets 64,935 69,411 53,238 (4,476) (6)
Average loans and acceptances 15,160 17,386 14,908 (2,226) (13)
Average deposits 34,853 36,335 24,920 (1,482) (4)
59 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Corporate Services, including Technology and Operations
Corporate Services consists of the corporate units that provide
enterprise-wide expertise and governance support in a variety of areas,
including strategic planning, risk management, corporate finance, legal and
compliance, communications and human resources. Our operating results reflect
the impact of certain securitization and asset-liability management
activities, the elimination of taxable equivalent adjustments and the impact
of our expected loss provisioning methodology.
Technology and Operations (T&O) manages, maintains and provides governance
over information technology, operations services, real estate and sourcing for
BMO Financial Group. T&O focuses on enterprise-wide priorities that improve
service quality and efficiency to deliver an excellent customer experience.
Financial Results
Operating results for T&O are included with Corporate Services for reporting
purposes. However, costs of T&O services are transferred to the three client
operating groups, and only minor amounts are retained in T&O results. As such,
results in this section largely reflect the corporate activities outlined
above.
Corporate Services net loss for the year was $1,155 million, compared with a
net loss of $490 million in 2008. The increase was attributable to lower
revenues, higher provisions for credit losses and increases in expenses. The
lower revenues primarily related to a negative carry on certain
asset-liability interest rate positions as a result of changes in market
interest rates, the impact of funding activities that were undertaken to
enhance our strong liquidity position, mark-to-market losses on hedging
activities compared with gains in the prior year, and the impact of credit
card securitizations completed in 2008. The provision for credit losses was
$148 million higher as a result of increased provisions charged to Corporate
Services under our expected loss provisioning methodology. Included in the
provision for credit losses was a $60 million increase in the general
allowance for credit losses, compared with a $260 million increase in 2008.
Non-interest expense increased $158 million largely due to a $118 million ($80
million after tax) severance charge and an increase in deposit insurance
premiums related to enhancements of protection levels and increased premium
rates.
As explained on page 47, BMO analyzes revenues on a teb basis at the operating
group level, with an offsetting adjustment in Corporate Services. Results reflect
teb reductions in net interest income and related income taxes of $189 million,
$195 million and $180 million for 2009, 2008 and 2007, respectively.
BMO's practice is to charge loss provisions to the client operating groups
each year, using an expected loss provisioning methodology based on each
group's share of expected credit losses. Corporate Services is generally
charged (or credited) with differences between expected loss provisions
charged to the client operating groups and provisions required under GAAP.
Corporate Services, including Technology and Operations
(Canadian $ in millions, except as noted)
Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Net interest income (teb) (1,211) (695) (539) (516) (74)
Non-interest revenue 401 446 216 (45) (10)
Total revenue (teb) (810) (249) (323) (561) (+100)
Provision for (recovery of) credit
losses 973 825 (84) 148 18
Non-interest expense 232 74 264 158 +100
Income (loss) before income taxes and
non-controlling interest in
subsidiaries (2,015) (1,148) (503) (867) (76)
Income taxes (recovery) (teb) (936) (732) (500) (204) (28)
Non-controlling interest 76 74 75 2 3
Net income (loss) (1,155) (490) (78) (665) (+100)
Full-time equivalent staff 9,446 9,388 8,821 58 1
U.S. Business Selected Financial Data
(US$ in millions)
Change from 2008
As at or for the year ended October 31 2009 2008 2007 $ %
Total revenue (265) (139) (142) (126) (91)
Provision for credit losses 766 783 17 (17) (2)
Non-interest expense (12) (68) 9 56 82
Income taxes (recovery) (387) (326) (81) (61) (19)
Net income (loss) (650) (546) (105) (104) (19)
Financial Condition Review
Summary Balance Sheet ($ millions)
As at October 31 2009 2008 2007 2006 2005
Assets
Cash and interest bearing
deposits with banks 13,295 21,105 22,890 19,608 20,721
Securities 110,813 100,138 98,277 67,411 57,034
Securities borrowed or
purchased under resale
agreements 36,006 28,033 37,093 31,429 28,280
Net loans and acceptances 167,829 186,962 164,095 159,565 146,057
Other assets 60,515 79,812 44,169 41,965 41,770
388,458 416,050 366,524 319,978 293,862
Liabilities and Shareholders' Equity
Deposits 236,156 257,670 232,050 203,848 193,793
Other liabilities 126,719 134,761 114,330 96,743 82,158
Subordinated debt 4,236 4,315 3,446 2,726 2,469
Capital trust securities 1,150 1,150 1,150 1,150 1,150
Preferred share liability - 250 250 450 450
Shareholders' equity 20,197 17,904 15,298 15,061 13,842
388,458 416,050 366,524 319,978 293,862
Total assets decreased $27.6 billion or 6.6% from last year to $388.5 billion
at October 31, 2009, largely due to the impact of the weaker U.S. dollar on
U.S.-dollar-denominated assets, which contributed approximately $16.1 billion
to the decrease. The average exchange rate is used for translation of revenues
and expenses and the U.S. dollar strengthened on this basis. The U.S. dollar
was weaker at October 31, 2009 than at October 31, 2008 and assets and
liabilities are translated at year-end rates. The $27.6 billion reported
decrease in assets primarily reflects reductions in other assets, including
derivative contracts, of $19.3 billion, reductions in net loans and
acceptances of $19.1 billion and reductions in cash and interest bearing
deposits with banks of $7.8 billion. These reductions were partially offset by
increases in securities of $10.7 billion and securities borrowed or purchased
under resale agreements of $8.0 billion.
Total liabilities and shareholders' equity decreased $27.6 billion or 6.6%.
The decrease was primarily comprised of a $21.5 billion decrease in deposits,
an $8.0 billion decrease in other liabilities and a $2.3 billion increase in
shareholders' equity.
60 BMO Financial Group 192nd Annual Report 2009
Cash and Interest Bearing Deposits with Banks
Cash and interest bearing deposits with banks decreased $7.8 billion to $13.3
billion in 2009. The decrease was largely attributable to movement of interest
bearing deposits with banks into highly liquid available-for-sale securities
to take advantage of investment opportunities.
Securities ($ millions)
As at October 31 2009 2008 2007 2006 2005
Investment - - - 14,166 12,936
Trading 59,071 66,032 70,773 51,820 44,087
Available-for-sale 50,303 32,115 26,010 - -
Other 1,439 1,991 1,494 1,414 -
Loan substitute - - - 11 11
110,813 100,138 98,277 67,411 57,034
Securities increased $10.7 billion to $110.8 billion in 2009.
Available-for-sale securities increased $18.2 billion to $50.3 billion,
primarily due to an increase in government and government-insured securities
to take advantage of investment opportunities. Trading securities decreased
$7.0 billion to $59.1 billion, despite the addition of $3.4 billion in
securities related to the BMO Life Assurance acquisition in the second quarter
of 2009, as a result of reduced market opportunities and the impact of the
weaker U.S. dollar. Further details on the composition of securities are
provided in Note 3 on page 115 of the financial statements.
Securities Borrowed or Purchased Under Resale Agreements
Securities borrowed or purchased under resale agreements increased $8.0
billion to $36.0 billion due to client preferences and higher trading volumes.
Loans and Acceptances ($ millions)
As at October 31 2009 2008 2007 2006 2005
Residential mortgages 45,524 49,343 52,429 63,321 60,871
Consumer instalment and
other personal loans 45,824 43,737 33,189 30,418 27,929
Credit cards 2,574 2,120 4,493 3,631 4,648
Businesses and governments 68,169 84,151 62,650 56,030 47,803
Acceptances 7,640 9,358 12,389 7,223 5,934
Gross loans and acceptances 169,731 188,709 165,150 160,623 147,185
Allowance for credit losses (1,902) (1,747) (1,055) (1,058) (1,128)
Net loans and acceptances 167,829 186,962 164,095 159,565 146,057
Net loans and acceptances decreased $19.1 billion to $167.8 billion, of which
approximately $8.0 billion was due to the impact of the weaker U.S. dollar.
Loans to businesses and governments, including acceptances, decreased $17.7
billion due to the impact of foreign exchange fluctuations, repayments, the
weaker economy and the replacement of corporate bank loans with long-term
debt. Consumer instalment and other personal loans increased $2.1 billion,
reflecting a rebound in demand for personal lending, particularly in the
Canadian market. Residential mortgages decreased $3.8 billion, due to the
conversion of BMO-underwritten Canadian mortgages to government-insured
mortgage-backed securities, which are included in securities. Credit card
loans increased a modest $0.5 billion, reflecting both new customer accounts
and higher consumer balances.
Table 11 on page 102 provides a comparative summary of loans by geographic
location and product. Table 13 on page 103 provides a comparative summary of
net loans in Canada by province and industry. Loan quality is discussed on
page 43 and further details on loans are provided in Notes 4, 5 and 8 to the
financial statements, starting on page 119.
Other Assets
Other assets decreased $19.3 billion to $60.5 billion. There was a decrease in
derivative assets and liabilities of $17.7 billion and $15.3 billion,
respectively, primarily due to reduced volatility in foreign exchange markets
and in underlying equity values as well as measures we undertook to reduce
exposures to credit contracts. Reduced volatility in exchange rates and
interest rates decreases the value of derivative assets and liabilities,
usually comparably.
Deposits ($ millions)
As at October 31 2009 2008 2007 2006 2005
Banks 22,973 30,346 34,100 26,632 25,473
Businesses and governments 113,738 136,111 121,748 100,848 92,437
Individuals 99,445 91,213 76,202 76,368 75,883
236,156 257,670 232,050 203,848 193,793
Deposits decreased $21.5 billion to $236.2 billion. The weaker U.S. dollar
decreased deposits by $10.2 billion. Deposits from businesses and governments,
which account for 48% of total deposits, decreased $22.4 billion and deposits
from individuals, which account for 42% of total deposits, increased $8.2
billion. Deposits by banks, which account for 10% of total deposits, decreased
$7.3 billion. Further details on the composition of deposits are provided in
Note 15 on page 139 of the financial statements and in the Liquidity and
Funding Risk section on page 86.
Other Liabilities
Other liabilities decreased $8.0 billion to $126.7 billion. Derivative
liabilities decreased $15.3 billion, in line with the decrease in derivative
assets outlined above. Securities sold but not yet purchased decreased $6.7
billion and securities lent or sold under repurchase agreements increased
$13.8 billion due to higher trading volumes and the movement of client
deposits, as noted above. Further details on the composition of other
liabilities are provided in Note 16 on page 140 of the financial statements.
Shareholders' Equity
Shareholders' equity increased $2.3 billion to $20.2 billion. The increase was
largely related to the issuance of 33.3 million common shares with gross
proceeds of approximately $1.0 billion through a syndicate of underwriters, as
well as the issuance of approximately 9.2 million shares at a value of $0.3
billion through the bank's Dividend Reinvestment and Share Purchase Plan,
which is described on page 64 of the Enterprise-Wide Capital Management
section. During the year, $0.8 billion of preferred shares were issued as
described in Note 21 on page 144 of the financial statements. Foreign exchange
losses on our net investment in foreign operations, which flow through
accumulated other comprehensive income, reduced the growth in shareholders'
equity. Our Consolidated Statement of Changes in Shareholders' Equity on page
112 provides a summary of items that increase or reduce shareholders' equity,
while Note 21 on page 144 of the financial statements provides details on the
components of and changes in share capital. Details of our enterprise-wide
capital management practices and strategies can be found on page 62.
61 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Enterprise-Wide Capital Management
Objective
BMO is committed to a disciplined approach to capital management that balances
the interests and requirements of shareholders, regulators, depositors and
rating agencies. Our objective is to maintain a strong capital position in a
cost-effective structure that:
- meets our target regulatory capital ratios and internal assessment of required economic capital;
- is consistent with our targeted credit ratings;
- underpins our operating groups' business strategies; and
- builds depositor confidence and long-term shareholder value.
Capital Management Framework
The principles and key elements of BMO's capital management framework are
outlined in our capital management corporate policy and in our annual capital
plan, which includes the results of the Internal Capital Adequacy Assessment
Process (ICAAP).
The ICAAP is an integrated process that evaluates capital adequacy, and is
used to establish capital targets and capital strategies that take into
consideration the strategic direction and risk appetite of the organization.
The ICAAP and capital plan are developed in conjunction with BMO's annual
business plan, ensuring an alignment between our business and risk strategies,
regulatory capital and economic capital requirements, and capital
availability. Capital adequacy is assessed by comparing capital supply (the
amount of capital available to support losses) to capital demand (the capital
required to support the risks underlying our business activities as measured
by economic capital). Enterprise-wide stress testing and scenario analysis are
also used to assess the impact of various stress conditions on the
enterprise's risk profile and capital requirements. The approach ensures that
we are adequately capitalized, given the risks we take, and supports the
determination of limits, goals and performance measures that are used to
manage balance sheet positions, risk levels and capital requirements at both
the consolidated entity and line of business level. Assessments of actual and
forecast capital adequacy are compared to the capital plan throughout the
year, and the capital plan is updated based on changes in our business
activities, risk profile or operating environment.
BMO uses both regulatory and economic capital to evaluate business performance
and as the basis for strategic, tactical and transactional decision-making.
By allocating capital to operating units and measuring their performance in relation
to the capital necessary to support the risks in their business, we maximize our
risk-adjusted return to shareholders. We also help ensure that we maintain a well-capitalized
position that protects our stakeholders from the risks inherent in our various
businesses, while still allowing the flexibility to deploy resources to the
high-return, strategic growth activities of our operating groups. Capital in
excess of what is necessary to support our line of business activities is held
in Corporate Services.
For further discussion of the risks that underlie our business activities,
refer to the Enterprise-Wide Risk Management section on page 75.
Governance
The Board of Directors and its Risk Review Committee provide ultimate
oversight and approval of capital management, including our capital management
corporate policy, capital plan and ICAAP results. They regularly review BMO's
capital position, capital adequacy assessment and key capital management
activities. The Risk Management Committee and Capital Management Committee
provide senior management oversight, and also review and discuss significant
capital policies, issues and action items that arise in the execution of our
enterprise-wide strategy. Finance and Risk Management are responsible for the
design and implementation of the corporate policies and framework related to
capital and risk management and the ICAAP. Our ICAAP operating processes are
reviewed on an annual basis by our Corporate Audit Division.
Regulatory Capital Review
Regulatory capital requirements for the consolidated entity are determined on
a Basel II basis. BMO uses the Advanced Internal Ratings Based (AIRB) Approach
to determine credit risk-weighted assets in our portfolio and the Standardized
Approach to determine operational risk-weighted assets. We were granted a
waiver by the Office of the Superintendent of Financial Institutions Canada
(OSFI), our regulator, ending after fiscal 2010, to apply the Standardized
Approach in determining the credit risk-weighted assets of our subsidiary
Harris Bankcorp, Inc. Market risk-weighted assets are primarily determined
using the Internal Models Approach, but the Standardized Approach is used for
some exposures.
The AIRB Approach is the most advanced of the approaches to determining credit
risk capital requirements under Basel II. It utilizes sophisticated techniques
to measure risk-weighted assets at the borrower level, based on sound risk
management principles, including consideration of estimates of the probability
of default, the likely loss given default, exposure at default, term to
maturity and the type of Basel Asset Class exposure. These risk parameters are
determined using historical portfolio data supplemented by benchmarking, and
are updated periodically. Validation procedures related to these parameters
are in place and are enhanced periodically in order to appropriately quantify
and differentiate risks so they reflect changes in economic and credit
conditions.
Under the Standardized Approach, operational risk capital requirements are
determined by the size and type of our lines of business. Gross income, as
defined under Basel II, serves as a proxy for the size of the line of business
and an indicator of operational risk. Gross income is segmented into eight
regulatory business lines by business type, and each segment amount is
multiplied by a corresponding factor prescribed by the Basel II framework to
determine its operational risk capital requirement. Further details regarding
Basel II can be found in the Risk section.
Our total risk-weighted assets (RWA) were $167.2 billion at October 31, 2009,
down from $191.6 billion in 2008. The decrease was attributable to the impact
of a weaker U.S. dollar, which reduced the translated value of
U.S.-dollar-denominated RWA, lower market risk RWA,
62 BMO Financial Group 192nd Annual Report 2009
and lower credit risk RWA mainly as a result of lower corporate and commercial
loan volumes and lower trading exposures. The reductions were partially offset
by credit migration that affected loan and securitization credit risk RWA. The
table below provides a breakdown of our RWA by risk type. The largest
component of BMO's total RWA is credit risk RWA. Credit risk RWA levels in
2010 will be influenced by asset growth, credit migration levels and the value
of the U.S. dollar. We expect RWA will increase in future years as a result of
pending regulatory changes that have been announced for 2010 and beyond.
Risk-Weighted Assets (RWA) ($ millions)
2009 2008
Credit risk 143,098 163,616
Market risk 6,578 11,293
Operational risk 17,525 16,699
Total RWA 167,201 191,608
The Tier 1 Capital Ratio, Tangible Common Equity Ratio, Total Capital Ratio
and Assets-to-Capital Multiple are our primary capital measures.
The Tier 1 Capital Ratio is defined as Tier 1 capital divided by risk-weighted
assets.
The Tangible Common Equity Ratio is defined as common shareholders' equity
less goodwill and intangibles divided by risk-weighted assets.
The Total Capital Ratio is defined as total capital divided by risk-weighted
assets.
The Assets-to-Capital Multiple is calculated by dividing total assets,
including specified off-balance sheet items net of other specified deductions,
by total capital.
Tier 1 capital represents more permanent forms of capital, and primarily
includes common shareholders' equity, preferred shares and innovative hybrid
instruments, less a deduction for goodwill and excess intangible assets and
certain other deductions required under Basel II. Our Tier 1 capital was $20.5
billion as at October 31, 2009, up from $18.7 billion in 2008. The increase
was primarily attributable to net capital issuances during the year. The
impact of those issuances was partially offset by an increase in certain Basel
II deductions and the impact of a new Basel II requirement we adopted on
November 1, 2008, whereby investments in non-consolidated entities and
substantial investments, excluding insurance subsidiaries held prior to
January 1, 2007, are deducted 50% from Tier 1 capital and 50% from Tier 2
capital. Our incremental investment in one of our insurance subsidiaries, to
support the insurance acquisition we completed in the second quarter of the
year, is also deducted 50% from Tier 1 capital and 50% from Tier 2 capital.
Previously, these investments were deducted from Tier 2 capital.
Total capital includes Tier 1 and Tier 2 capital, net of certain deductions.
Tier 2 capital is primarily comprised of subordinated debentures and the
eligible portion of the general allowance for credit losses. Deductions from
Tier 2 capital are primarily comprised of our investments in non-consolidated
subsidiaries and substantial investments and other Basel II deductions. Total
capital was $24.9 billion as at October 31, 2009, up from $23.3 billion in
2008. This increase was primarily attributable to net capital issuances as
outlined under Capital Management Activities.
Our target is to maintain a strong capital position. The Tier 1 Capital Ratio
and Tangible Common Equity Ratio are our key measures of capital adequacy and
both ratios were strong in 2009. Our Tier 1 Capital Ratio was 12.24% as at
October 31, 2009, up from 9.77% in 2008.
Basel II Regulatory Capital ($ millions)
2009 2008
Common shareholders' equity 17,132 15,974
Non-cumulative preferred shares 2,571 1,996
Innovative Tier 1 capital instruments 2,907 2,486
Non-controlling interest in subsidiaries 26 39
Goodwill and excess intangible assets (1,569) (1,635)
Accumulated net after-tax unrealized losses from available-for-sale equity
securities (2) (15)
Net Tier 1 capital 21,065 18,845
Securitization-related deductions (168) (115)
Expected loss in excess of allowance (AIRB Approach) (61) -
Substantial investments and investments in insurance subsidiaries (374) -
Other deductions - (1)
Adjusted Tier 1 capital 20,462 18,729
Subordinated debt 4,236 4,175
Trust subordinated notes 800 800
Eligible portion of general allowance for credit losses 296 494
Total Tier 2 capital 5,332 5,469
Securitization-related deductions (7) (6)
Expected loss in excess of allowance (AIRB Approach) (60) -
Investments in non-consolidated subsidiaries and substantial investments (868) (871)
Adjusted Tier 2 capital 4,397 4,592
Total capital 24,859 23,321
The Tier 1 Ratio was maintained at strong levels during 2009 in light of the
economic environment in order to maintain financial strength and flexibility
in continuing to execute our growth strategy. The Tangible Common Equity Ratio
reflects the amount of common equity net of certain deductions that is
available to support our RWA and is a reflection of the quality of our capital
base. The Tangible Common Equity Ratio was 9.21% at October 31, 2009, up from
7.47% in 2008. There is no standard industry definition for the Tangible
Common Equity Ratio and therefore ratios presented by our industry peers may
not be comparable. The improvement in both ratios year over year reflects a
reduction in RWA and an increase in capital.
Our Total Capital Ratio was 14.87% as at October 31, 2009, up from 12.17% in
2008. The increase reflects a reduction in RWA and an increase in Tier 1
capital. Both our Tier 1 and Total Capital Ratios remain well above OSFI's
stated minimum capital ratios of 7% and 10%, respectively, for a
well-capitalized financial institution. BMO's Assets-to-Capital
63 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Multiple was 14.1 as at October 31, 2009, down from 2008. The multiple remains
well below the maximum permitted by OSFI.
As noted in the Provisions for Income Taxes section, we hedge the foreign
exchange risk arising from our net investment in our U.S. operations by
funding the net investment in U.S. dollars. This strategy reduces the impact
on our capital ratios of changes in foreign exchange rates, as the effect of
foreign currency adjustments to Tier 1 capital arising from changes in the
value of the Canadian dollar is partially offset by the change in the
Canadian-dollar equivalent of U.S.-dollar-denominated RWA.
BMO Financial Group conducts business through a variety of corporate
structures, including subsidiaries and joint ventures. All of our subsidiaries
must meet the regulatory and legislative requirements of the jurisdictions in
which they operate. A framework is in place to ensure that subsidiaries and
their parent entities have access to capital and funding to support their
ongoing operations under both normal and stressed conditions.
Economic Capital Review
Economic capital is our internal assessment of the risks underlying BMO's
business activities. It represents management's estimation of the likely
magnitude of economic losses that could occur should adverse situations arise,
and allows returns to be measured on a basis that considers the risks taken.
Economic capital is calculated for various types of risk - credit, market
(trading and non-trading), operational and business - where measures are based
on a time horizon of one year. For further discussion of these risks, refer to
the Enterprise-Wide Risk Management section on page 75. Economic capital is a
key element of our risk-based capital management and ICAAP process.
Capital Management Activities
To maintain a strong capital position in the uncertain market environment, BMO
undertook a number of share issuances and one share redemption during 2009. We
issued approximately $1 billion of common shares, $150 million of 6.50% Class
B Preferred shares, Series 18, $275 million of 6.50% Class B Preferred shares,
Series 21, and $400 million of 5.40% Class B Preferred shares, Series 23. We
also raised $450 million of innovative Tier 1 capital through BMO Capital
Trust II, a closed-end trust wholly owned by BMO. We redeemed our $250 million
Class B Preferred shares, Series 6. Further details are provided in Notes 19
and 21 on pages 142 and 144 of the financial statements.
On November 19, 2009, we announced a new normal course issuer bid, commencing
December 2, 2009 and ending December 1, 2010, under which we may repurchase
for cancellation up to 15 million BMO common shares (representing
approximately 2.7% of our common shares). No common shares were repurchased
under our previous normal course issuer bid, which expired on September 7,
2009.
Dividends
BMO's target dividend payout range over the medium term is 45% to 55% of net
income available to common shareholders. The target is reflective of our
confidence in our continued ability to grow earnings and our strong capital
position. Dividends are generally increased in line with long-term trends in
earnings per share growth, while sufficient earnings are retained to support
anticipated business growth, fund strategic investments and provide continued
support for depositors.
Dividends declared per common share in 2009 totalled $2.80. While annual
dividends declared in 2009 represented 91.8% of net income available to common
shareholders, our quarterly dividend payout ratio decreased in each quarter of
the year, reaching 63.4% in the fourth quarter. At year-end, BMO's common
shares provided a 5.6% annual dividend yield based on the year-end closing
share price. On November 24, 2009, BMO's Board of Directors declared a
quarterly dividend on common shares of $0.70 per share, unchanged from both
the prior quarter and fiscal 2008.
We believe the current dividend rate is appropriate based on BMO's earning
power. We continue to focus on growing our earnings, which we expect, in
combination with lower loan loss provisions, will move the dividend payout
ratio towards our target range.
In January 2009, we announced changes to our Shareholder Dividend Reinvestment
and Share Purchase Plan (the Plan). Under the Plan, shareholders may elect to
have dividends on common shares reinvested in additional common shares of BMO.
We may offer a discount on the reinvestment of dividends. In fiscal 2009, we
issued shares from treasury at a 2% discount from the average market price (as
defined in the Plan). Previously, common shares purchased under the Plan had
been issued from treasury with no discount to the average market price. The
discount does not apply to shares purchased under the optional cash payment
feature of the Plan.
Eligible Dividends Designation
For the purposes of the Income Tax Act (Canada) and any similar provincial and
territorial legislation, BMO designates all dividends paid or deemed to be
paid on both its common and preferred shares after December 31, 2005, as
"eligible dividends" unless indicated otherwise.
Outstanding Shares and Securities Convertible into Common Shares
Number of shares Dividends declared per share
As at November 24, 2009 or dollar amount 2009 2008 2007
Common shares 552,030,000 $ 2.80 $ 2.80 $ 2.71
Class B Preferred shares
Series 5 $ 200,000,000 $ 1.33 $ 1.33 $ 1.33
Series 13 $ 350,000,000 $ 1.13 $ 1.13 $ 0.96
Series 14 $ 250,000,000 $ 1.31 $ 1.48 $ -
Series 15 $ 250,000,000 $ 1.45 $ 0.94 $ -
Series 16 $ 300,000,000 $ 1.30 $ 0.55 $ -
Series 18 $ 150,000,000 $ 1.55 $ - $ -
Series 21 $ 275,000,000 $ 1.11 $ - $ -
Series 23 $ 400,000,000 $ 0.59 $ - $ -
Convertible into common shares:
Class B Preferred shares (1)
Series 4 (2) $ - $ - $ - $ 0.91
Series 6 (3) $ - $ - $ 1.19 $ 1.19
Series 10 US$ 300,000,000 US$ 1.49 US$ 1.49 US$ 1.49
Stock options
- vested 11,264,000
- nonvested 7,003,000
(1) Convertible preferred shares may be exchanged for common shares on specific dates on a pro-rata
basis based on 95% of the average trading price of common shares for the 20 days ending four
days prior to the exchange date.
(2) Redeemed in August 2007.
(3) Redeemed on November 25, 2008. Note 21 on page 144 of the financial statements includes details
on share capital.
Caution
This Enterprise-Wide Capital Management section contains forward-looking
statements. Please see the Caution Regarding Forward-Looking Statements.
64 BMO Financial Group 192nd Annual Report 2009
Select Financial Instruments
At the request of the G7 finance ministers and central bank governors, The
Financial Stability Forum (since re-established as the Financial Stability
Board) issued a report in April 2008 on enhancing market and institutional
resilience. Among its recommendations, the report encouraged enhanced
disclosure related to financial instruments that markets had come to regard as
carrying higher risk. We expanded our discussion of certain financial
instruments in 2008 in keeping with these developments and continue to report
on them in 2009.
Caution
Given the uncertainty in the capital markets environment, our capital markets
instruments could experience further valuation gains and losses due to changes
in market value. This section, Select Financial Instruments, contains
forward-looking statements. Please see the Caution Regarding Forward-Looking
Statements on page 32.
Consumer Loans
In Canada, our consumer loan portfolio totalled $74.8 billion at October 31,
2009 and is comprised of three main asset classes: residential mortgages
(49%), instalment and other personal loans (47%) and credit card loans (4%).
In the United States, our consumer loan portfolio totalled US$15.3 billion and
is also primarily comprised of three asset classes: residential first
mortgages (37%), home equity products (34%) and indirect automobile loans
(27%).
The following is a discussion of subprime mortgage loans, Alt-A mortgage loans
and home equity products, portfolios that have been of increased investor
interest in the current economic environment.
Subprime Mortgage Loans
In the United States, subprime loans are typically considered to be those made
to borrowers with credit bureau scores of 620 or less. We do not originate
subprime mortgages through a subprime mortgage program in the United States;
however, we make loans available in the United States to individuals with
credit scores below 620 as part of our lending requirements under the
Community Reinvestment Act. We also occasionally lend to parties with credit
scores below 620 when there are other strong qualification criteria. As a
result, we have US$0.29 billion of first mortgage loans outstanding with
subprime characteristics at the date of authorization. A small portion of
these are uninsured loans with a loan-to-value ratio of greater than 80% at
issuance. At year end, US$18.5 million or 6.29% (US$5.4 million or 2.14% in
2008) of the US$0.29 billion of loans were 90 days or more in arrears. This
compares with a rate of 2.77% for BMO's total U.S. first mortgage loan
portfolio.
We also had net exposure of US$101 million (US$159 million in 2008) to a
business that buys distressed mortgages (including subprime mortgages) at a
discounted price.
Home equity products are secured by the homeowner's equity and rank
subordinate to any existing first mortgage on the property. In the United
States, we have a US$5.1 billion home equity loan portfolio, which amounted to
3.1% of BMO's total loan portfolio at October 31, 2009. Of the total
portfolio, loans of US$0.3 billion were extended to customers with credit
bureau scores below 620 and would be categorized as subprime loans. Of these,
only US$7 million or 2.1% (US$3 million or 0.8% in 2008) were 90 days or more
in arrears.
In Canada, BMO does not have any subprime mortgage programs, nor do we
purchase subprime mortgage loans from third-party lenders. BMO mortgage
lending decisions incorporate a full assessment of the customer and loan
structure. Credit score is only one component of our credit adjudication
process and consequently, we do not categorize loans based upon credit scores
alone. A nominal amount of subprime mortgage loans are held in certain
BMO-sponsored Canadian conduits that hold third-party assets, as described in
the discussion of those conduits that follows.
In Canada, we have a $16.8 billion home equity line of credit portfolio ($29.5
billion authorized). The portfolio is of high quality, with only 0.11% (0.08%
in 2008) of loans in the portfolio 90 days or more in arrears. Of these lines
of credit, one product line is offered only in first mortgage position and
represents approximately 61% of the total portfolio. We also have a $0.2
billion home equity instalment loan portfolio, in which $2 million of loans
were 90 days or more in arrears.
Alt-A First Mortgage Loans
In the United States, Alt-A loans are generally considered to be loans for
which borrower qualifications are subject to limited verification. The U.S.
loan portfolio had two loan programs that met this definition - our Easy Doc
and No Doc programs. We discontinued offering the Easy Doc and No Doc programs
in the third quarter of 2008. Loans under the No Doc program, which comprise
most of the exposure in this class, required minimum credit bureau scores of
660 and maximum loan-to-value ratios of 80% (90% with private mortgage
insurance). Due to these lending requirements, the credit quality of our Alt-A
portfolio is strong and the loans have performed relatively well. In the
United States, our direct Alt-A loans totalled US$1.2 billion at year end
(US$1.6 billion in 2008). Of these, US$65 million or 5.23% (US$10 million or
0.62% in 2008) were 90 days or more in arrears. This compares with a rate of
2.77% (0.94% in 2008) for BMO's total U.S. first mortgage loan portfolio.
BMO also offered two limited documentation programs within the home equity
loan portfolio in the United States, which would be categorized as Alt-A if
they were in the first mortgage loan portfolio. As of October 31, 2009, the
amount authorized under these programs was US$1.0 billion, and US$0.6 billion
was outstanding. Loans made under these programs have the same strong credit
score and loan-to-value requirements as the first mortgage loan portfolio, and
as such the portfolio has performed well. As at October 31, 2009, US$6 million
or 0.95% (US$4 million or 0.68% in 2008) of the loans in this portfolio were
90 days or more in arrears. This compares with a rate of 1.10% (0.57% in 2008)
for BMO's total U.S. home equity loan portfolio.
Subprime and Alt-A loans are generally considered to carry higher risk than
traditional prime loans. We also consider loans to customers with credit
scores between 620 and 660 and a loan-to-value ratio above 80% (without
private mortgage insurance) to be a higher-risk component of our portfolio. At
year end, this component represented a negligible amount within our total U.S.
loan portfolio.
In Canada, we do not have a mortgage program that we consider Alt-A. In the
past, we may have chosen to not verify income or employment for certain
customers when there are other strong qualifications that support the
creditworthiness of the loan as part of our credit adjudication process;
however, this approach is no longer in use. We also have a Newcomers to
Canada/non-resident mortgage program that permits limited income verification
but has other strong qualification criteria.
65 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
At October 31, 2009, there was approximately $2.4 billion ($2.2 billion in
2008) outstanding under this program. Of this, only $12 million or 0.50% ($11
million or 0.51% in 2008) of the loans were 90 days or more in arrears,
reflecting the high credit quality of these loans.
Leveraged Finance
Leveraged finance loans are defined by BMO as loans to private equity
businesses and mezzanine financings where our assessment indicates a higher
level of credit risk. BMO has limited exposure to leveraged finance loans,
which represent less than 1% of our total assets, with $3.6 billion
outstanding as at October 31, 2009 ($5.9 billion authorized), essentially
unchanged from a year ago. Of this amount, $201 million or 5.6% of loans were
classified as impaired ($234 million and 6.5% in 2008).
Monoline Insurers and Credit Derivative Product Companies
At October 31, 2009, BMO's direct exposure to companies that specialize in
providing default protection amounted to $256 million in respect of the
mark-to-market value of counterparty derivatives and $19 million in respect of
the mark-to-market value of traded credits ($573 million and $19 million in
2008). The cumulative adjustment for counterparty credit risk recorded against
these exposures was $20 million ($60 million in 2008).
Approximately 28% of the $256 million gross exposure is related to
counterparties rated AAA by Standard & Poor's (S&P) and a further 32% is
related to counterparties rated A. The remainder is largely related to
counterparties for whom ratings have been withdrawn. In 2008, 88% of the $573
million exposure was related to counterparties rated AA or better by S&P.
Moody's Investors Services (Moody's) credit ratings are lower. The notional
value of direct contracts involving monoline insurers and credit derivative
product companies was approximately $3.8 billion ($4.5 billion in 2008). Most
contracts with these companies relate to collateralized debt obligations
(CDOs) and credit default swaps (CDSs) within our trading portfolio and
provide protection against losses arising from defaults. These instruments
have minimal subprime exposure. Certain credit derivative product counterparty
exposures are discussed further in the Exposure to Other Select Financial
Instruments section.
At October 31, 2009, BMO also held $901 million of securities insured by
monoline insurers, of which $630 million were municipal bonds ($1,176 million
and $795 million in 2008). Approximately 91% (79% in 2008) of the municipal
bond portfolio is rated investment grade, including the benefits of the
insurance guarantees. Approximately 77% (approximately 68% in 2008) of the
municipal bond holdings have ratings exclusive of the insurance guarantees and
all of those are rated investment grade.
BMO-Sponsored Securitization Vehicles
BMO sponsors various vehicles that fund assets originated by either BMO (Bank
Securitization Vehicles) or its customers (Canadian Customer Securitization
Vehicles and U.S. Customer Securitization Vehicle). We earn fees for providing
services related to the securitizations in the Customer Securitization
Vehicles, including liquidity, distribution and financial arrangement fees for
supporting the ongoing operations of the vehicles. These fees totalled
approximately $93 million in 2009 and $99 million in 2008.
Bank Securitization Vehicles
Periodically, we sell loans to off-balance sheet entities or trusts, either
for capital management purposes or to obtain alternate sources of funding.
Gains on sales to the securitization vehicles, as well as revenues paid to us
for servicing the loans sold, are recognized in income.
BMO has retained interests in our three bank securitization vehicles, as we
are sometimes required to purchase subordinated
interests or maintain cash deposits in the entities, and we have also recorded
deferred purchase price amounts. These latter amounts represent the portion of
gains on sales to securitization vehicles that have not been received in cash.
Retained interests recorded as assets in our Consolidated Balance Sheet as at
October 31, 2009 and 2008 were $1,015 million and $912 million, respectively.
In the event there are defaults on the assets held by the vehicles, retained
interests may not be recoverable and would then be written down. In addition,
prepayments and changes in interest rates will affect the expected cash flows
from the vehicles, which may result in write-downs of retained interests.
During the year ended October 31, 2009, there was a $12 million write-down of
retained interests in bank securitization vehicles ($5 million of write-downs
in 2008).
The assets of two of the vehicles consist of Canadian residential mortgages
and the third holds Canadian credit card loans transferred from BMO. Our
investment in the asset-backed commercial paper (ABCP) of vehicles that hold
residential mortgages was reduced to $55 million ($509 million in 2008), as
market conditions improved significantly in 2009, and no losses have been
recorded on these investments. ABCP issued by the vehicles holding mortgages
is rated R-1 (high) by DBRS Limited (DBRS) and Prime-1 by Moody's. We have
provided $5.1 billion in liquidity facilities to the two vehicles that hold
residential mortgages and no amounts had been drawn against these facilities
at October 31, 2009. We have not provided liquidity facilities to the vehicle
that holds credit card loans as it issues longer-term asset-backed securities
and not ABCP. We hold subordinated notes issued by the credit card
securitization vehicle having a face value of $269 million, unchanged from a
year ago. The asset-backed securities issued by the vehicle holding credit
card loans are rated AAA by DBRS and Aaa by Moody's. Further information on
the impact of securitization activities on the Consolidated Balance Sheet is
outlined in Note 8 on page 125 of the financial statements.
Canadian Customer Securitization Vehicles
The 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, 2009 was $44
million, which was recorded as a derivative asset in our Consolidated Balance
Sheet (derivative liability of $55 million in 2008).
Some customer securitization vehicles are funded directly by BMO and others
are funded in the market. BMO consolidates the accounts of the customer
securitization vehicles where BMO provides the funding, as the majority of the
gains or losses of those vehicles are expected to accrue to BMO. Included in
the total assets of the bank-funded vehicles of $719 million at year end were
$42 million of mortgage loans with subprime or Alt-A characteristics. No
losses have been recorded on BMO's exposure to these vehicles.
66 BMO Financial Group 192nd Annual Report 2009
BMO's investment in the ABCP of the market-funded vehicles totalled $0.3
billion at October 31, 2009 ($2.1 billion in 2008), most of which reflects
BMO's decision to invest a portion of its excess structural liquidity in ABCP.
No losses have been recorded on these investments.
BMO provided liquidity support facilities to the market-funded vehicles
totalling $5.8 billion at October 31, 2009 ($11.0 billion in 2008). This
amount comprised part of other credit instruments outlined in Note 5 on page
121 of the financial statements. All of these facilities remain undrawn. The
assets of each of these market-funded customer securitization vehicles consist
primarily of diversified pools of Canadian auto receivables and Canadian
residential mortgages. These two asset classes represent 68% of the aggregate
assets of these vehicles. Included in these assets are $382 million of
Canadian residential mortgage loans with subprime or Alt-A characteristics.
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 Vehicle
We sponsor a U.S. ABCP multi-seller vehicle. This customer securitization
vehicle assists our customers with the securitization of their assets to
provide them with alternative sources of funding. The vehicle provides funding
to diversified pools of portfolios through 81 (91 in 2008) individual
securitization transactions with an average facility size of US$70 million.
The size of the pools ranged from US$0.7 million to US$270 million at October
31, 2009. Committed facility amounts include a wide range of asset classes.
Residential mortgages classified as subprime or Alt-A comprise 0.4% of the
portfolio.
Approximately 58% of the vehicle's commitments have been rated by Moody's or
S&P, and almost all of those are rated A or higher. Approximately $807 million
of the commitments are insured by mono-lines, primarily MBIA Inc. and Ambac
Financial Group. The ratings of MBIA and Ambac were downgraded in the third
quarter of 2009 but have no impact on the performance of the underlying
assets. None of the insurance guarantees involve mortgages or asset-backed
securities/ structured-finance CDOs. The vehicle holds exposures secured by a
variety of asset classes, including mid-market and corporate loans as well as
commercial real estate and auto loans.
The vehicle had US$4.4 billion of commercial paper outstanding at October 31,
2009, down from US$6.5 billion in 2008. The ABCP of the vehicle is rated A1 by
S&P and P1 by Moody's. BMO has not invested in the vehicle'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 vehicles in the United States. BMO provided committed
liquidity support facilities of US$5.7 billion to the vehicle at October 31,
2009 (US$8.2 billion in 2008).
BMO is also a counterparty to derivative contracts with the vehicle that are
used to manage its exposure to interest rates. The fair value of derivative
contracts outstanding with the vehicle and recorded in our Consolidated
Balance Sheet was a derivative liability of $1 million as at October 31, 2009
($1 million in 2008). BMO is not required to consolidate the vehicle, as the
vehicle has issued an expected-loss note. The holder of the note consolidates
the vehicle as the noteholder is exposed to the majority of expected losses.
In the event we choose to or are required to terminate our relationship with
the vehicle, 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 vehicle.
Credit Protection Vehicle
We also sponsor Apex Trust (Apex), a Canadian special purpose vehicle that
comprises 12 tranches of diversified corporate credits, each of which has the
benefit of first-loss protection. The 12 tranches in Apex have exposure to
approximately 450 corporate credits that are diversified by geographic region
and industry. Approximately 70% of the corporate credits are rated investment
grade (25% rated higher than BBB and 46% rated BBB) and 29% are rated below
investment grade. The ratings of a number of the corporate credits were
lowered in the first half of 2009 but there were few changes to the ratings of
the corporate credits in the latter half of the year. A number of the ratings
on the underlying companies are on watch or under review for downgrade. In
2009, we recorded charges of $521 million on Apex, compared with charges of
$230 million in 2008.
In the third and fourth quarters, we put in place hedges that reduced BMO's
risk exposure to Apex to levels that are not expected to expose BMO to
significant loss. No realized losses have been experienced in the vehicle to
date and the likelihood of realized losses exceeding the level of the hedges
we have is considered remote given the level of first-loss protection on the
tranches and the strength of the underlying corporate credits.
Apex has issued $2.2 billion of notes (Notes) with remaining terms of four and
seven years. After giving effect to the hedges we entered into, BMO has no net
exposure through the Apex Notes to realized credit losses in the tranches.
Prior to entering into the hedge in the fourth quarter, BMO's Notes exposure
was $815 million. Another party has a $600 million exposure to the Notes
through a total return swap with BMO. Realized credit losses in Apex would
only be incurred should losses on defaults on the underlying credits exceed
the first-loss protection on a tranche. As detailed below, a significant
majority of Apex's positions benefit from substantial first-loss protection.
Certain of the levels of first-loss protection were lowered in the first half
of 2009 but there was minimal change in these levels during the second half of
the year.
A senior funding facility of $1.13 billion has been made available to Apex,
with BMO providing $1.03 billion of that facility. During the third quarter,
we entered into a transaction that hedges the first $515 million of loss
exposure on our committed exposure under the senior funding facility. As of
October 31, 2009, $112 million ($553 million in 2008) was advanced through
BMO's committed share of the senior facility to fund collateral calls arising
from changes in mark-to-market values of the underlying CDSs.
BMO has entered into CDS contracts on the net notional positions in the
structure with the swap counterparties and into offsetting swaps with the
vehicle and has exposure to losses above the $3.33 billion of Notes and senior
funding facility.
Two of the 12 tranches have lower levels of first-loss protection than others.
If losses were realized by Apex investors on the full notional amounts of
$1,217 million in the two weakest tranches, BMO's exposure would be nil, given
the hedges that are now in place. Each of the other 10 tranches, which have a
net notional amount of $20.6 billion, is rated from A (low) to AAA and has
significant first-loss protection, ranging from 13.0% to 29.4% with a weighted
average of 23.5%.
BMO purchased Notes from other mid-term noteholders as part of the
restructuring of Apex in May 2008. BMO does not consider this purchase of
Notes to imply or indicate an intent to provide support to other mid-term
noteholders or provide additional subordinated support to Apex. Instead, the
purchase was a one-time, isolated event related to the restructuring of Apex.
We do not intend to purchase additional mid-term notes of Apex nor do we
intend to reimburse any other mid-term noteholder for any loss they may incur.
67 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Structured Investment Vehicles
Credit investment management vehicles provide investors with opportunities to
invest in customized, diversified debt portfolios in a variety of asset and
investment grade rating classes.
We hold subordinate capital notes of two BMO-managed London-based Structured
Investment Vehicles (SIVs), Links Finance Corporation (Links) and Parkland
Finance Corporation (Parkland), with a carrying value of nil. Our exposure to
loss relates to our investments in the vehicles, derivative contracts we have
entered into with the vehicles and senior funding we provide through a
liquidity facility in order to fund the repayment of the SIVs' senior notes.
The fair value of our derivative contracts outstanding with the SIVs was
recorded in our Consolidated Balance Sheet as a derivative asset of $12
million ($57 million in 2008). We earned investment management fees of $3
million and $5 million in 2009 and 2008, respectively, for managing these
portfolios.
In the event we choose to or are required to terminate our relationship with
these vehicles, any associated derivative contracts would be settled at their
fair value.
We provide senior-ranked support for the funding of Links and Parkland through
BMO liquidity facilities. The facilities backstop the repayment of senior note
obligations to facilitate the SIVs' access to further senior funding, provide
supplemental funding and permit the SIVs to continue the strategy of selling
assets in an orderly and value-sensitive manner.
At October 31, 2009, amounts drawn on the facilities totalled US$5.8 billion
and ae597 million (US$3.7 billion and ae477 million in 2008), down from their
peak in August 2009 of US$6.4 billion and ae622 million, respectively. The
liquidity facilities totalled US$6.0 billion for Links and ae627 million for
Parkland at October 31, 2009. Advances under the liquidity facilities rank
ahead of the SIVs' subordinated capital notes. Consistent with the strategy of
selling assets in an orderly manner, the pace of asset sales was measured
throughout 2009 as a result of market conditions. We anticipate that the SIVs
will continue the strategy of selling assets in an orderly manner based upon
market conditions and that asset sales in the near future will be modest. The
total amount drawn under the liquidity facilities is primarily affected by the
pace and price of asset sales and asset maturities. Amounts funded are
expected to decrease from current levels based on these factors. While the
assets of the SIVs will mature over time, a significant portion is expected to
be repaid in the period between 2010 and 2012.
The SIVs' capital noteholders will continue to bear the economic risk from
actual losses up to the full amount of their investment. The book value of the
subordinated capital notes in Links and Parkland at October 31, 2009 was
US$866 million and ae150 million, respectively. The par value of the assets
held by Links and Parkland totalled US$7.1 billion and ae752 million,
respectively, reduced from US$8.8 billion and ae830 million at October 31,
2008. The market value of the assets held by Links and Parkland, including hedges
and cash equivalents, totalled US$5.5 billion and ae631 million, respectively,
compared with US$6.8 billion and ae698 million at October 31, 2008. During 2009,
there were maturities and repayments of assets totalling US$277 million in Links
and ae11 million in Parkland, as well as asset sales of US$960 million in Links
and ae31 million in Parkland. While the market value of Links assets is currently
lower than the senior debt outstanding, BMO believes that the first-loss protection
provided by the subordinate capital notes exceeds future expected losses. The market
value of Parkland assets increased in the fourth quarter of 2009 and now exceeds the
amount of senior debt outstanding.
The asset quality of Links remains high. Based on market value, approximately
51% of debt securities are rated Aa3 or better by Moody's (84% in 2008) with
91% rated investment grade (98% in 2008). Approximately 47% are rated AA- or
better by S&P (73% in 2008) with 92% rated investment grade (98% in 2008).
Certain of the debt security ratings are on credit watch for downgrade. The
senior notes of the SIVs have ratings consistent with BMO's senior debt
ratings of Aa1 (Moody's) and A+ (S&P). On October 27, 2009, Moody's placed the
long-term senior debt ratings of Links and Parkland on review for possible
downgrade as a result of its review of BMO's long-term debt ratings. The SIVs
hold a diversified mix of debt securities and the mix of securities is largely
unchanged from October 31, 2008.
Exposure to Other Select Financial Instruments, including Collateralized Debt
Obligations (CDOs)
The following table provides additional detail on select financial instruments
that are held in our trading and available-for-sale portfolios. Most of our
CDOs and collateralized loan obligations (CLOs) are fully hedged with other
large financial institutions. Net CDO exposure is minimal at $16 million, and
net CLO exposure is also minimal, at $125 million, consisting of the $101
million carrying value of unhedged and wrapped instruments and a $24 million
net loss on hedged instruments.
BMO has invested only in senior and super-senior tranches of CDOs and CLOs.
Tranche ratings in the table use the lowest external rating available provided
by S&P, Moody's or Fitch Ratings. The differences between hedged investment
amounts and the carrying value of hedged investment amounts reflect
mark-to-market losses, which are generally recoverable through total return or
credit default swaps (CDSs). The underlying securities consist of a wide range
of corporate assets. Approximately 20% of hedged investment amounts have been
hedged through swaps with a single financial institution counterparty rated A.
The value of BMO's interest in those hedges is supported by collateral held,
with the exception of relatively modest amounts as permitted under
counterparty agreements. Another 60% of hedged investment amounts relate to
two counterparties rated AAA for which we have recorded $109 million of hedge
gains. The remaining 20% relates to a counterparty rated CC for which we have
recorded $14 million of hedge gains.
68 BMO Financial Group 192nd Annual Report 2009
Amounts in the table below exclude CDS protection purchases from two credit
derivative product company counter-parties that have a market value of US$140
million (before deduction of US$17 million of credit valuation adjustments)
with a US$1.5 billion notional value of CDOs' CDS protection provided to other
financial institutions in our role as intermediary.
One of the credit derivative product counterparties' credit rating is Ba1 and
the subordinated notes of the other counterparty are rated BBB-/Caa1. The
underlying security on the two exposures consists of three pools of broadly
diversified single-name corporate and sovereign credits. Each of the pools has
from 95 to 138 credits, of which 64% to 81% are investment grade with
first-loss protection that ranges from 7.4% to 19.2% with a weighted average
of 11.9% based on notional value.
Exposures to Other Select Financial Instruments (Canadian $ in millions) (1)
Carrying Carrying
value of value of Cumulative
unhedged loss in Net
and Hedged hedged value Cumulative losses on
Tranche wrapped investment investment hedged gain on hedged
As at October rating investments amounts amounts investments hedges investments
31, 2009
CDOs (2) AAA 16 Sundry
securities
CCC or Hedged with
below 258 57 (201) 201 - FI rated A
16 258 57 (201) 201 -
CLOs AAA 58 Mostly U.K.
and
European
mid-sized
corporate
loans
Hedged with
monolines
rated CC or
better U.K.
mid-sized
enterprise
AAA 943 855 (88) 67 (21) loans
A- to 43
AA+
A- to Hedged with
AA+ monolines
419 360 (59) 56 (3) rated AAA
101 1,362 1,215 (147) 123 (24)
Residential Mostly U.K.
MBS (4) (5) and
Australian
No subprime AAA 33 mortgages
Wrapped
with
U.S. subprime monolines
- A- to rated
wrapped AA+ 2 AAA (3)
CCC or 15 Wrapped
below with
monoline
rated
CC or no
longer
rated
U.S. subprime A- to Hedged with
AA+ FIs rated
60 51 (9) 9 - AA
CCC or Hedged with
below FIs rated
68 50 (18) 18 - AA
50 128 101 (27) 27 -
European,
U.K. and
U.S.
commercial
Commercial real estate
MBS (5) AAA 25 loans
A- to 138 Mostly
AA+ Canadian
commercial
and
multi-use
residential
loans
163
Asset-backed AAA 219 Mostly
securities Canadian
(ABS) credit card
receivables
and auto
loans
A- to 128 Mostly
AA+ Canadian
credit card
receivables
and auto
loans
BBB- to 70 Collateral
BBB+ notes on
Canadian
credit card
receivables
417
FIs = Financial Institutions
(1) Most of the unhedged and wrapped investments were transferred to the available-for-sale portfolio
effective August 1, 2008.
(2) CDOs include indirect exposure to approximately $49 million of U.S. subprime residential mortgages. As
noted above, this exposure is hedged via total return swaps with a large non-monoline financial
institution.
(3) Certain ratings are under review.
(4) Wrapped MBS have an insurance guarantee attached and are rated inclusive of the wrap protection.
Residential MBS included in the hedged investment amounts of $128 million have exposure to an estimated
$63 million of underlying U.S. subprime loans.
(5) Amounts exclude BMO Life Assurance holdings of $34 million of residential MBS and $237 million of
commercial MBS.
69 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Off-Balance Sheet Arrangements
BMO enters into a number of off-balance sheet arrangements in the normal
course of operations. Our arrangements with certain variable interest entities
have been addressed on pages 66 to 68 and 71 to 72 of this MD&A. The
discussion that follows addresses our remaining off-balance sheet
arrangements.
Credit Instruments
In order to meet the financial needs of our clients, we use a variety of
off-balance sheet credit instruments. These include guarantees and standby
letters of credit, which represent our obligation to make payments to third
parties on behalf of a customer if the customer is unable to make the required
payments or meet other contractual requirements. We also write documentary and
commercial letters of credit, which represent our agreement to honour drafts
presented by a third party upon completion of specified activities.
Commitments to extend credit are off-balance sheet arrangements that represent
our commitment to customers to grant them credit in the form of loans or other
financings for specific amounts and maturities, subject to meeting certain
conditions.
There are a large number of credit instruments outstanding at any time. Our
customers are broadly diversified and we do not anticipate events or
conditions that would lead a significant number of our customers to fail to
perform in accordance with the terms of the contracts. We use our credit
adjudication process in deciding whether to enter into these arrangements just
as we do when extending credit in the form of a loan. We monitor off-balance
sheet instruments to ensure that there are no undue concentrations in any
geographic region or industry.
The maximum amount payable by BMO in relation to these credit instruments was
approximately $73 billion at October 31, 2009 ($99 billion in 2008). However,
this amount is not representative of our likely credit exposure or liquidity
requirements for these instruments as it does not take into account customer
behaviour, which suggests that only a portion of customers utilize the
facility, and any amounts that could possibly be recovered under recourse or
collateralization provisions. In addition, a large majority of these
commitments expire without being drawn upon. Further information on these
instruments can be found in Note 5 on page 121 of the financial statements.
For the credit commitments outlined above, in the absence of an event that
triggers a default, early termination by BMO may result in breach of contract.
Variable Interest Entities (VIEs)
Our interests in VIEs are discussed primarily on pages 66 to 68 in the
BMO-Sponsored Securitization Vehicles and Structured Investment Vehicles
sections and on pages 71 to 72 in the Accounting for Variable Interest
Entities section. Capital and funding trusts are discussed below.
Capital and Funding Trusts
BMO Subordinated Notes Trust (SN Trust) issued $800 million of BMO Trust
Subordinated Notes (the Notes) in 2007, the proceeds of which were used to
purchase a senior deposit note from BMO. We hold all of the outstanding voting
trust units in SN Trust and will do so at all times while the Notes are
outstanding. We are not required to consolidate SN Trust. BMO will not
terminate SN Trust while the Notes are outstanding, unless SN Trust has
sufficient funds to pay the redemption price on the Notes and only with the
approval of OSFI. We also provide a $30 million credit facility to SN Trust,
of which $5 million had been drawn at October 31, 2009 ($5 million in 2008).
We guarantee payment of the principal, interest, redemption price, if any, and
any other amounts on the Notes on a subordinated basis.
During 2009, BMO Capital Trust II (Trust II) was created to issue $450 million
of BMO Tier 1 Notes - Series A. Trust II used the proceeds of the offering to
purchase a senior deposit note from BMO. We are not required to consolidate
Trust II.
Guarantees
Guarantees 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. Contracts under which we may be required
to make payments if a third party does not perform according to the terms of a
contract and contracts under which we provide indirect guarantees of
indebtedness are also considered guarantees. In the normal course of business,
we enter into a variety of guarantees, including standby letters of credit,
backstop and other liquidity facilities and derivatives (including but not
limited to credit default swaps and written options), along with
indemnification agreements.
The maximum amount payable was $82 billion as at October 31, 2009 ($120
billion in 2008). However, this amount is not representative of our likely
exposure as it does not take into account customer behaviour, which suggests
that only a portion of the guarantees will require payment, and does not take
into account recovery through recourse and collateral provisions.
For a more detailed discussion of these agreements, please see Note 7 on page
124 of the financial statements.
70 BMO Financial Group 192nd Annual Report 2009
Critical Accounting Estimates
The Notes to BMO's October 31, 2009 Consolidated Financial Statements outline
our significant accounting estimates. The following accounting estimates are
considered particularly important, as they require significant judgments by
management. Management has established detailed policies and control
procedures that are intended to ensure these judgments are well controlled,
independently reviewed and consistently applied from period to period. We
believe that our estimates of the value of BMO's assets and liabilities are
appropriate.
Allowance for Credit Losses
The allowance for credit losses adjusts the value of loans to reflect their
estimated realizable value. In assessing their estimated realizable value, we
must rely on estimates and exercise judgment regarding matters for which the
ultimate outcome is unknown. These include economic factors, developments
affecting companies in particular industries and specific issues with respect
to single borrowers. Changes in circumstances may cause future assessments of
credit risk to be materially different from current assessments, which could
require an increase or decrease in the allowance for credit losses.
One of our key performance measures is the provision for credit losses as a
percentage of average net loans and acceptances. Over the past 10 years, for our
Canadian peer group, the average annual ratio has ranged from a high of 1.24% in 2002
to a low of 0.17% in 2004. This ratio varies with changes in the economy and
credit conditions. If we applied these high and low ratios to average net
loans and acceptances in 2009, our provision for credit losses would range
from $2,205 million to $302 million. Our provision for credit losses in 2009
was $1,603 million.
Additional information on the process and methodology for determining the allowance
for credit losses can be found in the discussion of credit risk on page 80 as well
as in Note 4 on page 119 of the financial statements.
Financial Instruments Measured at Fair Value
BMO records securities and derivatives at their fair value. Fair value
represents our estimate of the amount we would receive, or would have to pay
in the case of a derivative liability, in a current transaction between
willing parties. We employ a fair value hierarchy to categorize the inputs we
use in valuation techniques to measure fair value. The extent of our use of
quoted market prices (Level 1), internal models using observable market
information (Level 2) and internal models without observable market
information (Level 3) in the valuation of securities, derivative assets and
derivative liabilities as at October 31, 2009, as well as a sensitivity
analysis of our Level 3 assets, is included in Note 30 on page 157 of the
financial statements.
Valuation models use general assumptions and market data and therefore do not
reflect the specific risks and other factors that would affect a particular
instrument's fair value. As a result, we incorporate certain adjustments when
using internal models to establish fair values. These fair value adjustments
take into account the estimated impact of credit risk, liquidity risk, valuation
considerations, administrative costs and closeout costs. For example, the credit
risk adjustment for derivative financial instruments incorporates credit risk into
our determination of fair values by taking into account factors such as the
counterparty's credit rating, the duration of the instrument and changes in
credit spreads.
Valuation Product Control (VPC), a group independent of the trading
lines of business, verifies the fair values at which financial instruments are recorded.
For instruments that are valued using models, VPC identifies situations where valuation
adjustments must be made to the model estimates to arrive at fair value.
The methodologies used for calculating these adjustments are reviewed on an
ongoing basis to ensure that they remain appropriate. Significant changes in
methodologies are rare and are made only when we feel that the change will
result in better estimates of fair value.
Valuation Adjustments ($ millions)
As at October 31 2009 2008
Credit risk 135 153
Liquidity risk 39 39
Administrative costs 8 7
Other 41 30
223 229
The decrease in the adjustment for credit risk was due to narrower relative
credit spreads between our counterparties and BMO.
Accounting for Securitizations
When loans are securitized, we record a gain or loss on sale. In determining
the gain or loss, management must estimate the net present value of expected
future cash flows by relying on estimates of the amount of interest and fees
that will be collected on the securitized assets, the yield to be paid to
investors, the portion of the securitized assets that will be repaid before
its scheduled maturity, credit losses, the fair value cost of servicing and
the rate at which to discount these estimated future cash flows. Actual cash
flows may differ significantly from those estimated by management. If
management's estimate of future cash flows were different, our gain on
securitization recognized in income would also be different.
Additional information concerning accounting for securitizations, including a
sensitivity analysis for key assumptions, is included in Note 8 on page 125 of the
financial statements.
Accounting for Variable Interest Entities
In the normal course of business, BMO enters into arrangements with variable
interest entities (VIEs). VIEs include entities where the equity is considered
insufficient to finance the entity's activities or for which the equity
holders do not have a controlling financial interest. We are required to
consolidate VIEs if the investments we hold in these entities and/or the
relationships we have with them result in us being exposed to the majority of
their expected losses, being able to benefit from a majority of their expected
residual returns, or both.
We determine whether an entity is a VIE and whether BMO holds a variable interest in
that VIE based primarily on quantitative analysis. These include a variety of complex
estimation processes involving qualitative and quantitative factors to calculate and
analyze a VIE's expected losses and 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 expected losses and expected residual
returns among the identified parties holding variable interests. These
analyses 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 right to receive expected 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 the credit protection vehicle Apex, reconsideration events include BMO
purchasing additional Notes, granting additional liquidity facilities, increasing the
amount of the loan extended by BMO beyond what is contemplated under the existing credit
lending facilities, or guaranteeing repayment of 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.
71 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
With respect to the structured investment vehicles Links and Parkland,
reconsideration events include a purchase or sale by BMO of capital notes,
provision of additional lending facilities, renegotiation of the loan facility
provided by BMO, asset for capital note exchanges and provision of a guarantee
by BMO to compensate noteholders for realized losses. The reconsideration
event that is most likely to occur is a renegotiation of certain terms in our
lending facilities. If we were to renegotiate certain terms of our lending
facilities, we would not expect to consolidate based on our current assessment
of our exposure to expected losses.
Reconsideration events for our Canadian multi-seller conduits include the
purchase or sale by BMO of asset-backed commercial paper (ABCP) issued by the
vehicles 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 continually monitor our exposure to
expected losses to ensure they do not approach consolidation thresholds.
Reconsideration events for our U.S. multi-seller conduit include the purchase
by BMO of ABCP issued by the vehicle, the granting of additional liquidity
facilities or credit enhancement, and a change in the size of the expected
loss note. Repayment of the expected loss note would also be a reconsideration
event and a third party would have to be found to absorb the exposure to the
majority of the expected losses. Otherwise, BMO would be required to
consolidate the vehicle. 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 66 to 68 as well as in Note 9 on page 127 of the
financial statements.
Pension and Other Employee Future Benefits
BMO's pension 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 a management estimate that significantly 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.
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. We determine discount rates at each
year-end for our Canadian and U.S. plans using high quality corporate bonds
with terms matching the plans' specific cash flows.
Additional information regarding our accounting for pension and other employee
future benefits, including a sensitivity analysis for key assumptions, is included
in Note 24 on page 148 of the financial statements.
Other Than Temporary Impairment
We 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, which are classified as
available-for-sale securities. 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 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.
At the end of 2009, there were total unrealized losses of $199 million on securities
for which cost exceeded fair value and an impairment write-down had not been recorded.
Of this amount, $74 million related to securities for which 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 115
of the financial statements.
Income Taxes
The provision for income taxes is calculated based on the expected tax
treatment of transactions recorded in our Consolidated Statements of Income or
Changes in Shareholders' Equity. In determining the provision for income
taxes, we interpret tax legislation in a variety of jurisdictions and make
assumptions about the expected timing of the reversal of future tax assets and
liabilities. If our interpretations differ from those of tax authorities or if
the timing of reversals is not as anticipated, our provision for income taxes
could increase or decrease in future periods. The amount of any such increase
or decrease cannot be reasonably estimated.
Additional information regarding our accounting for income taxes is included
in Note 25 on page 152 of the financial statements.
Goodwill and Intangible Assets
Goodwill is assessed for impairment at least annually. This assessment
includes a comparison of the carrying value and the fair value of each group
of businesses to ensure that the fair value of the group is greater than its
carrying value. If the carrying value exceeds the fair value of the group, a
more detailed goodwill impairment assessment would have to be undertaken. In
determining fair value, we employ internally developed valuation models such
as discounted cash flow models consistent with those used when we acquire
businesses. These models are dependent on assumptions related to revenue
growth, discount rates, synergies achieved on acquisitions and the
availability of comparable acquisition data. Changes in each of these
assumptions will affect the determination of fair value for each of the
business units in a different manner. Management must exercise judgment and
make assumptions in determining fair value, and differences in judgments and
assumptions could affect the determination of fair value and any resulting
impairment write-down. At October 31, 2009, the estimated fair value of each
of our groups of businesses was greater than its carrying value.
Intangible assets are amortized to income on either a straight-line or an accelerated
basis over a period not exceeding 15 years, depending on the nature of the
asset. There are no intangible assets with indefinite lives. We test
intangible assets for impairment when circumstances indicate the carrying
value may not be recoverable. No such impairment was identified for the years
ended October 31, 2009, 2008 and 2007.
Additional information regarding the composition of goodwill and intangible assets
is included in Note 13 on page 137 of the financial statements.
Contingent Liabilities
BMO and its subsidiaries are involved in various legal actions in the ordinary
course of business.
Contingent litigation loss provisions are recorded when it becomes likely that
BMO will incur a loss and the amount can be reasonably estimated. BMO's management
and internal and external experts are involved in assessing any likelihood and
estimating any amounts involved. The actual costs of resolving these claims may be
substantially higher or lower than the amounts provided. Additional information
regarding contingent liabilities can be found in Note 29 on page 156 of the
financial statements.
72 BMO Financial Group 192nd Annual Report 2009
Caution
This Critical Accounting Estimates section contains forward-looking
statements. Please see the Caution Regarding Forward-Looking Statements.
Changes in Accounting Policies in 2009
Goodwill and Intangibles
On November 1, 2008, we adopted the CICA's new accounting requirement for
goodwill and intangible assets. We have restated prior periods to reflect this
change. The new rules require us to reclassify certain computer software from
premises and equipment to intangible assets. The impact of implementation of
this new standard was not material to our results of operations or financial
position and had no impact on net income. Additional details of the specific
accounting change are provided in Note 13 on page 137 of the financial
statements.
Classification and Measurement of Financial Instruments
We adopted the CICA's new accounting requirements relating to the
classification and measurement of financial assets as of November 1, 2008. The
new standard redefines loans and receivables to include all non-derivative
financial assets with fixed or determinable repayment terms that are not
quoted in an active market. The standard also permits reclassification of
available-for-sale securities to loans when there is no active market.
Impairment on the reclassified debt securities will be calculated in a manner
consistent with our loan portfolio, based on our assessment of the
recoverability of principal and interest. This change in accounting policy
does not have any impact on our results of operations or financial position.
Future Changes in Accounting Policies
Transition to International Financial Reporting Standards
Canadian public companies will be required to prepare their financial
statements in accordance with International Financial Reporting Standards
(IFRS), as issued by the International Accounting Standards Board (IASB), for
fiscal years beginning on or after January 1, 2011. Effective November 1,
2011, we will adopt IFRS as the basis for preparing our consolidated financial
statements. We will report our financial results for the quarter ended January
31, 2012 prepared on an IFRS basis. We will also provide comparative data on
an IFRS basis, including an opening balance sheet as at November 1, 2010.
In order to meet the requirement to transition to IFRS, in 2008 we established
an enterprise-wide project and formed an executive steering committee. We are
following a transition plan comprising three phases: (1) IFRS diagnostic
assessment, (2) implementation and education, and (3) completion of all
integration changes. The project remains on track: we have completed the
diagnostic assessment, and the implementation and education phase of our
transition is well advanced.
The key elements of the implementation and education phase include identifying
and implementing the necessary changes within our existing financial reporting or
data collection processes to address the IFRS differences identified in our
diagnostic assessment; developing and executing internal training and awareness
programs; selecting accounting policy options permitted under IFRS; and, assessing
possible impacts to the primary capital measures monitored by our regulator, OSFI. For
details on the primary capital measures monitored by OSFI, refer to page 62.
We are also assessing the exemptions to full restatement that are permitted
under IFRS. Generally, with the adoption of IFRS, any change to our existing
accounting policies must be applied retroactively and reflected in our opening
balance sheet of the comparative period. There are, however, a number of
exemptions from full restatement available under IFRS.
The aspects of IFRS that have the potential to be the most impactful to the bank
are those that deal with securities, provision for credit losses on loans, hedge
accounting, asset securitization, variable interest entities, and pension and other
employee future benefits. In response to financial reporting issues emerging
from the global financial crisis, the IASB plans to make revisions to or to
replace existing IFRS standards that address many of these areas. Some of the
anticipated changes may be in effect prior to the bank's transition date, such
that IFRS may differ at transition date from its current form. However, it is
likely that the majority of the changes will be in effect subsequent to the
bank's date of transition; with the result that the impact to the bank of
adopting IFRS will extend beyond its transitional year.
Replacement of IAS 39 - Financial Instruments
The IASB's project plan reflects the replacement of its existing financial
instruments standard in several phases. The first phase was recently completed
with the publication of IFRS 9 - Financial Instruments, which addresses the
classification and measurement of financial instruments, including securities.
This new standard will not be mandatory until fiscal 2014, which is post-IFRS
implementation for the bank.
The second phase of the financial instruments replacement is to replace the
recognition and measurement requirement for impairment of financial instruments
recorded at amortized cost, which includes loans. Based on draft papers issued
by the IASB, significant changes to the existing standard are anticipated; however,
the IASB indicated that the new standard is unlikely to require adoption until at least
fiscal 2014. The IASB's third phase will deal with hedge accounting.
The IASB is scheduled to issue draft papers on this topic sometime in the first half
of the 2010 calendar year. It is unclear when adoption will be required.
Derecognition - replacement of existing requirements within IAS 39
The IASB is addressing the derecognition requirements for when a financial
asset or financial liability would be removed from an entity's statement of
financial position, which could impact whether securitized assets remain
off-balance sheet. The IASB has provided a tentative publication date for the
latter half of the 2010 calendar year. It is unclear when adoption will be
required.
Replacement of IAS 27 - Consolidated and Separate Financial Statements
The IASB is examining the IFRS standard affecting off-balance sheet vehicles,
which could impact the recognition requirements for variable interest entities
relative to the current standard. The IASB has provided a tentative
publication date for the latter half of the 2010 calendar year. It is unclear
when adoption will be required.
Amendments to IAS 19 - Post-Employment Benefits (including pensions)
The IFRS standard that addresses pension and other employee future benefits is
slated for revision by the IASB, with a tentative publication date sometime in
the first half of the 2011 calendar year. The extent of the change as well as
the timing of adoption are unclear.
Due to the uncertainty of the extent to which existing standards may change,
combined with the uncertainty surrounding the adoption dates of any new or revised
standard, we are not in a position to determine the impact of adopting IFRS on
either our future financial results or primary capital measures at this time.
Caution
This Future Changes in Accounting Policies section contains forward-looking
statements. Please see the Caution Regarding Forward-Looking Statements.
73 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Management's Annual Report on Disclosure Controls and Procedures and Internal Control
over Financial Reporting
Disclosure Controls and Procedures
Disclosure controls and procedures are designed to provide reasonable
assurance that all relevant information is gathered and reported to senior
management, including the President & Chief Executive Officer (CEO) and the
Chief Financial Officer (CFO), on a timely basis so that appropriate decisions
can be made regarding public disclosure.
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures was conducted as at October 31, 2009 by BMO
Financial Group's management under the supervision of the CEO and the CFO.
Based on this evaluation, the CEO and the CFO have concluded that, as at
October 31, 2009, our disclosure controls and procedures, as defined in Canada
by National Instrument 52-109, Certification of Disclosure in Issuers' Annual
and Interim Filings, and in the United States by Rule 13a-15(e) under the
Securities Exchange Act of 1934 (the Exchange Act), are effective to ensure
that information required to be disclosed in reports that we file or submit
under Canadian securities legislation and the Exchange Act is recorded,
processed, summarized and reported within the time periods specified therein.
Internal Control over Financial Reporting
Internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements in accordance with Canadian generally accepted
accounting principles and the requirements of the Securities and Exchange
Commission in the United States, as applicable. Management is responsible for
establishing and maintaining adequate internal control over financial
reporting for BMO Financial Group.
BMO's internal control over financial reporting includes policies and
procedures that: pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of BMO; provide reasonable assurance that transactions are
recorded as necessary to permit preparation of the financial statements in
accordance with Canadian generally accepted accounting principles and the
requirements of the Securities and Exchange Commission in the United States,
as applicable, and that receipts and expenditures of BMO are being made only
in accordance with authorizations by management and directors of BMO; and
provide reasonable assurance regarding prevention or timely detection of the
unauthorized acquisition, use or disposition of BMO's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
can provide only reasonable assurance and may not prevent or detect
misstatements. Furthermore, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
BMO Financial Group's management, under the supervision of the CEO and the
CFO, has evaluated the effectiveness of our internal control over financial
reporting using the framework and criteria established in Internal Control -
Integrated Framework, issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on this evaluation, management has concluded
that internal control over financial reporting was effective as of October 31,
2009.
BMO Financial Group's auditors, KPMG LLP (Shareholders' Auditors), an
independent registered public accounting firm, has issued an audit report on
our internal control over financial reporting. This audit report appears on
page 109.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting in
fiscal 2009 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Pre-Approval of Shareholders' Auditors' Services and Fees
Pre-Approval Policies and Procedures
As part of BMO Financial Group's corporate governance practices, the Board of
Directors ensures the strict application of BMO's corporate policy limiting
the services provided by the Shareholders' Auditors that are not related to
their role as auditors. All services provided by the Shareholders' Auditors
are pre-approved by the Audit Committee as they arise, or through an annual
pre-approval of amounts for specific types of services. All services comply
with our Auditor Independence Policy, as well as professional standards and
securities regulations governing auditor independence.
Shareholders' Auditors' Service Fees
Aggregate fees paid to the Shareholders' Auditors during the fiscal years
ended October 31, 2009 and 2008 were as follows:
Fees ($ millions) (1) 2009 2008
Audit fees 12.0 11.6
Audit-related fees (2) 0.2 0.1
Tax fees - -
All other fees (3) 0.2 0.1
Total 12.4 11.8
(1) The classification of fees is based on applicable Canadian securities
laws and United States Securities and Exchange Commission definitions.
(2) Audit-related fees for 2009 and 2008 relate to fees paid for accounting
advice, specified procedures on our Proxy Circular and other specified
procedures.
(3) All other fees for 2009 and 2008 relate primarily to fees paid for reviews
of compliance with regulatory requirements for financial information and
reports on internal controls over services provided by various BMO Financial
Group businesses. Also included in 2009 were translation services while 2008
included corporate recovery services grandfathered under BMO's Auditor
Independence Policy.
74 BMO Financial Group 192nd Annual Report 2009
Enterprise-Wide Risk Management
As a financial services company active in banking, investments, insurance and
wealth management services, the management of risk is integral to our
business. To achieve prudent and measured risk-taking, we are guided by an
integrated risk management operating framework in our daily business
activities and strategic planning process. The Risk Management Group develops
our risk appetite, risk policies and limits and provides a review and
oversight function across the enterprise on risk-related issues.
"We have maintained a strong focus on managing risk through a challenging
economic environment and at the same time on continuing to strengthen the
capabilities of our group."
Tom Flynn
Executive Vice-President and Chief Risk Officer
BMO Financial Group
Strengths and Value Drivers
- Strong credit risk management that provides customers with consistent access to financing solutions through the
economic cycle.
- Comprehensive risk management frameworks, covering all risks in the organization. We have strong market and credit
risk disciplines and a systematic process for review and mitigation of operational risks.
- Completion of our two-year change management project, the Risk Evolution Program, to strengthen our risk management
organization by implementing best practices, reorganizing the risk organization and adding new senior talent in a
number of areas.
- Effective engagement model with our lines of business.
- Experienced and respected team of risk professionals.
Challenges
- A difficult global economic environment that resulted in the deterioration of asset quality and significant
volatility in capital markets.
- Acceleration in the pace of change related to providing effective risk oversight for an expanding array of products
and services.
- Increased demand for resources to meet regulatory changes and enhanced risk management processes and requirements.
Our Functional Groups
Central Risk Group provides oversight and support in the establishment of
enterprise-wide risk management policies, infrastructure and processes.
Operating Group Risk Areas provide integrated risk oversight to our business
groups in the management of risk in support of the execution of our business
strategies to optimize return on capital.
Our Priorities
- Manage risk effectively in a changing environment.
- Maximize the value of our impaired loans.
- Build capabilities by continuing to embed a strong risk culture across the enterprise, strengthening our risk
management processes and championing risk-based capital management.
- Partner with the lines of business to generate opportunities with attractive risk-return profiles within the limits
of our risk appetite.
- Strengthen relationships with our regulators.
Our Path to Differentiation
- Promote a three-lines-of-defence approach to risk management with operating groups "owning" the risk in their
operations, the Risk Management Group along with other Corporate Support areas providing a second line of defence,
and Corporate Audit a third.
- Partner with the lines of businesses to optimize risk-return, ensure risk transparency and embed a strong risk
culture, while maintaining independent risk judgment.
- Seek out attractive customer-centric solutions, while working within our oversight framework and the limits of our
risk appetite.
- Promote excellence in risk management as a defining characteristic of BMO, both internally and externally.
- Provide leadership in the management of enterprise risk and emerging risk-related industry concerns.
Key Performance Indicators 2009 2008 2007
BMO Peer BMO Peer BMO Peer
avg. avg. avg.
Specific PCL as a % of
average net loans and
acceptances 0.85 0.74 0.61 0.43 0.18 0.27
Total PCL as a % of average
net loans and acceptances 0.88 0.90 0.76 0.48 0.21 0.27
General allowance as a % of
credit risk-weighted assets
(RWA) 0.91 1.01 0.81 0.71 nm nm
nm - Not meaningful. Measure prior to 2008 is not comparable to later years as
RWA is determined on a Basel II basis subsequent to 2007.
75 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
2009 Group Objectives and Achievements
During 2009 Risk Management Group had two principal objectives:
1. Manage risk effectively in a difficult environment.
2. Further strengthen our risk management practices by continuing the implementation of our Risk Evolution Program, a
comprehensive program that we initiated at the end of 2007.
Manage risk effectively in the difficult environment.
- Managed risks in a difficult economic environment by: reducing exposure to volatility in market risk and limiting
our activities in certain areas to manage credit risk more effectively; revising our underwriting parameters;
tightening lending standards as appropriate; accelerating reviews for industries of concern; enhancing our market
risk capabilities with additional reporting, valuation capabilities and stress testing; adding resources to manage
our impaired loan portfolios; expanding scenario analysis in operational risk; and enhancing the new products
approval process.
Further strengthen our risk management practices.
- We continued the implementation of our Risk Evolution Program during the year. Activities in the Risk Evolution
Program were organized around five themes: ownership and accountability, risk transparency, risk-return
optimization, partnership with the lines of business and implementing change with pace, and a strong enterprise risk
management foundation.
Enhance our risk culture of ownership and accountability.
- Championed and furthered implementation of the three-lines-of-defence operating model across the enterprise, with
our Operating Groups, our Risk Management Group and other Corporate Support areas, and our Corporate Audit Group
providing the first, second and third lines of defence, respectively.
- Further reorganized parts of the group structure and added highly qualified employees.
- Created greater focus on risk in strategic plans, performance management, leadership competency models and incentive
compensation plan structures.
Enhance risk transparency.
- Enhanced senior management, business unit and board risk reporting and discussions to provide greater insight and
oversight, with improved clarity in information and reports.
- Introduced a risk appetite dashboard to provide better transparency on risk profile, mix and concentration.
- Completed in-depth analysis of all our trading desks to improve risk transparency.
- Developed new leadership forums to discuss risk-return trade-offs and emerging risks.
Optimize risk-return.
- Increased the use of risk-based pricing models in our Personal and Commercial lines of business.
- Enhanced risk dialogue and assessment within our annual and long-term strategic planning processes.
- Enhanced a number of our economic capital models.
- Clarified definitions for enterprise risk appetite and tolerance to guide business unit strategy execution.
- Enhanced limit management usage in market risk and lending areas.
Build partnerships with the lines of business and implement change with pace.
- Implemented new or revised engagement models with our line of business partners to improve risk transparency and
risk dialogue.
- Worked with our business partners to identify and develop growth opportunities.
Strengthen enterprise risk management foundation.
- Enhanced risk education across the enterprise, including a comprehensive education program for all BMO executives,
and developed training specifically targeted to Capital Markets Trading Products, Finance and Legal staff.
- Defined levels of skill and competency in risk management capabilities to ensure that people are assigned to roles
that suit their capabilities while meeting our risk management requirements.
- Leveraged our Basel II infrastructure to further strengthen our risk management processes and our risk-based capital
framework.
- Established an IT strategy in support of the Risk Management foundation and plan to continue its development to
align with BMO's business and risk capabilities.
76 BMO Financial Group 192nd Annual Report 2009
Framework and Risks
Text and tables presented in a blue-tinted font in the Enterprise-Wide Risk
Management section of the MD&A form an integral part of the 2009 annual
consolidated financial statements. They present required GAAP disclosures as
set out by the Canadian Institute of Chartered Accountants (CICA) in CICA
Handbook section 3862, Financial Instruments - Disclosures, which permits
cross-referencing from the financial statement notes to the MD&A. See pages
114 and 121.
As a diversified financial services company active in a number of businesses,
managing risk is integral to our operations. A disciplined risk management
approach is essential to building competitive advantage and stability for our
enterprise and has a twofold objective: to provide appropriate and independent
risk oversight across the enterprise, and to partner with our lines of
business in generating sustainable advantage.
The effects of the economic downturn continue to be felt throughout the
economy. Though not immune to the challenges presented by these difficult
economic conditions, BMO has continued to exhibit a strong risk discipline and
has struck a balance between ensuring our customers are well served and
continuing to protect the interests of our shareholders. BMO has managed risk
effectively throughout this period and is well positioned for the future.
All financial institutions have learned lessons during the difficult
conditions our industry has faced recently. At BMO, we began a process to
incorporate lessons learned and recommendations for improvement over two years
ago. Since then, very substantial progress has been made to incorporate best
practice learning into our risk and business operations. While there is always
more work to do, the steps we have taken together with a solid foundation have
positioned us well for the future.
Operating Model
Our enterprise risk management framework includes our operating model and our
risk governance structure, underpinned by our risk culture. The operating
model and risk governance structure enable our business leaders and risk
professionals to operate effectively and contribute to the appropriate
oversight and management of risk.
The concept of three lines of defence in the management of risk is fundamental
to our operating model.
The first line of defence in our management of risk is our operating groups
who are responsible for the risks in their business. Their mandate is to
identify suitable business opportunities and to adopt strategies and practices
that will optimize return on capital or achieve other business objectives.
Each operating group must ensure that it is acting within its delegated
risk-taking authority, as set out in our corporate risk policies and limits.
Limits are set for the operating groups, each of which has effective processes
and controls in place to enable them to operate within these limits.
77 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Our second line of defence in the management of risk is provided by our Risk
Management Group and other Corporate Support areas. These groups partner with
the operating groups in pursuing their business objectives and provide
independent oversight. It is the responsibility of the Risk Management group
to recommend and set corporate risk management policies and establish
infrastructure, processes and practices that address all significant risks
across the enterprise. Risk Management works with the lines of business in the
assessment, quantification, monitoring and reporting of all significant risks
to senior management and, as appropriate, the Board of Directors.
Our third line of defence is our Corporate Audit Group. This group monitors
the efficiency and effectiveness of controls across various functions within
our operations, the reliability of financial reporting and compliance with
applicable laws and regulations. The Corporate Audit Group provides timely
independent assurance to stakeholders, through the Board of Directors, that
BMO Financial Group is adequately and effectively identifying the risks it
faces, is implementing appropriate controls and is following through on risk
mitigation plans.
Risk Governance
The foundation of our enterprise-wide risk management framework is a
governance structure that includes a robust committee structure and a
comprehensive set of corporate policies, which are approved by the Board of
Directors or its committees, as well as supporting corporate standards and
operating guidelines.
This enterprise-wide risk management framework is governed through a hierarchy
of committees and individual responsibilities as outlined in the diagram on
the previous page.
The governance of each risk enables risk-return optimization on both a
portfolio and transactional basis, consistent with our risk appetite. All
elements of our risk management framework are reviewed on a regular basis by
the Risk Review Committee of the Board of Directors to ensure that they
provide effective guidance for the governance of our risk-taking activities.
In each of our operating groups, management ensures that governance
activities, controls and management processes and procedures are in place and
operating effectively, consistent with our overall risk management framework.
Individual governance committees further establish and monitor comprehensive
risk management limits, consistent with and subordinate to the board-approved
limits.
Limits and Authorities
BMO's risk principles and risk appetite shape our risk limits, and these
limits are reviewed and approved annually by the Risk Review Committee of the
board and/or the Risk Management Committee:
- credit and counterparty risk - limits on country, industry, portfolio/ product segments, group and single-name
exposures;
- market risk - limits on Market Value Exposure, Earnings Volatility and stress testing exposures; and
- liquidity and funding risk - limits on minimum levels of liquid assets and maximum levels of asset pledging, as well
as guidelines approved by senior management for liability diversification and credit and liquidity requirements.
The Board of Directors, through the Risk Review Committee and based on
recommendations from the Risk Management Committee, delegates the setting of
credit and market risk limits to the President and CEO, who in turn delegates
more specific authorities to the CRO and the operating group CROs. These
delegated authorities allow the officers to set risk tolerances, approve
geographic and industry sector exposure limits within defined parameters, and
establish underwriting and inventory limits for trading and investment banking
activities.
These delegated authorities are reviewed and approved annually by the Board of
Directors and the Risk Review Committee. Risk Management Committee is
responsible for establishing the criteria whereby these authorities may be
further delegated throughout the organization, as well as the minimum control
requirements relating to documentation, communication and monitoring of
delegated authorities.
Risk Culture
At BMO, risk culture is characterized as the norms and behaviours exhibited by
our employees and groups as they identify, understand and discuss risk and
make choices in the face of both opportunity and risk. Our risk culture shapes
the way we operate and manage risks, and also the way we partner with our
colleagues to ensure the ongoing alignment of business strategies and
activities within the limits of our risk appetite.
Central elements of our risk culture are: an engagement model between Risk
Management and business groups that encourages and creates risk transparency
and a focus on risk-adjusted return; open and timely horizontal and vertical
information-sharing and discussion; escalation of potential or emerging risks
and areas of disagreement; continuous and constructive challenging of
decisions and actions; effective communication of risk appetite; active
learning from actions that fell short of expectations; business objectives
incorporating risk appetite and appropriate risk-based measures; and
performance assessments and incentives that appropriately incorporate
risk-based measures.
To enhance our risk management capabilities and support the continued
strengthening of our risk culture, BMO has significantly enhanced its
curriculum of relevant courses at BMO's Institute for Learning. These courses,
together with defined job descriptions, provide training and practice in sound
risk management as a prerequisite to the granting of appropriate discretionary
limits to qualified professionals. Over the past year, we have expanded our
risk education strategy, which builds on our highly regarded credit risk
management practices, through the creation of a series of programs tailored to
our Board of Directors, Capital Markets trading professionals, executive
leadership, and managerial and other risk management employees. These programs
are designed to foster a deeper understanding of BMO's capital and risk
frameworks across the enterprise. They provide our employees and management
with the tools and awareness required to undertake their accountabilities for
risk and return, regardless of their position in the organization. This
education strategy has been developed in partnership with our Institute for
Learning, our risk professionals, and external risk experts and teaching
professionals.
Risk Principles
The risks we face are classified as credit and counterparty, market, liquidity
and funding, operational, insurance, business, model, strategic, reputation
and environmental. Risk-taking and management activities across the enterprise
are guided by the following principles:
- Management of risk is shared at all levels of the organization, employing the concept of the three lines of defence.
- The risk appetite is approved by the Risk Review Committee, and is aligned with BMO's strategic direction.
- ER&PM will monitor our risk management framework to ensure that our risk profile is maintained within the established
risk tolerance and supported with adequate capital.
- All material risks to which the enterprise is exposed will be identified, measured, managed, monitored and reported.
- Decision-making will be based on a strong understanding of risk, accompanied by robust metrics and analysis.
78 BMO Financial Group 192nd Annual Report 2009
- Business activities will be developed, approved and executed within established risk limits and will generate an
appropriate level of return given their risk profile.
- Economic capital will be used to measure and aggregate risk across all risk types and business activities to
facilitate the incorporation of risk into the measurement of business returns.
- Incentive compensation programs will be designed and implemented to incorporate motivation that balances short-,
medium- and long-term profit generation with the achievement of sustainable, non-volatile earnings growth, in line
with our risk appetite.
Board of Directors is responsible for the stewardship of BMO and supervising
the management of BMO's business and affairs. The board, either directly or
through its committees, is responsible for oversight in the following areas:
strategic planning, defining risk appetite, identification and management of
risk, capital management, promoting a culture of integrity, internal controls,
succession planning and evaluation of senior management, communication, public
disclosure and corporate governance.
Risk Review Committee of the Board of Directors (RRC) assists the board in
fulfilling its oversight responsibilities in relation to BMO's identification
and management of risk, adherence to risk management corporate policies and
procedures, and compliance with risk-related regulatory requirements.
Audit Committee of the Board of Directors independently monitors and reports
to the Board of Directors on the effectiveness of disclosure controls and
procedures and internal controls, including internal controls over financial
reporting.
President and Chief Executive Officer (CEO) is directly accountable to the
board for all of BMO's risk-taking activities. The Risk Management Committee
and its sub-committees, as well as Enterprise Risk and Portfolio Management,
support the CEO.
Risk Management Committee (RMC) is BMO's senior risk committee. RMC reviews
and discusses significant risk issues and action plans that arise in executing
the enterprise-wide strategy. RMC ensures that risk oversight and governance
occur at the highest levels of management. This committee is chaired by the
Chief Risk Officer (CRO).
RMC Sub-committees have oversight responsibility for the risk and balance
sheet impacts of management strategies, governance, risk measurement and
contingency planning. RMC and its subcommittees ensure that the risks incurred
across the enterprise are identified, measured, monitored and reported in
accordance with policy guidelines and are within delegated limits.
Enterprise Risk and Portfolio Management (ER&PM) encompasses oversight of the
credit and counterparty, operational and market risk functions. It promotes
consistency of risk management practices and standards across the enterprise.
ER&PM facilitates a disciplined approach to risk-taking through the execution
of transactional and portfolio management, policy formulation, risk reporting,
stress testing, modelling, vetting and risk education responsibilities. This
approach seeks to meet corporate objectives and to ensure that risks taken are
consistent with BMO's risk tolerance.
Operating Group CROs provide advice and oversight to support business unit
activities across the enterprise and across all risk types, foster a
high-performance risk culture at the operating group level and provide
leadership for the operating group risk organization.
Operating Groups are responsible for managing risk within their respective
areas. They exercise business judgment and seek to ensure that policies,
processes and internal controls are in place and that significant risk issues
are appropriately escalated to ER&PM.
Risk Appetite
Our risk appetite speaks to the amount and type of risk that we are willing to
accept given our guiding principles and our capital capacity. Senior
management recommends our Risk Appetite Statement for approval by the Risk
Management Committee and the Risk Review Committee of the board. Our Risk
Appetite Statement is defined in both quantitative and qualitative terms and,
among other things, includes:
- Maintaining a capital position that meets or exceeds regulatory requirements, our risk-based capital requirement and
the expectations of the market (rating agencies, investors and depositors), and considers stress capital
requirements.
- Not taking risks that cannot be transparently understood, managed and monitored.
- Subjecting new products initiatives to a rigorous review and approval process to ensure risks are understood and can
be managed.
- Providing adequate resources for Risk Management, Finance and other Corporate Support functions.
- Targeting a credit rating for BMO of AA- or better.
- Not taking outsized risk positions that expose us to even low-probability adverse tail event risk that could
jeopardize our credit ratings, capital position or reputation.
- Maintaining a diversified and above-average quality lending portfolio relative to our peers.
- Value at risk (VaR) that is not outsized relative to our peers.
- Maintaining liquidity and funding positions that permit us to meet all funding commitments when they come due and
maintain our liquidity risk profile at the peer group average.
- Business practices and policies that ensure our reputation is safeguarded and protected at all times.
Risk Review and Approval
Risk review and approval processes are established by Risk Management
Committee based on the nature, size and complexity of the risks involved.
Generally, the risk review and approval process is a formal review and
approval of various categories by either an individual, group or sub-committee
of Risk Management Committee, independent of the originator. Delegated
authorities and approvals by category are as follows:
Portfolio transactions: Transactions are approved through risk assessment
processes for all types of transactions, including dual signatory authorities
for credit risk and transactional and position limits for market risk.
Structured transactions: The Reputation Risk Management Committee and Trading
Products Risk Committee review new structured products and transactions with
significant reputation, legal, accounting, regulatory or tax risk.
79 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Investment initiatives: Documentation of risk assessments is formalized
through our investment spending optimization requests, which are reviewed and
approved by Corporate Support areas.
New products and services: Policies and procedures for the approval of new or
amended products and services offered to our customers are reviewed and
approved by Corporate Support areas, as well as the Operational Risk
Committee, Trading Products Risk Committee and Reputational Risk Committee as
appropriate.
Risk Reporting
Enterprise-level risk transparency and associated reporting are critical
components of our framework and operating culture that allow all levels of
business leaders, risk leaders and committees and the Board of Directors to
effectively exercise their business management, risk management and oversight
responsibilities.
Internal reporting includes Enterprise Risk Chapters, which synthesize the key
risks and associated metrics that the organization currently faces. The
Chapters highlight top risks and potential or emerging risks to provide senior
management and the Board of Directors with timely, actionable and
forward-looking risk reporting on the significant risks our organization
faces. This reporting includes material to facilitate dialogue on how these
risks compare to our risk appetite and the relevant limits established within
our framework. It also includes material on emerging risk and the actions
taken by management to mitigate these risks.
Regular reporting on risk is also provided to stakeholders, including
regulators, external rating agencies and our shareholders, as well as others
in the investment community on a quarterly or annual basis.
Risk-Based Capital Assessment
Two measures of risk-based capital are used by BMO. These are Economic Capital
and Basel II Regulatory Capital. Both are aggregate measures of risk that we
undertake in pursuit of our financial targets.
Our operating model provides for the direct management of each risk type but
also provides for the management of risks on an integrated basis. Economic
Capital is our integrated internal measure of risk underlying our business
activities. It represents management's estimation of the likely magnitude of
economic losses that could occur if adverse situations arise, and allows
returns to be adjusted for risks. Economic Capital is calculated for various
risk types - credit, market (trading and non-trading), operational and
business - where measures are based on a time horizon of one year.
An enterprise-wide framework of scenario selection, analysis and stress
testing assists in determining the relative magnitude of risks taken and the
distribution of those risks across the enterprise's operations under different
conditions. Stress testing and scenario analysis measure the impact on our
operations and capital of stressed but plausible operational, economic, credit
and market events. Scenarios designed in collaboration with our economists,
risk management groups, finance and lines of business are based on historical
or hypothetical events, a combination thereof, or significant economic
developments. Economic variables derived from these scenarios are then applied
to all significant and relevant risk-taking portfolios across the enterprise.
As stipulated by the Basel II Accord, BMO also conducts stress testing of
regulatory credit capital across all material portfolios using the Advanced
Internal Ratings Based (AIRB) Approach calculation methodology.
We also conduct ongoing stress testing and scenario analysis designed to test
BMO's credit exposures to a specific industry, to several industries or to
specific products that are highly correlated. These tests gauge the effect of
various scenarios on default probabilities and loss rates in the portfolio
under review. The results provide senior management with significant insight
into the sensitivity of our exposures to the underlying risk characteristics
of specific industries.
Credit and Counterparty Risk
Credit and counterparty risk is the potential for loss due to the failure of a
borrower, endorser, guarantor or counterparty to repay a loan or honour
another predetermined financial obligation. This is the most significant
measurable risk that BMO faces.
Credit and counterparty risk exists in every lending activity that BMO enters
into, as well as in the sale of treasury and other capital markets products,
the holding of investment securities and securitization activities. BMO's
robust and effective credit risk management begins with our experienced and
skilled professional lending and credit risk officers, who operate in a dual
control structure to authorize lending transactions. These individuals are
subject to a rigorous lender qualification process and operate in a
disciplined environment with clear delegation of decision-making authority,
including individually delegated lending limits. Credit decision-making is
conducted at the management level appropriate to the size and risk of each
transaction in accordance with comprehensive corporate policies, standards and
procedures governing the conduct of credit risk activities.
Credit risk is assessed and measured using risk-based parameters:
Expected Loss (EL) is a measure representing the loss that is expected to
occur in the normal course of business in a given period of time. EL is
calculated as a function of Probability of Default, Exposure at Default and
Loss Given Default.
Exposure at Default (EAD) represents the outstanding amount of a credit
exposure, adding back any specific provisions taken or any amounts partially
written off. For off-balance sheet amounts and undrawn amounts, EAD includes
an estimate of any further amounts that may be drawn at the time of default.
Loss Given Default (LGD) is the amount that may not be recovered in the event
of a default, presented as a proportion of the exposure at default. LGD takes
into consideration the amount and quality of any collateral held.
Probability of Default (PD) represents the likelihood that a credit obligation
(loan) will not be repaid and will go into default. A PD is assigned to each
account, based on the type of facility, the product type and customer
characteristics. The credit history of the counterparty/portfolio and the
nature of the exposure are taken into account in the determination of a PD.
Unexpected Loss (UL) is a measure of the amount by which actual losses may
exceed expected loss in the normal course of business in a given period of
time.
80 BMO Financial Group 192nd Annual Report 2009
Risk Rating Systems
BMO's risk rating systems are designed to assess and measure the risk of any
exposure. The rating systems differ for the consumer/small business portfolio
and the commercial/corporate portfolio.
Consumer and Small Business
The consumer and small business portfolio is made up of a diversified group of
individual customer accounts and includes residential mortgages, personal
loans and credit card and small business loans. These are managed as pools of
homogeneous risk exposures. For these pools, credit risk models and decision
support systems are developed using established statistical techniques and
expert systems for underwriting and monitoring purposes. Adjudication models,
behavioural scorecards, decision trees and expert knowledge are combined to
produce optimal credit decisions in a centralized and automated environment.
The characteristics of both the borrower and the loan, along with past
portfolio experience, are used to predict the credit performance of new
accounts. Past performance is also used, along with borrower and loan
characteristics, to define the overall credit risk profile of the portfolio,
predict future performance of existing accounts for ongoing credit risk
management and determine both economic capital and Basel II regulatory
capital. Every exposure is assigned risk parameters, PD, LGD and EAD based on
the performance of the pool, and these assignments are updated monthly to
ensure up-to-date risk monitoring. The PD risk profile of the AIRB Retail
portfolio as of October 31, 2009 was as follows:
PD risk profile PD range % of Retail EAD
Exceptionally low a%n 0.05% 39.9
Very low > 0.05% to 0.20% 18.6
Low > 0.20% to 0.75% 24.1
Medium > 0.75% to 7.00% 15.9
High > 7.00% to 99.99% 1.2
Default 100% 0.3
Commercial and Corporate Lending
Within the commercial and corporate portfolios, we utilize an enterprise-wide
risk rating framework that applies to all of our sovereign, bank, corporate
and commercial counterparties. This framework is consistent with the
principles of Basel II, under which minimum regulatory capital requirements
for credit risk are determined. One key element of this framework is the
assignment of appropriate borrower risk ratings to help quantify potential
credit risk.
BMO's risk rating framework establishes counterparty risk ratings using
methodologies and rating criteria based on the specific risk characteristics
of each counterparty. The resulting rating is then mapped to a probability of
default over a one-year time horizon. As counterparties migrate between risk
ratings, the probability of their defaulting changes. We review our loans and
acceptances on an ongoing basis to assess whether any loans should be
classified as impaired and whether an allowance or write-off should be
recorded. Future losses are estimated based on the expected proportion of the
exposure that will be at risk if a counterparty default occurs, through an
analysis of transaction-specific factors such as the nature and terms of the
loan, collateral held and the seniority of our claim. For large corporate
transactions, we also utilize unexpected loss models to assess the extent and
correlation of risks before authorizing new exposures.
The risk profile of the AIRB Wholesale portfolio as of October 31, 2009 was as
follows:
Borrower Risk Rating Scale
Moody's Investor % of
BMO Services implied Standard & Poor's total
rating Description of risk equivalent implied equivalent EAD
Investment grade
I-1 Undoubted/
Sovereign Aaa Sovereign AAA Sovereign 34.6
I-2 Undoubted Aaa/Aa1 AAA/AA+ 1.8
I-3 Minimal Aa2/Aa3 AA/AA- 5.2
I-4 Modest A1/A2/A3 A+/A/A- 6.0
I-5 Modest Baa1 BBB+ 2.2
I-6 Average Baa2 BBB 14.0
I-7 Average Baa3 BBB- 7.8
Total investment grade 71.6
Non-investment grade
S-1 Acceptable Ba1 BB+ 9.6
S-2 Acceptable Ba2 BB 6.5
S-3 Marginal Ba3 BB- 4.6
S-4 Marginal B1 B+ 3.7
Total non-investment grade 24.4
Watchlist
P-1 Uncertain B2 B 0.9
P-2 Watchlist B3 B- 0.9
P-3 Watchlist Caa/C CCC/C 0.7
Total watchlist 2.5
D-1 Default C D 1.5
D-2 Default
and Impaired C D -
Total default and impaired 1.5
Policies and Standards
BMO's credit risk management framework is built on governing principles
defined in a series of corporate policies and standards, which flow through to
more specific guidelines and procedures. The framework elements are reviewed
on a regular basis to ensure they are current and consistent with BMO's risk
appetite. The structure, limits, collateral requirements, ongoing management,
monitoring and reporting of our credit exposures are all governed by these
lending principles.
Credit Risk Governance
The Risk Review Committee of the Board of Directors ultimately provides
oversight for the management of all risks faced by the enterprise, including
credit risk. Operating practices include the ongoing monitoring of credit risk
exposures and regular portfolio and sector reporting to the board and senior
management committees. Performing accounts are reviewed on a regular basis,
with most commercial and corporate accounts reviewed at least annually. The
credit review process ensures that an appropriate structure, including
covenant monitoring, is in place for each account. The frequency of reviews is
increased in accordance with the likelihood and size of potential credit
losses, with deteriorating higher-risk situations referred to specialized
account management groups for closer attention where appropriate. Corporate
Audit Group reviews and tests management processes and controls and samples
credit transactions for adherence to credit terms and conditions, as well as
to governing policies, standards and procedures. In addition, BMO carries out
regular portfolio sector reviews, including stress testing and scenario
analysis based on current, emerging or prospective risks.
81 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Portfolio Management
BMO's credit risk governance policies ensure that an acceptable level of
diversification is maintained at all times. Limits are in place for several
portfolio dimensions, including industry, country, product and single name
concentrations, as well as transaction-specific limits. 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-size
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.
Total enterprise-wide outstanding credit exposures were $356 billion as at
October 31, 2009, comprised of $233 billion in Canada, $95 billion in the
United States and $28 billion in other jurisdictions. Credit portfolio quality
is discussed on page 43. Note 4 on page 119 of the financial statements and
Tables 11 to 19 on pages 102 to 105 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 commercial 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 in the context of current
economic and market circumstances. Audited - See page 77.
Allowance for Credit Losses
Across all loan portfolios, BMO employs a disciplined approach to provisioning
and loan loss evaluation, with the 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 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 impairment 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.
Market Risk
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.
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 the Trading Products Risk Committee, Balance Sheet Management
Committee, Risk Management Committee and Risk Review Committee;
- an Economic Capital plan process that incorporates market risk measures (market value exposures, stress testing);
- a 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.
BMO's primary high-level market risk measures for Structural Market Risk are
Market Value Exposure (MVE) and Earnings Volatility (EV). The primary market
risk measure for Trading and Underwriting is MVE. EV is still calculated for
Trading and Underwriting, even though it is not a primary market risk measure.
The market value and earnings volatility exposures at October 31, 2009 and
2008 are summarized in the following table. Audited - See page 77.
82 BMO Financial Group 192nd Annual Report 2009
MVE and EV for Trading and Underwriting
and Structural Positions ($ millions)*
Market 12-month Market 12-month
As at October 31 value earnings value earnings
(After-tax Canadian equivalent) exposure volatility exposure volatility
2009 2009 2008 2008
Trading and underwriting (18.2) (14.3) (33.4) (28.7)
Structural (353.1) (69.0) (267.9) (30.2)
* Measured at a 99% confidence interval.
Trading and underwriting MVE and EV decreased over the past year primarily as
a result of the transfer of certain portfolios to our available-for-sale
portfolios, coupled with a lower credit spread environment. Structural MVE
increased over the prior year primarily due to higher modelled interest rate
volatility and growth in common shareholders' equity. Structural EV increased
over the prior year primarily owing to the lower interest rate environment, as
further reductions in interest rates reduce yields on assets more than rates
paid on deposits.
BMO's Market Risk group provides oversight of trading and underwriting and
structural portfolios with the goal of ensuring:
- market risk of trading and underwriting and structural portfolios is measured and modelled in compliance with
corporate policies and standards;
- risk profiles of our trading and underwriting and structural portfolios are maintained within our risk appetite, and
are monitored and reported to traders, senior executives, management and board committees;
- proactive identification and reporting to senior executives, management and board committees of specific exposures or
other factors that expose BMO to unusual, unexpected, inappropriate or otherwise not fully identified or quantified
risks associated with market or traded credit exposures; and
- all individuals authorized to execute trading and underwriting and structural transactions on behalf of BMO are
appropriately informed of BMO's risk-taking governance, authority structure, procedures and processes by providing
access to and guidance on the relevant corporate policies and standards.
Market Value Exposure (MVE) is a measure of the adverse impact of changes in
market parameters on the market value of a portfolio of assets, liabilities
and off-balance sheet positions, measured at a 99% confidence level over a
specified holding period. The holding period considers current market
conditions and composition of the portfolios to determine how long it would
take to neutralize the market risk without adversely affecting market prices.
For trading and underwriting activities, MVE is comprised of Value at Risk and
Issuer Risk.
Earnings Volatility (EV) is a measure of the adverse impact of potential
changes in market parameters on the projected 12-month after-tax net income of
a portfolio of assets, liabilities and off-balance sheet positions, measured
at a 99% confidence level over a specified holding period.
Value at Risk (VaR) is measured for specific classes of risk in BMO's trading
and underwriting activities: interest rate, foreign exchange rate, equity and
commodity prices and their implied volatilities. This measure calculates the
maximum likely loss from portfolios, measured at a 99% confidence level over a
specified holding period.
Issuer Risk arises in BMO's trading and underwriting portfolios, and measures
the adverse impact of credit spread, credit migration and default risks on the
market value of fixed income instruments and similar securities. Issuer risk
is measured at a 99% confidence level over a specified holding period.
Trading and Underwriting Market Risk
To capture the multi-dimensional aspects of market risk effectively, a number
of metrics are used, including VaR, stress testing, option sensitivities,
position concentrations, market and notional values and revenue losses.
VaR and stress testing are portfolio estimates of risk but have limitations.
Among the limitations of VaR are its assumption that all positions can be
liquidated within the assigned one-day holding period (ten-day holding period
for regulatory calculations), which may not be the case in illiquid market
conditions, and that historical data can be used as a proxy to predict future
market events. Scenario analysis and probabilistic stress testing are
performed daily to determine the impact of unusual and/or unexpected market
changes on our portfolios. As well, historical and event stresses are tested
on a weekly basis. Scenarios are amended, added or deleted to better reflect
changes in underlying market conditions. The results are reported to the lines
of business, Trading Products Risk Committee, Risk Management Committee and
Risk Review Committee on a regular basis. Stress testing is limited by the
number of scenarios that can be run, and by the fact that not all downside
scenarios can be predicted and effectively modelled. However, during the year,
measures were taken to strengthen the infrastructure supporting the capture of
basis risk within the model, as well as the identification and measurement of
the stress test scenarios. Neither VaR nor stress testing are viewed as
predictors of the maximum amount of losses that could occur in any one day,
because both measures are computed at prescribed confidence levels and could
be exceeded in highly volatile market conditions. On a daily basis, exposures
are aggregated by lines of business and risk type and monitored against
delegated limit levels, and the results are reported to the respective
stakeholders. All risk exposures that exceed their respective delegated limits
are escalated to senior management for resolution in a timely manner. The
business in question is required to either bring the exposure to within limits
or consult with the Market Risk group on the appropriate action to be taken.
Audited - See page 77.
Within the Market Risk group, the Valuation Product Control group checks
whether the valuations of all trading and underwriting portfolios within BMO
are materially accurate by:
- developing and maintaining valuation adjustment/reserve policies and issuer risk procedures in accordance with
regulatory requirements and GAAP;
- establishing official rate sources for valuation of mark-to-market portfolios; and
- providing an independent review of trading books where trader prices are used for valuation of mark-to-market
portfolios.
BMO's Independent Price Verification process is used to validate valuations
derived from trader inputs. This past year, the process has been strengthened
with additional resources and modelling, as well as enhanced coverage to
include available-for-sale (AFS) positions. Trader valuations are reviewed to
determine whether they align with an independent assessment of the market
value of the portfolio. If the valuation differences exceed the prescribed
tolerance threshold, a valuation adjustment is implemented in accordance with
accounting policy and regulatory requirements. Prior to the final month-end
general ledger close, meetings are held between the line of business, Market
Risk group, Capital Markets Finance and Accounting Policy to obtain
concurrence on all valuation reserves and adjustments.
83 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
At minimum, the following major categories of valuation reserves are
considered when determining appropriate valuation adjustment/reserve levels:
credit spreads, close-out costs, administrative costs, liquidity and model
risk. Also, a fair value hierarchy is used to categorize the inputs used in
the valuation of securities, fair value liabilities, derivative assets and
derivative liabilities. Level 1 covers the use of quoted market prices in the
fair valuation process, Level 2 covers internal models with observable market
information and Level 3 covers internal models without observable market
information. Details of Level 1, Level 2 and Level 3 fair valuation
measurements can be found in Note 30 on page 159 of the financial statements.
Our models are used to determine market risk Economic Capital for each of the
lines of business and to determine regulatory capital. For capital calculation
purposes, longer holding periods and/or higher confidence levels are used than
are employed in day-to-day risk management. Models used to determine EV
exposures are the same as or similar to those used to determine VaR exposures.
Prior to use, models are subject to review under the Model Risk Corporate
Standard by our Model Risk & Vetting group. The Model Risk Corporate Standard
outlines minimum requirements for the identification, assessment, monitoring
and management of models and model risk throughout the enterprise.
BMO measures the market risk for trading and underwriting portfolios that meet
our criteria for trading book regulatory capital treatment using an internal
models approach, as well as the market risk for money market portfolios that
are subject to accrual accounting rules under GAAP and are accorded banking
book regulatory capital treatment.
For trading and underwriting portfolios covered by the internal models
approach, VaR is computed using BMO's Trading Book Value at Risk model. Our
Trading Book Value at Risk model is a Monte Carlo scenario simulation model,
and its output is used for market risk management and reporting of exposures.
The model computes one-day VaR results using a 99% confidence interval and
reflects the correlations between the different classes of market risk
factors. For money market accrual portfolios, VaR is computed using an
Analytic Value at Risk approach.
We use a variety of methods to verify the integrity of our risk models,
including the application of backtesting against hypothetical losses. This
process assumes there are no changes in the previous day's closing positions.
The process then isolates the effects of each day's price movements against
these closing positions. Models are validated by assessing how often the
calculated hypothetical losses exceed the MVE measure over a defined period.
Results of this testing confirm the reliability of our models.
Market risk exposures arising from trading and underwriting activities are
summarized in the following table. The correlations and volatility data that
underpin our models are updated quarterly. The last update occurred in October
2009; as a consequence the MVE measures are reflective of current volatility.
Total Trading and Underwriting MVE Summary ($ millions)*
For the year ended October 31, 2009
(pre-tax Canadian equivalent) Year-end Average High Low
Commodity risk (0.7) (0.7) (1.7) (0.4)
Equity risk (10.2) (9.6) (16.3) (5.5)
Foreign exchange risk (0.8) (3.4) (8.2) (0.4)
Interest rate risk (mark-to-market) (18.4) (16.3) (29.1) (9.2)
Diversification 11.4 10.1 nm nm
Comprehensive risk (18.7) (19.9) (31.2) (13.4)
Interest rate risk (accrual) (7.3) (10.5) (15.8) (5.7)
Issuer risk (1.9) (3.5) (9.5) (1.3)
Total MVE (27.9) (33.9) (52.1) (24.2)
* One-day measure using a 99% confidence interval.
nm - not meaningful
For the year ended October 31, 2008
(pre-tax Canadian equivalent) Year-end Average High Low
Commodity risk (0.9) (3.1) (6.8) (0.9)
Equity risk (7.3) (10.9) (18.5) (5.6)
Foreign exchange risk (1.4) (1.4) (4.3) (0.3)
Interest rate risk (mark-to-market) (30.6) (18.9) (35.0) (8.7)
Diversification 6.4 9.2 nm nm
Comprehensive risk (33.8) (25.1) (39.3) (14.5)
Interest rate risk (accrual) (11.6) (5.7) (12.5) (1.3)
Issuer risk (6.1) (5.2) (8.4) (2.6)
Total MVE (51.5) (36.0) (57.9) (24.0)
* One-day measure using a 99% confidence interval.
nm - not meaningful
84 BMO Financial Group 192nd Annual Report 2009
Trading revenues include amounts from all trading and underwriting activities,
whether accounted for on a mark-to-market basis or an accrual basis, as well
as certain fees and commissions directly related to those activities.
Structural Market Risk
Structural market risk is comprised of interest rate risk arising from our
banking activities (loans and deposits) and foreign exchange risk arising from
our foreign currency operations. Structural market risk is managed by BMO's
Corporate Treasury in support of stable, high-quality earnings and
maximization of sustainable product spreads.
Structural interest rate risk arises primarily from interest rate mismatches
and embedded options. Interest rate mismatches result from differences in the
scheduled maturity or repricing dates of assets, liabilities and derivatives.
Embedded option risk results from product features that allow customers to
alter scheduled maturity or repricing dates. Embedded options include loan
prepayment and deposit redemption privileges and committed rates on unadvanced
mortgages. The net interest rate mismatch, representing residual assets funded
by common shareholders' equity, is managed to a target duration, which is
currently between two and three years, while embedded options are managed to
low risk levels. The net interest rate mismatch is primarily managed with
interest rate swaps and securities. Embedded option risk exposures are managed
by purchasing options or through a dynamic hedging process.
Structural foreign exchange risk arises primarily from translation risk
associated with the net investment in our U.S. operations and from transaction
risk associated with our U.S.-dollar-denominated net income. Translation risk
is managed by funding our net U.S. investment in U.S. dollars. Transaction
risk is managed by assessing at the start of each quarter whether to enter
into foreign exchange forward contract hedges that are expected to partially
offset the pre-tax effects of Canadian/U.S. dollar exchange rate fluctuations
in the quarter on the expected U.S. dollar net income for the quarter.
The Canadian dollar equivalents of BMO's U.S.-dollar-denominated results are
affected, favourably or unfavourably, by movements in the Canadian/U.S. dollar
exchange rate. The size of the impact on the Canadian dollar equivalents
depends on the level of U.S.-dollar-denominated results and the movement in
the exchange rate. If future results are consistent with the range of results
for the past three years, each one cent decrease in the Canadian/U.S. dollar
exchange rate, expressed in terms of how many Canadian dollars one U.S. dollar
buys, would be expected to change net income before income taxes by between $9
million and -$5 million. An increase of one cent would have the opposite
effect.
Structural MVE and EV measures both reflect holding periods of between one and
three months and incorporate the impact of correlation between market
variables. Audited - See page 77.
Structural MVE, as indicated on page 83, increased over the prior year
primarily due to higher modelled interest rate volatility and growth in common
shareholders' equity. Structural EV increased from the prior year primarily
owing to the lower interest rate environment, as further reductions in
interest rates reduce yields on loans more than rates paid on deposits.
In addition to MVE and EV, we use simulations, sensitivity analysis, stress
testing and gap analysis to measure and manage interest rate risk. Gap
analysis is disclosed in Note 20 on page 142 of the financial statements.
85 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Structural interest rate sensitivity to an immediate parallel increase or
decrease of 100 and 200 basis points in the yield curve is disclosed in the
table below. This sensitivity analysis is performed and disclosed by many
financial institutions and facilitates comparison with our peer group. The
changes in sensitivity from the prior year reflect the low interest rate
environment. Audited - See page 77.
Structural Interest Rate Sensitivity ($ millions)*
After-tax Canadian equivalent As at October 31, 2009 As at October 31, 2008
Economic 12-month Economic 12-month
value earnings value earnings
sensitivity sensitivity sensitivity sensitivity
100 basis point increase (229.6) 11.0 (220.8) (4.4)
100 basis point decrease 165.2 (75.6) 169.2 (21.0)
200 basis point increase (506.4) (10.6) (488.6) (16.2)
200 basis point decrease 255.3 (62.9) 328.4 (177.6)
*Exposures are in brackets and benefits are represented by positive amounts.
Audited - See page 77.
Models used to measure structural market risk project how interest rates and
foreign exchange rates may change and predict how customers would likely react
to the changes. For customer loans and deposits with scheduled maturity and
repricing dates (such as mortgages and term deposits), our models measure how
customers use embedded options to alter those terms. For customer loans and
deposits without scheduled maturity and repricing dates (such as credit card
loans and chequing accounts), our models assume a maturity profile that
considers historical and forecasted trends in balances. These models have been
developed using statistical analysis and are validated through regular model
vetting and backtesting processes and ongoing dialogue with the lines of
business. Models used to predict customer behaviour are also used in support
of product pricing and performance measurement. Audited - See page 77.
Liquidity and Funding Risk
Liquidity and funding risk is the potential for loss if BMO is unable to meet
financial commitments in a timely manner at reasonable prices as they fall
due. Financial commitments include liabilities to depositors and suppliers,
and lending, investment and pledging commitments.
Managing liquidity and funding risk is essential to maintaining both depositor
confidence and stability in earnings.
We actively manage liquidity and funding risk across the enterprise by holding
liquid assets in excess of an established minimum level at all times. Liquid
assets include unencumbered, high-quality credit assets that are marketable,
can be pledged as security for borrowings, and could be converted to cash in a
time frame that meets our liquidity and funding requirements. Liquid assets
are held both in our trading businesses and in supplemental liquidity pools
that are maintained for contingency purposes. Liquidity and funding
requirements consist of expected and potential cash outflows. These arise from
obligations to repay deposits that are withdrawn or not renewed, and from the
need to fund asset growth, strategic investments, drawdowns on off-balance
sheet arrangements and other credit instruments, and purchases of collateral
for pledging. Liquidity and funding requirements are assessed under expected
and stressed economic, market, political and enterprise-specific environments,
which determine the minimum amount of liquid assets to be held at all times.
It is BMO's policy to ensure that sufficient liquid assets and funding
capacity are available to meet financial commitments, even in times of stress.
Our liquidity and funding risk management framework includes:
- oversight by senior governance committees, including the Balance Sheet Management Committee, Risk Management
Committee and Risk Review Committee;
- an independent oversight group within Corporate Treasury;
- a Risk Review Committee-approved limit structure to support the maintenance of a strong liquidity position;
- effective processes and models to monitor and manage risk;
- strong controls over processes and models and their uses;
- a framework of scenario tests for stressed operating conditions; and
- contingency plans to facilitate managing through a disruption.
Fiscal 2009 began in an environment in which global wholesale funding capacity
had been reduced for all banks due to the financial disruption that started in
2007 and was exacerbated by the collapse of Lehman Brothers in September 2008.
Coordinated global efforts by governments and central banks to provide
liquidity and stabilize financial markets that began in 2007 have led to
improved confidence and an increase in wholesale funding capacity for all
market participants. Short-term money market funding has remained available to
BMO during this time, and BMO has seen an increase in deposit levels as
investors have moved assets to BMO in a "flight to safety." BMO's liquidity
and funding management framework has been effective in ensuring we maintained
a sound position throughout this disruption in the financial markets, and
continues to help ensure that we will maintain a sound position.
Data provided in this section reflect BMO's consolidated position. BMO
subsidiaries include regulated and foreign entities, and therefore movements
of funds between companies in the corporate group are subject to the
liquidity, funding and capital adequacy considerations of the subsidiaries, as
well as tax considerations. Such matters do not materially affect BMO's
liquidity and funding position.
Three of the measures we use to evaluate liquidity and funding risk are the
liquidity ratio, the level of core deposits, and the customer deposits and
capital to loans ratio. The liquidity ratio represents the sum of cash
resources and securities as a percentage of total assets. BMO's liquidity
ratio was 31.9% at October 31, 2009, up from 29.1% in 2008, and averaged 28.9%
for the years 2005 to 2007. The ratio reflects a strong liquidity position.
Cash and securities totalled $124.1 billion at the end of the year, compared
with $121.2 billion in 2008.
Liquidity provided by cash and securities is supplemented by securities
borrowed or purchased under resale agreements, which also can be readily
converted into cash or cash substitutes to meet financial commitments.
Securities borrowed or purchased under resale agreements totalled $36.0
billion at the end of the year, up from $28.0 billion in 2008.
In the ordinary course of business, a portion of cash, securities and
securities borrowed or purchased under resale agreements is pledged as
collateral to support trading activities and participation in clearing and
payment systems, in Canada and abroad. At October 31, 2009, $39.3 billion of
cash and securities and $25.9 billion of securities borrowed or purchased
under resale agreements had been pledged, compared with $37.7 billion and
$22.9 billion, respectively, in 2008.
86 BMO Financial Group 192nd Annual Report 2009
These changes were driven by trading activities. Additional information on
cash and securities can be found in Table 5 on page 97 and in Notes 2 and 3
beginning on page 115 of the financial statements.
Core deposits are comprised of customer operating and savings account deposits
and smaller fixed-date deposits (less than or equal to $100,000). Canadian
dollar core deposits totalled $95.4 billion at the end of the year, up from
$85.8 billion in 2008, and U.S. dollar and other currency core deposits
totalled US$27.7 billion at the end of the year, down from US$32.8 billion in
2008. The decrease in U.S. dollar and other currency core deposits reflects
investors' flight to safety in 2008 and the subsequent return of those funds
to higher yielding investments as markets normalized in 2009. U.S. dollar and
other currency core deposits have increased from pre-2008 levels. Larger
fixed-date customer deposits totalled $23.0 billion at the end of the year,
compared with $20.2 billion in 2008. Total deposits decreased $21.5 billion
during 2009 to $236.2 billion at the end of the year. The decrease in total
deposits primarily reflects the impact of the depreciation of the U.S. dollar
relative to the Canadian dollar, the decline in U.S. dollar and other currency
core deposits noted above and repayment of wholesale deposits given lower loan
balances.
Our large base of customer deposits, along with our strong capital base,
reduces our requirements for wholesale funding. Customer deposits and capital
equalled 106.8% of loans at the end of the year, up from 94.2% in the prior
year.
Our funding philosophy requires that wholesale funding used to support loans
is longer term (typically maturing in two to ten years) to better match the
terms to maturity of our loans. Wholesale funding that supports liquid trading
and underwriting assets and liquid available-for-sale securities is generally
shorter term (maturing in less than two years). Diversification of our
wholesale funding sources is an important part of our overall liquidity
management strategy. In accordance with internal guidelines, our wholesale
funding is diversified by customer, type, market, maturity term, currency and
geographic region. BMO has the ability to raise long-term funding through
various platforms, including Canadian, European and U.S. Note Programs, a
European Mortgage Covered Bond Program, Canadian and U.S. mortgage
securitizations, Canadian credit card securitizations, and Canadian and U.S.
senior (unsecured) deposits. Information on deposit maturities can be found in
Table 20 on page 106.
Our funding capacity and collateral requirements are dependent on our credit
ratings. Our senior debt ratings remained unchanged in 2009. All four ratings
are indicative of high-grade, high-quality issues. They are DBRS (AA); Fitch
Ratings (AA-); Moody's Investor Service (Aa1); and Standard & Poor's Ratings
Services (A+). In October 2009, Moody's placed the long term ratings of BMO
and all of its subsidiaries on review for downgrade. Moody's rating action has
not impacted BMO's funding capacity or collateral requirements. DBRS, Fitch
and S&P have a stable outlook for BMO. Certain agreements could require
incremental funding or collateral under lower ratings. Minor downgrades would
not be expected to materially influence our funding capacity or collateral
requirements; however, a series of downgrades could have adverse consequences.
Long-term Wholesale Funding Sources ($ millions)
As at October 31 2009 2008 2007 2006 2005
Unsecured long-term wholesale funding 21,756 35,274 21,628 16,840 10,459
Secured long-term wholesale funding 4,162 4,396 - - -
Mortgage and credit card
securitization issuances 28,047 25,077 12,992 9,792 5,918
Unsecured Long-term Wholesale Funding Maturities ($ millions)
As at October 31, 2009
Less than 1 to 2 to 3 to 4 to Over
1 year 2 years 3 years 4 years 5 years 5 years Total
10,430 3,761 2,979 1,105 525 2,956 21,756
Operational Risk
Operational risk is the potential for loss resulting from inadequate or failed
internal processes or systems, human interactions or external events, but
excludes business risk.
Operational risk is inherent in all business activities and can never be
entirely eliminated; however, shareholder value can be preserved and enhanced
by managing, mitigating and, in some cases, insuring against operational risk.
To achieve this goal, BMO established an Enterprise Operational Risk Management
group, which has developed an Operational Risk Management Framework (ORMF) that
includes identification, measurement, management, monitoring, Economic Capital
attribution and risk control and mitigation elements. This group gives effect to
the ORMF within corporate policy, oversees the risk assessment methodology and
defines the reporting requirements. A variety of underlying processes and
controls have been developed as part of this framework, including risk and
control self-assessments, business contingency plans, event management, change
management, outsourcing management and acquisition and integration management.
Process enhancements under development include operational risk quantification,
system support and performance metrics. Scenario analysis is also being
incorporated into a number of current ORMF processes.
87 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
BMO's operational risk governance structure includes the Operational Risk
Committee (ORC), a sub-committee of Risk Management Committee (RMC). ORC has
oversight responsibility for operational risk strategy, management and
governance. It provides advice and guidance to the lines of business on
operational risk assessments, measurement and mitigation, and related
monitoring and change initiatives.
Operational risk is difficult to measure, since it is inherent in business
activities and is not like other risks we actively seek to manage. BMO's
intention is to make operational risk, like all other risks, transparent
throughout the enterprise. Therefore, this framework includes regular
reporting of relevant operational risk management activities and processes to
senior line and corporate management, ORC, RMC and the Board of Directors.
Operational risk programs work with other risk disciplines to better manage
converging risks across the enterprise.
Each line of business is responsible for using ORMF processes and control
programs to manage its operational risk within the guidance provided by
corporate policy and standards. To ensure that all operational risks to which
a line of business is exposed are adequately managed, Corporate Support areas
provide guidance and oversight for specific risks across the organization.
Primary Corporate Support areas include Finance, Business Continuity, Legal,
Compliance, Privacy, Human Resources and Technology and Operations.
Secondary mitigation of certain operational risk exposures is provided through
insurance. BMO purchases insurance in amounts that provide protection against
unexpected material loss and when insurance is required by law, regulation or
contractual agreement.
Under Basel II methodologies, BMO has implemented The Standardized Approach
(TSA) for the calculation of operational risk regulatory capital requirements
enterprise-wide. TSA processes and capital measures have been implemented at
both the consolidated enterprise and applicable legal entity levels.
Insurance Risk
Insurance risk is the risk of loss due to actual experience being different
than that assumed when an insurance product was designed and priced. Insurance
risk exists in all our insurance businesses, including annuities and life,
accident and sickness, and creditor insurance, as well as our reinsurance
business.
Insurance risk can be grouped into the following categories:
- Claims risk - The risk that the actual magnitude or frequency of claims will differ from the levels assumed in the
pricing/underwriting process. Claims risk includes mortality risk, morbidity risk and natural catastrophe risk.
- Policyholder behaviour risk - The risk that the behaviour of policyholders relating to premium payments, withdrawals
or loans, policy lapses and surrenders and other voluntary terminations will differ from the behaviour assumed in the
pricing calculations.
- Expense risk - The risk that actual expenses associated with acquiring and administering policies and claims
processing will exceed the expected expenses assumed in pricing calculations.
Insurance risk approval authority is delegated by BMO's Board of Directors to
senior management.
The boards of directors of our insurance subsidiaries are responsible for the
stewardship of their respective insurance companies. This includes BMO Life
Assurance Company (formerly AIG Life of Canada), which was purchased in 2009.
Through oversight and monitoring, the boards are responsible for ensuring the
insurance subsidiaries are managed and function in accordance with established
insurance strategies and policies.
BMO's Enterprise Risk and Portfolio Management group is responsible for
providing risk management direction and oversight to the insurance businesses.
The Appointed Actuaries of our Canadian insurance subsidiaries are appointed
by the boards of directors and have statutory responsibility for providing
opinions on the adequacy of provisions for the policyholder liabilities, the
solvency of the insurance company and fairness of treatment of participating
policyholders. In accordance with OSFI Guideline E-15, the work of the
Appointed Actuary is subject to an external, independent review by a qualified
actuary every three years.
Consistent with BMO's three-lines-of-defence risk management model, our
insurance subsidiaries "own" the risk in their businesses. Risk Management,
together with other Corporate Support areas, provides a second line of defence
and Corporate Audit a third.
BMO's Board of Directors delegates through the Insurance Corporate Policy the
authorities and limits for managing insurance risk. Enterprise Risk and
Portfolio Management provides an independent risk framework that ensures
compliance with applicable policies, as well as subsidiary policies, with any
exceptions requiring approval of Enterprise Risk and Portfolio Management.
A robust new products approval process is a cornerstone for identifying,
assessing and mitigating risks associated with new insurance products or
changes to existing products and for the appropriate pricing of our insurance
offerings. When combined with effective guidelines and practices for
underwriting and claims management, this process provides us with the tools to
effectively manage risk. Reinsurance, which involves transactions that
transfer insurance risk to independent reinsurance companies, is also used to
manage our exposure to insurance risk.
Actuarial liabilities are estimates of the amounts required to meet insurance
obligations. Liabilities are established in accordance with the standards of
practice of the Canadian Institute of Actuaries and the CICA. Actuarial
liabilities are calculated using the Canadian asset liability method, which
includes provisions for adverse deviations to ensure the adequacy of the
liabilities. The liabilities are validated through extensive internal and
external reviews and audits.
Our insurance subsidiaries provide independent evaluation and reporting on
insurance risk exposures to their boards of directors and at the enterprise
level. The insurance businesses are also incorporated into risk reporting at
the Private Client Group level. Reporting includes an assessment of all risks
facing the insurance subsidiaries, trends relating to claims and adequacy of
provisions for actuarial liabilities.
88 BMO Financial Group 192nd Annual Report 2009
Business Risk
Business risk arises from the specific business activities of a company and
the effects these could have on the earnings of the company.
Business risk encompasses the potential causes of earnings volatility that are
distinct from credit, market or operational risk factors. It identifies
factors related to the risk that volumes will decrease or margins will shrink
with no opportunity being available to offset the revenue declines with a
reduction in costs.
BMO faces many risks that are similar to those faced by non-financial firms,
principally that our profitability, and hence value, may be eroded by changes
in the business environment or by failures of strategy or execution. Sources
of these risks include, but are not limited to, changing client expectations,
adverse business developments and relatively ineffective responses to industry
changes.
Within BMO, each operating group is responsible for controlling its respective
business risk by assessing, managing and mitigating the risks that may affect
earnings arising from changes in business volume and cost structure, among
other factors.
Model Risk
Model risk arises from the possible divergence between what a model estimates
will occur and what actually does occur. Model risk also arises from the
possibility of the use of an inappropriate model or the inappropriate use of a
model.
BMO uses models that range from the very simple to those that value complex
transactions or involve sophisticated portfolio and capital management
methodologies. These models are used to guide strategic decisions and to
assist in making daily lending, trading, underwriting, funding, investment and
operational decisions. Models have also been developed to measure exposure to
specific risks and to measure total risk on an integrated basis, using
Economic Capital. We have effective controls over the development,
implementation and application of these models.
BMO uses a variety of models, which can be grouped within six categories:
- valuation models for valuation of assets, liabilities or reserves;
- risk exposure models measuring credit risk, market risk, liquidity risk and operational risk, which also address
expected loss and its applications;
- capital and stress testing models for measuring capital, capital allocations and regulatory and economic capital
management;
- fiduciary models for asset allocation, optimization and portfolio management;
- major business strategy models to forecast the possible outcomes of new strategies in support of our business
decision process; and
- models driven by regulatory and other stakeholder requirements.
Prior to use, models are subject to review under the Model Risk Corporate
Standard by our Model Risk & Vetting group. The Model Risk Corporate Standard
outlines minimum requirements for the identification, assessment, monitoring
and management of models and model risk throughout the enterprise. All models
are rated according to their risk levels, which determines the frequency of
ongoing review.
Strategic Risk
Strategic risk is the potential for loss due to fluctuations in the external
business environment and/or failure to properly respond to these fluctuations
due to inaction, ineffective strategies or poor implementation of strategies.
Strategic risk arises from two sources: external risks inherent in the
business environment within which BMO operates and the risk of potential loss
if BMO is unable to deal with those external risks effectively. While external
strategic risks - including economic, political, regulatory, technological,
social and competitive risks - cannot be controlled, the likelihood and
magnitude of their impact can be mitigated through an effective strategic
management process.
BMO's Office of Strategic Management (OSM) oversees the governance and
management processes for identifying, monitoring and mitigating strategic
risks across the enterprise. A rigorous strategic management process
incorporates a consistent approach to the development of strategies and
incorporates accurate and comprehensive financial information linked to
financial commitments. The OSM works with lines of business and key
corporate stakeholders during the strategy development process to promote
consistency and adherence to strategic management standards.
Included in this process is a review of the changing business environments
within which each of our lines of business operates, including broad industry
trends and the actions of our competitors. Strategies are reviewed with the
Management Committee and the Board of Directors annually in interactive
sessions designed to test assumptions and ensure that strategies reflect
current and potential future environments.
Performance commitments established through the strategic management process
are regularly monitored and reported upon quarterly, using both leading and
lagging indicators of performance, so that strategies can be reviewed and
adjusted when necessary. Regular strategic and financial updates are also
monitored closely to identify any significant issues.
89 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Reputation Risk
Reputation risk is the risk of negative impacts resulting from the
deterioration of BMO's reputation with stakeholders. These potential impacts
include revenue loss, reductions in our customer or client base and declines
in BMO's share price.
BMO's reputation is one of its most valuable assets, and must be protected and
safeguarded. Key to effectively building and maintaining BMO's reputation is
fostering a business culture in which integrity and ethical conduct are core
values.
The potential for damage to BMO's reputation exists in every business
decision. Therefore, we believe that active, ongoing and effective management
of reputation risk is best conducted through integration of explicit
assessments of reputation risk into strategy development, strategic and
operational implementation and transactional or initiative decision-making.
Reputation risk is also managed through our corporate governance practices,
code of conduct and risk management framework.
It is the responsibility of all employees to conduct themselves in accordance
with FirstPrinciples, BMO's code of conduct, and thus build and maintain BMO's
reputation.
The Reputation Risk Management Committee considers significant potential
reputation risks to the enterprise, specifically reviewing complex credit and
structured financings as required.
Environmental Risk
Environmental risk is the risk of loss or damage to BMO's reputation resulting
from environmental concerns related to BMO or its customers. Environmental
risk is often associated with credit and operational risk.
We are committed to minimizing the impact of our operations on the environment
and to demonstrating leadership by integrating environmental considerations
into our business practices.
Environmental risk management activities are overseen by both the Corporate
Sustainability and the Environmental Sustainability groups, with support from
our lines of business and other Corporate Support areas.
Environmental risk covers a broad spectrum of issues, such as climate change,
biodiversity and ecosystem health, unsustainable resource use, pollution,
waste and water. We work with external stakeholders to understand the impact
our operations have in the context of these issues, and we use this
understanding to determine the consequences for our businesses.
In addition, specific line of business guidelines outline how environmental
risk inherent in lending activities is managed. Environmental risks associated
with lending transactions are managed within BMO's credit and counterparty
risk framework by our experienced professionals. Specific guidelines related
to climate change are applied to transactions with clients operating in
emissions-intensive industry sectors, and we adhere to the standards set out
in the Equator Principles, a framework for evaluating social and environmental
risk in project finance transactions based on the World Bank's International
Finance Corporation Performance Standards.
We have committed to being carbon neutral in 2010 with respect to energy and
transportation by reducing absolute emissions relative to 2007 baseline
levels, purchasing renewable energy and using carbon offsets. We measure our
progress using an enterprise-wide greenhouse gas inventory tool that complies
with recognized international guidelines. Annually, the absolute emissions
numbers are reviewed to assess progress toward our reduction objectives, with
corrective measures implemented as required.
Environmental risk is addressed in our board-approved sustainability corporate
policy. Executive oversight of our environmental activities is provided by
BMO's Sustainability Council, comprised of executives representing the various
areas of the organization.
Senior management committees are provided with reports on the progress of
activities mandated by our environmental strategy, as appropriate. Our
environmental policies and practices are outlined in detail in our Corporate
Responsibility Report and Public Accountability Statement, which is published
each year and is available on our website. We also report on our Equator
Principles experience on our website.
90 BMO Financial Group 192nd Annual Report 2009
Non-GAAP Measures
BMO uses both GAAP and certain non-GAAP measures to assess performance.
Securities regulators require that companies caution readers that earnings and
other measures adjusted to a basis other than GAAP do not have standardized
meanings under GAAP and are unlikely to be comparable to similar measures used
by other companies. The adjacent table reconciles the non-GAAP measures, which
management regularly monitors, to their GAAP counterparts.
At times, we indicate that certain amounts or measures exclude the effects of
items but we generally do so in conjunction with disclosure of the nearest
GAAP measure and provide details of the reconciling item. Amounts and measures
stated on such a basis are considered useful as they could be expected to
reflect ongoing operating results or assist readers' understanding of
performance. To assist readers, we have also provided a schedule that
summarizes notable items that have affected results in the reporting periods.
Cash earnings, cash productivity and cash operating leverage measures may
enhance comparisons between periods when there has been an acquisition,
particularly because the purchase decision may not consider the amortization
of acquisition-related intangible assets to be a relevant expense. Cash EPS
measures are also disclosed because analysts often focus on this measure, and
cash EPS is used by Thomson First Call to track third-party earnings estimates
that are frequently reported in the media. Cash measures add the after-tax
amortization of acquisition-related intangible assets to GAAP earnings to
derive cash net income (and associated cash EPS) and deduct the amortization
of acquisition-related intangible assets from non-interest expense to derive
cash productivity and cash operating leverage measures.
Net economic profit represents cash net income available to common
shareholders, less a charge for capital, and is considered an effective
measure of added economic value.
GAAP and Related Non-GAAP Measures used in the MD&A
($ millions, except as noted) 2009 2008 2007
Total non-interest expense (a) 7,381 6,894 6,601
Amortization of acquisition-related
intangible assets (1) (44) (42) (46)
Cash-based non-interest expense (b) (2) 7,337 6,852 6,555
Net income 1,787 1,978 2,131
Amortization of acquisition-related intangible assets, net of
income taxes 35 35 38
Cash net income (2) 1,822 2,013 2,169
Preferred share dividends (120) (73) (43)
Charge for capital (2) (1,770) (1,535) (1,523)
Net economic profit (2) (68) 405 603
Revenue (c) 11,064 10,205 9,349
Revenue growth (%) (d) 8.4 9.2 (6.4)
Productivity ratio (%) ((a/c) x 100) 66.7 67.6 70.6
Cash productivity ratio (%) ((b/c) x 100) (2) 66.3 67.1 70.1
Non-interest expense growth (%) (e) 7.1 4.4 3.9
Cash-based non-interest
expense growth (%) (f) (2) 7.1 4.5 3.9
Operating leverage (%) (d - e) 1.3 4.8 (10.3)
Cash operating leverage (%) (d - f) (2) 1.3 4.7 (10.3)
EPS (uses net income) ($) 3.08 3.76 4.11
Cash EPS (uses cash net income) ($) (2) 3.14 3.83 4.18
(1) The amortization of non-acquisition-related intangible assets is not added back in the determination of cash net
income.
(2) These are non-GAAP amounts or non-GAAP measures.
(3) The table above outlines non-GAAP measures used by BMO together with their closest GAAP counterparts.
Review of Fourth Quarter Performance
Results in the fourth quarter of 2009 were strong, reflecting good revenue
growth and effective expense management. BMO's focus on customers continued to
yield results. In P&C Canada there was robust growth in both revenue and net
income. Our U.S. retail banking franchise saw net income improve from a year
ago when results were lowered by integration and other costs. Private Client
Group results were up strongly from a year ago when results were affected by
charges associated with the decision to purchase certain holdings from our
U.S. clients. Net income in BMO Capital Markets was in line with the fourth
quarter of 2008, which benefited from significant recoveries of prior periods'
income taxes. Revenues were up sharply and expenses were well controlled.
BMO's net income was $647 million, an increase of $87 million or 16% from the
fourth quarter of 2008. Summary income statements and data for the quarter and
comparative quarters are outlined on page 94. Notable items totalling $125
million after tax affected quarterly results in the fourth quarter of 2008.
They included charges of $45 million pre-tax related to the deterioration in
the capital markets environment and a $150 million increase in the general
allowance for credit losses.
Personal and Commercial Banking net income increased $83 million or 25% from a
year ago to $419 million. P&C Canada net income increased $70 million or 22%
to $394 million. There was good volume growth in each of our personal,
commercial and cards businesses, led by volume growth in most products and an
improved net interest margin. There was particularly strong growth in personal
and commercial deposits. Good revenue growth, together with effective
management of operating expenses while investing for the future, resulted in
strong cash operating leverage of 9%. Revenue rose $100 million or 8% and
non-interest expense decreased $5 million or 1%.
P&C U.S. net income increased US$12 million from a year ago to US$23 million.
Results benefited from reductions in integration costs related to our
Wisconsin subsidiaries and the Visa litigation accrual. There are higher
levels of impaired loans and the costs of managing this portfolio reduced net
income in the quarter by US$12 million (by US$9 million a year ago). Cash net
income was US$39 million, including a severance charge of US$2.4 million after
tax, on a basis that adjusts for the impact of impaired loans, integration
costs and the Visa litigation accrual. This was in line with the preceding
five quarters, where cash net income on this basis had exceeded US$40 million.
Private Client Group net income was $110 million, an increase of $26 million
or 32% from last year. Results in the fourth quarter of 2008 included charges
of $31 million ($19 million after tax) associated with the decision to
purchase certain holdings from our U.S. clients in the difficult market
environment. The BMO Life Assurance acquisition increased net income by $9
million. Revenues were lower in the brokerage businesses but effective expense
control contributed to improved results. Assets under management and
administration benefited from improving market conditions, growing $8 billion
or 3% from a year ago despite a $9 billion decline related to the weaker U.S.
dollar.
91 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
BMO Capital Markets net income of $289 million was in line with a year ago.
However, results a year ago benefited from a $52 million recovery of prior
periods' income taxes and a higher proportion of tax-exempt revenue. In this
quarter, there were no capital markets environment charges. The prior year
included largely offsetting gains and losses with respect to the capital
markets environment. Revenue for the quarter increased $172 million from a
year ago to $894 million. Corporate banking revenues increased significantly,
primarily as a result of higher lending fees and higher net interest income.
Equity and debt underwriting fees were also up from the prior year. Trading
revenues were down from a year ago and investment securities gains increased.
Corporate Services net loss of $171 million increased $21 million from the
fourth quarter of 2008. Provisions for credit losses were $106 million better
as results a year ago included a $150 million increase in the general
allowance for credit losses. Revenues were $135 million worse, primarily due
to lower mark-to-market gains on hedging activities than in the prior year,
the impact of credit card securitizations completed in the latter part of 2008
and lower one-time securitization gains in 2009.
BMO's revenue increased $176 million or 6% from a year ago to $2,989 million.
There was good growth in all of the operating groups and a reduction in
Corporate Services. The weaker U.S. dollar decreased revenue by $20 million or
1%.
Net interest income in the current quarter increased $33 million or 2% from a
year ago. BMO's overall net interest margin improved by 2 basis points, driven
by P&C Canada due mainly to favourable prime rates relative to bankers'
acceptance rates and actions to mitigate the impact of rising long-term
funding costs. Average earning assets increased $3 billion or 1%, driven by
Private Client Group as a result of the inclusion of BMO Life Assurance in
2009 and loan growth in Private Banking.
Non-interest revenue increased $143 million or 10% from a year ago. The
improvement was in part attributable to the prior year's $45 million of
charges related to the deterioration in the capital markets environment. They
comprised $228 million of charges in securities gains (losses) other than
trading, a reduction of $30 million in other revenue and a $213 million
increase in trading non-interest revenue. There were higher lending and
underwriting fees in BMO Capital Markets, increased revenues in Private Client
Group attributable to the BMO Life Assurance acquisition in the second quarter
of 2009 and increases in securitization revenues.
Non-interest expense decreased $39 million or 2% from a year ago to $1,779
million. There were decreases in each of the groups except Private Client
Group and Corporate Services, which both increased modestly. The weaker U.S.
dollar reduced expense by $12 million or 1%. This was offset by higher
expenses of $15 million from the impact of acquired businesses. Decreased
expenses were reflected in lower salaries expense, due to fewer staff, and
reductions in computer costs, professional fees and capital taxes.
Performance-based compensation was modestly higher and benefits costs
increased. Cash operating leverage was 8.3% in the current quarter.
Specific provisions for credit losses for the quarter totalled $386 million
and there was no increase in the general allowance. Provisions totalled $465
million a year ago and included an increase in the general allowance of $150
million. Specific provisions this quarter represented an annualized 89 basis
points of average net loans and acceptances, compared with 68 basis points in
the same quarter last year.
The provision for income taxes increased $207 million from the fourth quarter
of 2008 to $158 million. The effective tax rate for the quarter was 19.2%,
compared with a recovery rate of 9.2% in the same quarter last year. The
higher effective tax rate in the quarter was due primarily to reductions in
the proportion of income from lower-tax-rate jurisdictions and lower
recoveries of prior periods' income taxes.
92 BMO Financial Group 192nd Annual Report 2009
Quarterly Earning Trends
BMO's results and performance measures for the past eight quarters are
outlined on page 94.
We have remained focused on our objectives and priorities and made good
progress in embracing a culture that places the customer at the focus of
everything we do. We maintained this focus in the face of very difficult
capital and credit market conditions as well as a slowing economy during the
latter stages of 2008 and into the current fiscal year. In 2009, many of our
businesses delivered solid results and we believe we are well positioned for
the economic recovery.
BMO's quarterly earnings, revenue and expense are modestly affected by
seasonal factors. Since our second fiscal quarter has 89 days (90 days in
2008) and other quarters have 92 days, second-quarter results are lower
relative to other quarters because there are three fewer calendar days (two in
2008), and thus fewer business days. The months of July (third quarter) and
August (fourth quarter) are typically characterized by lower levels of capital
markets activity, which has an effect on results in Private Client Group and
BMO Capital Markets. The December holiday season also contributes to a
slowdown in some activities; however, credit card purchases are particularly
robust in that first-quarter period, as well as in the back-to-school period
that falls in our fourth quarter.
Notable items affected revenues in BMO Capital Markets in 2008 and 2009. These
charges, which related to deterioration in the capital markets environment,
totalled $388 million ($260 million after tax) in 2008 and were concentrated
in the first and fourth quarters of the year. The charges totalled $521
million ($355 million after tax) in 2009 and were concentrated in the first
half of the year.
Personal and Commercial Banking earnings and revenues have trended higher over
2008 and 2009 and are strong.
P&C Canada has been successful in its development of a more customer-focused
culture which is in line with the mindset across the organization. P&C Canada
has increased market share in some of its priority markets and continued to
grow net income while investing for future growth. Revenues have trended
higher due to volume growth in most products and improving net interest
margin.
On a U.S. dollar basis, P&C U.S. net income held relatively steady over the
course of 2008 but was reduced in the fourth quarter of that year as results
were affected by higher levels of costs associated with completing the
integration of the Wisconsin acquisitions. Results in 2009 have been affected
by higher levels of non-performing loans. Cash net income has approximated
US$40 million over the last six quarters, on a basis that adjusts for the
impact of impaired loans, integration costs, a Visa litigation accrual and a
gain on the partial sale of our investment in Visa. Revenues were stronger in
2009, reflecting deposit growth and a full year of results for our Wisconsin
acquisitions.
Private Client Group's results were weaker in the first half of 2009 as stock
markets were weak and interest rates were low. Asset levels were reduced and
clients held high cash balances as they waited for markets to recover.
Performance improved over the last six months as equity markets regained
strength. Results in the fourth quarter of 2008 and first quarter of 2009 were
reduced by charges related to our decision to purchase certain holdings from
our U.S. clients. Results in the third quarter of 2009 included a recovery of
prior periods' income taxes.
BMO Capital Markets earnings in 2008 reflected strong performance in our
interest-rate-sensitive businesses, high trading revenues and, in the last
half of 2008, lower income taxes. Results were up significantly in 2009 due to
strong trading performance as we capitalized on market opportunities, and
improved corporate banking revenues as we benefited from our continued focus
on client relationships. BMO Capital Markets has refocused its business over
the past two years with the goal of improving its risk-return profile and
concentrating on core profitable client relationships.
Corporate Services quarterly net income varies in large part because of our
expected loss provisioning methodology, general provisions for credit losses
and the impact from revenue, expenses and income taxes not attributed to the
operating groups. Revenues were affected in 2009 by the impact of market rate
changes on our balance sheet management activities as described in the group
section but the effects were lowered over the course of the year. Results in
the second quarter of 2009 were lowered by a $118 million ($80 million after
tax) severance charge.
The U.S. and Canadian dollar traded at approximately par in the first three
quarters of 2008. The U.S. dollar then strengthened significantly in the
fourth quarter of 2008, holding that strength until weakening rapidly in the
third quarter of 2009. A strong U.S. dollar increases the translated value of
BMO's U.S.-dollar-denominated results. The effect of movements in exchange
rates is sometimes muted by decisions to hedge the impact of exchange
movements within a single quarter, which is explained on page 39.
BMO's provision for credit losses measured as a percentage of loans and
acceptances increased significantly in the third quarter of 2008 and remained
at elevated levels in 2009 due to the difficult credit market conditions and a
slowdown in the economy.
The effective income tax rate can vary, as it depends on the timing of
resolution of certain tax matters, recoveries of prior periods' income taxes
and the relative proportion of earnings attributable to the different
jurisdictions in which we operate.
Caution
This Quarterly Earning Trends section contains forward-looking statements.
Please see the Caution Regarding Forward-Looking Statements.
93 BMO Financial Group 192nd Annual Report 2009
MANAGEMENT'S DISCUSSION AND ANALYSIS
Summarized Statement of Income and Quarterly Financial Measures
Oct. 31 July 31 April 30 Jan. 31 Oct. 31 July 31 April 30 Jan. 31
($ millions) 2009 2009 2009 2009 2008 2008 2008 2008 2009 2008 2007
Net interest
income 1,442 1,466 1,335 1,327 1,409 1,282 1,171 1,210 5,570 5,072 4,829
Non-interest
revenue 1,547 1,512 1,320 1,115 1,404 1,464 1,449 816 5,494 5,133 4,520
Total revenue 2,989 2,978 2,655 2,442 2,813 2,746 2,620 2,026 11,064 10,205 9,349
Provision for
credit losses -
specific 386 357 372 428 315 434 151 170 1,543 1,070 303
Provision for
credit losses -
general - 60 - - 150 50 - 60 60 260 50
Non-interest
expense 1,779 1,883 1,888 1,841 1,826 1,782 1,680 1,614 7,391 6,902 6,442
Restructuring
charge (reversal) - (10) - - (8) - - - (10) (8) 159
Income before
provision for
income taxes and
non-controlling
interest in
subsidiaries 824 688 395 173 530 480 789 182 2,080 1,981 2,395
Provision for
(recovery of)
income taxes 158 112 18 (71) (49) (59) 128 (91) 217 (71) 189
Non-controlling
interest in
subsidiaries 19 19 19 19 19 18 19 18 76 74 75
Net income 647 557 358 225 560 521 642 255 1,787 1,978 2,131
Amortization of
acquisition-related
intangible assets,
net of income taxes 8 9 10 8 10 9 8 8 35 35 38
Cash net income 655 566 368 233 570 530 650 263 1,822 2,013 2,169
Operating group net
income:
Personal and
Commercial Banking 419 381 359 342 336 343 335 291 1,501 1,305 1,264
Private Client
Group 110 120 78 73 84 125 121 122 381 452 528
BMO Capital Markets 289 343 249 179 290 263 187 (29) 1,060 711 417
Corporate Services,
including T&O (171) (287) (328) (369) (150) (210) (1) (129) (1,155) (490) (78)
BMO Financial Group
net income 647 557 358 225 560 521 642 255 1,787 1,978 2,131
Information per
Common Share ($)
Dividends declared 0.70 0.70 0.70 0.70 0.70 0.70 0.70 0.70 2.80 2.80 2.71
Earnings
Basic 1.12 0.97 0.61 0.39 1.06 1.00 1.25 0.48 3.09 3.79 4.18
Diluted 1.11 0.97 0.61 0.39 1.06 0.98 1.25 0.47 3.08 3.76 4.11
Cash earnings
Basic 1.13 0.98 0.63 0.41 1.08 1.01 1.27 0.50 3.15 3.86 4.25
Diluted 1.13 0.98 0.63 0.40 1.08 1.00 1.26 0.49 3.14 3.83 4.18
Book value 31.95 31.26 32.22 32.18 32.02 30.15 29.71 28.64 31.95 32.02 28.29
Market price
High 54.75 54.05 41.03 44.88 51.74 52.31 58.78 63.44 54.75 63.44 72.75
Low 49.01 38.86 24.05 29.60 35.65 37.60 38.00 51.35 24.05 35.65 60.21
Close 50.06 54.02 39.50 33.25 43.02 47.94 50.10 56.75 50.06 43.02 63.00
Financial Measures
(%)
Five-year average
annual total
shareholder return 1.8 4.0 (1.2) (6.9) 0.9 5.1 8.2 10.1 1.8 0.9 14.2
Dividend yield 5.6 5.2 7.1 8.4 6.5 5.8 5.6 4.9 5.6 6.5 4.3
Diluted earnings
per share growth 4.7 (1.0) (51.2) (17.0) 21.8 (23.4) (3.1) (29.9) (18.1) (8.5) (20.2)
Diluted cash
earnings per share
growth 4.6 (2.0) (50.0) (18.4) 21.3 (23.1) (3.8) (27.9) (18.0) (8.4) (20.1)
Return on equity 14.0 12.1 8.1 4.9 14.0 13.5 17.9 6.7 9.9 13.0 14.4
Net economic profit
growth 10.4 (35.1) (132.9) (71.8) 103.4 (56.5) (7.9) (242.7) (116.7) (32.8) (51.0)
Net income growth 15.6 6.9 (44.3) (11.7) 23.9 (21.1) (4.3) (26.8) (9.7) (7.2) (20.0)
Revenue growth 6.3 8.4 1.3 20.5 27.9 7.5 3.6 (2.0) 8.4 9.2 (6.4)
Net interest margin
on earning assets 1.73 1.74 1.55 1.51 1.71 1.58 1.47 1.45 1.63 1.55 1.59
Productivity ratio 59.5 62.9 71.1 75.4 64.6 64.9 64.1 79.7 66.7 67.6 70.6
Provision for
credit losses as a
% of average net
loans and
acceptances 0.89 0.94 0.79 0.90 1.01 1.10 0.35 0.55 0.88 0.76 0.21
Effective tax rate 19.2 16.4 4.4 (41.0) (9.2) (12.2) 16.3 (50.3) 10.5 (3.6) 7.9
Canadian/U.S.
dollar average
exchange rate ($) 1.083 1.110 1.242 1.227 1.111 1.012 1.007 0.998 1.165 1.032 1.093
Gross impaired
loans and
acceptances as a %
of equity and
allowance for
credit losses 14.06 12.75 12.95 11.91 11.34 9.09 9.54 7.46 14.06 11.34 4.07
Cash and
securities-to-total
assets 31.9 30.0 28.2 28.2 29.1 29.6 29.6 30.7 31.9 29.1 33.1
Tier 1 Capital
Ratio (1) 12.24 11.71 10.70 10.21 9.77 9.90 9.42 9.48 12.24 9.77 9.51
(1) A new framework, Basel II, was adopted in 2008. Basel II and Basel I
methodologies are not comparable.
In the opinion of BMO's management, information that is derived from unaudited
financial information, including information as at and for interim periods,
includes all adjustments necessary for a fair presentation of such
information. All such adjustments are of a normal and recurring nature.
Financial ratios for interim periods are stated on an annualized basis where
appropriate, and all growth rates represent year-over-year growth. Ratios, as
well as interim operating results, are not necessarily indicative of actual
results for the full fiscal year.
94 BMO Financial Group 192nd Annual Report 2008
2008 Financial Performance Review
The preceding discussions in the MD&A focused on our performance in 2009. This
section summarizes our performance in fiscal 2008 relative to fiscal 2007.
Net income decreased $153 million or 7.2% to $1,978 million in fiscal 2008 and
earnings per share fell $0.35 or 8.5% to $3.76. Results for the year were
affected by charges related to notable items totalling $426 million after tax
($0.84 per share). Results in 2007 were affected by charges related to notable
items totalling $637 million after tax ($1.25 per share). Amounts are detailed
in the Notable Items section. Return on equity was 13.0%, down from 14.4% in
2007, due to the $153 million reduction in net income.
Revenue rose $856 million or 9.2% in 2008 to a strong $10,205 million. Revenue
in 2008 was reduced by charges of $388 million associated with notable items
related to the impact of the weak capital markets environment. In 2007,
revenue was reduced by $947 million of charges related to notable items,
consisting of charges related to the weak capital markets environment and
commodities losses. The lower charges in 2008 accounted for $559 million of
the revenue increase. The weaker U.S. dollar reduced overall revenue growth by
$63 million or 0.7 percentage points, while the net impact of acquired
businesses increased revenue growth by $76 million or 0.8 percentage points.
The remaining increase was primarily attributable to business growth as there
was solid revenue growth in each of the operating groups.
Credit conditions in 2008 were difficult as the U.S. housing market softened
significantly and the North American economic environment weakened. BMO
recorded a $1,330 million provision for credit losses, consisting of $1,070
million of specific provisions and a $260 million increase in the general
allowance for credit losses. These amounts compare to a $353 million provision
recorded in 2007 comprised of specific provisions of $303 million and a $50
million increase in the general allowance.
Non-interest expense increased $293 million or 4.4% to $6,894 million. The net
effect of businesses acquired in 2008 and 2007 increased expenses in 2008
relative to 2007 by $74 million (1.1%). The weaker U.S. dollar reduced costs
in 2008 by $93 million (-1.4%) and the change in restructuring charges reduced
expenses by $167 million (-2.5%). Other factors, including other
business-based costs, increased overall expenses in 2008 by 6.9%. These
included higher salaries and benefits costs associated with the expansion of
our sales force, as well as initiatives and costs associated with business
growth.
There was a $71 million recovery of income taxes in 2008, compared with a $189
million charge in 2007. Low income taxes in 2008 were attributable to
recoveries of prior years' income taxes and a higher proportion of income from
lower-tax-rate jurisdictions.
Net income in P&C Canada rose $61 million or 5.3% from 2007 to $1,209 million.
Revenue increased $245 million or 5.3% to $4,878 million. Results largely
reflected improved volumes with solid growth in personal banking, cards and
payment services revenue. While there was volume growth in commercial
products, commercial revenue decreased slightly due to a 2007 gain on an
investment security and increased funding costs. Non-interest expense
increased $168 million or 6.5% to $2,736 million due to initiatives spending,
including expansion and renovation of the branch network and debit and credit
card chip technology, as well as higher operating costs.
Net income in P&C U.S. decreased $20 million to $96 million in 2008. On a U.S.
dollar basis, net income decreased $12 million or 11%. Revenue increased $82
million to $990 million, but increased $126 million or 15% on a U.S. dollar
basis. The increase was largely driven by acquisitions (US$51 million) and the
gain on sale of a portion of our investment in Visa upon its successful initial
public offering (IPO) (US$38 million). The remaining increase reflected volume
and deposit spread improvement as well as stronger fee revenues, partially
offset by the impact of increases in impaired loans. Non-interest expense
increased $109 million or 16% to $802 million, but increased $139 million or
22% on a U.S. dollar basis. Excluding a Visa litigation accrual of US$24
million related to the IPO and operating and integration costs of acquired
businesses of US$55 million, expense increased US$60 million or 9.5%. This
increase reflected our continued targeted investment and expansion efforts,
increased costs of managing impaired loans and costs associated with higher
business volumes.
Net income in Private Client Group was $452 million, down $76 million from
2007. Results in 2008 were affected by $31 million ($19 million after tax) of
charges associated with actions taken to support U.S. clients in the difficult
capital markets environment. Results in 2007 benefited from a $57 million
recovery of prior years' income taxes and a $26 million ($23 million after
tax) insurance gain. Revenue of $2,146 million decreased $16 million due
primarily to the impact of the charges in fiscal 2008 and the insurance gain
in the prior year. Adjusted for the charges and the insurance gain, revenue
was higher, reflecting increased deposit balances in the brokerage businesses
as well as higher trust and investment revenue in North American Private
Banking, partially offset by lower commission revenues in the brokerage
businesses. In 2008, BMO Mutual Funds began absorbing the operating expenses
of its funds in return for a fixed administration fee. This had the effect of
increasing both non-interest revenue and expense. The weaker U.S. dollar
reduced revenue growth by $19 million or 1 percentage point. Non-interest
expense increased $30 million or 2.0% to $1,531 million. The increase in
expense was primarily attributable to the impact of the fixed mutual fund
administration fee, partially offset by lower revenue-based costs in line with
lower revenue. The weaker U.S. dollar reduced expense growth by $12 million or
1 percentage point.
Net income in BMO Capital Markets increased $294 million to $711 million.
Results in 2008 were affected by charges of $388 million ($260 million after
tax) related to the deterioration in capital markets. Results in 2007 were
affected by charges of $947 million ($501 million after tax and compensation
adjustments) related to the capital markets environment and commodities
losses. Revenue increased $471 million or 24% to $2,440 million. Trading
revenues were significantly higher, driven by improvements in commodities
trading as management successfully reduced the size and risk profile of the
commodities portfolio. However, gains in trading were partially offset by
lower investment banking revenues, particularly lower merger and acquisition
fees and equity underwriting fees. Net interest income increased as revenues
from our interest-rate-sensitive businesses were significantly higher and
trading net interest income also increased, partially offset by lower
corporate banking net interest income and increased funding costs.
Non-interest expense increased $176 million or 11% to $1,751 million,
primarily due to increased employee costs and higher allocated costs.
Corporate Services net loss for the year was $490 million, compared with a net
loss of $78 million in 2007. The increased loss was largely due to higher
provisions for credit losses, including a $260 million ($166 million after
tax) increase in the general allowance, compared with a $50 million ($33
million after tax) increase in the prior year. Non-interest expense was $190
million lower, largely related to a $159 million ($103 million after tax)
restructuring charge in 2007.
95 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Supplemental Information
Table 1: Shareholder Value
As at or for the
year ended
October 31 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000
Market Price per Common
Share ($)
High 54.75 63.44 72.75 70.24 62.44 59.65 50.26 40.65 44.40 35.80
Low 24.05 35.65 60.21 56.86 53.05 49.28 37.79 31.00 32.75 21.00
Close 50.06 43.02 63.00 69.45 57.81 57.55 49.33 38.10 33.86 35.25
Common Share Dividends
Dividends declared
per share ($) 2.80 2.80 2.71 2.26 1.85 1.59 1.34 1.20 1.12 1.00
Dividends paid
per share ($) 2.80 2.80 2.63 2.13 1.80 1.50 1.29 1.18 1.09 0.99
Dividend
payout ratio (%) 91.8 74.0 64.8 43.0 39.1 35.2 38.2 44.0 40.8 30.2
Dividend
yield (%) 5.6 6.5 4.3 3.3 3.2 2.8 2.7 3.1 3.3 2.8
Total Shareholder Return (%)
Five-year average
annual return 1.8 0.9 14.2 19.1 13.8 18.9 12.9 7.9 14.3 22.9
One-year return 25.1 (27.9) (5.8) 24.1 3.7 20.0 33.4 16.2 (1.2) 29.0
Common Share Information
Number outstanding (in thousands)
End of
period 551,716 504,575 498,563 500,726 500,219 500,897 499,632 492,505 489,085 522,584
Average basic 540,294 502,062 499,950 501,257 500,060 501,656 496,208 490,816 511,286 531,318
Average
diluted 542,313 506,697 508,614 511,173 510,845 515,045 507,009 499,464 523,561 540,815
Number of
shareholder
accounts 37,061 37,250 37,165 38,360 40,104 41,438 42,880 44,072 45,190 46,663
Book value
per share ($) 31.95 32.02 28.29 28.89 26.48 24.20 22.09 21.07 19.69 19.63
Total market
value of shares
($ billions) 27.6 21.7 31.4 34.8 28.9 28.8 24.6 18.8 16.6 18.4
Price-to-earnings multiple
(based on
diluted EPS) 16.3 11.4 15.3 13.5 12.5 13.1 14.3 14.2 12.7 10.8
Price-to-cash earnings multiple
(based on
diluted cash EPS)15.9 11.2 15.1 13.3 12.1 12.6 13.7 13.5 11.8 10.4
Market-to-book
value multiple 1.57 1.34 2.23 2.40 2.18 2.38 2.23 1.81 1.72 1.80
Table 2: Summary Income Statement and Growth Statistics ($ millions, except as noted)
5-year 10-year
For the year ended October 31 2009 2008 2007 2006 2005 CAGR(1) CAGR(1)
Income Statement
Net interest income (2) 5,570 5,072 4,829 4,732 4,776 3.0 2.9
Non-interest revenue 5,494 5,133 4,520 5,253 5,063 3.8 4.6
Total revenue 11,064 10,205 9,349 9,985 9,839 3.4 3.7
Provision for credit losses 1,603 1,330 353 176 179 nm 17.5
Non-interest expense 7,381 6,894 6,601 6,353 6,332 3.7 3.4
Income before provision for income
taxes and
non-controlling interest in
subsidiaries 2,080 1,981 2,395 3,456 3,328 (8.7) -
Provision for (recovery of) income
taxes (2) 217 (71) 189 717 874 (25.8) (11.5)
Non-controlling interest in
subsidiaries 76 74 75 76 58 34.0 13.6
Net income 1,787 1,978 2,131 2,663 2,396 (4.9) 3.3
Year-over-year growth (%) (9.7) (7.2) (20.0) 11.2 4.4 na na
Earnings per Share (EPS) ($)
Basic 3.09 3.79 4.18 5.25 4.73 (7.3) 2.6
Diluted 3.08 3.76 4.11 5.15 4.63 (6.9) 2.8
Year-over-year growth (%) (18.1) (8.5) (20.2) 11.2 5.2 na na
Diluted Cash Earnings per Share (Cash
EPS) ($) (3) 3.14 3.83 4.18 5.23 4.78 (7.1) 2.5
Year-over-year growth (%) (18.0) (8.4) (20.1) 9.4 5.1 na na
(1) Compound annual growth rate (CAGR) expressed as a percentage.
(2) Effective in 2008, net interest income, total revenue and income taxes are no longer reported on a taxable
equivalent basis at the enterprise level. Prior year data has been restated.
(3) Refer to the Non-GAAP Measures section on page 91.
nm - not meaningful
na - not applicable
Throughout this Supplemental Information section, certain amounts for years
prior to 2004 have not been restated to reflect changes in accounting policies
in 2006 as the changes were not significant.
96 BMO Financial Group 192nd Annual Report 2009
Table 3: Returns on Equity
and Assets
($ millions, except as noted)
For the year ended October 31 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000
Net income 1,787 1,978 2,131 2,663 2,396 2,295 1,781 1,373 1,402 1,766
Preferred dividends 120 73 43 30 30 31 38 35 11 10
Net income available to
common shareholders 1,667 1,905 2,088 2,633 2,366 2,264 1,743 1,338 1,391 1,756
Average common shareholders'
equity 16,865 14,612 14,506 13,703 12,577 11,696 10,646 9,973 10,100 9,745
Return on equity (%) 9.9 13.0 14.4 19.2 18.8 19.4 16.4 13.4 13.8 18.0
Cash return on equity (%) 10.1 13.3 14.7 19.5 19.4 20.0 17.1 14.2 14.8 18.8
Return on average assets (%) 0.41 0.50 0.59 0.86 0.81 0.87 0.67 0.55 0.58 0.75
Return on average assets
available
to common shareholders (%) 0.38 0.48 0.58 0.85 0.80 0.86 0.66 0.54 0.57 0.75
Table 4: Summary
Balance Sheet ($ millions)
As at October 31 2009 2008 2007 2006 2005
Assets
Cash and cash equivalents 9,955 9,134 3,650 2,458 2,412
Interest bearing deposits
with banks 3,340 11,971 19,240 17,150 18,309
Securities 110,813 100,138 98,277 67,411 57,034
Securities borrowed or
purchased
under resale agreements 36,006 28,033 37,093 31,429 28,280
Net loans and acceptances 167,829 186,962 164,095 159,565 146,057
Other assets 60,515 79,812 44,169 41,965 41,770
Total assets 388,458 416,050 366,524 319,978 293,862
Liabilities and Shareholders'
Equity
Deposits 236,156 257,670 232,050 203,848 193,793
Other liabilities 126,719 134,761 114,330 96,743 82,158
Subordinated debt 4,236 4,315 3,446 2,726 2,469
Capital trust securities 1,150 1,150 1,150 1,150 1,150
Preferred share liability - 250 250 450 450
Share capital
Preferred 2,571 1,746 1,196 596 596
Common 6,198 4,708 4,411 4,231 4,022
Contributed surplus 79 69 58 49 35
Retained earnings 11,748 11,632 11,166 10,974 9,801
Accumulated other
comprehensive
loss (399) (251) (1,533) (789) (612)
Total liabilities and
shareholders'
equity 388,458 416,050 366,524 319,978 293,862
Average Daily Balances
Net loans and acceptances 182,097 175,079 165,783 153,282 139,414
Assets 438,548 397,609 360,575 309,131 296,502
Table 5: Liquid Assets ($ millions, except as noted)
As at October 31 2009 2008 2007 2006 2005
Canadian Dollar Liquid Assets
Deposits with other banks 787 1,842 1,531 3,346 1,855
Other cash resources 2,411 89 1,981 551 586
Securities 74,249 58,639 57,206 30,647 28,723
Total Canadian dollar liquid
assets 77,447 60,570 60,718 34,544 31,164
U.S. Dollar and Other
Currencies Liquid Assets
Deposits with other banks 9,305 16,477 19,209 14,465 17,232
Other cash resources 792 2,697 169 1,246 1,048
Securities 36,564 41,499 41,071 36,764 28,311
Total U.S. dollar and other
currencies liquid assets 46,661 60,673 60,449 52,475 46,591
Total Liquid Assets (1) 124,108 121,243 121,167 87,019 77,755
Cash and securities-to-total
assets (%) 31.9 29.1 33.1 27.2 26.5
Pledged assets included in
total liquid assets (2) 39,638 38,142 30,369 26,299 27,760
(1) Includes liquid assets pledged as security for securities sold but not yet purchased, securities lent or
sold under repurchase agreements and other secured liabilities.
(2) Includes reserves or minimum balances which some of our subsidiaries are required to maintain with
central banks in their respective countries of operation.
97 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Table 6: Other Statistical Information
As at or for the
year ended
October 31 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000
Other Information
Employees (1) 36,173 37,073 35,827 34,942 33,785 33,593 33,993 34,568 34,693 33,884
Bank branches 1,195 1,280 1,224 1,182 1,180 1,174 1,142 1,134 1,129 1,135
Automated
banking
machines
(Canada) 2,030 2,026 1,978 1,936 1,952 1,993 2,023 2,000 1,982 1,987
Rates
Average Canadian
prime rate (%) 2.70 5.21 6.08 5.57 4.30 4.05 4.69 4.15 6.55 7.05
Average U.S.
prime rate (%) 3.34 5.69 8.19 7.76 5.85 4.17 4.17 4.79 7.68 9.18
Canadian/U.S. dollar
exchange rates ($)
High 1.30 1.29 1.19 1.20 1.27 1.40 1.59 1.61 1.49 1.44
Low 1.03 0.92 0.95 1.10 1.16 1.22 1.30 1.51 1.59 1.53
Average 1.16 1.03 1.09 1.13 1.21 1.31 1.44 1.57 1.54 1.48
End of period 1.08 1.20 0.94 1.12 1.18 1.22 1.32 1.56 1.59 1.52
(1) Reflects full-time equivalent number of employees, comprising full-time and part-time employees and
adjustments for overtime hours.
Table 7: Revenue and
Revenue Growth
($ millions, except as noted)
5-year 10-year
For the year ended October 31 2009 2008 2007 2006 2005 CAGR CAGR
Net Interest Income 5,570 5,072 4,829 4,732 4,776 3.0 2.9
Year-over-year growth (%) 9.8 5.0 2.0 (0.9) (0.5) na na
Net Interest Margin (1)
Average earning assets 341,848 326,803 304,471 261,461 243,196 8.7 5.5
Net interest margin (%) 1.63 1.55 1.59 1.81 1.97 na na
Canadian dollar net interest margin (%) 1.78 2.00 2.12 2.38 2.45 na na
U.S. dollar and other currencies net
interest margin (%) 1.43 0.92 0.80 0.84 1.16 na na
Non-Interest Revenue
Securities commissions and fees 973 1,105 1,145 1,051 1,092 (1.6) 3.9
Deposit and payment service charges 820 756 728 729 734 1.9 2.9
Trading revenues (losses) 723 546 (487) 718 496 29.3 9.4
Lending fees 556 429 406 337 313 11.9 5.4
Card fees 121 291 107 396 334 (14.2) (5.1)
Investment management and
custodial fees 344 339 322 298 305 2.3 (2.0)
Mutual fund revenues 467 589 576 499 437 4.3 8.5
Securitization revenues 929 513 296 100 113 39.3 12.1
Underwriting and advisory fees 397 353 528 407 357 2.9 8.5
Securities gains (losses), other
than trading (354) (315) 247 145 165 nm (15.4)
Foreign exchange, other than trading 53 80 132 102 97 (21.6) (8.9)
Insurance income 295 237 246 221 184 16.3 15.0
Other revenues 170 210 274 250 436 (9.2) (0.6)
Total non-interest revenue 5,494 5,133 4,520 5,253 5,063 3.8 4.6
Year-over-year growth (%) 7.0 13.6 (14.0) 3.8 11.2 na na
Non-interest revenue as a % of
total revenue 49.7 50.3 48.3 52.6 51.5 na na
Total Revenue 11,064 10,205 9,349 9,985 9,839 3.4 3.7
Year-over-year growth (%) 8.4 9.2 (6.4) 1.5 5.2 na na
(1) Net interest margin is calculated based on average earning assets.
na - not applicable
nm - not meaningful
98 BMO Financial Group 192nd Annual Report 2009
Table 8: Non-Interest Expense and Expense-to-Revenue Ratio
($ millions, except as noted)
5-year 10-year
For the year ended October 31 2009 2008 2007 2006 2005 CAGR CAGR
Non-Interest Expense
Employee compensation
Salaries 2,395 2,149 1,964 1,903 1,903 4.7 1.7
Performance-based
compensation 1,338 1,297 1,275 1,322 1,277 2.9 10.1
Employee benefits 652 530 586 599 571 2.3 8.5
Total employee compensation 4,385 3,976 3,825 3,824 3,751 3.8 4.5
Premises and equipment
Rental of real estate 306 279 257 246 198 11.0 7.7
Premises, furniture and
fixtures 272 255 242 230 253 0.7 (0.1)
Property taxes 30 29 28 26 45 (10.9) (5.5)
Computers and equipment 673 678 634 709 768 (1)
Total premises and equipment 1,281 1,241 1,161 1,211 1,264 (1)
Other expenses
Communications 221 202 149 131 122 9.8 (1.9)
Business and capital taxes 44 42 47 94 107 (14.5) (10.0)
Professional fees 362 384 301 287 243 6.7 0.6
Travel and business
development 309 328 287 253 247 5.3 3.1
Other 586 546 484 509 504 6.3 10.5
Total other expenses 1,522 1,502 1,268 1,274 1,223 5.4 2.6
Amortization of intangible
assets 203 183 188 44 94 (1)
Restructuring charge
(reversal) (10) (8) 159 - - nm nm
Total Non-Interest Expense 7,381 6,894 6,601 6,353 6,332 3.7 3.4
Year-over-year growth (%) 7.1 4.4 3.9 0.3 2.6 na na
Non-interest
expense-to-revenue ratio (%) 66.7 67.6 70.6 63.6 64.4 na na
Government Levies and Taxes
(2)
Government levies other than
income taxes
Payroll levies 171 164 165 162 152 0.9 3.0
Property taxes 30 29 28 26 45 (10.9) (5.5)
Provincial capital taxes 35 32 37 86 100 (17.0) (11.5)
Business taxes 9 10 10 8 7 2.6 2.1
Goods and services tax and 116 142 122 128 127 (4.9) (0.2)
sales tax
Sundry taxes 3 3 3 2 2 3.4 nm
Total government levies other
than income taxes 364 380 365 412 433 (4.8) (1.5)
Provision for (recovery of)
income taxes 217 (71) 189 717 874 (25.8) (11.5)
Total Net Government Levies
and Taxes 581 309 554 1,129 1,307 (16.5) (6.7)
Total net government levies
and taxes as a % of
net income before government
levies and taxes 23.8 13.1 20.1 29.2 34.7 na na
Effective income tax rate 10.5 (3.6) 7.9 20.7 26.3 na na
(1) In 2009, we adopted new accounting requirements for intangible assets and reclassified certain computer
equipment from premises and equipment to intangible assets. Computer and equipment expense and the amortization
of intangible assets were restated for 2007 and 2008. As such, five-year and ten-year growth rates for these
expense categories are not meaningful. Together, computer and equipment expense and the amortization of intangible
assets increased at a compound annual growth rate of 0.4% over five years and 2.7% over ten years. Together, total
premises and equipment expense and the amortization of intangible assets increased at a compound annual growth
rate of 1.8% over five years and 2.6% over ten years.
(2) Government levies are included in various non-interest categories.
na - not applicable
nm - not meaningful
99 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Table 9: Average Assets, Liabilities and Interest Rates ($ millions, except as noted)
For the year ended October 31 2009 2008 2007
Average Interest Average Interest Average Interest
Average interest income/ Average interest income/ Average interest income/
balances rate (%) expense balances rate (%) expense balances rate (%) expense
Assets
Canadian Dollar
Deposits
with other
banks 823 1.25 10 2,059 4.02 83 3,469 4.22 146
Securities 66,347 2.49 1,651 55,114 3.58 1,971 42,252 3.44 1,454
Securities borrowed or
purchased under resale
agreements 15,773 0.78 123 20,548 2.94 604 22,566 3.62 818
Loans
Residential
mortgages 41,586 3.65 1,519 45,926 4.99 2,294 54,735 5.14 2,813
Non-
residential
mortgages 3,304 5.28 174 3,200 5.78 185 2,832 5.99 170
Consumer
instalment
and other
personal 32,729 4.12 1,349 27,891 5.74 1,601 21,972 6.80 1,495
Credit cards 2,067 12.69 262 4,162 12.00 499 3,831 11.61 445
Businesses
and
governments 30,358 5.98 1,815 30,702 5.69 1,747 28,953 6.01 1,740
Total loans 110,044 4.65 5,119 111,881 5.65 6,326 112,323 5.93 6,663
Other non-interest bearing
assets 64,989 35,752 45,648
Total
Canadian
dollar 257,976 2.68 6,903 225,354 3.99 8,984 226,258 4.02 9,081
U.S. Dollar and Other Currencies
Deposits with
other banks 16,487 1.07 176 20,985 4.04 847 20,661 4.75 982
Securities 41,627 1.86 776 35,959 3.39 1,220 41,206 4.09 1,686
Securities
borrowed or
purchased under
resale
agreements 24,759 0.49 121 25,019 3.06 767 15,804 6.04 955
Loans
Residential
mortgages 7,430 5.25 390 6,816 5.39 367 6,635 5.17 343
Non-
residential
mortgages 3,772 5.88 222 3,622 6.18 224 3,107 6.47 201
Consumer
instalment
and other
personal 11,657 4.70 548 10,035 5.79 581 9,921 6.43 638
Credit cards 63 11.48 7 36 10.23 4 25 5.94 1
Businesses and
governments 39,291 3.64 1,430 31,844 5.47 1,741 24,266 7.98 1,937
Total loans 62,213 4.18 2,597 52,353 5.57 2,917 43,954 7.10 3,120
Other non-interest
bearing
assets 35,486 37,939 12,692
Total U.S. dollar
and other
currencies 180,572 2.03 3,670 172,255 3.34 5,751 134,317 5.02 6,743
Total All Currencies
Total assets and interest
income 438,548 2.41 10,573 397,609 3.71 14,735 360,575 4.39 15,824
Liabilities
Canadian Dollar
Deposits
Banks 3,525 0.16 6 2,641 1.94 51 2,650 3.43 91
Businesses
and
governments 61,513 2.08 1,278 64,881 3.43 2,227 60,653 3.27 1,984
Individuals 76,676 1.77 1,355 65,586 2.27 1,491 59,375 2.52 1,495
Total
deposits 141,714 1.86 2,639 133,108 2.83 3,769 122,678 2.91 3,570
Subordinated
debt and other
interest bearing
liabilities 39,587 1.98 785 38,276 3.62 1,387 41,285 4.01 1,655
Other non-
interest bearing
liabilities 57,963 38,220 47,233
Total
Canadian
dollar 239,264 1.43 3,424 209,604 2.46 5,156 211,196 2.47 5,225
U.S. Dollar and Other
Currencies
Deposits
Banks 23,589 1.59 374 31,975 3.88 1,242 29,676 4.97 1,475
Businesses and
governments 65,298 1.06 691 64,783 2.91 1,882 54,223 4.23 2,295
Individuals 21,964 1.53 337 18,373 2.44 448 17,799 3.18 565
Total
deposits 110,851 1.26 1,402 115,131 3.10 3,572 101,698 4.26 4,335
Subordinated debt
and other
interest bearing
liabilities 35,918 0.49 177 31,076 3.01 935 23,939 5.99 1,435
Other non-interest
bearing
liabilities 33,453 25,738 8,351
Total U.S. dollar
and other
currencies 180,222 0.88 1,579 171,945 2.62 4,507 133,988 4.31 5,770
Total All Currencies
Total liabilities and
interest
expense 419,486 1.19 5,003 381,549 2.53 9,663 345,184 3.19 10,995
Shareholders'
equity 19,062 16,060 15,391
Total Liabilities, Interest
Expense and Shareholders'
Equity 438,548 1.14 5,003 397,609 2.43 9,663 360,575 3.05 10,995
Net interest margin
- based on
earning assets 1.63 1.55 1.59
- based on
total assets 1.27 1.28 1.34
Net interest income based on
total assets 5,570 5,072 4,829
100 BMO Financial Group 192nd Annual Report 2009
Table 10: Volume/Rate Analysis of Changes in Net Interest Income ($ millions)
For the year ended October 31 2009/2008 2008/2007
Increase (decrease) due to change in Increase (decrease) due to change in
Average Average Average Average
balance rate Total balance rate Total
Assets
Canadian Dollar
Deposits with other banks (48) (23) (71) (59) (4) (63)
Securities 403 (722) (319) 443 75 518
Securities borrowed or
purchased under resale
agreements (139) (341) (480) (73) (140) (213)
Loans
Residential mortgages (215) (558) (773) (452) (67) (519)
Non-residential mortgages 6 (17) (11) 22 (7) 15
Consumer instalment and other
personal 278 (530) (252) 403 (297) 106
Credit cards (252) 14 (238) 38 16 54
Businesses and governments (21) 87 66 104 (98) 6
Total loans (204) (1,004) (1,208) 115 (453) (338)
Other non-interest bearing
assets - - - - - -
Change in Canadian dollar
interest income 12 (2,090) (2,078) 426 (522) (96)
U.S. Dollar and Other
Currencies
Deposits with other banks (183) (490) (673) 14 (149) (135)
Securities 192 (636) (444) (215) (251) (466)
Securities borrowed or
purchased under resale
agreements (7) (638) (645) 557 (746) (189)
Loans
Residential mortgages 33 (10) 23 9 15 24
Non-residential mortgages 9 (11) (2) 34 (11) 23
Consumer instalment and other
personal 93 (127) (34) 7 (64) (57)
Credit cards 3 1 4 1 2 3
Businesses and governments 408 (719) (311) 605 (801) (196)
Total loans 546 (866) (320) 656 (859) (203)
Other non-interest
bearing assets - - - - - -
Change in U.S. dollar and
other currencies interest
income 548 (2,630) (2,082) 1,012 (2,005) (993)
Total All Currencies
Change in total interest
income (a) 560 (4,720) (4,160) 1,438 (2,527) (1,089)
Liabilities
Canadian Dollar
Deposits
Banks 17 (63) (46) (1) (39) (40)
Businesses and governments (116) (833) (949) 139 104 243
Individuals 252 (385) (133) 157 (161) (4)
Total deposits 153 (1,281) (1,128) 295 (96) 199
Subordinated debt and other
interest bearing liabilities 47 (650) (603) (120) (148) (268)
Other non-interest bearing
liabilities - - - - - -
Change in Canadian dollar
interest expense 200 (1,931) (1,731) 175 (244) (69)
U.S. Dollar and Other
Currencies
Deposits
Banks (325) (542) (867) 114 (347) (233)
Businesses and governments 15 (1,206) (1,191) 447 (860) (413)
Individuals 88 (199) (111) 18 (135) (117)
Total deposits (222) (1,947) (2,169) 579 (1,342) (763)
Other interest bearing
liabilities 146 (904) (758) 428 (928) (500)
Other non-interest bearing
liabilities - - - - - -
Change in U.S. dollar and
other currencies interest
expense (76) (2,851) (2,927) 1,007 (2,270) (1,263)
Total All Currencies
Change in total interest
expense (b) 124 (4,782) (4,658) 1,182 (2,514) (1,332)
Change in total net interest
income (a - b) 436 62 498 256 (13) 243
101 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Table 11: Net Loans and Acceptances -
Segmented Information ($ millions, except as noted)
Canada United States
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages(1) 36,916 38,490 43,442 53,922 51,481 6,160 8,086 5,948 6,425 6,274
Cards 2,574 2,117 4,493 3,631 4,648 - 3 - - -
Consumer
instalment and
other personal
loans 35,296 31,633 24,393 20,482 18,683 10,477 12,102 8,795 9,935 9,245
Total consumer 74,786 72,240 72,328 78,035 74,812 16,637 20,191 14,743 16,360 15,519
Commercial and
corporate 46,062 52,148 51,548 42,453 37,097 21,560 31,827 21,531 21,024 17,600
Total loans
and acceptances,
net of specific
allowances 120,848 124,388 123,876 120,488 111,909 38,197 52,018 36,274 37,384 33,119
General allowance (589) (579) (587) (555) (590) (717) (742) (311) (350) (369)
Total net loans
and acceptances 120,259 123,809 123,289 119,933 111,319 37,480 51,276 35,963 37,034 32,750
Other countries Total
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages(1) - - - - - 43,076 46,576 49,390 60,347 57,755
Cards - - - - - 2,574 2,120 4,493 3,631 4,648
Consumer
instalment and
other personal
loans - - - - - 45,773 43,735 33,188 30,417 27,928
Total consumer - - - - - 91,423 92,431 87,071 94,395 90,331
Commercial and
corporate 10,090 11,877 4,843 2,598 1,988 77,712 95,852 77,922 66,075 56,685
Total loans
and acceptances,
net of specific
allowances 10,090 11,877 4,843 2,598 1,988 169,135 188,283 164,993 160,470 147,016
General allowance - - - - - (1,306) (1,321) (898) (905) (959)
Total net loans
and acceptances 10,090 11,877 4,843 2,598 1,988 167,829 186,962 164,095 159,565 146,057
Table 12: Net Impaired Loans and Acceptances -
Segmented Information ($ millions, except as noted)
Canada United States
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages 236 211 112 110 87 - - - - -
Consumer
instalment and
other personal
loans 97 89 54 42 33 194 91 - 5 5
Total consumer 333 300 166 152 120 194 91 - 5 5
Commercial and
corporate 376 374 183 143 166 1,673 1,147 211 202 326
Total impaired
loans and
acceptances, net
of specific
allowances 709 674 349 295 286 1,867 1,238 211 207 331
General allowance (589) (579) (587) (555) (590) (717) (742) (311) (350) (369)
Total net
impaired loans
and acceptances
(NIL) 120 95 (238) (260) (304) 1,150 496 (100) (143) (38)
Condition
Ratios
Gross impaired
loans and
acceptances as
a % of equity
and allowance
for credit losses un un un un un un un un un un
NIL as a % of net
loans and
acceptances(2) 0.10 0.08 (0.19) (0.22) (0.27) 3.07 0.97 (0.28) (0.39) (0.12)
NIL as a % of net
loans and
acceptances(2)
Consumer 0.45 0.42 0.23 0.19 0.16 1.17 0.45 - 0.03 0.03
Commercial and
corporate 0.82 0.72 0.36 0.34 0.45 7.76 3.60 0.98 0.96 1.85
Other countries Total
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages - - - - - 236 211 112 110 87
Consumer
instalment and
other personal
loans - - - - - 291 180 54 47 38
Total consumer - - - - - 527 391 166 157 125
Commercial and
corporate 125 49 3 11 18 2,174 1,570 397 356 510
Total impaired
loans and
acceptances, net
of specific
allowances 125 49 3 11 18 2,701 1,961 563 513 635
General allowance - - - - - (1,306) (1,321) (898) (905) (959)
Total net
impaired loans
and acceptances
(NIL) 125 49 3 11 18 1,395 640 (335) (392) (324)
Condition
Ratios
Gross impaired
loans and
acceptances as
a % of equity
and allowance
for credit losses un un un un un 14.06 11.34 4.07 3.81 4.92
NIL as a % of net
loans and
acceptances(2) 1.24 0.41 0.06 0.42 0.91 0.83 0.34 (0.20) (0.25) (0.22)
NIL as a % of net
loans and
acceptances(2)
Consumer - - - - - 0.58 0.42 0.19 0.17 0.14
Commercial and
corporate 1.24 0.41 0.06 0.42 0.91 2.80 1.64 0.51 0.54 0.90
(1) Excludes residential mortgages classified as commercial or corporate loans (2009 - $2.3 billion,
2008 - $2.7 billion, 2007 - $3.0 billion, 2006 - $2.9 billion, 2005 - $3.1 billion).
(2) Aggregate balances are net of specific and general allowances; the consumer and commercial and
corporate categories are stated net of specific allowances only.
un - unavailable, as equity is not allocated on a country of risk basis
Certain comparative figures in Table 11 have been reclassified to conform with the current year's
presentation.
102 BMO Financial Group 192nd Annual Report 2009
Table 13: Net Loans and Acceptances - Segmented Information ($ millions)
As at October 31 2009 2008 2007 2006 2005
Net Loans and
Acceptances by
Province (3)
Atlantic
provinces 7,227 7,127 5,314 5,256 5,101
Quebec 19,396 21,346 13,110 14,254 14,586
Ontario 50,079 49,996 71,160 68,879 63,181
Prairie
provinces 22,877 24,378 19,002 16,696 14,703
British Columbia
and territories 21,269 21,541 15,290 15,403 14,338
Total net loans
and acceptances
in Canada 120,848 124,388 123,876 120,488 111,909
Net Commercial
and Corporate
Loans by
Industry
Commercial
mortgages (4) 9,284 10,121 8,994 8,505 8,246
Commercial real
estate 7,076 8,300 6,532 5,830 4,242
Construction
(non-real
estate) 1,795 1,857 1,425 1,102 936
Retail trade 4,864 5,269 4,398 3,842 3,494
Wholesale trade 2,854 3,849 3,200 3,025 2,804
Agriculture 3,505 3,769 3,471 3,211 2,842
Communications 1,041 1,404 1,218 1,547 1,179
Manufacturing 7,006 9,290 7,238 7,733 6,977
Mining 1,049 3,256 1,522 510 375
Oil and gas 4,280 6,199 5,474 5,230 2,829
Transportation 1,386 1,788 1,467 1,322 932
Utilities 1,197 1,591 977 985 916
Forest products 696 875 767 692 644
Service
industries 8,879 9,613 8,307 6,904 7,043
Financial
institutions 17,867 23,710 16,393 9,595 6,348
Government 601 865 un un un
Other 4,332 4,096 6,539 6,042 6,878
77,712 95,852 77,922 66,075 56,685
Table 14: Net Impaired Loans and Acceptances - Segmented Information ($ millions)
As at October 31 2009 2008 2007 2006 2005
Net Impaired
Commercial and
Corporate Loans
Commercial
mortgages (4) 510 38 43 31 36
Commercial real
estate 542 460 96 8 22
Construction
(non-real
estate) 9 15 5 7 7
Retail trade 40 41 9 21 39
Wholesale trade 48 51 24 18 24
Agriculture 100 73 18 22 15
Communications - - - 88 116
Manufacturing 252 275 80 98 117
Mining - - - - -
Oil and gas 44 47 - 1 1
Transportation 42 27 15 8 18
Utilities - 1 - - 24
Forest products 63 16 5 4 5
Service
industries 142 93 58 36 54
Financial
institutions 363 244 23 4 11
Government - 3 un un un
Other 19 186 21 10 21
2,174 1,570 397 356 510
Table 15: Changes in Impaired Loans and Allowance for Credit Losses ($ millions)
As at October 31 2009 2008 2007 2006 2005
Gross impaired
loans and
acceptances,
beginning of
year 2,387 720 666 804 1,119
Additions to
impaired loans
and acceptances 2,690 2,506 588 420 423
Reductions in
impaired loans
and acceptances
(5) (288) 131 (143) (220) (319)
Write-offs (1,492) (970) (391) (338) (419)
Gross Impaired
Loans and
Acceptances, End
of Year 3,297 2,387 720 666 804
Allowance for
credit losses,
beginning of
year 1,747 1,055 1,058 1,128 1,308
Increases -
specific
allowances 1,662 1,239 395 322 290
Change in the
general
allowance (15) 423 (7) (54) (51)
Write-offs (1,492) (970) (391) (338) (419)
Allowance for
Credit Losses,
End of Year 1,902 1,747 1,055 1,058 1,128
(3) In 2009, we changed how we accumulate data on net loans and acceptances by province and the
resulting reporting of the provincial distribution, as we now source the data from our
Basel II systems. The 2008 comparative figures have been restated to reflect this change.
The provincial allocations for years prior to 2008 have not been restated and are therefore
not comparable.
(4) In 2009, the industry allocation of impaired loans for U.S. operations was revised to reclassify
impairment on commercial mortgages to the commercial mortgages category. Previously commercial
mortgages for U.S. operations were classified in applicable industry categories.
Periods prior to 2009 have not been restated.
(5) Includes amounts returning to performing status, sales, repayments, the impact of foreign exchange,
and offsets for consumer write-offs that are not recognized as formations.
un - unavailable, as equity is not allocated on a country of risk basis
103 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Table 16: Changes in Allowance for Credit Losses - Segmented Information
($ millions, except as noted)
Canada United States
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Allowance for
credit losses,
beginning of year 708 692 651 687 762 998 362 403 435 514
Provision for
credit losses 517 340 257 181 192 1,065 942 99 (3) 14
Transfer of
allowance - - 5 - - - - 7 - -
Recoveries 58 61 53 47 37 87 53 38 65 30
Write-offs (451) (387) (274) (263) (303) (1,041) (576) (117) (75) (116)
Other, including
foreign exchange
rate changes (2) 2 - (1) (1) (98) 217 (68) (19) (7)
Allowance for
credit losses,
end of year 830 708 692 651 687 1,011 998 362 403 435
Allocation of
Write-offs by
Market
Consumer (383) (303) (246) (229) (219) (302) (125) (43) (38) (27)
Commercial and
corporate (68) (84) (28) (34) (84) (739) (451) (74) (37) (89)
Allocation of
Recoveries by
Market
Consumer 57 56 50 39 33 47 35 22 21 16
Commercial and
corporate 1 5 3 8 4 40 18 16 44 14
Net write-offs
as a % of average
loans and
acceptances un un un un un un un un un un
Other countries Total
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Allowance for
credit losses,
beginning of year 41 1 4 6 32 1,747 1,055 1,058 1,128 1,308
Provision for
credit losses 21 48 (3) (2) (27) 1,603 1,330 353 176 179
Transfer of
allowance - - - - - - - 12 - -
Recoveries - - - - - 145 114 91 112 67
Write-offs - (7) - - - (1,492) (970) (391) (338) (419)
Other, including
foreign exchange
rate changes (1) (1) - - 1 (101) 218 (68) (20) (7)
Allowance for
credit losses,
end of year 61 41 1 4 6 1,902 1,747 1,055 1,058 1,128
Allocation of
Write-offs by
Market
Consumer - - - - - (685) (428) (289) (267) (246)
Commercial and
corporate - (7) - - - (807) (542) (102) (71) (173)
Allocation of
Recoveries by
Market
Consumer - - - - - 104 91 72 60 49
Commercial and
corporate - - - - - 41 23 19 52 18
Net write-offs
as a % of average
loans and
acceptances un un un un un 0.7 0.4 0.1 0.1 0.2
Table 17: Allocation of Allowance for Credit Losses - Segmented Information
($ millions, except as noted)
Canada United States
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages 33 13 14 5 5 - - - - -
Consumer
instalment and
other personal
loans 51 2 1 1 1 - - - - -
Total consumer 84 15 15 6 6 - - - - -
Commercial and
corporate 157 114 90 90 91 294 256 51 53 66
Off-balance sheet - - - - - - - - - -
Total specific
allowances 241 129 105 96 97 294 256 51 53 66
General allowance 589 579 587 555 590 717 742 311 350 369
Allowance for
credit losses 830 708 692 651 687 1,011 998 362 403 435
Coverage Ratios
Allowance for
credit losses
as a % of gross
impaired loans
and acceptances
Total 87.4 88.2 152.4 166.5 179.4 46.8 66.8 138.2 155.0 109.6
Consumer 20.1 4.8 8.3 3.8 4.8 - - - - -
Commercial and
corporate 29.5 23.4 33.0 38.6 35.4 14.9 18.2 19.5 20.8 35.4
Other countries Total
As at October 31 2009 2008 2007 2006 2005 2009 2008 2007 2006 2005
Consumer
Residential
mortgages - - - - - 33 13 14 5 5
Consumer
instalment and
other personal
loans - - - - - 51 2 1 1 1
Total consumer - - - - - 84 15 15 6 6
Commercial and
corporate 61 41 1 4 6 512 411 142 147 163
Off-balance sheet - - - - - - - - - -
Total specific
allowances 61 41 1 4 6 596 426 157 153 169
General allowance - - - - - 1,306 1,321 898 905 959
Allowance for
credit losses 61 41 1 4 6 1,902 1,747 1,055 1,058 1,128
Coverage Ratios
Allowance for
credit losses
as a % of gross
impaired loans
and acceptances
Total 32.8 45.6 25.0 26.7 25.0 57.7 73.2 146.5 158.8 140.2
Consumer - na na na na 13.7 3.7 8.3 3.7 4.6
Commercial and
corporate 32.8 45.5 25.0 26.7 25.0 19.1 20.7 26.3 29.2 24.2
na - not applicable
104 BMO Financial Group 192nd Annual Report 2009
Table 18: Provision for Credit Losses - Segmented Information ($ millions)
For the year ended October 31 2009 2008 2007 2006 2005
Consumer
Residential mortgages 26 5 11 7 3
Cards 174 154 137 132 141
Consumer instalment and other
personal loans 450 178 81 67 53
Total consumer 650 337 229 206 197
Commercial and Corporate
Commercial mortgages (1) 114 1 - - 4
Commercial real estate 277 254 14 (2) 2
Construction (non-real estate) 31 2 1 (2) 9
Retail trade 7 10 7 (5) 15
Wholesale trade 44 3 7 4 13
Agriculture 10 2 5 2 4
Communications 3 - - (6) (34)
Manufacturing 237 132 (9) 20 23
Mining - - - - -
Oil and gas 7 27 - - -
Transportation 32 12 4 7 13
Utilities - - - (19) (26)
Forest products 17 5 - (1) -
Service industries 50 33 2 2 5
Financial institutions 62 251 40 (1) (1)
Government 1 2 un un un
Other 1 (1) 3 6 (5)
Total commercial and corporate 893 733 74 5 22
Total specific provisions 1,543 1,070 303 211 219
General provision for credit losses 60 260 50 (35) (40)
Total provision for credit losses 1,603 1,330 353 176 179
Table 19: Specific Allowances for Credit Losses - Segmented Information
($ millions)
As at October 31 2009 2008 2007 2006 2005
Commercial and Corporate Specific
Allowances by Industry
Commercial mortgages (1) 29 - - - -
Commercial real estate 76 108 25 7 6
Construction (non-real estate) 7 4 4 3 4
Retail trade 8 6 7 9 18
Wholesale trade 28 14 17 21 20
Agriculture 19 9 13 9 13
Communications - - - 1 2
Manufacturing 129 108 35 57 53
Mining - - - - -
Oil and gas 6 25 - - 1
Transportation 21 8 5 11 3
Utilities - - - - -
Forest products 22 6 2 2 2
Service industries 43 23 17 19 26
Financial institutions 113 70 10 1 7
Government 2 2 un un un
Other 9 28 7 7 8
Total specific allowances for credit
losses on commercial and corporate loans 512 411 142 147 163
(1) In 2009, the industry allocation of impaired loans for U.S. operations was revised to reclassify impairment on
commercial mortgages to the commercial mortgages category.
Previously commercial mortgages for U.S. operations were classified in applicable industry categories. Periods
prior to 2009 have not been restated.
un - unavailable
105 BMO Financial Group 192nd Annual Report 2009
SUPPLEMENTAL INFORMATION
Table 20: Contractual Obligations ($ millions)
Less than 1 to 3 3 to 5 Over 5 No fixed
As at October 31, 2009 one year years years years maturity Total
On-Balance Sheet
Financial Instruments
Deposits 90,842 31,375 7,111 5,097 99,259 233,684
Subordinated debt (1) 216 678 929 4,640 - 6,463
Capital trust
securities 428 853 - - - 1,281
Other financial
liabilities (1) 53,414 24 42 2,742 3,527 59,749
(1) Includes
interest
payments.
Less than 1 to 3 3 to 5 Over 5 No fixed
As at October 31, 2009 one year years years years maturity Total
Off-Balance Sheet
Financial Instruments
Commitments to extend
credit (2) 28,438 22,441 6,969 2,216 - 60,064
Operating leases 238 390 273 641 - 1,542
Financial guarantee
contracts (2) 51,857 - - - - 51,857
Purchase obligations 286 576 317 119 - 1,298
(2) A large majority of our commitments to extend credit and financial guarantee contracts expire without being drawn
upon. As a result, the contractual amounts may not be representative of the funding likely to be required for
these commitments. Further details on these obligations are included in Notes 6 and 7 on page 124 of the
financial statements.
Table 21: Capital Adequacy ($ millions, except as noted)
Basel II basis Basel I basis(1)
As at October 31 2009 2008 2007 2006 2005
Tier 1 capital
Common shareholders'
equity 17,132 15,974 14,233 14,465 13,246
Non-cumulative
preferred shares (2)
(3) 2,571 1,996 1,446 1,046 1,046
Innovative Tier 1
capital instruments
(2) 2,907 2,486 2,422 2,192 2,192
Non-controlling
interest in
subsidiaries 26 39 33 36 37
Goodwill and excess
intangible assets (4) (1,569) (1,635) (1,140) (1,098) (1,091)
Accumulated net
after-tax unrealized
losses from
available-for-sale
equity securities (2) (15) - - -
Net Tier 1 capital 21,065 18,845 16,994 16,641 15,430
Securitization-related
deductions (168) (115) na na na
Expected loss in
excess of allowance
(AIRB Approach) (5) (61) - na na na
Substantial
investments and
investments in
insurance subsidiaries
(7) (374) na na na na
Other deductions - (1) na na na
Adjusted Tier 1
capital 20,462 18,729 16,994 16,641 15,430
Tier 2 capital
Preferred shares of a
subsidiary (3) - - - 273 287
Subordinated debt 4,236 4,175 3,335 2,306 2,130
Trust subordinated
notes 800 800 800 - -
Accumulated net
after-tax unrealized
gain from
available-for-sale
equity securities - - 26 - -
Eligible portion of
general allowance for
credit losses (5) (6) 296 494 898 905 958
Total Tier 2 capital 5,332 5,469 5,059 3,484 3,375
First-loss protection na na (85) (44) (123)
Securitization-related
deductions (7) (6) na na na
Expected loss in
excess of allowance
(AIRB Approach) (5) (60) - na na na
Investments in
non-consolidated
subsidiaries and
substantial
investments (7) (868) (871) (994) (937) (963)
Other deductions - - na na na
Adjusted Tier 2
capital 4,397 4,592 3,980 2,503 2,289
Total capital 24,859 23,321 20,974 19,144 17,719
Risk-weighted assets 167,201 191,608 178,687 162,794 149,855
Capital ratios (%)
Tier 1 Capital Ratio 12.24 9.77 9.51 10.22 10.30
Total Capital Ratio 14.87 12.17 11.74 11.76 11.82
Assets-to-capital
multiple 14.1 16.4 17.2 16.1 16.3
(1) Beginning in fiscal 2008, capital is calculated under the Basel II guidelines, whereas for all prior periods
capital is calculated using the Basel I methodology.
(2) Non-cumulative preferred shares and Innovative Tier 1 capital instruments include amounts that were reclassified
to liabilities on the consolidated balance sheet, but are eligible for inclusion in the capital calculation for
regulatory purposes.
(3) In 2007, OSFI approved the reclassification of preferred shares issued by a subsidiary from Tier 2 capital to
Innovative Tier 1 capital.
(4) In addition to goodwill, intangible assets in excess of 5% of gross Tier 1 capital are deducted from Tier 1
capital.
(5) When expected loss as calculated under the Advanced Internal Ratings Based (AIRB) Approach exceeds total
provisions, 50% of the difference is deducted from Tier 1 capital and 50% from Tier 2. When the expected loss is
less than total provisions, the difference is added to Tier 2 capital. The general allowance related to
credit risk measured under the Standardized Approach is included in Tier 2 capital, up to 1.25% of risk-weighted
assets.
(6) Under Basel I, OSFI permits the inclusion of the lesser of the balance of our general allowance for
credit losses and 0.875% of risk-weighted assets.
(7) Effective November 1, 2008, substantial investments are deducted 50% from Tier 1 capital and 50% from Tier
2 capital. Previously these investments were deducted from Tier 2 capital. Investments in insurance
subsidiaries held prior to January 1, 2007 are deducted from Tier 2 capital. Effective 2012, these
investments in insurance subsidiaries will be deducted 50% from Tier 1 capital and 50% from Tier 2 capital. In
addition, incremental investments in insurance subsidiaries are immediately deducted 50% from Tier 1
capital and 50% from Tier 2 capital.
na - not applicable
106 BMO Financial Group 192nd Annual Report 2009
Table 22: Risk-Weighted Assets (RWA) ($ millions)
As at October 31 RWA RWA
Exposure Standardized Advanced 2009 Exposure at Standardized Advanced 2008
at Default Approach Approach Total Default Approach Approach Total
Credit Risk
Wholesale
Corporate,
including
specialized
lending 108,368 10,776 41,398 52,174 130,758 15,957 47,306 63,263
Corporate small
and medium-sized
enterprises 44,229 8,194 18,201 26,395 46,521 9,837 21,015 30,852
Sovereign 53,978 - 593 593 35,351 - 382 382
Bank 32,597 283 4,254 4,537 63,406 442 6,465 6,907
Retail
Residential
mortgages,
excluding home
equity line of
credit 44,176 3,158 1,293 4,451 47,821 3,908 1,058 4,966
Home equity line
of credit 27,342 3,348 1,115 4,463 25,922 3,338 966 4,304
Qualifying
revolving
retail 25,167 - 3,210 3,210 24,225 - 2,263 2,263
Other retail,
excluding small
and medium-sized
enter-
prises 19,489 4,232 5,663 9,895 18,861 5,007 4,210 9,217
Retail small and
medium-sized
enterprises 908 - 492 492 2,586 - 920 920
Equity 1,380 - 1,168 1,168 1,518 - 1,282 1,282
Trading
book 52,023 25 7,945 7,970 66,304 - 11,759 11,759
Securit-
ization 47,541 - 11,207 11,207 50,015 - 6,717 6,717
Other credit
risk assets -
non-counterparty
managed
assets 62,996 - 10,751 10,751 84,177 - 14,524 14,524
Scaling factor
for credit risk
assets under
AIRB (1) - - 5,792 5,792 - - 6,260 6,260
Total Credit
Risk 520,194 30,016 113,082 143,098 597,465 38,489 125,127 163,616
Market Risk 1,471 5,107 6,578 3,497 7,796 11,293
Operational Risk 17,525 - 17,525 16,699 - 16,699
Total Basel II
Risk-Weighted
Assets 49,012 118,189 167,201 58,685 132,923 191,608
(1) The scaling factor is applied to the RWA amounts for credit risk under the AIRB Approach.
Table 23: Average Deposits ($ millions, except as noted)
2009 2008 2007
Average Average Average Average Average Average
balance rate paid (%) balance rate paid (%) balance rate paid (%)
Deposits
Booked in
Canada
Demand
deposits -
interest
bearing 13,640 0.34 11,544 1.83 9,400 2.94
Demand
deposits -
non-interest
bearing 16,383 - 14,175 - 13,076 -
Payable
after notice 42,480 0.48 38,112 1.83 36,255 2.32
Payable on a
fixed date 89,155 2.92 90,822 3.53 80,220 3.66
Total
deposits
booked in
Canada 161,658 1.76 154,653 2.66 138,951 2.92
Deposits
Booked in
the United
States and
Other
Countries
Banks
located in
the United
States and
other
countries 9,327 0.72 15,652 3.51 17,401 4.82
Governments
and
institutions
in the
United
States and
other
countries 9,607 1.08 11,354 3.71 10,107 5.37
Other demand
deposits 7,847 0.02 4,000 0.68 2,523 0.24
Other
deposits
payable
after notice
or on a
fixed date 64,126 1.59 62,580 3.57 55,394 4.44
Total
deposits
booked in
the United
States and
other
countries 90,907 1.31 93,586 3.45 85,425 4.51
Total
average
deposits 252,565 1.60 248,239 2.96 224,376 3.52
As at October 31, 2009, 2008 and 2007: deposits by foreign depositors in our
Canadian bank offices amounted to $14,392 million, $14,781 million and $11,544
million, respectively; total deposits payable after notice included $23,477
million, $22,203 million and $21,477 million, respectively, of chequing
accounts that would have been classified as demand deposits under U.S.
reporting requirements; and total deposits payable on a fixed date included
$16,994 million, $28,074 million and $29,318 million, respectively, of federal
funds purchased, commercial paper issued and other deposit liabilities. These
amounts would have been classified as short-term borrowings for U.S. reporting
purposes.
Certain comparative figures have been reclassified to conform with the current
period's presentation.
Table 24: Unrealized Gains (Losses) on Securities, Other Than Trading
($ millions)
Unrealized gains (losses)(1)
As at October 31 Amortized cost Fair value 2009 2008 2007 2006 2005
Canadian
governments debt 18,940 19,086 146 30 - - -
U.S. governments
debt 7,129 7,199 70 32 8 (29) (23)
Mortgage-backed
securities -
Canada 9,331 9,578 247 87 20 - -
- United States 789 817 28 3 (6) (10) (7)
Corporate debt 4,705 4,828 123 (255) (3) 3 6
Corporate equity 2,011 2,005 (6) (19) 26 90 20
Other
governments debt 8,182 8,229 47 1 - 1 1
Total
securities,
other than
trading 51,087 51,742 655 (121) 45 55 (3)
(1) Unrealized gains (losses) may be offset by related losses (gains) on liabilities or hedge contracts.
107 BMO Financial Group 192nd Annual Report 2009
GLOSSARY
Glossary of Financial Terms
Allowance for Credit Losses Earnings Per Share (EPS) is Mark-to-Market represents Provision for Credit
represents an amount deemed calculated by dividing net the valuation of securities Losses is a charge to
adequate by management to income, after deduction of and derivatives at market income that represents an
absorb credit-related preferred dividends, by the rates as of the balance amount deemed adequate by
losses on loans and average number of common sheet date, where required management to fully
acceptances and other shares outstanding. Diluted by accounting rules. provide for impairment in
credit instruments. EPS, which is our basis for loans and acceptances and
Allowances for credit measuring performance, Net Economic Profit (NEP) other credit instruments,
losses can be specific or adjusts for possible represents cash net income given the composition of
general and are recorded on conversions of financial available to common the portfolios, the
the balance sheet as a instruments into common shareholders, less a charge probability of default,
deduction from loans and shares if those conversions for capital. NEP is an the economic environment
acceptances or, as they would reduce EPS. effective measure of and the allowance for
relate to credit See pages 36 and 153. economic value added. NEP credit losses already
instruments, as other is a non-GAAP measure. established.
liabilities. Forwards and Futures are See pages 37 and 91. See pages 43, 82 and 119.
See pages 40, 82 and 119. contractual agreements to
either buy or sell a Net Interest Income is Return on Equity or Return
Assets under Administration specified amount of a comprised of earnings on on Common Shareholders'
and under Management refers currency, commodity, assets, such as loans and Equity (ROE) is calculated
to assets administered or interest-rate-sensitive securities, including as net income, less
managed by a financial financial instrument or interest and dividend preferred dividends, as a
institution that are security at a specific price income and BMO's share of percentage of average
beneficially owned by and date in the future. income from investments common shareholders'
clients and therefore not accounted for using the equity. Common
reported on the balance Forwards are customized equity method of shareholders' equity is
sheet of the administering contracts transacted in the accounting, less interest comprised of common share
or managing financial over-the-counter market. expense paid on capital, contributed
institution. Futures are transacted in liabilities, such as surplus, accumulated other
standardized amounts on deposits. comprehensive income
Asset-Backed Commercial regulated exchanges and are See page 40. (loss) and retained
Paper is a short-term subject to daily cash earnings.
investment with a maturity margining. Net Interest Margin is the See page 37.
that is typically less than See page 129 ratio of net interest
180 days. The commercial income to earning assets, Securities Borrowed or
paper is backed by physical General Allowance is expressed as a percentage Purchased under Resale
assets such as trade maintained to cover or in basis points. Net Agreements are low-cost,
receivables, and is impairment in the existing interest margin is low-risk instruments,
generally used for credit portfolio that cannot sometimes computed using often supported by the
short-term financing needs. yet be associated with total assets. pledge of cash collateral,
specific credit assets. Our See page 40. which arise from
Assets-to-Capital Multiple approach to establishing and transactions that involve
is defined as assets plus maintaining the general Notional Amount refers to the borrowing or
guarantees and letters of allowance is based on the the principal used to purchasing of securities.
credit, net of specified guideline issued by our calculate interest and
deductions (or adjusted regulator, OSFI. The general other payments under Securities Lent or Sold
assets), divided by total allowance is reviewed on a derivative contracts. The under Repurchase
capital. quarterly basis and a number principal amount does not Agreements are low-cost,
of factors are considered change hands under the low-risk liabilities,
Average Earning Assets when determining its terms of a derivative often supported by cash
represents the daily or appropriate level. We employ contract, except in the collateral, which arise
monthly average balance of a general allowance model case of cross-currency from transactions that
deposits with other banks that applies historical swaps. involve the lending or
and loans and securities, expected and unexpected loss selling of securities.
over a one-year period. rates, based on Operating Leverage is the
probabilities of default and difference between revenue Specific Allowances reduce
Bankers' Acceptances (BAs) loss given default factors, and expense growth rates. the carrying value of
are bills of exchange or to current balances. Cash operating leverage is specific credit assets to
negotiable instruments See pages 43, 82 and 119. the difference between the amount we expect to
drawn by a borrower for revenue and cash-based recover if there is
payment at maturity and Hedging is a risk management expense growth rates. evidence of deterioration
accepted by a bank. BAs technique used to neutralize See page 30. in credit quality.
constitute a guarantee of or manage interest rate, See pages 43, 82 and 119.
payment by the bank and can foreign currency, equity, Options are contractual
be traded in the money commodity or credit agreements that convey to Swaps are contractual
market. The bank earns a exposures arising from the buyer the right but not agreements between two
"stamping fee" for normal banking activities. the obligation to either parties to exchange a
providing this guarantee. buy or sell a specified series of cash flows. The
Impaired Loans are loans for amount of a currency, various swap agreements
Basis Point: One which there is no longer commodity, that we enter into are as
one-hundredth of a reasonable assurance of the interest-rate-sensitive follows:
percentage point. timely collection of financial instrument or
principal or interest. security at a fixed future
Derivatives are contracts date or at any time within
whose value is "derived" Innovative Tier 1 Capital: a fixed future period. - Commodity swaps -
from movements in interest OSFI allows banks to issue See page 129. counterparties generally
or foreign exchange rates, instruments that qualify as exchange fixed and
or equity or commodity "Innovative" Tier 1 capital. Productivity Ratio (or floating rate payments
prices. Derivatives allow In order to qualify, these Expense-to-Revenue Ratio) based on a notional value
for the transfer, instruments have to be is our key measure of of a single commodity.
modification or reduction issued indirectly through a productivity. It is
of current or expected special purpose vehicle, be calculated as non-interest
risks from changes in rates permanent in nature and expense divided by total
and prices. receive acceptable revenues, expressed as a - Credit default swaps -
accounting treatment. percentage. The cash one counter-party pays the
Innovative Tier 1 capital productivity ratio is other a fee in exchange
cannot comprise more than calculated in the same for that other
20% of net Tier 1 capital, manner, after removing the counterparty agreeing to
at time of issue, with 15% amortization of make a payment if a credit
qualifying as Tier 1 capital acquisition-related event occurs, such as
and the remaining 5% intangible assets from bankruptcy or failure to
included in total capital. non-interest expenses. pay.
See pages 44 and 91.
- Cross-currency interest
rate swaps - fixed and
floating rate interest
payments and principal
amounts are exchanged in
different currencies.
166 BMO Financial Group 192nd Annual Report 2009
Total Capital includes Tier
- Cross-currency swaps - 1 and Tier 2 capital, net Risk-Related Definitions
fixed rate interest payments of certain deductions. Tier
and principal amounts are 2 capital is primarily
exchanged in different comprised of subordinated
currencies. debentures and the eligible Liquidity and Funding Risk
portion of the general Business Risk arises from is the potential for loss
allowance for credit the specific business if BMO is unable to meet
losses. Deductions from activities of a company and financial commitments in a
Tier 2 capital are the effects these could timely manner at
primarily comprised of our have on the earnings of the reasonable prices as they
- Equity swaps - investments in company. Business risk due fall due. Financial
counterparties exchange the non-consolidated to earnings volatility commitments includereturn on an equity security subsidiaries and other measures the risk that liabilities to depositors
or a group of equity substantial investments. volumes will decrease or and suppliers, and
securities for the return margins will shrink with no lending, investment and
based on a fixed or floating Total Capital Ratio is opportunity being available pledging commitments.
interest rate or the return defined as total capital to offset the revenue See pages 86 and 123.
on another equity security divided by risk-weighted declines with a reduction
or group of equity assets. in costs. Market Risk is the
securities. See pages 63 and 146. See page 89. potential for a negative
impact on the balance
Total Shareholder Return Credit and Counterparty sheet and/or income
(TSR): The five-year Risk is the potential for statement resulting from
average annual total loss due to the failure of adverse changes in the
shareholder return (TSR) a borrower, endorser, value of financial
- Interest rate swaps - represents the average guarantor or counterparty instruments as a result of
counter-parties generally annual total return earned to repay a loan or honour changes in certain market
exchange fixed and floating on an investment in BMO another predetermined variables. These variables
rate interest payments based common shares made at the financial obligation. include interest rates,
on a notional value in a beginning of a five-year See page 80. foreign exchange rates,
single currency. period. The return includes equity and commodity
See page 129. the change in share price Earnings Volatility (EV) is prices and their implied
and assumes that dividends a measure of the adverse volatilities, as well as
received were reinvested in impact of potential changes credit spreads, credit
additional common shares. in market parameters on the migration and default.
The one-year TSR also projected 12-month See pages 82 and 123.
Tangible Common Equity assumes that dividends were after-tax net income of a
reflects common equity net reinvested in shares. portfolio of assets, Market Value Exposure
of certain deductions. There See page 35. liabilities and off-balance (MVE) is a measure of the
is no standard industry sheet positions, measured adverse impact of changes
definition of this measure. Trading-Related Revenues at a 99% confidence level in market parameters on
See page 63. include net interest income over a specified holding the market value of a
and non-interest revenue period. portfolio of assets,
Tangible Common Equity to earned from on and See page 83. liabilities and
Risk-Weighted Assets Ratio off-balance sheet positions off-balance sheet posi-
represents tangible common undertaken for trading Economic Capital is our tions, measured at a 99%
equity divided by purposes. The management of internal assessment of the confidence level over a
risk-weighted assets. these positions typically risks underlying BMO's specified holding period.
See page 63. includes marking them to business activities. It The holding period
market on a daily basis. represents management's considers current market
Taxable Equivalent Basis Trading revenues include estimation of the likely conditions and the
(teb): Revenues of operating income (expense) and gains magnitude of economic composition of the
groups reflected in our MD&A (losses) from both cash losses that could occur if portfolios to determine
are presented on a taxable instruments and interest adverse situations arise, how long it would take to
equivalent basis (teb). The rate, foreign exchange and allows returns to be neutralize the market risk
teb adjustment increases (including spot positions), adjusted for risks. without adversely
GAAP revenues and the equity, commodity and Economic capital is affecting market prices.
provision for income taxes credit contracts. calculated for various For trading and
by an amount that would See page 42. types of risk -- credit, underwriting activities,
increase revenues on certain market (trading and MVE is comprised of Value
tax-exempt securities to a Variable Interest Entities non-trading), operational at Risk and Issuer Risk.
level that would incur tax (VIEs) include entities and business -- where See page 83.
at the statutory rate, to with equity that is measures are based on a
facilitate comparisons. considered insufficient to time horizon of one year. Operational Risk is the
See page 40. finance the entity's (For further discussion of potential for loss
activities or in which the these risks, refer to the resulting from inadequate
Tier 1 Capital represents equityholders do not have a Enterprise-Wide Risk or failed internal
more permanent forms of controlling financial Management section on page processes or systems,
capital, and primarily interest. We are required 75.) Economic capital is a human interactions or
consists of common to consolidate VIEs if the key element of our external events, but
shareholders' equity, investments we hold in risk-based capital excludes business risk.
preferred shares and these entities and/or the management process. See page 87.
innovative hybrid relationships we have with See pages 37 and 91.
instruments, less a them result in us being Reputation Risk is the
deduction for goodwill and exposed to the majority of Environmental Risk is the risk of negative impacts
excess intangible assets and their expected losses, risk of loss or damage to resulting from the
certain other deductions being able to benefit from BMO's reputation resulting deterioration of BMO's
required under Basel II. a majority of their from environmental concerns reputation with key
expected residual returns, related to BMO or its stakeholders. These
Tier 1 Capital Ratio is or both, based on a customers. Environmental impacts include revenue
defined as Tier 1 capital calculation determined by risk is often associated loss, reductions in our
divided by risk-weighted standard setters. with credit and operational customer or client base
assets. See page 71. risk. and declines in BMO's
See pages 63 and 146. See page 90. share price.
See page 90.
Issuer Risk arises in BMO's
trading and underwriting Value at Risk (VaR) is
portfolios, and measures measured for specific
the adverse impact of classes of risk in BMO's
credit spread, credit trading and underwriting
migration and default risks activities: interest rate,
on the market value of foreign exchange rate,
fixed income instruments equity and commodity
and similar securities. prices and their implied
Issuer risk is measured at volatilities. This measure
a 99% confidence level over calculates the maximum
a specified holding period likely loss from
See page 83. portfolios, measured at a
99% confidence level over
a specified holding
period.
See page 83.
BMO Financial Group 192nd Annual Report 2009 167
Management's Discussion and Analysis, including graphics, can be viewed in pdf format by clicking
on the attached link or copying the link into your browser.
http://www2.bmo.com/ar2009/downloads/bmo_ar09_mda.pdf
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Company: Bank of Montreal (BMO)
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