BMO Financial Group
198th Annual Report 2015
There are many ways to talk about what lies ahead: Change. Disruption. Opportunity. Growth.
We’ve gotten closer to our customers. Made banking simpler. Unified our businesses. Expanded our footprint. Invested in new platforms. Embraced a better rulebook. And through it all, delivered consistently strong results.
Business Review
Financial Review
2
4
10
11
16
17
18
20
21
23
24
26
118
132
Financial Snapshot/Who We Are
Year in Review
Chairman’s Message
CEO’s Message
Executive Committee
Our Strategic Footprint
Reasons to Invest in BMO
Corporate Governance
Board of Directors
CFO’s Foreword to the Financial Review
Financial Performance and Condition at a Glance
Management’s Discussion and Analysis
Supplemental Information
Statement of Management’s Responsibility for
Financial Information
133 Independent Auditors’ Report of Registered
Public Accounting Firm
134 Report of Independent Registered Public
Accounting Firm
135 Consolidated Financial Statements
140 Notes to Consolidated Financial
Statements
Resources and Directories
202 Glossary of Financial Terms
204 Where to Find More Information
IBC Shareholder Information
now it gets interesting Financial Snapshot
Reported 1
Adjusted 1,2
As at or for the year ended October 31
2015
2014
2015
2014
19,389
18,223
19,391
18,223
liabilities3 (CCPB) (p 41)
1
1,254
1,505
1,254
1,505
Revenue, net of CCPB (p 38)
18,135
8
16,718
18,137
16,718
612
561
612
561
12,182
10,921
11,819
10,761
4,405
4,333
4,681
4,453
6.57
6.41
7.00
6.59
12.5%
14.0%
13.3%
14.4%
(3.0)%
(2.7)%
(1.3)%
(1.6)%
10.7%
10.1%
10.7%
0 %
10.1%
2,104
2,016
2,108
2,020
U.S. P&C (p 51)
827
654
880
706
Wealth Management (p 55)
850
780
955
955
843
BMO Capital Markets (p 58)
1,032
1,077
1,034
1,078
Corporate Services4 (p 62)
(408)
(194)
(296)
(194)
Net income (p 34)
4,405
4,333
4 681
4,681
4,453
659
597
701
0
644
(Canadian $ in millions, except as noted)
Revenue3 (p 38)
Insurance claims, commissions and changes in policy benefit
Provision for credit losses (p 42)
Non-interest expense (p 43)
Net income (p 34)
Earnings per share – diluted ($) (p 34)
Return on equity (p 35)
Operating leverage, net of CCPB (p 43)
Basel III Common Equity
Tier 1 Ratio (p 35)
Net Income by Segment
Canadian P&C (p 48)
U.S. P&C (US$ in millions) (p 51)
1
Effective November 1, 2014, BMO adopted several new and amended accounting pronouncements issued by the International Accounting Standards Board, which are outlined in Note 1 on page 140 of the financial statements. The adoption of these new and amended accounting standards only impacted our results prospectively. Certain other prior year data has been reclassified to conform with the current year’s presentation. See pages 45 and 46.
2
Adjusted results are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
Management assesses performance on a reported basis and on an adjusted basis and considers both to be useful in assessing the underlying ongoing business performance. Presenting results on both bases provides readers with a better understanding of how management assesses results.
3
Effective the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
4
Corporate Services, including Technology & Operations.
Bank of Montreal brands the organization’s member companies as BMO Financial Group. Note 28 on page 196 of the financial statements lists the intercorporate relationships among Bank of
Montreal and its significant subsidiaries.
2 BMO Financial Group 198th Annual Report 2015
Who We Are
Established in 1817, BMO Financial Group is a highly diversified financial services provider based in North
America. With total assets of $642 billion and close to 47,000 employees, BMO provides a broad range of personal and commercial banking, wealth management and investment banking products and services to more than 12 million customers and conducts business through three operating groups:
Personal and Commercial Banking, Wealth
Management and BMO Capital Markets.
Mark Gilbert,
Commercial Account Manager,
Mid Market.
BMO Financial Group 198th Annual Report 2015 3
Russell Pereira,
Management Governance Analyst,
Barrie Computer Centre.
How our in-the-moment IT architecture delivers value right now:
Integrate everything A sophisticated connector grid brings together more than
1,400 applications across the bank.
+
Build once Over 1,000 reusable software-based services can be employed to create applications quickly and easily.
4 BMO Financial Group 198th Annual Report 2015
+
Understand more Bank-wide data aggregation and distributed platforms enable detailed analytics of everything from risk to sales and marketing.
=
A more personal bank for a digital world Sensing and responding to customers’ needs.
Intuitive, consistent experience across all channels.
Boosted productivity and fast speed to market.
We’re not waiting for things to change. For five years we’ve been investing in transformative technology that is literally reshaping our bank.
We’ve dramatically extended BMO’s technology capabilities to meet a clear set of goals:
More personalized, intuitive applications built to respond in the moment. A more unified experience across all channels, products, services and geographies. More customerspecific solutions – delivered to market at greater speed and at a lower cost. Enhanced risk management. And the digitization of business processes to further boost productivity.
The result? We’re reaching a new level of operating efficiency as we expand and rethink how to give customers a deeper sense of control over their finances.
“The technology architecture we’ve built has moved us right where we want to be competitively as we continue to reimagine the customer experience.”
Jean-Michel Arès
For the third consecutive year, BMO was recognized by global financial services research firm Celent with a 2015 Model Bank Award for excellence in the digital banking category.
BMO’s Chief Technology & Operations Officer
BMO Financial Group 198th Annual Report 2015 5
We’re using new tools, insights and ways of connecting to make banking more personal and intuitive.
Our customers experience a bank that’s built for them.
Smart branches where digital and human interactions blend seamlessly. ABMs with video tellers offering immediate expert help. Ideas tailored to customers’ needs using data-driven insights. Fast, secure mobile payments, and cash withdrawals using only a smartphone.
A tablet app that integrates personal banking with investing and financial management.
A callback feature that actually calls you back. And access to all of our products and services through single points of contact. This is what we’re here to help means in the digital age. We make banking easier. Smarter. And flexible enough to fit comfortably into our customers’ busy, connected lives.
Best of 2015
Best Commercial
Bank in Canada
Best Wealth Management
Bank Canada
Best Domestic
Private Bank, U.S.
– World Finance Magazine
– International Finance Magazine
– Global Financial Market Review
Live Agent & Automated
Telephone Banking (Big
Five Banks) award winner
– Ipsos Best Banking Awards
6 BMO Financial Group 198th Annual Report 2015
Honey Rejzek,
Director, Business Finance,
Commercial Banking.
Best Full-Service
Investment Advisory in Canada
– Global Banking &
Finance Review
Best Supply Chain Finance
Bank in North America
World’s Best Metals &
Mining Investment Bank
Best Wealth Management in Canada
– Trade Finance magazine
– Global Finance magazine
– Global Banking &
Finance Review
BMO Financial Group 198th Annual Report 2015 7
Our customers create their own futures, knowing the help we provide is anchored by integrity, accountability and shared values.
You can’t buy trust, or invent it.
Trust is earned.
Consistently in the top rankings for sound corporate governance. Solid capital strength, with the longest-running dividend payout record of any company in
Canada. A champion of financial literacy. A pioneer in Aboriginal banking.
Contributing $56.9 million in corporate donations across North America in 2015, and funding US$947.3 million in U.S. community development loans. This is who we are: diverse, inclusive, socially engaged and accountable to each new generation of stakeholders – who expect us to fulfill our responsibilities as a vital intermediary while constantly refining our disciplined approach to risk.
The AML Opportunity
BMO’s anti-money laundering (AML) group is working to turn responsibility into opportunity. Our AML team used to spend 80% of their time analyzing vast amounts of data and only 20% gaining insights into customers’ choices. Now we are working to change that ratio. Using tools developed by our Technology & Operations group, we’re learning more about how, when and where people bank with us, helping us deliver an experience that delights in every way.
8 BMO Financial Group 198th Annual Report 2015
Insights
Data
Sister Edna Lonergan,
President and founder of
Milwaukee’s St. Ann Center for Intergenerational Care, speaking with Chuck Roedel,
VP, Business Banking, BMO
Harris Bank.
Generosity
More than 90% of BMO employees participated in the bank’s 2015 Employee
Giving Campaign. Over 42,000 of us personally donated over $18 million to
United Ways and other charities.
Best 50
How we help BMO has been named one of the Best 50 Corporate
Citizens in Canada for
13 consecutive years by
Corporate Knights.
BMO Financial Group 198th Annual Report 2015 9
Chairman’s message
Strong, Strategic Growth
J. Robert S. Prichard
Chairman of the Board
Being able to produce good results under favourable conditions is always welcome – but it is also expected.
However, producing strong results in times of uncertainty is evidence both of a successful business strategy and a highly effective management team.
As your representatives on the Board of Directors, we are pleased to report that your bank had another year of good results, despite challenges in the global economy and here at home. We congratulate the bank’s employees and the management team for raising the bar yet again. All of us as shareholders have benefitted from the team’s efforts under the excellent leadership of our Chief Executive.
The core businesses of the bank continued to show strong growth in 2015. The investments we have made in recent years are producing solid results, and we expect these will continue to grow. Of particular note are the investments we are making in the bank’s technology platform to better respond to customers’ needs as they choose to manage their finances in new and different ways.
Such changes bring new and different risks as well. Your board has worked closely with the management team, as well as our regulators and supervisors, to ensure we remain on the leading edge of these developments. We have made significant investments in risk management and compliance that make us stronger and more resilient. I am also pleased that the bank’s capital base remains strong, giving us the flexibility to make acquisitions such as the purchase of GE Capital
Corporation’s transportation finance business in the U.S. and
Canada, a transaction that closed on December 1.
All of these building blocks rest on a deeper foundation: the trust that your bank has earned from its customers and other stakeholders. Our confidence – as we introduce high-quality
10 BMO Financial Group 198th Annual Report 2015
digital strategies in pursuit of a differentiated customer experience, efficiency and quality earnings growth – is supported by the consistent track record of a bank that has always acted with responsibility, transparency and integrity.
Since last year’s Annual Report, we have had two excellent additions to the BMO board. Lorraine Mitchelmore and Dr. Martin
Eichenbaum, both elected at the last annual meeting, have brought valuable experience and fresh insights to our deliberations.
In the meantime, however, Dr. Martha Piper, former president of the University of British Columbia, stepped down from the board as she returned to UBC to serve as interim president.
Martha was a superb director for a decade and we will miss her enduring contributions to the effectiveness of this board. Martha was an outstanding chair of the Governance and Nominating
Committee but she was much more than that. She was an inspiration to management and directors alike as she brought her passion for Canada and the bank to our work and set high expectations for all of us to meet. On behalf of all shareholders, we thank her for being such a splendid colleague and contributor.
The coming year will be an important one for all of us. We continue to have great confidence in the long-term success of the bank: the strategy is sound and management is focused. We look forward to working closely with Bill Downe and the bank’s senior leaders, supporting their efforts as they capitalize on new opportunities and ensure the bank is positioned for the future.
As your representatives, we thank all of our shareholders for your continuing confidence in BMO and the management team.
It is a privilege to serve you.
J. Robert S. Prichard
Chief Executive Officer’s message
Here and Now
William A. Downe
Chief Executive Officer
We’re using technology to create new business models – and to unlock new sources of value for our customers and shareholders. Because in our experience, a changing landscape conveys advantage to those who are willing to disrupt, accept some degree of trial and error, and try again.
The strategy of BMO Financial Group is summed up in a set of clear, concise statements that frame our decision-making and guide how we execute our business activities. These strategic priorities take a long-term perspective, providing a touchstone we can return to regularly as we gauge our progress and define new areas of focus. While remaining consistent at the core, they have evolved to reflect the changing business environment and our response to it.
Our priorities have been refined to highlight the investments we’ve been making in the underlying architecture of the bank’s technology platform (as detailed on pages 4-5), and to recognize technology’s potential to transform the business of banking. Of course, technology has played an important role in our thinking for decades; this year we’re bringing it to the forefront as a fundamental element of our strategy.
As we publish this 2015 Annual Report, with the 2016 fiscal year already well underway, these are BMO’s strategic priorities: The tremendous opportunities we see to enhance proven business models – and replace inefficient ones – are evident throughout this introductory section of the annual report, which sets BMO’s recent performance in the context of our longer-term view. The record results we achieved in 2015
(detailed in the Management’s Discussion and Analysis section) are key indicators of progress. From the bank’s perspective, they are underscored by our sense of purpose.
1. Achieve industry-leading customer loyalty by delivering on our brand promise
2. Enhance productivity to drive performance and shareholder value
3. Accelerate deployment of digital technology to transform our business
4. Leverage our consolidated North American platform and expand strategically in select global markets to deliver growth
Our success lies in earning the trust of our customers, ensuring that any actions we take to help them reach their goals are anchored by integrity and a shared set of values.
And we’re differentiated by our deep desire to connect with customers: in making banking more personal, we’re
5. Ensure our strength in risk management underpins everything we do for our customers
BMO Financial Group 198th Annual Report 2015 11
Chief Executive Officer’s message
forging relationships that represent sustainable value. This mindset shapes how we think about the role technology should play in deepening customer loyalty, driving profitability and rewarding our shareholders.
Technology is part of our strategy
Without question, 2015 confirmed how much our substantial – and forward-looking – investment in technology transformation has been reshaping the bank.
Over the past five years, we’ve reengineered our systems to enable a clear, relationship-based view of all relevant information with a bank-wide data aggregation platform and distributed analytic capabilities. We’re making it easy for customers and their bankers to access a wealth of knowledge as they explore options and make better decisions. And through what can only be described as a passion for deepening customers’ sense of control over their own finances, we’re also giving them confidence that we’ll uphold our promise to protect their interests while keeping their information secure and managing risk.
As we integrate advanced digital and mobile capabilities into all of our businesses – from our award-winning smartphone
Our strategic priorities*
*
Updated fiscal 2016
12 BMO Financial Group 198th Annual Report 2015
and tablet apps to BMO SmartFolio, our automated investment portfolio – each new solution is built on the powerful platform we’ve put in place. Our highly reliable core systems have been configured to efficiently meet the competing demands of multiple stakeholders – the most fundamental of which is customers’ anticipation that their needs will be perfectly met. Equally important is the expectation that BMO’s various businesses will deliver services as one bank, and our employees’ corresponding need to have a single view of every customer. And right alongside is the drive to adopt more agile work processes, with faster release cycles for new products and services; the rigour we’ve brought to strengthening compliance disciplines such as anti-money laundering; and our continued vigilance around issues of privacy, information security and consumer protection.
To simultaneously address these interrelated goals, achieving each without compromising the others, has required an unprecedented investment of time, energy, capital and creativity. We’ve been listening closely to customers’ feedback, and sharpening our analytics to better understand their priorities and behaviours, as we expand and rethink the banking experience. Expectations around response times in a mobile, connected world have dramatically increased the speed at which innovation
1
2
Achieve industry-leading customer loyalty by delivering on our brand promise
Enhance productivity to drive performance and shareholder value needs to happen. And because our work calls for new knowledge and skills, we’re developing and recruiting people with the specialized expertise to find alternative solutions and reinvent existing models – including our own.
As we accelerate these efforts, we’re alert to the potential in collaborating with third parties who are using technology in new and interesting ways that complement our own thinking.
We’ve long seen the value of working with external specialists in the service of our customers. BMO was a founding partner of the 10-million-member AIR MILES rewards program. We work closely with companies such as Shell Canada to offer more rewards to BMO MasterCard customers. And in the past year we announced relationships with two providers of specialized services to small businesses: FreshBooks for financial management tools, and e8ight Business Services
Inc. for help managing online and social media presence.
Collaboration makes sense when we can see the opportunity to speed up change at an advantageous cost.
Technology is one part of innovation
It’s sometimes suggested that banks themselves need to become technology companies. In BMO’s case, we have a
legacy of technological innovation dating from initial signs of digitization in the 1970s, when we were the first
Canadian bank to connect our branches nationwide across a real-time network. From the earliest fully automated cheque-processing systems in the United States to ABM cash withdrawals requiring only a smartphone, we have a long history of combining breakthrough thinking with continuous experimentation to make banking better for our customers.
What’s different today is that instead of simply finding faster, smarter ways of doing what banks have always done, we’re using technology to unlock new sources of value for our customers and shareholders. Because in our experience, a changing landscape conveys advantage to those who are willing to disrupt, accept some degree of trial and error, and try again.
Our bank has an advantage that would be challenging for a startup to duplicate: more than 12 million customers who are ready to try new solutions and provide invaluable input as we refine and enhance them. We’re able to assess the impact of smart ideas quickly, and we can spread the investment over a diverse, established base. Above all, we know that unless a new development yields tangible
3
4
5
Accelerate deployment of digital technology to transform our business Leverage our consolidated
North American platform and expand strategically in select global markets to deliver growth
Ensure our strength in risk management underpins everything we do for our customers BMO Financial Group 198th Annual Report 2015 13
Chief Executive Officer’s message
Our bank has important strategic advantages – technology expertise, a wealth of customer data, deep capital strength, a well-established brand, a solid record of regulatory compliance and a prudent, disciplined approach to risk. benefits in both customer satisfaction and return on investment, it’s not sustainable. We never lose sight of our ultimate objective: to delight the maximum number of people at the lowest cost consistent with our brand.
Technology is helping us reduce operating costs and eliminate work that doesn’t add value. It’s allowing us to approach tasks differently and execute them more quickly. And as we meet the demand for increasingly sophisticated digital capabilities, especially through the mobile channel, we’re attracting and retaining more customers – and in the process, earning higher revenue with less expense. Becoming more connected to our customers and delivering services more cost-effectively are not mutually exclusive goals.
The fact is our bank has many strategic advantages – technology expertise, a wealth of customer data, deep capital strength, a well-established brand, a solid record of regulatory compliance and a prudent, disciplined approach to risk – that enable us to compete successfully with disruptors and traditional players alike. And the single thread tying together all of these competitive advantages is trust.
Trust remains the foundation of loyalty
You can create an app in an instant – and it can take about the same amount of time to erode trust that has
14 BMO Financial Group 198th Annual Report 2015
required years to build. You can’t attract trust with features or purchase it with rewards. Trust must be earned. Even as the pace of change continues to accelerate – in fact, precisely because the world has become so complex and fast-moving – we see that our customers sense what BMO stands for: that we act responsibly, not only in our interactions with them, but in everything we do.
In the downturn of 2008–2009, after having declared dividends to shareholders every year since 1829 – a payout record unequalled by any other Canadian company – we took steps to protect that dividend because we knew how important it was to individual shareholders. The bank has a history spanning generations of social change and evolving expectations. We understand that trust can only be built over time, through the accumulation of consistent actions by everyone at BMO. We’re rightly judged not by what we say, but by what we do.
It’s relevant to all of our stakeholders that we act with integrity, transparency and accountability. We earn trust by managing our business responsibly and upholding the highest standards of governance. We reinforce it by giving back to the communities where we live and work – and by fostering an inclusive, socially conscious culture in which employees feel empowered to show their own remarkable generosity. None of these things can be accomplished by technology alone.
Customers remain the key to value creation
Our business is built on relationships. We base our brand promise on the recognition that money is personal, and the investment we’re making in technology is entirely focused on that belief. We’re creating tools that empower our customers while helping us understand their preferences and priorities. And we’re blending virtual and face-to-face conversations to ensure we’re delivering value at every touch point, providing customers with quick, clear, knowledgeable support – and more, when that’s what they’re looking for.
As we work to deepen our relationships with existing customers, the best measure of our strategy’s success is the growth of the bank through our ability to attract new business – which translates into top-line revenue growth. This is why we so closely measure both net new customers and product categories per customer in every business. Our progress over the past year is reflected in the bank’s adjusted annual net revenue growth of 8%, to
$18.1 billion. Adjusted net income for 2015 was $4.7 billion, or $7.00 in earnings per share, an increase of 6% over the previous year.
Banking and by 13% in Wealth Management, while BMO
Capital Markets earned over $1 billion for the third consecutive year.
A relevant strategy drives results
Based on these positive results, we raised the bank’s dividend by $0.16 per share, a year-over-year increase of
5%. Our one-year total shareholder return (TSR), although negative 3%, was better than the average of our Canadian bank peer group and the overall market return in Canada.
Moreover, our three-year TSR was also better than peer average at positive 13.5%. At the same time, our success in further strengthening our capital position was reflected in a Common Equity Tier 1 Ratio of 10.7% at year-end.
These results underline the importance of BMO’s diversified business mix in driving growth. In the past year, we surpassed the ambitious goal we set in 2011 to generate more than $1 billion of after-tax earnings from our Personal and Commercial Banking and Wealth Management businesses in the United States. Performance measures for all of our businesses confirm that the clear priorities we’ve mapped out are delivering sustainable value.
Critical to achieving the strategic priorities that ultimately drive BMO’s performance are our principal areas of operating focus: extending the digital experience across all channels; leveraging data to manage our business and serve customers better; simplifying and automating for greater efficiency; and elevating the brand of the bank. Results from our principal operating groups show that this consistent strategic focus is paying off:
BMO’s market leadership in commercial banking in the United States and Canada was further strengthened with the announcement, in September 2015, of our planned acquisition of the Transportation Finance division of General
In 2015, adjusted annual net income grew by 4% year over year in Canadian Personal and Commercial Banking, by 9%
(on a U.S. dollar basis) in U.S. Personal and Commercial
Adjusted Net Revenue
Adjusted Net Income
(C$ billions)
(C$ billions)
Basel III Common
Equity Tier 1 Ratio
(%)
15.4
2013
16.7
18.1
4.2
2014
2015
2013
4.5
2014
4.7
2015
10.7
9.9
10.1
2013
2014
2015
BMO Financial Group 198th Annual Report 2015 15
Chief Executive Officer’s message
Electric Capital Corporation – North America’s largest provider of truck and trailer financing. This extends our reach across the entire transportation supply chain – including original equipment manufacturers, dealers and end users – and positions us well in the context of improving economic conditions.
The purchase closed on December 1, 2015.
The here and now
We aren’t waiting for the future to come to us – we’re on it. As technology opens up new opportunities, BMO’s
47,000 bankers understand that working together more productively not only yields higher returns for our shareholders, but also leads to more meaningful work and greater prospects for personal growth. Together, we’re eliminating geographical boundaries and those between lines of business. We’re using the knowledge we’ve gained
– from our belief in rigorous risk management and a level of regulatory engagement that once seemed a daunting
challenge – to be more proactive and adaptive in everything we do. And above all, we’re leveraging technology to understand our customers better, to make their banking experience more personal and intuitive.
Propelled forward by the momentum of growth, we’re meeting customers’ changing priorities in ways that reinforce our brand and resonate in the digital marketplace.
And after multiple consecutive years of investment, we’re confidently executing on our strategy in a world that reveals new potential – and becomes more interesting – every day.
William A. Downe
Chief Executive Officer,
BMO Financial Group
Executive Committee*
William A. Downe
Chief Executive Officer,
BMO Financial Group
Frank Techar
Chief Operating Officer,
BMO Financial Group
Jean-Michel Arès
Chief Technology
& Operations Officer,
BMO Financial Group
Christopher Begy
U.S. Country Head &
Chief Executive Officer,
BMO Financial Corp.
David R. Casper
President & Chief Executive Officer,
BMO Harris Bank N.A. and Group
Head, Commercial Banking
Cameron Fowler
Group Head,
Canadian Personal and Commercial
Banking, BMO Financial Group
Alexandra Dousmanis-Curtis
Group Head,
U.S. Retail and Business Banking
Gilles G. Ouellette
Group Head,
Wealth Management
Simon A. Fish
General Counsel,
BMO Financial Group
Surjit Rajpal
Chief Risk Officer,
BMO Financial Group
Thomas E. Flynn
Chief Financial Officer,
BMO Financial Group
Lynn Roger
Chief Transformation Officer,
BMO Financial Group
16 BMO Financial Group 198th Annual Report 2015
Joanna Rotenberg
Head, Personal Wealth Management,
BMO Financial Group
Richard Rudderham
Chief Human Resources Officer,
BMO Financial Group
Connie Stefankiewicz
Chief Marketing Officer,
BMO Financial Group
Darryl White
Group Head,
BMO Capital Markets
*As at January 5, 2016.
Our Strategic Footprint
BMO’s strategic footprint spans strong regional economies.
Our three operating groups serve individuals, businesses, governments and corporate customers across Canada and the United States with a focus in six U.S. Midwest states – Illinois, Indiana, Wisconsin, Minnesota, Missouri and Kansas.
Our significant presence in North America is bolstered by operations in select global markets in Europe, Asia and the
Middle East, allowing us to provide all our customers with access to economies and markets around the world.
NT
YT
BC
NU
SK
AB
MB
NL
QC
ON
WA
MT
NB
MN
WI
OR
NE
UT
CO
MI
IL
KS
NY
IA
IN
MO
NS
MA
CT
Personal & Commercial
Banking and Wealth
Management footprint
VA
CA
PE
Other Commercial
Banking offices
AZ
TX
Mexico City and
Rio de Janeiro
GA
Other Wealth
Management offices
BMO Capital Markets offices FL
Our European and Middle Eastern presence
Our Asia-Pacific presence
Beijing
Edinburgh
Dublin
Paris
Madrid
Lisbon
London
Shanghai
Stockholm
Amsterdam
Frankfurt
Munich
Guangzhou
Taipei
Hong Kong
Zurich
Singapore
Milan
Luxembourg
Abu Dhabi
Sydney
Melbourne
BMO Financial Group 198th Annual Report 2015 17
Reasons to
Invest in BMO
A consistent strategy. Top-tier shareholder returns. Great customer experience. Innovative technology. And a solid foundation of trust. It all adds up to a compelling set of reasons to invest in BMO.
Clear opportunities for growth across a diversified North American footprint:
• Large North American commercial banking business with advantaged market share.
• Well-established, highly profitable core banking business in Canada.
Strong capital position with an attractive dividend yield.
Focus on efficiency through technology innovation, simplifying and automating processes, and extending the digital experience across our channels.
• Fast-growing, award-winning wealth franchise.
Customer-centric operating model guided by disciplined loyalty measurement program.
• Leading Canadian and growing mid-cap focused U.S. capital markets business.
Adherence to the highest standards of business ethics and corporate governance.
• U.S. operations well-positioned to capture benefit of improving economic conditions.
18 BMO Financial Group 198th Annual Report 2015
4
+ %
Operating Group
Performance
2,020
BMO’s performance in 2015 reflects the benefits of our diversified business mix, with Canadian and U.S. banking and Wealth Management all contributing to the bank’s growth. Canadian and U.S. Personal and Commercial
Banking and Wealth Management had record years in adjusted net income. Wealth Management’s performance reflected good organic growth and the addition of F&C
Asset Management plc. BMO Capital Markets results were solid given market conditions.
13.5
%
2,108
+
25
880
4
- %
13%
843
1,078 1,034
955
706
Canadian P&C
U.S. P&C
Wealth
Management
Adjusted Net Income (C$ millions)
BMO Capital
Markets
2014
2015
U.S. Commercial and
Industrial Loans (US$ billions)
Strength in
Commercial Banking
BMO’s total shareholder return
(TSR) outperformed our
Canadian bank peer group average and the overall market return in Canada and yielded an average annual TSR of 13.5% over the past three years.
+
%
BMO is a market leader in North
American commercial banking.
In U.S. Personal and Commercial
Banking, the C&I (commercial and industrial) portfolio continues to experience robust growth, increasing by $4.3 billion or 16% from a year ago to $30.9 billion.
16%
+
30.9
26.6
2014
2015
Our Dividend Record
BMO Financial Group has the longest-running dividend payout record of any company in Canada, at 187 years. BMO common shares had an annual dividend yield of 4.26% at October 31, 2015.
Compound annual growth rate:
8.2%
3.0%
BMO 15-year
BMO 5-year
Dividends Declared ($ per share)
2.71
1.34
2003
1.59
2004
1.85
2005
2.80
2.80
2.80
2.80
2.82
2.94
3.08
3.24
2007
2008
2009
2010
2011
2012
2013
2014
2015
2.26
2006
BMO Financial Group 198th Annual Report 2015 19
Corporate Governance
When we measure BMO’s performance, shareholder return is an important metric – but only as it reflects a more fundamental commitment to earning the trust of all stakeholders. We have a responsibility not simply to meet regulatory requirements, but to act in accordance with our stated values.
And the cornerstone of our efforts is sound corporate governance.
Our board oversees our business
Our Board of Directors provides stewardship, including direction-setting and general oversight of our management and operations. Its members have sophisticated expertise and a range of perspectives. The board approves the bank’s overall strategy and makes decisions based on
BMO’s values, emphasizing long-term performance over short-term gain.
The board operates independently of management
The Chairman of the Board and our directors, other than the Chief Executive Officer, operate independently of management. Board meetings include time for the independent directors to meet without management or non-independent directors present.
Our focus on diversity reflects our values
The board has adopted a written Board Diversity Policy to facilitate more effective governance. In so doing, the board positions itself to be made up of highly-qualified directors whose diverse backgrounds reflect the changing demographics of the markets in which we operate, the talent available with the expertise required, and the bank’s evolving customer and employee base. The Board Diversity
Policy includes the goal that each gender comprise at least one-third of the independent directors. A diverse board helps us make better decisions.
In addition, the board oversees the development of the next generation of leaders at BMO, ensuring the bank has a solid, diverse team of executives to keep BMO strong and growing in the years to come.
20 BMO Financial Group 198th Annual Report 2015
We compensate our directors and executives in ways that encourage good decisions
Our model for compensating directors and executives follows best practices for good governance. We use a pay-for-performance model for executives that includes clawbacks and discourages unreasonable risk-taking.
Directors and executives must own shares, in order to align their interests with those of other shareholders. We do not allow directors and employees to hedge their investments in our shares, securities or related financial instruments.
We maintain a strong focus on ethical conduct
BMO’s Code of Conduct is approved by the board and is rooted in our values of integrity, empathy, diversity and responsibility. Every year, all directors and employees are required to confirm that they have read, understood, complied with and will continue to comply with the code.
The Chief Ethics Officer is responsible for ensuring that awareness and understanding of ethical business principles are embedded in all aspects of our business, and reports on the state of ethical conduct across our organization to the
Audit and Conduct Review Committee of the board.
Our ethical culture is supported by an environment where concerns can be raised without fear of retaliation. We provide various means for raising concerns, including the ability to report them on an anonymous basis. All reports are investigated, and breaches of the code are dealt with swiftly and decisively.
Our board and management stay connected with our shareholders
We engage and inform our shareholders through our annual meeting of shareholders, annual report, management proxy circular, annual information form, sustainability report, corporate responsibility report, quarterly reports, news releases, earnings conference calls, industry conferences and other meetings. Our website provides extensive information about the board, its mandate, the board committees and their charters, and our directors.
Board of Directors
1
To promote alignment of our strategic goals across all our businesses, each director sits on at least one board committee and the Chief Executive www.bmo.com/corporategovernance Officer is invited to all committee meetings. We review the membership of all committees annually.
Janice M. Babiak
Sophie Brochu
George A. Cope
William A. Downe
Christine A. Edwards
Dr. Martin S. Eichenbaum
Ronald H. Farmer
Eric R. La Flèche
Lorraine Mitchelmore
Philip S. Orsino
J. Robert S. Prichard
Don M. Wilson III
Janice M. Babiak
Former Managing Partner,
Ernst & Young
Board/Committees: Audit and Conduct
Review, Risk Review, The Pension Fund
Society of the Bank of Montreal
Other public boards: Experian PLC,
Walgreens Co.
Director since: 2012
Sophie Brochu
President and Chief Executive Officer,
Gaz Métro
Board/Committees: Audit and Conduct
Review
Other public boards: BCE Inc.
Director since: 2011
George A. Cope
President and Chief Executive Officer,
Bell Canada and BCE Inc.
Board/Committees: Governance and
Nominating, Human Resources
Other public boards: BCE Inc.
Director since: 2006
William A. Downe
Chief Executive Officer,
BMO Financial Group
Board/Committees: Attends all committee meetings as an invitee
Other public boards: ManpowerGroup
Director since: 2007
Christine A. Edwards
Capital Partner, Winston & Strawn
Board/Committees: Governance and
Nominating (Chair), Human Resources,
Risk Review, The Pension Fund Society of the Bank of Montreal (Chair)
Director since: 2010
Dr. Martin S. Eichenbaum
Charles Moskos Professor of Economics,
Northwestern University
Board/Committees: Audit and Conduct
Review, Risk Review
Director since: 2015
Ronald H. Farmer
Managing Director,
Mosaic Capital Partners
Board/Committees: Audit and Conduct Review, Governance and
Nominating, Human Resources (Chair)
Other public boards: Valeant
Pharmaceuticals International Inc.
Director since: 2003
Eric R. La Flèche
President and Chief
Executive Officer, Metro Inc.
Board/Committees:
Risk Review
Other public boards:
Metro Inc.
Director since: 2012
Lorraine Mitchelmore
President and Country Chair, Shell
Canada Limited and Executive Vice
President, Heavy Oil for Upstream
Americas
Director since: 2015
Philip S. Orsino, O.C., F.C.P.A., F.C.A.
President and Chief Executive Officer,
Brightwaters Strategic Solutions, Inc.
Board/Committees: Audit and Conduct
Review (Chair), Governance and
Nominating
Director since: 1999
J. Robert S. Prichard, O.C., O.Ont.
Chairman of the Board, BMO Financial
Group, and Chair of Torys LLP
Board/Committees: Governance and
Nominating, Human Resources, Risk
Review, The Pension Fund Society of the Bank of Montreal
Other public boards: George Weston
Limited, Onex Corporation
Director since: 2000
Don M. Wilson III
Corporate Director
Board/Committees: Governance and
Nominating, Human Resources, Risk
Review (Chair), The Pension Fund
Society of the Bank of Montreal
Director since: 2008
1
As at October 31, 2015.
Honorary Directors
Robert M. Astley, Waterloo, ON
Stephen E. Bachand, Ponte Vedra Beach, FL, USA
Ralph M. Barford, Toronto, ON
Matthew W. Barrett, O.C., LL.D., Oakville, ON
David R. Beatty, O.B.E., Toronto, ON
Peter J.G. Bentley, O.C., O.B.C., LL.D., Vancouver, BC
Robert Chevrier, F.C.A., Montreal, QC
Tony Comper, C.M., LL.D., Toronto, ON
C. William Daniel, O.C., LL.D., Toronto, ON
A. John Ellis, O.C., LL.D., O.R.S., Vancouver, BC
John F. Fraser, O.C., LL.D., O.R.S., Winnipeg, MB
David A. Galloway, Toronto, ON
Richard M. Ivey, C.C., Q.C., Toronto, ON
Betty Kennedy, O.C., LL.D., Campbellville, ON
Harold N. Kvisle, Calgary, AB
Eva Lee Kwok, Vancouver, BC
J. Blair MacAulay, Oakville, ON
Ronald N. Mannix, O.C., Calgary, AB
Robert H. McKercher, Q.C., Saskatoon, SK
Bruce H. Mitchell, Toronto, ON
Eric H. Molson, Montreal, QC
Jerry E.A. Nickerson, North Sydney, NS
Dr. Martha C. Piper, O.C., O.B.C., FRSC, Vancouver, BC
Jeremy H. Reitman, Montreal, QC
Lucien G. Rolland, O.C., Montreal, QC
Guylaine Saucier, F.C.P.A., F.C.A., C.M., Montreal, QC
Nancy C. Southern, Calgary, AB
BMO Financial Group 198th Annual Report 2015 21
Financial Review
23
CFO’s Foreword to the Financial Review
24
Financial Performance and Condition at a Glance
26
Management’s Discussion and Analysis
118 Supplemental Information
132 Statement of Management’s Responsibility for Financial Information
133 Independent Auditors’ Report of Registered Public
Accounting Firm
134 Report of Independent Registered Public
Accounting Firm
135 Consolidated Financial Statements
140 Notes to Consolidated Financial Statements
Resources and Directories
202 Glossary of Financial Terms
204 Where to Find More Information
IBC Shareholder Information
22 BMO Financial Group 198th Annual Report 2015
CFO’s Foreword to the Financial Review
“ We have an advantaged business mix, a strong capital position and a customer-centric operating model that provide clear opportunities for growth across a diversified North American footprint.”
Thomas E. Flynn, CPA, CA
Chief Financial Officer, BMO Financial Group
BMO had a strong finish to 2015, with record financial performance driven by operating group performance.
Reported net income was $4.4 billion. On an adjusted basis, net income was $4.7 billion and EPS was $7.00, up 6% from last year, with record results in Personal and Commercial
Banking on both sides of the border as well as in Wealth
Management. We maintained a strong capital position, ending the year with a Common Equity Tier 1 Ratio of 10.7%, and we increased our dividend twice. Our disciplined approach to capital management also gave us the flexibility to buy back 8 million shares and to complete the acquisition of GE Capital’s transportation finance business, which closed on December 1, 2015.
Our performance continues to generate attractive returns for BMO’s shareholders. Our three-year average annual total shareholder return was 13.5%, outperforming our Canadian bank peer group average and the S&P/TSX Composite Index.
In the Management’s Discussion and Analysis (MD&A) that follows, we examine our results and performance in detail.
We are proud that our commitment to ensuring that investors receive timely and informative financial reporting was recently recognized with the Chartered Professional
Accountants of Canada’s 2015 Award of Excellence in
Corporate Reporting in Financial Services.
We have an advantaged business mix, a strong capital position and a customer-centric operating model that provide clear opportunities for growth across a diversified
North American footprint:
• Our large North American commercial banking business has advantaged market share positions.
• Our Canadian core banking business is well-established and highly profitable.
• Our wealth franchise is fast-growing and award-winning.
• We have a leading Canadian and growing mid-cap focused U.S. capital markets business.
• Our U.S. operations are well-positioned to capture the benefit of improving economic conditions.
• We are focused on driving efficiency through technology innovation, simplifying and automating processes and extending the digital experience across our channels.
As we head into 2016, we are well-positioned to build on our results in 2015, while adhering to the highest standards of business ethics and corporate governance.
Thomas E. Flynn
BMO Financial Group 198th Annual Report 2015 23
Financial Performance and Condition at a Glance
Our Performance (Note 1)
Total Shareholder Return (TSR)
Peer Group Performance
TSR (%)
P 32
• BMO shareholders have earned a strong average annual return
•
of 13.5% over the past three years, which outperformed our
Canadian bank peer group average and was above the 6.0% return on the S&P/TSX Composite Index.
The one-year TSR of negative 3.0% and the five-year average annual return of 9.5% both outperformed the S&P/TSX
Composite Index, and the one-year TSR also outperformed our Canadian bank peer group average.
Graph shows average annual three-year TSR.
Earnings per Share (EPS) Growth
• The Canadian peer group three-year average annual
16.7
13.5
11.5
2013
2014
2015
EPS Growth (%)
P 34
• Adjusted EPS grew $0.41 or 6% to $7.00, primarily reflecting
•
• The Canadian peer group average EPS growth
higher earnings. Reported EPS grew $0.16 or 2% to $6.57.
On an adjusted basis, higher revenue exceeded incremental costs, contributing to growth in net income. There were lower credit recoveries and a slightly higher effective income tax rate.
•
6
4
Return on Equity (ROE)
2
2013
2014
2015
compared with 14.4% and 14.0%, respectively, in 2014. ROE declined in 2015 primarily due to growth in common equity exceeding growth in income. There was growth in both earnings and adjusted earnings available to common shareholders.
Average common shareholders’ equity increased primarily due to the impact of the stronger U.S. dollar on our investments in foreign operations and higher capital to support regulatory capital ratios.
North American peer group data is not to scale.
ROE (%)
P 35
• Adjusted ROE was 13.3% and reported ROE was 12.5% in 2015,
14.9 15.0
• The Canadian peer group average ROE of 16.4% was
14.0 14.4
12.5
13.3
•
2013
Revenue Growth
6
was 6%, with all banks in the peer group reporting increases in EPS.
Average EPS growth for the North American peer group was 2%, with significant variability among our U.S. peer banks.
4
1
All EPS measures are stated on a diluted basis.
•
TSR was 11.5%. The one-year TSR was negative 4.6%, and the five-year average annual TSR was 9.7%.
The North American peer group three-year average annual TSR was 12.4%, the one-year TSR was negative
0.7%, and the five-year average annual TSR was
10.8%, each above the Canadian peer group averages.
2014
P 38
9
*
• On a net revenue basis*, revenue increased $1,417 million or
8% to $18,135 million, mainly due to growth in Canadian P&C and Wealth Management, as well as the impact of the stronger
U.S. dollar. Total revenue increased $1,166 million or 6% in 2015 to $19,389 million.
lower than the average return of 17.3% in 2014, as
ROE declined for all but one bank in our Canadian peer group.
Average ROE for the North American peer group was
11.5%, compared to 12.2% in 2014, with ROE declining for all but two banks in our North American peer group.
2015
Revenue Growth (%)
8
8
• Revenue growth for the Canadian peer group
•
4
averaged 5%, significantly lower than the average growth of 9% in 2014.
Average revenue growth for the North American peer group of 2% was consistent with the prior year.
3
1
*Graph shows net revenue, calculated using total revenue net of claims, commissions and changes in policy benefit liabilities.
Efficiency Ratio
(Expense-to-Revenue Ratio)
2014
63.7 63.5
65.3 64.4
P 43
• The adjusted efficiency ratio was 60.9% and the reported efficiency
•
2013
2015
67.2
Efficiency Ratio (%)
65.2
ratio was 62.8% in 2015. On a net revenue basis*, the adjusted efficiency ratio increased 80 basis points from 2014 to 65.2%, primarily due to the impact of the stronger U.S. dollar.
On a net revenue basis, excluding the impact of the stronger
U.S. dollar and purchased loan accounting impacts, the efficiency ratio would have been 40 basis points lower year over year.
*Graph shows the efficiency ratio on a net revenue basis, calculated using revenue net of claims, commissions and changes in policy benefit liabilities.
• The Canadian peer group average efficiency ratio was
•
2013
2014
60.2%, up from 59.5% in 2014 as growth in expenses exceeded growth in revenue.
The average efficiency ratio for the North American peer group was 63.3%, up from the group’s average ratio of 62.5% in 2014, and worse than the average of our Canadian peer group.
2015
Note 1: Adjusted results in this section are non-GAAP. Please see the Non-GAAP Measures section on page 33.
Effective November 1, 2014, BMO and our Canadian peers adopted several new and amended accounting pronouncements issued by the International
Accounting Standards Board (IASB), which are outlined in Note 1 on page 140 of the financial statements. The adoption of these new and amended accounting standards only impacted our results prospectively. Effective November 1, 2013, BMO and our Canadian peers adopted several new and amended accounting pronouncements issued by the IASB. The consolidated financial statements for fiscal 2013 have been restated. U.S. peer group data continues to be reported in accordance with U.S. GAAP.
24 BMO Financial Group 198th Annual Report 2015
BMO reported
BMO adjusted
Canadian peer group average
North American peer group average
Our Performance (Note 1)
Peer Group Performance
Credit Losses
Provision for Credit Losses as a % of Average
Net Loans and Acceptances
P 42, 96
• Provisions for credit losses (PCL) totalled $612 million,
•
up from $561 million in 2014 due to lower recoveries in
Corporate Services and higher provisions in BMO Capital
Markets, partially offset by reduced provisions in the
P&C businesses.
PCL as a percentage of average net loans and acceptances was 0.19% in 2015, consistent with the prior year.
New provisions were lower across both our consumer and commercial loan portfolios, compared to 2014.
• The Canadian peer group average PCL represented
0.22
0.19
2013
Impaired Loans
2014
•
0.19
2015
Gross Impaired Loans and Acceptances as a % of Gross Loans and Acceptances
P 96
• Gross impaired loans and acceptances (GIL) decreased
•
• The Canadian peer group average ratio of GIL as a
to $1,959 million from $2,048 million in 2014, and represented 0.58% of gross loans and acceptances, compared with 0.67% a year ago.
Formations of new impaired loans and acceptances, a key driver of provisions for credit losses, totalled
$1,921 million, down from $2,142 million in 2014, reflecting decreases in formations in both Canada and the United States.
0.67
0.58
2014
Capital Adequacy
9.9
and exceeds regulatory requirements.
Our CET1 Ratio was 10.7%, up from 10.1% in 2014, primarily due to higher capital from accumulated other comprehensive income and retained earnings, partially offset by an increase in risk-weighted assets.
• The Canadian peer group average Basel III CET1 Ratio
10.7
10.1
•
2013
P 110
Credit Rating
2014
was 10.3% in 2015, compared with an average CET1 Ratio of 9.9% a year ago.
The basis for computing capital adequacy ratios in Canada and the United States is not completely comparable.
2015
Credit Rating
• Credit ratings for BMO’s long-term debt, as assessed by the four major rating agencies, are listed below and all four ratings are considered to indicate high-grade, high-quality issues. Moody’s and DBRS have a negative outlook on the long-term credit ratings of BMO and other Canadian banks in response to the federal government’s proposed bail-in regime for senior unsecured debt. On December 11, 2015, Standard and Poor’s (S&P) revised its outlook to stable from negative on BMO and other systemically important
Canadian banks.
BMO Financial Group
percentage of gross loans and acceptances was 0.58%, down slightly from 0.59% in 2014.
The average ratio for our North American peer group improved from 1.40% a year ago to 1.15% in 2015, but continues to be higher than the average for the
Canadian peer group.
2015
P 35, 70
• BMO’s Common Equity Tier 1 (CET1) Ratio is strong
•
•
0.91
2013
Capital Adequacy
30 basis points of average net loans and acceptances, down slightly from 31 basis points in 2014.
The North American peer group average PCL represented
26 basis points, unchanged from 2014, and lower than the average PCL for the Canadian peer group.
• The Canadian peer group median credit ratings were unchanged from 2014.
• The North American peer group median credit ratings were unchanged from 2014, and remain slightly lower than the median of the Canadian peer group for three of the ratings.
Canadian peer group median*
2013
2014
2015
DBRS
AA
AA
AA
Fitch
AA–
AA–
Moody’s
Aa3
S&P
A+
North American peer group median*
2013
2014
2015
2013
2014
2015
DBRS
AA
AA
AA
DBRS
AAL
AAL
AAL
AA–
Fitch
AA–
AA–
AA–
Fitch
AA–
AA–
AA–
Aa3
Aa3
Moody’s
Aa3
Aa3
Aa3
Moody’s
A1
A1
A1
A+
A+
S&P
A+
A+
A+
S&P
A
A
A
*Data for all years reflects the peer group composition in the most recent year.
The Canadian peer group averages exclude BMO and are based on the performance of Canada’s five other largest banks: Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, Scotiabank and TD Bank Group. The North American peer group averages are based on the performance of 12 of the largest banks in North America. These include the Canadian peer group, except National Bank of Canada, as well as BB&T Corporation, Bank of New York Mellon Corporation, Fifth Third Bancorp, KeyCorp, The PNC Financial Services Group Inc., Regions Financial
Corporation, SunTrust Banks Inc. and U.S. Bancorp.
BMO reported
BMO adjusted
Canadian peer group average
North American peer group average
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.
BMO Financial Group 198th Annual Report 2015 25
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Management’s Discussion and Analysis
BMO’s Chief Executive Officer and its Chief Financial Officer have signed a statement outlining management’s responsibility for financial information in the annual consolidated financial statements and Management’s Discussion and Analysis (MD&A). The statement, which can be found on page 132, also explains the roles of the Audit and Conduct Review Committee and Board of Directors in respect of that financial information.
The MD&A comments on BMO’s operations and financial condition for the years ended October 31, 2015 and 2014. The MD&A should be read in conjunction with our consolidated financial statements for the year ended October 31, 2015. The MD&A commentary is as of December 1, 2015.
Unless otherwise indicated, all amounts are stated in Canadian dollars and have been derived from financial statements prepared in accordance with
International Financial Reporting Standards (IFRS). References to generally accepted accounting principles (GAAP) mean IFRS.
Since November 1, 2011, BMO’s financial results have been reported in accordance with IFRS. Results for years prior to 2011 have not been restated and are presented in accordance with Canadian GAAP as defined at that time (CGAAP). As such, certain growth rates and compound annual growth rates (CAGR) may not be meaningful. On November 1, 2013, BMO adopted several new and amended accounting pronouncements issued by the International Accounting Standards Board. The consolidated financial statements for comparative periods in the fiscal years 2013 and 2012 have been restated. Certain other prior year data has been reclassified to conform with the current year’s presentation. The adoption of new IFRS standards in 2015 only impacted our results prospectively. Prior periods have been reclassified for methodology changes and transfers of certain businesses between operating groups. See pages 45 and 46.
Index
27
Who We Are provides an overview of BMO Financial Group, explains the links between our financial objectives and our overall vision, and outlines “Reasons to Invest in BMO” along with relevant key performance data.
28
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 priorities.
30
Caution Regarding Forward-Looking Statements advises readers about the limitations and inherent risks and uncertainties of forwardlooking statements.
30
Value Measures reviews financial performance on the four key measures that assess or most directly influence shareholder return. It also includes explanations of non-GAAP measures, a reconciliation to their GAAP counterparts for the fiscal year, and a summary of adjusting items that are excluded from results to assist in the review of key measures and adjusted results.
Total Shareholder Return
Non-GAAP Measures
Summary Financial Results and Earnings per Share Growth
Return on Equity
Basel III Common Equity Tier 1 Ratio
68
70
76
77
Economic Developments and Outlook includes commentary on the
Canadian, U.S. and international economies in 2015 and our expectations for 2016.
32
68
32
33
34
35
35
36
2015 Financial Performance Review provides a detailed review of
BMO’s consolidated financial performance by major income statement category. It also includes a summary of the impact of changes in foreign exchange rates.
45
2015 Operating Groups Performance Review outlines the strategies and key priorities of our operating groups and the challenges they face, along with their strengths and value drivers. It also includes a summary of their achievements in 2015, their focus for 2016, and a review of their financial performance for the year and the business environment in which they operate.
Summary
Personal and Commercial Banking
Canadian Personal and Commercial Banking
U.S. Personal and Commercial Banking
BMO Wealth Management
BMO Capital Markets
Corporate Services, including Technology and Operations
46
47
48
51
55
58
62
63
78
78
80
80
81
82
83
84
86
87
87
89
94
100
105
111
112
114
114
116
116
116
117
118
Financial Condition Review comments on our assets and liabilities by major balance sheet category. It includes a review of our capital adequacy and our approach to optimizing our capital position to support our business strategies and maximize returns to our shareholders. It also includes a review of off-balance sheet arrangements and certain select financial instruments.
Summary Balance Sheet
Enterprise-Wide Capital Management
Select Financial Instruments
Off-Balance Sheet Arrangements
Accounting Matters and Disclosure and Internal Control reviews critical accounting estimates and changes in accounting policies in
2015 and for future periods. It also outlines our evaluation of disclosure controls and procedures and internal control over financial reporting, and provides an index of disclosures recommended by the
Enhanced Disclosure Task Force.
Critical Accounting Estimates
Changes in Accounting Policies in 2015
Future Changes in Accounting Policies
Transactions with Related Parties
Management’s Annual Report on Disclosure Controls and Procedures and Internal Control over Financial Reporting
Shareholders’ Auditors’ Services and Fees
Enhanced Disclosure Task Force
Enterprise-Wide Risk Management outlines our approach to managing key financial risks and other related risks we face.
Overview
Risks That May Affect Future Results
Framework and Risks
Credit and Counterparty Risk
Market Risk
Liquidity and Funding Risk
Operational Risk
Model Risk
Insurance Risk
Legal and Regulatory Risk
Business Risk
Strategic Risk
Reputation Risk
Environmental and Social Risk
Supplemental Information presents other useful financial tables and more historical detail.
Review of Fourth Quarter 2015 Performance, 2014 Financial
Performance Review and Summary Quarterly Earnings Trends provide commentary on results for relevant periods other than fiscal 2015.
Regulatory Filings
Our continuous disclosure materials, including our interim financial statements and interim MD&A, annual audited consolidated financial statements and annual MD&A, Annual
Information Form and Notice of Annual Meeting of Shareholders and Management Proxy Circular, are available on our website at www.bmo.com/investorrelations, 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 Chief Executive Officer and its Chief
Financial Officer certify the appropriateness and fairness of BMO’s annual and interim consolidated financial statements, MD&A and Annual Information Form, the effectiveness of BMO’s disclosure controls and procedures and the effectiveness of, and any material weaknesses relating to, BMO’s internal control over financial reporting.
26 BMO Financial Group 198th Annual Report 2015
Who We Are
Established in 1817, BMO Financial Group is a highly diversified financial services provider based in North America. With total assets of $642 billion and close to 47,000 employees, BMO provides a broad range of personal and commercial banking, wealth management and investment banking products and services to more than 12 million customers. We serve eight million customers across Canada through our Canadian personal and commercial arm, BMO Bank of Montreal. We also serve customers through our wealth management businesses: BMO Global Asset Management, BMO
Nesbitt Burns, BMO Private Banking, BMO Insurance and BMO InvestorLine. BMO Capital Markets, our investment and corporate banking and trading products division, provides a full suite of financial products and services to North American and international clients. In the United States, BMO serves customers through BMO Harris Bank, based in the U.S. Midwest with more than two million retail, small business and commercial customers. BMO
Financial Group conducts business through three operating groups: Personal and Commercial Banking, Wealth Management and BMO Capital Markets.
Our Financial Objectives
Reasons to Invest in BMO
‰ Clear opportunities for growth across a diversified North American footprint:
‰ Large North American commercial banking business with advantaged market share.
‰ Well-established, highly profitable core banking business in Canada.
‰ Fast-growing, award-winning wealth franchise.
‰ Leading Canadian and growing mid-cap focused U.S. capital markets business.
‰ U.S. operations well-positioned to capture benefit of improving economic conditions.
‰ Strong capital position and an attractive dividend yield.
‰ Focus on efficiency through technology innovation, simplifying and automating processes and extending the digital experience across our channels. ‰ Customer-centric operating model guided by disciplined loyalty measurement program.
‰ Adherence to the highest standards of business ethics and corporate governance.
Canadian banks have been ranked the world’s soundest for the 8th year in a row(1)
(1) Based on the Global Competitiveness Report by the World Economic Forum.
As at and for the periods ended October 31, 2015 (%, except as noted)
Average annual total shareholder return
Average growth in annual adjusted EPS
Average annual adjusted ROE
Average growth in annual EPS
Average annual ROE
Compound growth in annual dividends declared per share
Dividend yield**
Price-to-earnings multiple**
Market value/book value ratio**
Common Equity Tier 1 Ratio (Basel III basis)
1-year
(3.0)
6.2
13.3
2.5
12.5
5.2
4.3
11.6
1.35
10.7
5-year*
10-year*
9.5
7.9
14.8
7.1
14.5
3.0
4.3
11.6
1.53
7.7
5.1
15.7
5.4
14.4
5.8
4.6
12.7
1.70
na
na
* 5-year and 10-year growth rates reflect growth based on CGAAP in 2010 and 2005, respectively, and IFRS in 2015.
** 1-year measure as at October 31, 2015. 5-year and 10-year measures are the average of year-end values. na – not applicable
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
The Our Financial Objectives section above and the Enterprise-Wide Strategy and Economic Developments and Outlook 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 30 of this MD&A for a discussion of such risks and uncertainties and the material factors and assumptions related to the statements set forth in such sections.
BMO Financial Group 198th Annual Report 2015 27
MD&A
BMO’s medium-term financial objectives for certain important performance measures are set out below. We believe that we will deliver top-tier total shareholder return and meet our medium-term financial objectives by aligning our operations with, and executing on, our strategic priorities, along with our vision and guiding principle, as outlined on the following page. We consider top-tier returns to be top-quartile shareholder returns relative to our Canadian and North American peer group.
BMO’s business planning process is rigorous, sets ambitious goals and considers the prevailing economic conditions, our risk appetite, 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 both internal and external benchmarks and progress toward our strategic priorities.
Over the medium term, our financial objectives on an adjusted basis are to achieve average annual earnings per share (adjusted EPS) growth of
7% to 10%, earn an average annual return on equity (adjusted ROE) of 15% or more, generate average annual adjusted net operating leverage of 2% or more and maintain strong capital ratios that exceed regulatory requirements. These objectives are key guideposts as we execute against our strategic priorities, and we believe they are consistent with delivering top-tier total shareholder return. In managing our operations and risk, we recognize that current profitability and the ability to meet these objectives in a single period must be balanced with the need to invest in our businesses for their future long-term health and growth prospects.
Our five-year average annual adjusted EPS growth rate was 7.9%, in line with our target growth range of 7% to 10%. We did not meet our medium-term objective of generating above 2% average annual adjusted operating leverage due to lower than expected source currency revenue.
We remain focused on improving efficiency and generated improved operating leverage on a net revenue basis through 2015. Our five-year average annual adjusted ROE of 14.8% was slightly below our target range as we held increased levels of common shareholders’ equity to meet increased capital expectations for banks. Our capital position is strong, with a Common Equity Tier 1 Ratio of 10.7%.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Enterprise-Wide Strategy
Our Vision
To be the bank that defines great customer experience.
Our Guiding Principle
We aim to deliver top-tier total shareholder return and balance our commitments to financial performance, our customers and employees, the environment and the communities where we live and work.
MD&A
Our 2015 Strategy in Context
The economic environment is constantly evolving. As we navigate through this constant change, we continue to remain grounded in our brand promise. We’re here to help is a simple statement meant to inspire and guide what we do every day. We aim to help customers feel valued, understood and confident in the decisions they make.
Our strategic priorities have proven to be robust, providing us with consistent direction in the midst of evolving expectations, increasingly intense competitive activity and continued market uncertainty. Digital technologies continue to play a critical role across our strategic priorities in enabling our objectives. We believe that the strength of our business model, customer base, balance sheet, risk management framework and leadership team, along with the advantages offered by the scale of our consolidated North American platform, will continue to generate sustainable growth and help us deliver on our vision and brand promise.
Our commitment to stakeholders is evident in our focus on delivering an industry-leading customer experience, managing revenues and expenses to achieve our financial goals, and maintaining a prudent approach to risk management. We have made good progress on our enterprise strategic priorities, with select accomplishments outlined below, as well as on our group strategies, detailed in the 2015 Operating Groups
Performance Review, which starts on page 45.
Our 2015 Priorities and Progress
1. Achieve industry-leading customer loyalty by delivering on our brand promise.
‰ Developed further capabilities in digital banking and investing to help customers in new and innovative ways:
‰ Launched Touch ID log-in in Canada and the United States, enabling customers to log in to the BMO mobile banking application using fingerprint recognition. Within a month of the launch in Canada, approximately 115,000 new users registered for the mobile app.
‰ Introduced Mobile Cash in the United States, allowing customers to withdraw money from a BMO Harris automated banking machine (ABM) using their smartphone; we now have the largest network of mobile-enabled cardless ABMs in the United States.
‰ Launched a new BMO Banking and InvestorLine portal, becoming the first major Canadian bank to provide customers with access to both personal banking and self-directed investment accounts all in one place.
‰ Enhanced our cash management offerings with the launch of BMO DepositEdge™ in Canada, enabling business customers to deposit cheques remotely, and BMO Spend Dynamics™, giving corporate card clients convenient access to their transaction data and the ability to analyze their program spend.
‰ For the third consecutive year, BMO was recognized by global financial services research firm Celent with a 2015 Model Bank Award for excellence in the digital banking category.
‰ Completed the successful launch of BMO’s refreshed brand with innovative tactics, including the “Help Given” social media campaign, which generated over 7.7 million views in Canada and the United States, and sponsorship of The Amazing Race Canada, which allowed BMO to reach millions of Canadians during its 12-week season.
‰ Recognized with awards across our groups, including Best Wealth Management in Canada, 2015 (Global Banking and Finance Review), Best FullService Investment Advisory in Canada, 2015 (Global Banking and Finance Review), 2015 Greenwich Quality Leader in Canadian Equity Sales and
Corporate Access and 2015 Greenwich Share Leader for Canadian Fixed Income Research (Greenwich Associates) and, for the sixth consecutive year,
World’s Best Metals & Mining Investment Bank (Global Finance).
2. Enhance productivity to drive performance and shareholder value.
‰ Continued to make our processes more efficient, enabling front-line employees to add new customers and strengthen existing relationships:
‰ In Canadian P&C, our automated leads management engine, which uses data to identify customer opportunities, has generated incremental revenue by presenting customers with proactive needs-based product and service offers.
‰ In U.S. P&C, launched a new Home Lending Loan Origination system with e-disclosures, online loan tracker and digital loan processing.
‰ Across the business, improved online sales processes driving growth in sales volumes. Online retail banking sales volumes across Canada are now equivalent to sales at over 100 branches.
‰ Optimized our cost structure to deliver greater efficiencies:
‰ Continued to roll out new branch formats offering smaller, more flexible and more cost-effective points of distribution across North America, including the introduction of our Smart Branch format in the United States, which allows customers to conduct transactions with ABM videotellers and makes day-to-day banking easier and more convenient.
‰ Continued to expand eStatements participation across North America, as more customers move to the paperless option.
‰ Divested our retirement services and municipal bond trading businesses to increase focus on our core Wealth and Capital Markets businesses.
‰ Improved data and analytical capabilities, which helped generate revenues and improved management of BMO’s expense base.
28 BMO Financial Group 198th Annual Report 2015
4. Expand strategically in select global markets to create future growth.
‰ Completed the integration of F&C Asset Management plc (F&C), and rebranded it as BMO Global Asset Management. This acquisition strengthens the position of BMO Global Asset Management as a top 50 global asset manager.
‰ BMO served as a co-chair of the Toronto Financial Services Alliance (TFSA) Renminbi (RMB) Working Group, which played a crucial role in establishing an offshore renminbi clearing hub in Canada. The Canadian hub facilitates settlements in renminbi, with the intention of encouraging trade and strengthening ties between Canadian companies and their Chinese business partners.
‰ Ranked among top 20 global investment banks and 12th largest investment bank in North and South America, based on fees, by Thomson Reuters.
5. Ensure our strength in risk management underpins everything we do for our customers.
‰ Leveraged our capital processes to enhance our risk appetite and limit framework through further alignment with our businesses’ capacity to bear risk.
‰ Developed and embedded our stress testing capabilities in business management processes and provided additional risk insights.
‰ Continued to improve risk culture as evidenced by internal and external surveys.
‰ Responded to rising regulatory expectations, evidenced by improvements in stress testing, market risk measurement and anti-money laundering.
‰ Continued to develop the next generation of our risk infrastructure by integrating, automating and upgrading our foundational capabilities.
BMO Financial Group 198th Annual Report 2015 29
MD&A
3. Leverage our consolidated North American platform to deliver quality earnings growth.
‰ Continued to develop consolidated North American capabilities and platforms in priority areas:
‰ Provided consistent brand messaging across the Canadian and U.S. businesses, building on shared customer insights to address the changing expectations of the banking industry.
‰ Completed a reorganization of Trading Products by asset class to further enhance customer experience and North American franchise value.
‰ Maintained key North-South leadership mandates to achieve greater consistency, eliminate duplication and leverage best practices.
‰ Continued to expand our business and capabilities in the United States:
‰ Announced the signing of an agreement to acquire General Electric Capital Corporation’s (GE Capital) Transportation Finance business with net earning assets on closing of approximately $11.9 billion (US$8.9 billion). The acquisition builds on our position as a market leader in commercial banking, and enhances our business position in the United States by further diversifying net income, adding scale and enhancing profitability and margins.
‰ Improved sales productivity across key products and segments through enhanced coaching and performance management, and deployment of customer acquisition programs.
‰ Introduced compelling offers in Canada that increased sales and established and strengthened client relationships, including the new Savings
Builder Account, Spring Home Financing and Summer Everyday Banking Campaigns.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Factors That May Affect Future Results
As noted in the following 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 actual results to differ materially from the expectations expressed in any forward-looking statement. The Enterprise-Wide Risk Management section starting on page 86 describes a number of risks, including credit and counterparty, market, liquidity and funding, operational, model, insurance, legal and regulatory, business, strategic, reputation, environmental and social. Should our risk management framework prove ineffective, there could be a material adverse impact on our financial position. MD&A
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 document, 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 2016 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, U.S. and international 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 document 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, volatile or illiquid capital and/or credit markets; interest rate and currency value fluctuations; changes in monetary, fiscal, tax or economic policy; the level of competition in the geographic and business areas in which we operate; changes in laws or in supervisory expectations or requirements, including capital, interest rate and liquidity requirements and guidance; 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, including obtaining regulatory approvals; the anticipated benefits from the acquisition of the GE Capital Transportation Finance business are not realized in the time frame anticipated or at all; critical accounting estimates and the effect of changes to accounting standards, rules and interpretations on these estimates; operational and infrastructure risks; changes to our credit ratings; general political conditions; global capital markets activities; the possible effects on our business of war or terrorist activities; outbreaks of disease or illness that affect local, national or international economies; natural disasters and disruptions to public infrastructure, such as transportation, communications, power or water supply; technological changes; and our ability to anticipate and effectively manage risks associated with all of the foregoing factors.
We caution that the foregoing list is not exhaustive of all possible factors. Other factors and risks could adversely affect our results. For more information, please see the discussion in the Risks That May Affect Future Results section on page 87, and the sections related to credit and counterparty, market, liquidity and funding, operational, model, insurance, legal and regulatory, business, strategic, reputation and environmental and social risk, which begin on page 94 and outline certain key factors and risks 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 and risks, 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 performance of the Canadian and U.S. economies, as well as overall market conditions and their combined effect on our business, are material factors we consider when determining our strategic priorities, objectives and expectations for our business. 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. See the Economic
Developments and Outlook section of this document.
Assumptions about current and expected capital requirements, GE Capital’s Transportation Finance business revenues and expenses, potential for earnings growth as well as costs associated with the transaction and expected synergies, were material factors we considered in estimating the impact of the acquired business on our net income, profitability and margins in 2016 and beyond.
Assumptions about current and expected capital requirements and our models used to assess those requirements under applicable capital guidelines, GE Capital’s
Transportation Finance business revenues and expenses, potential for earnings growth as well as costs associated with the transaction and expected synergies were material factors we considered in estimating the impact on our capital ratios in 2016 and beyond.
Economic Developments and Outlook
Economic Developments in 2015 and Outlook for 2016
Growth in the Canadian economy weakened in the first half of 2015, largely due to a sharp reduction in investment in the oil-producing regions and to continued weakness in the mining sector. Still, growth remained steady across most of the country, supported by an upturn in exports, as well as stable consumer spending and housing markets. Exports have benefitted from the effects of stronger U.S. demand, a weaker Canadian dollar and a modest pickup in the Eurozone economy, offset in part by slower growth in most emerging-market economies, notably China. While growth in
Canadian consumer spending has moderated as a result of elevated debt levels, it continues at a healthy rate, reflecting record sales of motor vehicles and steady demand for services. Home sales remain strong in the Vancouver and Toronto regions, supported by immigration and the millennial generation, many of whom are now in their prime home-buying years. Real GDP growth is expected to improve from an estimated 1.1% in
2015 to 2.0% in 2016, supported by modestly expansionary federal fiscal policy. Canadian households should continue to help sustain the economic expansion, as growth in employment remains healthy and interest rates are low, while the downturn in business investment is projected to stabilize in response to an expected partial recovery in oil prices. Growth in residential mortgages is expected to slow modestly to around 5% in 2016, and consumer credit should expand by close to 3%. Growth in business loans is projected to moderate from recent rates of around 8% this year to about
6%, reflecting lower levels of capital expenditures in the resource sector. After two rate reductions in 2015, the Bank of Canada is expected to hold interest rates steady in 2016, before shifting to a tightening stance in early 2017. The Canadian dollar is projected to weaken modestly in response to expected higher U.S. interest rates, before an anticipated upturn in oil prices provides some support in 2016.
30 BMO Financial Group 198th Annual Report 2015
Real Growth in Gross
Domestic Product (%)
Canadian and U.S.
Unemployment Rates (%)
(in thousands)
2.6
2.5
2.4 2.4
Housing Starts
7.0
6.6
7.0
6.6
6.8
5.7
5.0
1.5
1500
1000
150
2.0
250
200
2.0
500
4.6
1.1
100
2013
2014
2015*
2016*
Jan
2014
Canada
United States
Oct
2014
Oct Oct
2015 2016*
Canada
United States
*Forecast
0
09 10 11 12 13 14 15* 16*
Canada
United States
*Forecast
*Forecast
The Canadian and U.S. economies are expected to grow moderately in 2016.
Unemployment rates in
Canada and the United States are projected to decline modestly.
Housing market activity should moderate in Canada but strengthen in the United States.
Consumer Price Index
Inflation (%)
Canadian and U.S.
Interest Rates (%)
Canadian/U.S. Dollar
Exchange Rates
1.9
1.5
1.7
1.6
1.31 1.31
1.8
1.13
1.00
1.00
1.09
1.12
Jan
2014
Oct
2014
1.1
0.9
0.50 0.50
0.13
0.1
2013
2014
2015*
2016*
Jan
2014
0.13
Oct
2014
0.13
Oct Oct
2015 2016*
Oct Oct
2015 2016*
Canadian overnight rate
U.S. federal funds rate
Canada
United States
*Forecast
Inflation is expected to turn higher but remain low.
*Forecast
The Federal Reserve will likely raise interest rates moderately, while the Bank of Canada remains on the sidelines.
*Forecast
The Canadian dollar is expected to stabilize against the U.S. dollar as oil prices recover.
Note: Data points are averages for the month, quarter or year, as appropriate. References to years are calendar years.
BMO Financial Group 198th Annual Report 2015 31
MD&A
After a slow start to 2015 due to severe winter weather, shipping disruptions and a reduction in oil drilling activity, the U.S. economy has strengthened over the course of the year. Consumer spending has been sustained by improvements in household finances and steady growth in employment, while the housing market continues to benefit from low mortgage rates and less restrictive lending standards. Economic growth has also been impacted by weakness in exports due to the strong dollar, a decline in agriculture investment owing to low crop prices, and the effects of the downturn in the oil industry. Overall, real GDP is expected to grow by 2.5% in 2015 and 2.6% in 2016. Despite an expected modest increase in borrowing costs, growth in consumer credit and residential mortgages is expected to strengthen in 2016, supported by rising consumer confidence and robust demand for automobiles. Business loan growth should also remain healthy, supported by lower costs for imported machinery. With the unemployment rate projected to fall below 5% in 2016, the Federal Reserve is expected to increase interest rates. However, we anticipate a very modest tightening cycle in the face of global economic headwinds and continued low inflation. This should help to keep long-term interest rates relatively low in 2016.
Following modest economic growth in recent years, the pace of expansion in the U.S. Midwest region, which includes the six contiguous states comprising the BMO footprint, should improve to 1.8% in 2015 and 2.1% in 2016 in response to an increase in automobile production, the recovery in housing markets and generally expansionary fiscal policies. However, because of the ongoing weakness in exports, the region could continue to lag the national average.
This Economic Developments and Outlook section contains forward-looking statements. Please see the Caution Regarding Forward-Looking
Statements.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Value Measures
MD&A
Total Shareholder Return
The average annual total shareholder return (TSR) is a key measure of shareholder value, and confirms that our strategic priorities drive value creation for our shareholders. Our one-year TSR of negative 3% was better than the average of our Canadian bank peer group and the overall market return in
Canada. Our three-year average annual TSR of 13.5% was strong, outperforming our Canadian bank peer group and the overall market return in
Canada. Our five-year average annual TSR of 9.5% outperformed the overall market return in Canada, although it was slightly below our Canadian bank peer group.
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 BMO common shares made at the beginning of fiscal 2011 would have been worth $1,576 at October 31, 2015, assuming reinvestment of dividends, for a total return of 57.6%.
On December 1, 2015, BMO announced that the Board of Directors had declared a quarterly dividend payable to common shareholders of $0.84 per common share, an increase of $0.02 per share or 2% from the prior quarter and up $0.04 per share or 5% from a year ago. The dividend is payable on February 26, 2016 to shareholders of record on February 2, 2016. We have increased our quarterly dividend declared four times over the past two years from $0.76 per common share for the first quarter of 2014. Dividends paid over a ten-year period have increased at an average annual compound rate of 5.9%.
Three-Year Average Annual
Total Shareholder Return (%)
One-Year Total
Shareholder Return (%)
Five-Year Average Annual
Total Shareholder Return (%)
9.7
13.5
9.5
Canadian
Peer
Group
Average
BMO
Common
Shares
11.5
4.3
6.0
-3.0
-4.6
-4.6
S&P/TSX
Composite
Index
Canadian
Peer Group
Average
BMO
Common
Shares
S&P/TSX
Composite
Index
Canadian
Peer
Group
Average
BMO
Common
Shares
S&P/TSX
Composite
Index
All returns represent total returns.
All returns represent total returns.
All returns represent total returns.
BMO’s one-year TSR was better than the average of our Canadian peer group.
BMO’s three-year average annual return was strong.
BMO’s five-year average annual return outperformed the overall market return in Canada.
The average annual total shareholder return (TSR) represents the average annual total return earned on an investment in BMO common shares made at the beginning of a fixed period. The return includes the change in share price and assumes that dividends received were reinvested in additional common shares.
Total Shareholder Return
For the year ended October 31
Closing market price per common share ($)
Dividends paid ($ per share)
Dividend yield (%)
Increase (decrease) in share price (%)
Total annual shareholder return (%) (2)
2015
76.04
3.20
4.3
(7.0)
(3.0)
2014
2013
2012
81.73
3.04
3.8
12.5
17.1
72.62
2.92
4.0
23.0
28.8
59.02
2.80
4.8
0.2
5.2
2011
58.89
2.80
4.8
(2.2)
2.4
(1) Compound annual growth rate (CAGR) expressed as a percentage.
(2) 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. nm – not meaningful
32 BMO Financial Group 198th Annual Report 2015
3-year
CAGR (1)
5-year
CAGR (1)
8.8
4.6
4.8
2.7
nm
nm
nm
nm
13.5
9.5
Non-GAAP Measures
Results and measures in this MD&A are presented on a GAAP basis. They are also presented on an adjusted basis that excludes the impact of certain items as set out in the following table. Management assesses performance on a reported basis and on an adjusted basis and considers both to be useful in assessing underlying ongoing business performance. Presenting results on both bases provides readers with a better understanding of how management assesses results. It also permits readers to assess the impact of certain specified items on results for the periods presented and to better assess results excluding those items if they consider the items to not be reflective of ongoing results. As such, the presentation may facilitate readers’ analysis of trends, as well as comparisons with our competitors. Adjusted results and measures are non-GAAP and as such do not have standardized meaning under GAAP. They are unlikely to be comparable to similar measures presented by other companies and should not be viewed in isolation from or as a substitute for GAAP results.
(Canadian $ in millions, except as noted)
Reported Results
Revenue (1)
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
2015
2014
2013
18,223
(1,505)
16,830
(767)
18,135
(612)
(12,182)
16,718
(561)
(10,921)
16,063
(587)
(10,226)
Income before income taxes
Provision for income taxes
5,341
(936)
5,236
(903)
5,250
(1,055)
Net Income
Diluted EPS ($)
4,405
6.57
4,333
6.41
4,195
6.17
Revenue, net of CCPB
Provision for credit losses
Non-interest expense
Adjusting Items (Pre-tax) (2)
Credit-related items on the purchased performing loan portfolio (3)
Acquisition integration costs (4)
Amortization of acquisition-related intangible assets (5)
Decrease in the collective allowance for credit losses (6)
Run-off structured credit activities (7)
Restructuring costs (8)
–
(53)
(163)
–
–
(149)
–
(20)
(140)
–
–
–
406
(251)
(125)
2
40
(82)
Adjusting items included in reported pre-tax income
(365)
(160)
(10)
Adjusting Items (After tax) (2)
Credit-related items on the purchased performing loan portfolio (3)
Acquisition integration costs (4)
Amortization of acquisition-related intangible assets (5)
Increase in the collective allowance for credit losses (6)
Run-off structured credit activities (7)
Restructuring costs (8)
–
(43)
(127)
–
–
(106)
–
(16)
(104)
–
–
–
250
(155)
(89)
(9)
34
(59)
Adjusting items included in reported net income after tax
Impact on diluted EPS ($)
(276)
(0.43)
(120)
(0.18)
(28)
(0.04)
19,391
(1,254)
18,223
(1,505)
16,139
(767)
18,137
(612)
(11,819)
16,718
(561)
(10,761)
15,372
(357)
(9,755)
5,706
(1,025)
5,396
(943)
5,260
(1,037)
4,681
7.00
4,453
6.59
4,223
6.21
Adjusted Results
Revenue (1)
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
Revenue, net of CCPB
Provision for credit losses
Non-interest expense
Income before income taxes
Provision for income taxes
Net Income
Diluted EPS ($)
Adjusted results and measures in this table are non-GAAP amounts or non-GAAP measures.
(1) Effective the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
(2) Adjusting items are included in Corporate Services with the exception of the amortization of acquisition-related intangible assets, which is charged to the operating groups, and acquisition integration costs in 2015 and 2014 related to F&C, which are charged to Wealth Management.
(3) Credit-related items on the purchased performing portfolio in 2013 were comprised of revenue of $638 million, provisions for credit losses of $232 million and provisions for income taxes of
$156 million, resulting in an increase in reported net income after tax of $250 million. Effective the first quarter of 2014, Corporate Services adjusted results include credit-related items in respect of the purchased performing loan portfolio, including $103 million of revenue and $5 million of specific provisions for credit losses in 2015 ($238 million and $82 million in 2014, respectively).
(4) Acquisition integration costs related to F&C are charged to Wealth Management and acquisition integration costs related to Marshall & Isley Corporation and GE Capital’s Transportation Finance business are charged to Corporate Services. Acquisition integration costs are primarily recorded in non-interest expense.
(5) These expenses were included in the non-interest expense of the operating groups. Before and after-tax amounts for each operating group are provided on pages 47, 49, 53, 56 and 60.
(6) In 2013, the impact of the purchased performing portfolio on the collective allowance is reflected in credit-related items.
(7) Primarily comprised of valuation changes associated with these activities that are mainly included in trading revenues in non-interest revenue.
(8) Primarily due to restructuring to drive operational efficiencies. The charge in 2015 also includes the settlement of a legacy legal matter from an acquired entity.
BMO Financial Group 198th Annual Report 2015 33
MD&A
19,389
(1,254)
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Summary Financial Results and Earnings per Share Growth
The year-over-year percentage change in earnings per share (EPS) and in adjusted EPS are our key measures for analyzing earnings growth. All references to EPS are to diluted EPS, unless indicated otherwise.
EPS was $6.57, up $0.16 or 2% from $6.41 in 2014. Adjusted EPS was $7.00, up $0.41 or 6% from $6.59 in
2014. Our five-year average annual adjusted EPS growth rate was 7.9%, in line with our current medium-term objective of achieving average annual adjusted EPS growth of 7% to 10%. EPS growth in both 2015 and 2014 primarily reflected increased earnings. Adjusted net income available to common shareholders was 67% higher over the five-year period, while the average number of diluted common shares outstanding increased 15% over the same period.
Net income was $4,405 million in 2015, up $72 million or 2% from the previous year. Adjusted net income was $4,681 million, up $228 million or 5%.
On an adjusted basis, there was solid revenue growth in 2015. Higher revenue exceeded incremental costs, contributing to growth in net income. There were modestly higher provisions for credit losses and a slightly higher effective income tax rate in 2015.
There was good adjusted net income growth in Canadian P&C, Wealth Management and U.S. P&C, a decline in BMO Capital Markets and lower results in Corporate Services. In addition to operating performance, adjusted net income benefitted from the stronger U.S. dollar. This benefit was more than offset by lower purchased loan accounting benefits.
Canadian P&C adjusted net income increased $88 million or 4% to $2,108 million, due to continued revenue growth as a result of higher balances and improved non-interest revenue, with stable net interest margin, partially offset by higher expenses. Expenses rose primarily due to continued investment in the business, net of expense management, and higher costs associated with a changing business and regulatory environment.
Canadian P&C results are discussed in the operating group review on page 48.
U.S. P&C adjusted net income increased $174 million or 25% to $880 million, and increased $57 million or
9% to $701 million on a U.S. dollar basis, primarily due to lower provisions for credit losses. Revenue was stable as higher balances and increased mortgage banking revenue offset the effects of lower net interest margin. Noninterest expenses also remained stable. U.S. P&C results are discussed in the operating group review on page 51.
Wealth Management adjusted net income was $955 million, up $112 million or 13% from a year ago.
Adjusted net income in traditional wealth was $715 million, up $158 million or 28% from a year ago, due to good organic growth from the businesses, a gain on the sale of BMO’s U.S. retirement services business, and the full year benefit from the acquired F&C business. Adjusted net income in insurance was $240 million, compared to
$286 million a year ago, primarily due to higher taxes in the current year and higher actuarial benefits in the prior year. Wealth Management results are discussed in the operating group review on page 55.
BMO Capital Markets adjusted net income decreased $44 million or 4% to $1,034 million as the benefit of the stronger U.S. dollar was more than offset by higher provisions in the current year compared to net recoveries in the prior year. BMO Capital Markets results are discussed in the operating group review on page 58.
Corporate Services adjusted net loss for the year was $296 million, compared with an adjusted net loss of
$194 million a year ago. Adjusted results decreased mainly due to lower purchased loan portfolio revenues and lower credit recoveries. Corporate Services results are discussed in the operating group review on page 62.
Changes to reported and adjusted net income for each of our operating groups are discussed in more detail in the 2015 Operating Groups Performance Review, which starts on page 45.
EPS ($)
7.00
6.59
6.57
6.41
6.17 6.21
2013
2014
EPS
2015
Adjusted EPS
Growth demonstrates the benefits of our diversified business mix.
Earnings per share (EPS) is calculated by dividing net income attributable to bank shareholders, 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 25 on page 191 of the financial statements. Adjusted EPS is calculated in the same manner using adjusted net income.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
34 BMO Financial Group 198th Annual Report 2015
Return on Equity
Increased capital expectations for banks internationally have resulted in increased levels of common shareholders’ equity over the last several years which, all else being equal, negatively impacts return on equity
(ROE). ROE was 12.5% in 2015 and adjusted ROE was 13.3%, compared with 14.0% and 14.4%, respectively, in
2014. ROE declined in 2015 primarily due to growth in common equity exceeding growth in income. There was an increase of $96 million in earnings ($252 million in adjusted earnings) available to common shareholders in
2015. Average common shareholders’ equity increased by $4.5 billion from 2014, primarily due to the impact of the stronger U.S. dollar on our investments in foreign operations and increased retained earnings. Adjusted return on tangible common equity (ROTCE) was 16.4%, compared with 17.4% in 2014. Book value per share increased
17% from the prior year to $56.31, given the substantial increase in shareholders’ equity. ROTCE is meaningful both because it measures the performance of businesses consistently, whether they were acquired or developed organically, and because it is commonly used in the North American banking industry.
17.4
17.3
14.9 15.0
16.4
14.0 14.4
12.5
2013
ROE
2014
Adjusted ROE
13.3
2015
Adjusted ROTCE
ROE remains strong.
MD&A
Return on common shareholders’ equity (ROE) is calculated as net income, less non-controlling interest in subsidiaries and 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. Adjusted ROE is calculated using adjusted net income rather than net income.
ROE (%)
Adjusted return on tangible common equity (ROTCE) is calculated as adjusted net income available to common shareholders as a percentage of average tangible common equity. Tangible common equity is calculated as common shareholders’ equity less goodwill and acquisition-related intangible assets, net of related deferred tax liabilities.
Return on Equity and Adjusted Return on Tangible Common Equity
(Canadian $ in millions, except as noted)
For the year ended October 31
Reported net income
Attributable to non-controlling interest in subsidiaries
Preferred dividends
Net income available to common shareholders
Average common shareholders’ equity
Return on equity (%)
Adjusted net income available to common shareholders
Adjusted return on equity (%)
Average tangible common equity
Adjusted return on tangible common equity (%)
2015
2014
2013
2012
2011*
4,405
(35)
(117)
4,333
(56)
(120)
4,195
(65)
(120)
4,156
(74)
(136)
3,114
(73)
(146)
4,253
34,135
4,157
29,680
4,010
26,956
3,946
24,863
2,895
19,145
12.5
14.0
14.9
15.9
15.1
4,529
13.3
4,277
14.4
4,038
15.0
3,849
15.5
3,056
16.0
27,666
24,595
22,860
20,798
16,790
16.4
17.4
17.3
18.0
17.9
* 2011 has not been restated to reflect the IFRS standards adopted in 2014.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
Basel III Common Equity Tier 1 Ratio
BMO’s Basel III Common Equity Tier 1 (CET1) Ratio is the last of our four key value measures. BMO’s CET1 Ratio is strong and exceeds the Office of the Superintendent of Financial Institutions Canada’s requirements for large
Canadian banks. Our CET1 Ratio was 10.7% at October 31, 2015, compared to 10.1% at October 31, 2014.
The CET1 Ratio increased by 60 basis points from the end of fiscal 2014 primarily due to higher capital, partially offset by an increase in risk-weighted assets. The acquisition of GE Capital’s Transportation Finance business is expected to reduce BMO’s CET1 Ratio by approximately 70 basis points on closing in the first quarter of 2016.
Basel III Common Equity Tier 1 (CET1) Ratio is calculated as CET1 capital, which is comprised of common shareholders’ equity less deductions for goodwill, intangible assets, pension assets, certain deferred tax assets and other items, divided by risk-weighted assets for CET1.
Basel III CET1 Ratio (%)
9.9
10.1
2013
2014
10.7
2015
BMO’s CET1 Ratio has been consistently strong.
BMO Financial Group 198th Annual Report 2015 35
MANAGEMENT’S DISCUSSION AND ANALYSIS
2015 Financial Performance Review
This section provides a review of our enterprise financial performance for 2015 that focuses on the Consolidated Statement of Income included in our consolidated financial statements, which begin on page 135. A review of our operating groups’ strategies and performance follows the enterprise review. A summary of the enterprise financial performance for 2014 appears on page 64. This section contains adjusted results, which are non-GAAP and are disclosed in more detail in the Non-GAAP Measures section on page 33.
Highlights
MD&A
‰ On a net revenue basis(1), revenue increased $1,417 million or 8% in
‰ Provisions for credit losses totalled $612 million in the current year,
2015 to $18,135 million. Adjusted revenue increased $1,419 million or 8% to $18,137 million. Revenue growth was due to the benefits of our diversified business mix and successful execution against our strategic priorities. The impact of the stronger U.S. dollar increased adjusted net revenue growth by $732 million or 4%. The remaining increase was mainly due to revenue growth in Canadian P&C and
Wealth Management.
‰ Revenue growth in Canadian P&C reflected higher balances and improved non-interest revenue. U.S. P&C revenue increased
$458 million or 15% on a Canadian dollar basis, and was stable on a
U.S. dollar basis as strong commercial loan growth and increased mortgage banking revenue offset the effects of lower net interest margin. Wealth Management revenue growth was driven by traditional wealth growth of 20%, including the full year contribution from the acquired F&C business. Insurance net revenue declined due to higher actuarial benefits in the prior year. BMO Capital Markets revenue increased, driven by the stronger U.S. dollar. Corporate
Services adjusted revenue declined mainly due to lower revenue related to the purchased loan portfolio.
up from $561 million in 2014, primarily due to lower recoveries in
Corporate Services and higher provisions in BMO Capital Markets, partially offset by reduced provisions in the P&C businesses.
‰ Adjusted non-interest expense increased $1,058 million or 10% to $11,819 million, of which approximately 6% was due to the stronger U.S. dollar, 2% was due to the inclusion of F&C results for two additional quarters relative to a year ago, and 2% was due to business growth.
‰ The effective income tax rate in 2015 was 17.5%, compared with
17.2% in 2014. The adjusted effective income tax rate(2) was
18.0%, compared with 17.5% in 2014. The higher adjusted effective tax rate was attributable to a lower proportion of income from lower tax rate jurisdictions.
36 BMO Financial Group 198th Annual Report 2015
(1) See page 38 for a description of net revenue.
(2) The adjusted rate is computed using adjusted net income rather than net income in the determination of income subject to tax.
Foreign Exchange
Effects of Changes in Exchange Rates on BMO’s Reported and Adjusted Results
2015 vs.
2014
(Canadian $ in millions, except as noted)
Canadian/U.S. dollar exchange rate (average)
2015
2014
2013
1.2550
1.0937
Effects on reported results
Increased net interest income
Increased non-interest revenue
2014 vs.
2013
1.0937
1.0235
409
351
183
150
760
(5)
(598)
(33)
333
(1)
(262)
(14)
Increased reported net income before impact of hedges
Hedging losses in current year after tax
124
(21)
56
(10)
Increased reported net income
103
46
Effects on adjusted results
Increased net interest income
Increased non-interest revenue
409
351
183
150
760
(15)
(578)
(34)
333
(2)
(255)
(15)
Increased adjusted net income before impact of hedges
Hedging losses in current year after tax
133
(21)
61
(10)
Increased adjusted net income
112
51
Increased revenues
Increased provision for credit losses
Increased expenses
Increased income taxes
Increased revenues
Increased provision for credit losses
Increased expenses
Increased income taxes
Caution
This Foreign Exchange section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 37
MD&A
The U.S. dollar was stronger compared to the Canadian dollar at October 31, 2015 than at October 31, 2014. BMO’s U.S.-dollar-denominated assets and liabilities are translated at year-end rates. The average exchange rate over the course of 2015, which is used in the translation of BMO’s
U.S.-dollar-denominated revenues and expenses, was higher in 2015 than in 2014. Consequently, the Canadian dollar equivalents of BMO’s
U.S.-dollar-denominated net income, revenues, expenses, recovery of (provision for) credit losses and income taxes in 2015 increased relative to the preceding year. The table below indicates average Canadian/U.S. dollar exchange rates in 2015, 2014 and 2013 and the impact of changes in the average rates on our U.S. segment results. At October 31, 2015, the Canadian dollar traded at $1.3075 per U.S. dollar. It traded at $1.1271 per
U.S. dollar at October 31, 2014.
Changes in the exchange rate will affect future results measured in Canadian dollars and the impact on those results is a function of the periods in which revenues, expenses and provisions for (recoveries of) credit losses arise. If future results are consistent with results in 2015, each one cent increase (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 increase (decrease) the Canadian dollar equivalent of U.S.-dollar-denominated adjusted net income before income taxes for the year by
$10 million in the absence of hedging transactions.
Economically, our U.S. dollar income stream was largely unhedged to changes in foreign exchange rates during the year. During 2015, we hedged a portion of the forecasted BMO Capital Markets U.S. dollar net income. These hedges are subject to mark-to-market accounting, which resulted in a $21 million after tax loss in 2015, which was recorded in our BMO Capital Markets business.
We regularly determine whether to execute hedging transactions to mitigate the impact of foreign exchange rate movements on net income.
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Revenue(1)
Revenue increased $1,166 million or 6% in 2015 to $19,389 million. On a basis that nets insurance claims, commissions and changes in policy benefit liabilities (CCPB) against insurance revenue (net revenue), revenue increased $1,417 million or 8% to $18,135 million.
Amounts in the rest of this Revenue section are stated on an adjusted basis.
Net revenue increased $1,419 million or 8% to $18,137 million, including a $732 million or 4% impact of the stronger U.S. dollar, mainly due to growth in Canadian P&C and Wealth Management. BMO analyzes revenue at the consolidated level based on GAAP revenues as reported in the financial statements, and on an adjusted basis. Consistent with our Canadian peer group, we analyze revenue on a taxable equivalent basis (teb) at the operating group level. The teb adjustments for 2015 totalled $524 million, up from $476 million in 2014.
Canadian P&C revenue increased $235 million or 4% as a result of higher balances and improved non-interest revenue, with stable net interest margin. U.S. P&C revenue increased $458 million or 15% on a Canadian dollar basis and remained stable at $2,877 million on a U.S. dollar basis, as higher balances and increased mortgage banking revenue offset the effects of lower net interest margin.
Wealth Management revenue increased $676 million or 18% to $4,509 million on a net revenue basis, with traditional wealth growth of 20% due to good growth in client assets, including the full year benefit from the acquired F&C business. Net insurance revenue decreased due to higher actuarial benefits in the prior year.
BMO Capital Markets revenue increased $153 million or 4% to $3,873 million due to the stronger U.S. dollar. Higher trading revenues, including the prior year unfavourable impact of implementing a funding valuation adjustment, and higher lending revenues were offset by lower investment banking fees and reduced securities gains.
Corporate Services adjusted revenue declined by $105 million, mainly due to lower revenue related to the purchased loan portfolio.
(1) Commencing in 2015, insurance claims, commissions and changes in policy benefit liabilities are reported separately. They were previously reported as a reduction in insurance revenue in noninterest revenue. Prior period amounts and ratios have been reclassified. Insurance can experience variability arising from fluctuations in the fair value of insurance assets and the related liabilities.
The investments which support actuarial liabilities are predominantly fixed income assets recorded at fair value with changes in the fair values recorded in insurance revenue in the Consolidated
Statement of Income. These fair value changes are largely offset by changes in the fair value of policy benefit liabilities, the impact of which is reflected in insurance claims, commissions and changes in policy benefit liabilities. The discussion of revenue on a net basis reduces this variability in the results, which allows for a better discussion of operating results.
Taxable equivalent basis (teb) Revenues of operating groups are presented in our MD&A on a taxable equivalent basis (teb). The teb adjustment increases GAAP revenue and the provision for income taxes by an amount that would increase revenue on certain tax-exempt items to a level that would incur tax at the statutory rate, to facilitate comparisons. This adjustment is offset in Corporate Services.
Revenue and Adjusted Revenue (1)
(Canadian $ in millions, except as noted)
For the year ended October 31
2014
2013
2012
2011*
8,461
(3)
9,762
20
8,677
(3)
8,153
–
8,937
20
8,166
8
7,474
20
7,587
8
18,223
319
8
2
16,830
87
(2)
1
17,103
98
14
1
15,061
(188)
14
1
8,971
6
10,420
7
8,461
5
9,762
20
8,020
(2)
8,119
3
8,158
13
7,882
4
7,248
16
7,612
8
Total adjusted revenue (2)
Year-over-year growth (%)
19,391
6
18,223
13
16,139
1
16,040
8
14,860
12
Total adjusted revenue, net of CCPB (2)
Cdn./U.S. dollar translation effect
Year-over-year growth (%)
Impact of Cdn./U.S. dollar translation effect (%)
18,137
732
8
4
16,718
319
9
2
15,372
78
3
1
14,866
85
8
1
13,742
(173)
12
1
2015
Net interest income
Year-over-year growth (%)
Non-interest revenue
Year-over-year growth (%)
8,970
6
10,419
7
Total revenue
Cdn./U.S. dollar translation effect
Year-over-year growth (%)
Impact of Cdn./U.S. dollar translation effect (%)
19,389
732
6
4
Adjusted net interest income
Year-over-year growth (%)
Adjusted non-interest revenue
Year-over-year growth (%)
* Growth rates for 2011 reflect growth based on CGAAP in 2010 and IFRS in 2011. 2011 has not been restated to reflect the new IFRS standards adopted in 2014.
(1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
(2) Adjusted revenue for 2011-2013 excludes the portion of the credit mark recorded in net interest income on the purchased performing loan portfolio and income or losses from run-off structured credit activities recorded in non-interest revenue, which are recorded in Corporate Services, as discussed in the Non-GAAP Measures section on page 33.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
38 BMO Financial Group 198th Annual Report 2015
Net Interest Income
Net interest income for the year was $8,970 million, an increase of $509 million or 6% from 2014, due to the impact of the stronger U.S. dollar and volume growth, partially offset by lower net interest margin and lower revenue from the purchased loan portfolio. The impact of the stronger
U.S. dollar increased net interest income by $409 million.
BMO’s average earning assets increased $51 billion or 10% in 2015, including a $32 billion increase as a result of the stronger U.S. dollar.
There was growth in all operating groups.
The main drivers of BMO’s overall net interest margin are the individual group margins, changes in the magnitude of each operating group’s average earning assets and changes in net interest income in Corporate Services. Changes are discussed in the 2015 Operating Groups Performance
Review section starting on page 45.
Table 5 on page 122 and Table 6 on page 123 provide further details on net interest income and net interest margin.
Net interest income is comprised of earnings on assets, such as loans and securities, including interest and dividend income and BMO’s share of income from investments accounted for using the equity method of accounting, less interest expense paid on liabilities, such as deposits.
Average Earning Assets and
Net Interest Margin
Net Revenue by Country (%)
Net Revenue
Net Interest Income and Net Non-Interest Revenue
MD&A
Net interest margin is the ratio of net interest income to average earning assets, expressed as a percentage or in basis points.
($ billions)
($ billions)
529
485
579
16.1 15.4
7.4 7.4
16.7 16.7
18.1 18.1
16.1 15.4
8.2 8.2
16.7 16.7
18.1 18.1
65
64
33
1.79
1.60
1.60
1.65
8.7 8.0
8.5 8.5
9.0 9.0
2014
2015
Average earning assets ($ billions)
Net interest margin (%)
Adjusted net interest margin (%)
Average earning assets increased 10% and adjusted net interest margin decreased in the low-rate environment.
2013
2014
2013
2015
Net interest income
Net non-interest revenue
Adjusted net interest income
Adjusted net non-interest revenue
2014
2013
2015
2014
2015
Canada
United States
Other countries
Total net revenue
Total net adjusted revenue
The change in net revenue in other countries is primarily due to the F&C acquisition.
Canadian P&C and Wealth
Management drove net revenue growth. There was growth in adjusted net non-interest revenue and net interest income, reflecting good underlying business growth. 6
5
3
2013
32
30
1.55
1.55
62
9.1 9.1
Change in Net Interest Income, Average Earning Assets and Net Interest Margin
(Canadian $ in millions, except as noted)
For the year ended October 31
Canadian P&C
U.S. P&C
Personal and Commercial Banking (P&C)
Wealth Management
BMO Capital Markets
Corporate Services
Net interest income (teb)
Change
Average earning assets
Change
Net interest margin
(in basis points)
2015
2014
%
2015
2014
%
2015
2014
4,937
2,834
4,780
2,482
3
14
189,505
81,965
183,406
68,312
3
20
261
346
261
363
–
(17)
7,771
642
1,334
(777)
7,262
560
1,177
(538)
7
15
13
44
271,470
23,784
238,916
45,301
251,718
21,169
222,471
33,428
8
12
7
36
286
270
56
289
265
53
(3)
5
3
nm
nm
Change
nm
Total BMO reported
8,970
8,461
6
579,471
528,786
10
155
160
(5)
U.S. P&C (US$ in millions)
2,259
2,269
–
65,319
62,443
5
346
363
(17)
nm – not meaningful
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 39
MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
Non-Interest Revenue
Non-interest revenue, which comprises all revenue other than net interest income, increased $908 million or 11% on a net revenue basis to
$9,165 million. Excluding the impact of the stronger U.S. dollar, net non-interest revenue increased 7% with the majority of the growth driven by strong performance in Wealth Management, as well as growth in the P&C businesses.
Mutual fund revenue increased $312 million and investment management and custodial fees increased $254 million, both due to good organic growth in client assets and the contribution from six additional months of revenue from the F&C business relative to a year ago and the impact of the stronger U.S. dollar.
Deposit and payment service charges increased $75 million, due to the impact of the stronger U.S. dollar and growth in Canadian P&C.
Lending fees increased $57 million, due to the impact of the stronger U.S. dollar and growth in lending activity in BMO Capital Markets and in the Canadian P&C loan portfolio.
Trading revenues increased $38 million and are discussed in the Trading-Related Revenues section that follows.
Securities commissions and fees increased $19 million. These revenues consist largely of brokerage commissions within Wealth Management, which account for about three-quarters of the total, and institutional equity trading commissions within BMO Capital Markets. The increase is due to the stronger U.S. dollar and higher client activity in BMO Capital Markets, partially offset by lower securities commissions in Wealth Management due to softer equity markets.
Insurance revenue decreased $246 million from a year ago, when lower long-term interest rates increased the fair value of insurance investments, partially offset by increased underlying business premium income in 2015. The decrease in insurance revenue was largely offset by lower insurance claims, commissions and changes in policy benefit liabilities as discussed on page 41.
Underwriting and advisory fees decreased $38 million, due to more challenging market conditions, offset in part by the impact of the stronger
U.S. dollar.
Other non-interest revenue includes various sundry amounts and increased by $186 million from the prior year, primarily due to a gain on sale of
BMO’s U.S. retirement services business and a legal settlement.
Foreign exchange, other than trading, securities gains and card fees were largely consistent with the prior year.
Table 3 on page 120 provides further details on revenue and revenue growth.
Non-Interest Revenue (1)
(Canadian $ in millions)
For the year ended October 31
Securities commissions and fees
Deposit and payment service charges
Trading revenues
Lending fees
Card fees
Investment management and custodial fees
Mutual fund revenues
Underwriting and advisory fees
Securities gains, other than trading
Foreign exchange, other than trading
Insurance revenue (1)
Other
Total BMO reported (1)
BMO reported, net of CCPB
Insurance revenue, net of CCPB
Change from 2014
2015
2014
2013
953
1,077
987
737
460
1,500
1,385
706
171
172
1,762
509
934
1,002
949
680
462
1,246
1,073
744
162
179
2,008
323
846
916
849
603
461
971
832
659
285
172
1,212
347
2
8
4
8
–
20
29
(5)
6
(4)
(12)
58
10,419
9,762
8,153
7
9,165
8,257
7,386
11
508
503
445
1
(1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
40 BMO Financial Group 198th Annual Report 2015
(%)
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 managing, within prescribed limits, the overall risk of the net positions. On a limited basis, BMO also earns revenue from principal trading positions.
Interest and non-interest trading-related revenues increased $86 million or 9%. Excluding the impact of the stronger U.S. dollar and the result of hedging a portion of U.S. net income, trading-related revenues increased by $75 million or 8%. Interest rate trading-related revenues increased
$82 million or 25%, including the prior year unfavourable impact of implementing a funding valuation adjustment, primarily due to increased client activity in our fixed income businesses. Foreign exchange trading-related revenues were up $25 million or 7%, driven by increased client activity in response to, among other things, the Bank of Canada rate changes and potential changes by the U.S. Federal Reserve. Equities trading-related revenues increased $7 million or 1%, reflecting increased activity with corporate and investor clients. Commodities trading-related revenues increased
$3 million or 6% due to increased client hedging activity.
The Market Risk section on page 100 provides more information on trading-related revenues.
MD&A
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-related revenues also include income (expense) and gains (losses) from both on-balance sheet instruments and interest rate, foreign exchange (including spot positions), equity, commodity and credit contracts.
Interest and Non-Interest Trading-Related Revenues (1)
Change
from 2014
(%)
(Canadian $ in millions)
(taxable equivalent basis)
For the year ended October 31
2015
2014
2013
Interest rates
Foreign exchange
Equities
Commodities
Other (2)
422
364
638
56
6
325
356
626
46
13
479
285
499
43
29
Total (teb)
Teb offset
1,486
467
1,366
433
1,335
309
9
8
Reported Total
1,019
933
1,026
9
499
987
417
949
486
849
20
4
Total (teb)
Teb offset
1,486
467
1,366
433
1,335
309
9
8
Reported Total, net of teb offset
1,019
933
Reported as:
Net interest income
Non-interest revenue – trading revenues
Adjusted net interest income, net of teb offset
Adjusted non-interest revenue – trading revenues
Adjusted total, net of teb offset
32
987
1,019
30
2
2
21
(54)
1,026
9
(16)
949
157
815
+100
4
933
972
9
(1) Trading-related revenues are presented on a taxable equivalent basis.
(2) Includes nominal revenues from run-off structured credit activities and hedging exposures in BMO’s structural balance sheet. Prior to 2014, the structured credit revenues were adjusting items and excluded from adjusted trading-related revenues.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
Insurance Claims, Commissions and Changes in Policy Benefit Liabilities
Insurance claims, commissions and changes in policy benefit liabilities were $1,254 million in the current year, down $251 million from
$1,505 million in 2014 when lower long-term interest rates increased the fair value of investments backing our policy benefit liabilities, partially offset by increased underlying business premium income in 2015. The decline was largely offset in revenue.
BMO Financial Group 198th Annual Report 2015 41
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Provision for Credit Losses
The provision for credit losses (PCL) was $612 million in the current year, up from $561 million in 2014. There was no net change to the collective allowance in the year. The increase in PCL was due to lower recoveries in Corporate Services and higher provisions in BMO Capital Markets, partially offset by reduced provisions in the P&C businesses.
PCL as a percentage of average net loans and acceptances was 0.19% in 2015, consistent with the prior year.
On an operating group basis, most of our provisions relate to Personal and Commercial Banking. In Canadian P&C, PCL decreased by $32 million to $496 million in 2015, reflecting lower provisions in both the consumer and commercial portfolios. U.S. P&C PCL was $119 million, down $58 million from 2014, reflecting better credit quality in both the consumer and commercial loan portfolios and loan sale benefits. Wealth Management provisions increased to $7 million in 2015, compared to a net recovery of $3 million in the previous year. BMO Capital Markets recorded provisions of
$26 million, compared to net recoveries of $18 million in the prior year. Corporate Services recoveries of credit losses of $36 million in 2015 were down from $123 million in 2014, primarily reflecting lower recoveries.
On a geographic basis, the majority of our provisions relate to our Canadian loan portfolio. Specific PCL in Canada and other countries (excluding the United States) was $498 million, compared to $527 million in 2014. Specific PCL in the United States was $114 million, up from $34 million in
2014, reflecting lower Corporate Services loan recoveries in 2015. Note 4 on page 148 of the financial statements provides PCL information on a geographic basis. Table 15 on page 130 provides further PCL segmentation information.
Provision for Credit Losses
(Canadian $ in millions, except as noted)
For the year ended October 31
New specific provisions
Reversals of previously established allowances
Recoveries of loans previously written off
Specific provision for credit losses
Decrease in collective allowance
2015
2014
2013
1,278
(210)
(456)
1,413
(228)
(624)
1,636
(267)
(772)
612
–
561
–
597
(10)
Provision for credit losses (PCL)
612
561
587
PCL as a % of average net loans and acceptances (annualized)
0.19
0.19
0.22
2015
2014
2013
496
119
528
177
559
236
Personal and Commercial Banking
Wealth Management
BMO Capital Markets
Corporate Services, including T&O (1)
Impaired real estate loans
Interest on impaired loans
Purchased credit impaired loans
Purchased performing loans (1)
615
7
26
705
(3)
(18)
795
3
(36)
28
17
(86)
5
21
26
(252)
82
(43)
48
(410)
–
Adjusted provision for credit losses
Purchased performing loans (1)
Decrease in collective allowance
612
–
–
561
–
–
357
240
(10)
Provision for credit losses
612
561
587
Provision for Credit Losses by Operating Group
(Canadian $ in millions)
For the year ended October 31
Canadian P&C
U.S. P&C
(1) Effective the first quarter of 2014, Corporate Services adjusted results include credit-related items in respect of the purchased performing loan portfolio. Further details are provided in the Non-GAAP
Measures section on page 33.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
42 BMO Financial Group 198th Annual Report 2015
Non-Interest Expense
(1) This ratio is calculated excluding insurance claims, commissions and changes in policy benefit liabilities (CCPB).
The efficiency ratio (or expense-to-revenue ratio) is a key measure of productivity. It is calculated as non-interest expense divided by total revenue (on a taxable equivalent basis in the operating groups), expressed as a percentage. The adjusted efficiency ratio is another key measure of productivity and is calculated in the same manner, utilizing adjusted revenue and expense.
Contribution to Growth in Adjusted Non-Interest Expense and Non-Interest Expense (%)
For the year ended October 31
2015
2014
2013
Significant businesses acquired
Canadian/U.S. dollar translation effect, excluding acquisitions
Other
2.3
5.4
2.1
1.5
2.5
6.3
0.4
0.8
2.5
Total adjusted non-interest expense growth
Impact of adjusting items
9.8
1.7
10.3
(3.5)
3.7
(2.8)
11.5
6.8
0.9
Total non-interest expense growth
BMO Financial Group 198th Annual Report 2015 43
MD&A
Non-interest expense increased $1,261 million or 12% to $12,182 million in 2015. Reported results in 2015 included a $149 million charge, primarily due to restructuring to drive operational efficiencies.
Amounts in the rest of this Non-Interest Expense section are stated on an adjusted basis, unless otherwise noted.
Adjusted non-interest expense excludes acquisition integration costs for certain significant acquisitions and amortization of acquisition-related intangible assets in 2015, 2014 and 2013, and restructuring costs in 2015 and 2013 to align our cost structure with the environment.
Adjusted non-interest expense increased $1,058 million or 10% to $11,819 million, of which approximately 6% was due to the stronger U.S. dollar, and 2% was due to the inclusion of F&C results for two additional quarters, excluding which adjusted non-interest expense increased by 2% due to business growth.
The dollar and percentage changes in expense by category are outlined in the adjacent Adjusted Non-Interest Expense and Non-Interest Expense table. Table 4 on page 121 provides more detail on expenses and expense growth.
Performance-based compensation was unchanged, excluding the impact of the stronger U.S. dollar and the inclusion of F&C’s results for two additional quarters relative to a year ago. On the same basis, other employee compensation, which includes salaries, benefits and severance, increased $214 million or 5%, primarily due to merit increases and higher pension costs.
Premises and equipment costs increased $143 million or 7%, excluding the impact of the stronger U.S. dollar, mainly due to higher costs related to technology investments.
Other adjusted expenses declined $20 million or 1%, excluding the impact of the stronger U.S. dollar.
BMO’s reported efficiency ratio was 62.8% and its adjusted efficiency ratio was 60.9% in 2015. On a net revenue basis, the adjusted efficiency ratio increased 80 basis points to 65.2% from 2014, primarily due to the currency impact of our foreign operations. On a basis that excludes the impact of the stronger U.S. dollar and purchased loan accounting impacts, operating leverage was 0.6% and the efficiency ratio would have been lower year over year.
Canadian P&C is BMO’s largest operating segment, and its reported efficiency ratio of 50.3% increased by 60 basis points, mainly due to lower revenue growth.
The adjusted efficiency ratio in U.S. P&C increased by 60 basis points to 64.2% due to modestly higher expenses in a challenging revenue growth environment for U.S. banks.
The adjusted efficiency ratio in Wealth Management on a net revenue basis improved by 40 basis points to 71.5%.
BMO Capital Markets reported efficiency ratio increased by 100 basis points to 64.2%, as the stronger U.S. dollar increased the weighting of its higher efficiency U.S. business.
On a net revenue basis, reported operating leverage was negative 3.0% in 2015 and adjusted operating leverage was negative 1.3%. On a net revenue basis and excluding the impact of the stronger U.S. dollar, adjusted operating leverage was negative 0.3%, and also excluding purchased loan accounting impacts it was positive 0.5%. Our ongoing focus on improving efficiency and generating positive operating leverage, by driving revenue growth through a strong customer focus and maintaining disciplined cost management, resulted in positive adjusted operating leverage on a net revenue basis in each of the last two quarters of 2015.
Examples of initiatives to enhance productivity are outlined in the 2015 Operating Groups Performance Review, which starts on page 45.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Adjusted Non-Interest Expense and Non-Interest Expense
2015
2014
2013
Change from 2014
(%)
Performance-based compensation
Other employee compensation (1)
2,087
4,835
1,939
4,294
1,682
4,026
8
12
Total employee compensation
Premises and equipment
Other
Amortization of intangible assets
6,922
2,130
2,519
248
6,233
1,908
2,378
242
5,708
1,743
2,083
221
11
12
6
2
Total adjusted non-interest expense
Adjusting items
11,819
363
10,761
160
9,755
471
10
+100
Total non-interest expense
12,182
10,921
10,226
12
9.8
11.5
10.3
6.8
3.7
0.9
na na MD&A
(Canadian $ in millions, except as noted)
For the year ended October 31
Adjusted non-interest expense growth (%)
Non-interest expense growth (%)
(1) Includes restructuring costs in 2015 and 2013 to align our cost structure with the environment. na – not applicable
Efficiency Ratio by Group (teb) (%)
For the year ended October 31
2015
2014
2013
Efficiency Ratio
Canadian P&C
U.S. P&C
Wealth Management
BMO Capital Markets
50.3
66.1
58.3
64.2
49.7
65.9
53.2
63.2
50.7
64.6
55.8
61.5
Total BMO
62.8
59.9
60.8
Adjusted Efficiency Ratio
Canadian P&C
U.S. P&C
Wealth Management
Wealth Management, net of CCPB
BMO Capital Markets
50.2
64.2
55.9
71.5
64.1
49.6
63.6
51.7
71.9
63.2
50.7
61.8
54.9
67.1
61.5
Total BMO
Total BMO, net of CCPB
60.9
65.2
59.1
64.4
60.4
63.5
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
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 24 on page 189 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 $936 million in 2015, compared with $903 million in 2014. The reported effective tax rate in 2015 was
17.5%, compared with 17.2% in 2014. The adjusted provision for income taxes(1) was $1,025 million in 2015, compared with $943 million in 2014.
The adjusted effective tax rate in 2015 was 18.0%, compared with 17.5% in 2014. The change in the tax rate from year to year is attributable to a lower proportion of income from lower tax rate jurisdictions.
BMO partially hedges the foreign exchange risk arising from its foreign operations by funding the investments in the corresponding foreign currency. The gain or loss on hedging and the unrealized gain or loss on translation of foreign operations are charged or credited to shareholders’ equity. For income tax purposes, the gain or loss on the hedging activities results in 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 foreign operations does not incur 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 foreign operations has given rise to an income tax recovery in shareholders’ equity of $167 million for the year, compared with $144 million in 2014. Refer to the Consolidated Statement of Changes in Equity on page 138 of the financial statements for further details.
Table 4 on page 121 details the $1,651 million of total net government levies and income tax expense incurred by BMO in 2015. The increase from $1,505 million in 2014 was primarily due to higher payroll levies and sales taxes.
(1) The adjusted rate is computed using adjusted net income rather than net income in the determination of income subject to tax.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
44 BMO Financial Group 198th Annual Report 2015
2015 Operating Groups Performance Review
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 54)
Net income was $2,931 million in 2015, an increase of $261 million or 10% from 2014. Adjusted net income was $2,988 million, an increase of
$262 million or 10%. Personal and Commercial Banking is comprised of two operating segments: Canadian Personal and Commercial Banking
(Canadian P&C) and U.S. Personal and Commercial Banking (U.S. P&C).
Wealth Management (pages 55 to 57)
Net income was $850 million in 2015, an increase of $70 million or 9% from 2014. Adjusted net income was $955 million, an increase of
$112 million or 13%.
Corporate Services, including Technology and Operations (page 62)
Net loss was $408 million in 2015, compared with a net loss of $194 million in 2014. Adjusted net loss was $296 million, compared with an adjusted net loss of $194 million in 2014.
Allocation of Results
The basis for the allocation of results geographically and among operating groups is outlined in Note 27 on page 194 of the financial statements.
Certain prior year data has been restated, as explained on the following page, which also provides further information on the allocation of results.
Adjusted Net Income by Operating Segment*
Adjusted Net Income by Country
2015
2015
2014
Canadian P&C 42%
U.S. P&C 18%
Wealth Management 19%
BMO CM 21%
Canadian P&C 44%
U.S. P&C 15%
Wealth Management 18%
BMO CM 23%
2014
Canada 71%
U.S. 22%
Other countries 7%
Canada 74%
U.S. 20%
Other countries 6%
Results provide attractive diversification across businesses and geographies.
*Percentages determined excluding results in Corporate Services.
BMO Financial Group 198th Annual Report 2015 45
MD&A
BMO Capital Markets (BMO CM) (pages 58 to 61)
Net income was $1,032 million in 2015, a decrease of $45 million or 4% from 2014. Adjusted net income was $1,034 million, a decrease of
$44 million or 4%.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Contributions to Revenue, Expenses, Net Income and Average Assets by Operating Group and by Location
(Canadian $ in millions, except as noted) For the year ended
October 31
Personal and
Commercial Banking
2015
2014
2013
Wealth
Management
2015
2014
BMO
Capital Markets
2013
MD&A
Operating Groups Relative Contribution to BMO’s Performance (%)
Revenue
52.9
52.4
53.6
29.7
29.3
25.1
Expenses
47.0
48.2
48.8
27.6
26.0
23.0
Net income
66.5
61.6
57.3
19.3
18.0
19.7
Adjusted net
63.8
61.2
58.3
20.4
18.9
20.2 income Average assets
43.0
44.5
43.7
4.4
4.2
4.0
Total Revenue
Canada
United States
Other countries
Corporate
Services
Total
Consolidated
2015
2014
2013
2015
2014
2013
2015
2014
2013
20.0
20.4
23.4
20.4
21.5
24.9
20.1
20.4
24.8
(2.6)
5.0
(9.2)
(2.1)
4.3
(4.5)
1.2
7.8
(1.8)
100
100
100
100
100
100
100
100
100
22.1
43.7
24.2
43.7
24.7
44.4
(6.3)
8.9
(4.3)
7.6
(3.2)
7.9
100
100
100
100
100
100
6,639
3,609
1
6,403
3,151
2
6,019
3,000
1
3,279
1,016
1,468
3,739
788
811
2,795
910
511
2,298
1,379
196
2,249
1,261
210
2,167
1,064
152
(447)
(108)
59
(374)
(39)
22
(262)
467
6
11,769
5,896
1,724
12,017
5,161
1,045
10,719
5,441
670
10,249
9,556
9,020
5,763
5,338
4,216
3,873
3,720
3,383
(496)
(391)
211
19,389
18,223
16,830
3,340
2,386
–
3,188
2,071
–
3,051
1,940
–
1,969
818
570
1,824
721
295
1,651
599
101
1,171
1,116
199
1,186
970
195
1,084
842
156
252
336
25
97
326
48
194
575
33
6,732
4,656
794
6,295
4,088
538
5,980
3,956
290
5,726
5,259
4,991
3,357
2,840
2,351
2,486
2,351
2,082
613
471
802
12,182
10,921
10,226
2,103
827
1
2,011
658
1
1,813
588
1
497
127
226
498
58
224
425
206
196
851
178
3
815
235
27
832
207
1
(249)
(184)
25
(45)
(120)
(29)
(173)
117
(18)
3,202
948
255
3,279
831
223
2,897
1,118
180
2,931
2,670
2,402
850
780
827
1,032
1,077
1,040
(408)
(194)
(74)
4,405
4,333
4,195
Adjusted Net Income
Canada
2,107
United States
880
Other countries
1
2,015
710
1
1,818
643
1
534
150
271
516
80
247
426
228
200
851
180
3
814
237
27
832
209
1
(143)
(186)
33
(45)
(120)
(29)
(88)
(26)
(21)
3,349
1,024
308
3,300
907
246
2,988
1,054
181
2,988
2,726
2,462
955
843
854
1,034
1,078
1,042
(296)
(194)
(135)
4,681
4,453
4,223
Total Expenses
Canada
United States
Other countries
Net Income
Canada
United States
Other countries
Average Assets
Canada
196,739 190,053 177,015
United States
88,905 74,371 65,764
Other countries
49
39
18
19,907 18,368 17,438
4,888 4,055 3,527
4,352 2,557 1,178
160,547 142,859 133,513
106,540 97,228 94,840
23,238 19,659 18,349
24,973 19,407 17,737
34,175 25,261 25,345
78
71
707
402,166 370,687 345,703
234,508 200,915 189,476
27,717 22,326 20,252
285,693 264,463 242,797
29,147 24,980 22,143
290,325 259,746 246,702
59,226 44,739 43,789
664,391 593,928 555,431
How BMO Reports Operating Group Results
Periodically, certain business lines and units within the business lines are transferred between client and corporate support groups to more closely align BMO’s organizational structure with its strategic priorities. In addition, revenue and expense allocations are updated to more accurately align with current experience. Results for prior periods are restated to conform to the current presentation.
Corporate Services results reflect certain items in respect of the purchased loan portfolio, including the recognition of a portion of the credit mark that is reflected in net interest income over the term of the purchased loans and provisions and recoveries of credit losses on the purchased portfolio.
Restructuring costs are also included in Corporate Services. Amounts excluded from adjusted results in prior years included credit-related items in respect of the purchased performing loan portfolio, acquisition integration costs and run-off structured credit activities.
Starting in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately.
They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
Effective November 1, 2014, we adopted several new and amended accounting pronouncements issued by the International Accounting
Standards Board (IASB), which are outlined in Note 1 on page 140 of the financial statements.
BMO analyzes revenue at the consolidated level based on GAAP revenue reflected in the consolidated financial statements rather than on a taxable equivalent basis (teb), which is consistent with our Canadian peer group. Like many banks, we analyze revenue on a teb basis at the operating group level. This basis includes an adjustment that increases GAAP revenue and the GAAP provision for income taxes by an amount that would raise revenue on certain tax-exempt items 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 revenue and income tax provisions.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
46 BMO Financial Group 198th Annual Report 2015
Personal and Commercial Banking
The Personal and Commercial Banking (P&C) operating group represents the sum of our two retail and business banking operating segments,
Canadian P&C and U.S. P&C. These operating segments are reviewed separately in the sections that follow.
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
Canadian P&C
U.S. P&C
Total P&C
2014
2013
2015
2014
2013
2015
2014
2013
Net interest income (teb)
Non-interest revenue
4,937
1,703
4,780
1,625
4,536
1,484
2,834
775
2,482
669
2,321
679
7,771
2,478
7,262
2,294
6,857
2,163
Total revenue (teb)
Provision for credit losses
Non-interest expense
6,640
496
3,340
6,405
528
3,182
6,020
559
3,055
3,609
119
2,386
3,151
177
2,077
3,000
236
1,936
10,249
615
5,726
9,556
705
5,259
9,020
795
4,991
Income before income taxes
Provision for income taxes (teb)
2,804
700
2,695
679
2,406
594
1,104
277
897
243
828
238
3,908
977
3,592
922
3,234
832
Reported net income
Amortization of acquisition-related intangible assets (1)
2,104
4
2,016
4
1,812
5
827
53
654
52
590
55
2,931
57
2,670
56
2,402
60
Adjusted net income
2,108
2,020
1,817
880
706
645
2,988
2,726
2,462
4.4
4.4
3.7
5.0
4.9
11.2
11.2
6.4
4.2
4.2
2.3
2.4
2.0
3.4
3.4
26.5
24.8
14.6
14.9
15.6
10.7
9.2
5.1
7.3
8.1
6.9
3.7
(2.5)
(3.2)
(2.4)
(1.3)
(1.2)
50.3
50.2
2.61
2.2
2.2
49.7
49.6
2.61
(1.4)
(1.4)
50.7
50.7
2.66
(0.3)
(1.0)
66.1
64.2
3.46
(2.2)
(3.0)
65.9
63.6
3.63
0.7
(0.1)
64.6
61.8
3.88
Key Performance Metrics and Drivers
Net income growth (%)
Adjusted net income growth (%)
Revenue growth (%)
Non-interest expense growth (%)
Adjusted non-interest expense growth (%)
Return on equity (%)
Adjusted return on equity (%)
Operating leverage (teb) (%)
Adjusted operating leverage (teb) (%)
Efficiency ratio (teb) (%)
Adjusted efficiency ratio (teb) (%)
Net interest margin on average earning assets (teb) (%)
Average common equity
Average earning assets
Average current loans and acceptances
Average deposits
Assets under administration
Full-time equivalent employees
189,505
194,199
132,767
22,848
15,715
183,406
187,788
124,925
24,150
15,795
170,739
174,534
113,901
23,190
15,879
81,965
73,455
77,795
126,513
7,661
68,312
60,414
65,412
123,082
7,835
59,813
53,033
61,344
112,732
7,991
9.8
9.7
7.3
8.9
9.1
16.1
16.4
(1.6)
(1.8)
55.9
55.1
2.86
17,848
271,470
267,654
210,562
149,361
23,376
11.1
10.7
5.9
5.4
5.7
16.7
17.1
0.5
0.2
55.0
54.2
2.89
15,410
251,718
248,202
190,337
147,232
23,630
3.4
2.7
0.5
0.7
1.1
16.9
17.4
(0.2)
(0.6)
55.3
54.4
2.97
13,723
230,552
227,567
175,245
135,922
23,870
(1) Before tax amounts of $73 million in 2015, $75 million in 2014 and $87 million in 2013 are included in non-interest expense.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 47
MD&A
2015
MANAGEMENT’S DISCUSSION AND ANALYSIS
Canadian Personal and Commercial Banking
Canadian Personal and Commercial Banking provides a full range of financial products and services to eight million customers. We’re here to help our customers make the right financial decisions as they do business with us seamlessly across our channels: getting advice from our
16,000 employees at their place of business, in our branches, on their mobile devices, online, over the telephone, and through our automated banking machines.
Cameron Fowler
MD&A
Group Head
Canadian Personal and Commercial Banking, BMO Financial Group
Lines of Business
Personal Banking provides customers with a wide range of products and services, including chequing and savings accounts, credit cards, mortgages, creditor insurance and everyday financial and investment advice.
Our employees are focused on providing exceptional service to all of our customers every time they interact with us.
Commercial Banking provides small business and commercial banking customers with a broad suite of commercial products and services, including business deposit accounts, commercial credit cards, business loans and commercial mortgages, cash management solutions, foreign exchange and specialized banking programs. Our Commercial bankers partner with our customers to help them grow and manage their business. Strengths and Value Drivers
‰
‰
‰
‰
Strong commercial banking business, reflected by BMO’s number two ranking in Canadian market share for business loans of $25 million or less.
Largest MasterCard® issuer in Canada, and one of the top commercial card issuers in North America.
Leading issuer of AIR MILES®, Canada’s premier coalition loyalty program.
Recognized for the third consecutive year by the global financial services research firm Celent with a 2015 Model Bank Award for excellence in the digital banking category.
‰ Proud to be the official bank of the Canadian defence community, serving the unique needs of the Canadian military.
‰ Consistently applied credit risk management practices that provide customers with reliable access to appropriate financing solutions in all economic conditions. Strategy and Key Priorities
Our strategy is focused on capturing key growth and loyalty opportunities while capitalizing on the shift to digital to improve efficiency.
Continued our focus on customer loyalty and growth
2015 Achievements
‰ Improved our industry-leading employee engagement score by another two percentage points in our annual survey.
‰ Established new customer service standards across all channels to provide a differentiated experience for our customers and build their loyalty.
‰ Redesigned our fraud recovery and personal estate processes, in order to make our customers’ involvement easier for them in moments that matter. Personal banking
‰ Achieved personal lending (excluding retail cards) and deposit growth of 2% and 6%, respectively.
‰ Increased share of wallet, demonstrating that our products continue to meet the needs of our valued customers.
‰ Our Spring Home Financing and Summer Everyday Banking Campaigns were a success. Our Summer Everyday Banking Campaign resulted in everyday banking plan sales growing 26% compared to last year.
‰ Introduced the BMO Savings Builder Account, becoming the first Canadian bank to reward customers with bonus interest for saving monthly.
‰ World Elite MasterCard® recognized as the Best Travel Reward Credit Card and Best Travel Points Credit Card.
‰ BMO’s Premium CashBack MasterCard for Business was named #1 in MoneySense™ magazine’s annual ranking of Canada’s Best Business Cash Back.
Commercial banking
‰ Achieved 7% growth in both commercial lending and deposits.
‰ Launched the BMO Biz Basic™ Plan, to help small business owners easily manage their daily banking simply and cost-effectively.
‰ Expanded our cash management offerings with the launch of BMO DepositEdge™, enabling our clients to deposit cheques remotely, and BMO Spend
Dynamics™, giving corporate card clients convenient access to their transaction data and the ability to analyze their program spend.
‰ Named as the Best Commercial Bank in Canada by World Finance Magazine in recognition of our commitment to building long-term customer relationships and innovative solutions with a strong regional and industry focus, particularly in the areas of Aboriginal Banking and Women in
Business.
2016 Focus
‰ Focus on improving customer loyalty to deepen relationships. In personal banking, increase personal share of wallet and in commercial banking, target opportunities across geography, segment and industry.
48 BMO Financial Group 198th Annual Report 2015
Accelerating our digital channel strategy
2015 Achievements
‰ Digital channel sales volume continued to grow, rising ~14% from last year, which is equivalent to the total sales volume at ~100 branches.
‰ First major Canadian financial institution to offer Touch ID, allowing mobile banking features to be securely accessed with the touch of a button.
‰ Launched a new BMO Banking and InvestorLine portal, becoming the first major Canadian bank to provide customers with online access to both personal banking and self-directed investment accounts, as well as a personal finance management tool, all in one place.
‰ Provided Interac® e-Transfers for all business customer services through our digital channels (Online Banking, Mobile Banking and Online Banking for Business).
‰ Opened or upgraded 24 branches across Canada and expanded our channel network with more than 400 ABMs at Shell locations. We have improved the network with image-enabled ABM technology that offers enhanced interface and transactional capabilities.
2016 Focus
‰ Focus on continuing to accelerate our channel strategy and increase our digital capabilities.
MD&A
Continued our strong risk leadership and operating discipline
2015 Achievements
‰ Enhanced our risk appetite framework with more effective linkages to strategic planning.
‰ Provisions for credit losses declined by 6% and gross impaired loan formations were 11% lower year over year.
‰ Continued to make enhancements to our automated leads management engine, which leverages data to identify banking opportunities that we can present to our customers; these relevant and timely offers support our front-line bankers in increasing share of wallet.
‰ Continued to invest in maintaining strong anti-money laundering capabilities to protect our customers.
2016 Focus
‰ Continue to focus on our strength in productivity and risk management.
Canadian P&C
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
Reported Net Income
($ millions)
2015
2014
2,016
Net interest income
Non-interest revenue
4,937
1,703
4,780
1,625
6,640
496
3,340
6,405
528
3,182
2,804
700
2,695
679
2,406
594
Reported net income
Amortization of acquisition-related intangible assets (1)
2,104
4
2,016
4
1,812
5
Adjusted net income
2,108
2,020
1,817
2015
6,020
559
3,055
Income before income taxes
Provision for income taxes
1,812
4,536
1,484
Total revenue (teb)
Provision for credit losses
Non-interest expense
2,104
2014
2013
Key Performance Metrics and Drivers
Personal revenue
Commercial revenue
Net income growth (%)
Revenue growth (%)
Non-interest expense growth (%)
Operating leverage (%)
Efficiency ratio (%)
Net interest margin on average earning assets (%)
Average earning assets
Average current loans and acceptances
Average deposits
Full-time equivalent employees
2013
Average Current Loans and Acceptances
($ billions)
4,415
2,225
4.4
3.7
5.0
(1.3)
50.3
2.61
189,505
194,199
132,767
15,715
4,237
2,168
11.2
6.4
4.2
2.2
49.7
2.61
183,406
187,788
124,925
15,795
3,993
2,027
2.3
2.0
3.4
(1.4)
50.7
2.66
170,739
174,534
113,901
15,879
(1) Before tax amounts of $5 million in 2015, $4 million in 2014 and $5 million in 2013 are included in non-interest expense.
141.2
138.1
129.1
Personal
Commercial
53.0
49.7
45.4
2013
2014
2015
Average Deposits
($ billions)
84.1
79.6
Personal
72.5
Commercial
41.4
2013
45.3
2014
48.7
2015
BMO Financial Group 198th Annual Report 2015 49
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Financial Review
Canadian P&C reported net income of $2,104 million, up $88 million or 4% from a year ago, with improved performance in the second half of the year. Revenue increased $235 million or 4% to $6,640 million as a result of higher balances and improved non-interest revenue, with stable net interest margin.
Revenue increased $178 million or 4% in our personal banking business as a result of higher balances and improved non-interest revenue.
In our commercial banking business, revenue increased $57 million or 3%, mainly driven by higher balances.
Our credit performance improved, as provisions for credit losses declined $32 million or 6% to $496 million, due to lower provisions in both the consumer and commercial portfolios.
Non-interest expense was $3,340 million, up $158 million or 5% from a year ago, primarily due to continued investment in the business, net of expense management, and higher costs associated with a changing business and regulatory environment. Adjusted operating leverage improved over the course of the year, demonstrating the benefit of actions we took related to containing expenses.
Average current loans and acceptances increased $6.4 billion or 3% from a year ago to $194.2 billion. Total personal lending balances (excluding retail cards) increased 2% year over year, with solid residential mortgage growth partially offset by declines in indirect auto loans. Credit card balances were consistent with the prior year in both retail and corporate cards. Commercial loan balances (excluding corporate cards) increased 7% year over year with growth across a number of industry sectors.
Average deposits increased $7.8 billion or 6% to $132.8 billion. Personal deposit balances increased 6%, driven by strong growth in primary chequing accounts. Commercial deposit growth was broad-based, with balances growing 7% year over year.
Business Environment, Outlook and Challenges
Canada’s economic growth and employment are expected to improve in 2016, benefitting from firm demand from the United States, the lower
Canadian dollar, and a moderate rise in oil prices. Interest rates are expected to stay low.
In the Canadian personal banking sector, retail operating deposits are projected to grow by approximately 4% in 2016, in line with growth in personal income. Credit card loan balances are expected to continue to grow at a pace a little below 4%, as a result of increasing customer preferences for prime-based lines of credit. Residential mortgage balance growth is projected to approximate 5% in 2016.
In the commercial banking sector, growth in commercial operating deposits and short-term business credit is expected to ease moderately to just under 6% in 2016, partly reflecting a carry-over from weak conditions in the resource sector in 2015.
We expect to generate growth by increasing our customer share of wallet, improving sales force productivity and targeting commercial opportunities across geography, segment and industry. We will continue to operate within the parameters of our risk appetite and our effective governance framework should position us well as information security needs increase and high regulatory expectations continue. Our evolving digital capabilities are expected to help us improve productivity over time as customer transactions migrate to digital channels and this, combined with our strong employee engagement, will improve customer loyalty.
The Canadian economic environment in 2015 and outlook for 2016 are discussed in more detail in the Economic Developments and Outlook section on page 30.
Caution
This Canadian P&C Banking section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
50 BMO Financial Group 198th Annual Report 2015
U.S. Personal and Commercial Banking
We’re here to help our more than two million customers feel confident in their financial decisions by providing a banking experience with a human touch. Our retail and small and mid-sized business banking customers are served through more than 500 branches, contact centres, online and mobile banking platforms and more than 1,300 ABMs across eight states. Our commercial banking customers are offered in-depth specific industry knowledge, as well as strategic capital markets solutions. David R. Casper
Group Head
U.S. Retail and Business Banking
Group Head
Commercial Banking and President and CEO,
BMO Harris Bank
MD&A
Alexandra Dousmanis-Curtis
Lines of Business
Personal Banking offers a broad range of products and services to individuals, as well as small and mid-sized business customers, including deposits, mortgages, consumer credit, business lending, credit cards and other banking services.
Commercial Banking provides business customers that have annual revenue above $20 million with a broad range of banking products and services, including lending, deposits, treasury management and risk management. Strengths and Value Drivers
‰ Rich heritage of more than 160 years in the U.S. Midwest, with a deep commitment to our communities and helping our customers succeed.
‰ Strong, experienced leadership team that knows how to compete and excel in our markets.
‰ Unique, differentiated platform for profitable growth provided by our attractive branch footprint and top-tier deposit market share in key U.S.
Midwest markets.
‰ Large-scale, relationship-based national commercial banking business centred in the U.S. Midwest, complemented by in-depth industry knowledge in select sectors.
‰ Comprehensive and integrated control structure that allows us to actively manage risks and regulatory compliance.
Strategy and Key Priorities
We aim to grow our business and be a leader in our markets by creating a differentiated, intuitive customer experience and advising our customers on a wide range of financial topics, leveraging our brand reputation, local presence and high-performance teams.
Deliver a great customer experience to a loyal, profitable and growing customer base
2015 Achievements
‰ Delivered strong and improving net promoter score (NPS) results for the commercial banking segment, as we revitalized our internal and external customer experience initiatives to build greater loyalty.
‰ Our NPS for the retail and business banking segments improved year over year, as we continued to focus on customer feedback.
‰ Enhanced sales coaching with a focus on the customer experience drove significant year-over-year improvements:
‰ Consumer deposit sales per retail banker increased 7%.
‰ Consumer loan sales per retail banker increased 27%.
‰ Mortgage sales per mortgage banker and sales of loans and deposits to our mass affluent customers per team both increased in excess of 25%.
2016 Focus
‰ Maintain strong customer loyalty and increase brand awareness, while growing our customer base in high-opportunity segments, including mass affluent customers.
Continue to improve our product and channel capabilities to meet our customers’ evolving needs
2015 Achievements
‰ Continued our multi-year investment in improving our treasury management capabilities and services, including significant enhancements to our online banking solution.
‰ Introduced our Smart Branch format, which allows customers to conduct transactions with ABM video tellers and makes day-to-day banking easier and more convenient.
‰ BMO Harris was named as the Most Innovative Financial Institution at this year’s ATM & Mobile Innovation Summit, which recognizes innovators in
ATM and mobile technology, by Networld Media Group, publishers of ATMmarketplace.com and MobilePaymentsToday.com.
‰ With the introduction of Mobile Cash, which allows customers to withdraw money from an ABM using their smartphones, we now have the largest network of mobile-enabled cardless ABMs in the United States.
‰ Enhanced our mobile banking application with the addition of Touch ID and Passcode for a faster and more secure log-in process.
2016 Focus
‰ Build on our mobile and online channel capabilities as we continue to enhance our customer experience.
BMO Financial Group 198th Annual Report 2015 51
MANAGEMENT’S DISCUSSION AND ANALYSIS
Improve financial performance by growing revenue and effectively managing costs
2015 Achievements
‰ Maintained stable revenue in a low interest rate environment and a highly competitive U.S. personal and commercial banking market.
‰ Total loans increased by $3.3 billion or 6%, while the total commercial loan portfolio grew by $4.5 billion or 14%.
‰ Deposits grew by $2.2 billion or 4% as a result of strong chequing account growth of $3.7 billion or 11%. In the Chicago and Wisconsin areas, we maintained our strong second place rankings, while holding the number four market share position within our primary footprint of Illinois,
Wisconsin, Missouri, Kansas, Indiana and Minnesota and increasing our overall market share to 6.4%.
‰ Managed expenses effectively while continuing to invest in our business.
2016 Focus
‰ Continue to focus on profitable growth by deepening existing client relationships and acquiring new customers, while managing costs.
MD&A
Continue to deploy our unique commercial operating model by delivering local access and industry expertise to our clients across a broad geographic footprint
2015 Achievements
‰ Continued strong growth in commercial and industrial (C&I) loans and commercial real estate loans, with year-over-year increases of $4.3 billion or 16% and $0.5 billion or 15%, respectively.
‰ Announced the signing of an agreement with General Electric Capital Corporation (GE Capital) to acquire its Transportation Finance business.
GE Capital’s Transportation Finance business is the largest provider of financing for the truck and trailer sector in North America, with over 40 years of experience servicing the complete supply chain.
‰ Launched the “One Bank” initiative to better serve customers with operations across North America.
‰ Deepened customer relationships by providing treasury management services, driving a 6% increase in fee income year over year.
2016 Focus
‰ Continue to leverage our North American commercial franchise and partnerships to deliver a “One Bank” customer experience and successfully integrate the acquired GE Capital Transportation Finance business.
Continue our strong risk leadership and operating discipline
2015 Achievements
‰ Provision for credit losses improved by 41% over the prior year.
‰ Actively managed risks and regulatory compliance through a reinforced oversight and control structure.
‰ Continued to invest in maintaining strong anti-money laundering capabilities to protect our customers.
2016 Focus
‰ Continue to focus on our strength in productivity and risk management.
52 BMO Financial Group 198th Annual Report 2015
U.S. P&C
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
Adjusted Net Income
($ millions)
2015
2014
3,609
827
880
26.5
24.8
14.6
14.9
15.6
3,151
654
706
10.7
9.2
5.1
7.3
8.1
3,000
590
645
6.9
3.7
(2.5)
(3.2)
(2.4)
Net interest income (teb)
Non-interest revenue
2,259
618
2,269
611
2,268
664
Total revenue (teb)
Provision for credit losses
Non-interest expense
2,877
95
1,901
2,880
162
1,899
2,932
230
1,892
Income before income taxes
Provision for income taxes (teb)
881
222
819
222
810
231
Reported net income
Amortization of acquisition-related intangible assets (1)
659
42
597
47
579
54
Adjusted net income
701
644
633
Total revenue (teb)
Reported net income
Adjusted net income
Net income growth (%)
Adjusted net income growth (%)
Revenue growth (%)
Non-interest expense growth (%)
Adjusted non-interest expense growth (%)
2013
Canadian Dollar
880
U.S. Dollar
645
633
706
701
644
2014
2013
2015
(US$ in millions, except as noted)
Net income growth (%)
Adjusted net income growth (%)
Revenue growth (%)
Non-interest expense growth (%)
Adjusted non-interest expense growth (%)
Operating leverage (teb) (%)
Adjusted operating leverage (teb) (%)
Efficiency ratio (teb) (%)
Adjusted efficiency ratio (teb) (%)
Net interest margin on average earning assets (teb) (%)
Average earning assets
Average current loans and acceptances
Average deposits
Full-time equivalent employees
10.3
8.8
(0.2)
0.1
0.7
(0.3)
(0.9)
66.1
64.2
3.46
65,319
58,520
61,962
7,661
3.2
1.8
(1.8)
0.4
1.2
(2.2)
(3.0)
65.9
63.6
3.63
62,443
55,224
59,804
7,835
5.1
1.9
(4.4)
(5.1)
(4.4)
0.7
–
64.6
61.8
3.88
58,432
51,955
59,941
7,991
(US$ billions)
Personal
35.4
Commercial
30.8
26.9
25.1
2013
24.4
2014
23.1
2015
Average Deposits
(US$ billions)
Personal
Commercial
39.5
20.4
2013
37.7
22.1
2014
37.4
24.6
2015
(1) Before tax amounts of $55 million in 2015, $67 million in 2014 and $81 million in 2013 are included in non-interest expense.
Financial Review
Net income of $827 million increased $173 million or 26%. Adjusted net income of $880 million increased $174 million or 25%. Revenue grew
$458 million or 15% to $3,609 million. All amounts in the remainder of this section are on a U.S. dollar basis.
Net income of $659 million increased $62 million or 10% from a year ago. Adjusted net income of $701 million increased $57 million or 9%.
Revenue remained stable at $2,877 million as higher balances and increased mortgage banking revenue offset the effects of lower net interest margin. In our commercial banking business, revenue increased $27 million or 2% to $1,431 million, reflecting strong loan volume growth, primarily in the C&I loan portfolio, partially offset by the impact of competitive spread compression.
In our personal banking business, revenue decreased by $30 million or 2% to $1,446 million, primarily due to declines in loan spreads and balances and reduced fees from deposits and credit cards, partially offset by increased mortgage banking revenue and chequing balance growth.
Net interest margin decreased by 17 basis points to 3.46%, driven by competitive loan pricing, changes in mix including loans growing faster than deposits and the low rate environment.
Provisions for credit losses of $95 million improved by $67 million or 41% from a year ago, primarily due to lower provisions in both the consumer and commercial loan portfolios and loan sale benefits.
Non-interest expense of $1,901 million remained stable. Adjusted non-interest expense of $1,846 million increased $14 million, or less than 1%, as we continue to focus on expense management while making selective investments in the business.
Average current loans and acceptances increased $3.3 billion or 6% to $58.5 billion. The C&I loan portfolio continues to experience strong growth, increasing by $4.3 billion or 16% from a year ago to $30.9 billion. We have grown our commercial real estate portfolio by $0.5 billion or 15%.
These increases offset decreases in home equity and mortgage loans, due in part to the effects of our continued practice of selling most mortgage originations in the secondary market.
Average deposits of $62.0 billion increased $2.2 billion, as growth in our commercial business and in our personal chequing accounts was partially offset by a reduction in higher-cost personal money market and time deposit accounts.
BMO Financial Group 198th Annual Report 2015 53
MD&A
Key Performance Metrics and Drivers (US$ basis)
Average Current Loans and Acceptances
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Business Environment, Outlook and Challenges
U.S. P&C has a significant footprint in eight states, primarily concentrated in six contiguous states in the U.S. Midwest region (Illinois, Wisconsin,
Indiana, Minnesota, Missouri and Kansas).
Following modest growth in recent years, the U.S. Midwest economy is expected to improve to 1.8% in 2015 and 2.1% in 2016. Growth in consumer and commercial loans strengthened this year. Consumer loan volumes are expected to trend higher in 2016 due to relatively low interest rates, improvements in household finances, rising consumer confidence and steady demand for automobiles. Residential mortgage growth shows improvement as housing remains relatively healthy. Commercial loan growth, including non-residential mortgages, should remain strong in response to improvements in economic growth and business confidence across our footprint.
The U.S. Midwest banking environment continues to be highly competitive, and the low interest rate environment remains a challenge for the banking industry. We continue to concentrate on our customer-focused growth strategy, offering multiple product packages and attracting new customers through our differentiated channel offerings, while deepening our existing client relationships by focusing on cross-selling and delivering a
“One Bank” experience. We expect to deliver growth from executing on our strategies, while still operating within the parameters of our risk appetite and the GE Capital Transportation Finance business acquisition. We are also positioned to benefit from rising interest rates. We will continue to actively manage risks and regulatory compliance through a reinforced oversight and control structure.
The U.S. economic environment in 2015 and the outlook for 2016 are discussed in more detail in the Economic Developments and Outlook section on page 30.
Caution
This U.S. P&C Banking section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
54 BMO Financial Group 198th Annual Report 2015
BMO Wealth Management
BMO’s wealth business serves a full range of client segments, from mainstream to ultra-high net worth and institutional, with a broad offering of wealth management products and services including insurance. Wealth Management is a global business with an active presence in markets across Canada, the United States, Europe and Asia.
Gilles Ouellette
Group Head
Wealth Management
Our Personal wealth businesses provide wealth management solutions to retail clients in Canada, the United States and Asia:
BMO Nesbitt Burns, our full-service investing business in Canada, offers comprehensive and client-focused investment and wealth advisory services leveraging strong financial planning capabilities.
BMO InvestorLine is an online investing service that offers clients two ways to invest: our top-ranked self-directed service, which provides tools to help investors make independent investment decisions; or adviceDirect™, which provides investors with online advice and investment recommendations for their portfolios.
BMO Global Asset Management is a global investment organization that provides investment management, and trust and custody services to institutional, retail and high net worth investors around the world.
BMO Insurance operates in Canada and internationally. In Canada, we manufacture life insurance, accident and sickness insurance, and annuity products that are marketed both to brokers and directly to individuals. Our creditor insurance division markets group creditor insurance, and internationally, we provide reinsurance solutions.
BMO’s Private Banking businesses operate in Canada, the United
States, Hong Kong and Singapore, offering a comprehensive range of financial services and solutions to high net worth and ultra-high net worth clients and, under BMO Harris Financial Advisors, to mass affluent clients in the United States.
Strengths and Value Drivers
‰
‰
‰
‰
‰
‰
‰
Planning and advice-based approach that integrates investment, insurance, specialized wealth management and core banking solutions.
Team of highly skilled wealth professionals who are committed to providing an exceptional client experience.
Prestigious brand that is broadly recognized and trusted.
Strong presence in North America, and globally in asset management and private banking in select markets, including Europe and Asia.
Diversified portfolio of digital investment solution platforms, ranging from self-directed investing to professional money management.
Access to BMO’s broad client base and distribution networks.
Transparent and effective risk management framework.
Strategy and Key Priorities
Our aim is to be the wealth management solutions provider that defines great client experience. Our strategy is to deliver on our clients’ wealth management needs now and in the future by enhancing the client experience, while focusing on productivity and investing for future growth.
Enhance our clients’ experience by delivering on their evolving wealth management needs
2015 Achievements
‰ Improved financial planning capabilities through the use of remote and in-field training and the addition of financial planning professionals, as well as enhancements to financial planning software.
‰ Expanded wealth management offerings, solutions and programs for targeted growth demographics, such as millennials and women investors.
‰ Strong focus on collaboration across BMO, in order to offer our clients holistic solutions to their financial needs at every stage of their lives.
‰ BMO Global Asset Management is now positioned as a Top 50 Asset Manager Worldwide in the “personal investments” category by Pensions &
Investments, and BMO Funds was rated second among U.S. mutual fund families by the annual Barron’s/Lipper Fund Family Ranking.
‰ Received numerous awards, including Best Wealth Management in Canada, 2015 (Global Banking and Finance Review); Best Wealth Management
Bank Canada, 2015 (International Finance Magazine); BMO Harris Private Banking was named Best Private Bank in Canada, 2015 (Global Banking and Finance Review); BMO Nesbitt Burns was named the Best Full-Service Investment Advisory in Canada, 2015 (Global Banking and Finance
Review) and recognized as having the Best Integrated Investment Advisor Digital Platform in Canada, 2015 (Global Banking and Finance Review); and BMO InvestorLine was named Best Overall Discount Brokerage, 2015 (Money Sense).
2016 Focus
‰ Attract new clients and focus on delivering a great client experience.
Drive productivity and increase revenue per employee
2015 Achievements
‰ Introduced automated sales processes across our business, including Insurance.
BMO Financial Group 198th Annual Report 2015 55
MD&A
Lines of Business
‰
‰
‰
‰
‰
Enhanced our data analytics capabilities to increase sales force capacity and efficiency.
Launched a comprehensive training program to develop best-in-class sales and relationship management capabilities.
Divested our U.S. retirement services business to focus on core businesses.
Accelerated credit portfolio growth with improvements in lending processes and expansion in select areas.
Effectively managed within our risk appetite and responded to heightened regulatory expectations.
2016 Focus
‰ Continue to improve productivity, while managing our risks with an emphasis on increasing revenue per employee.
Invest in our people, products, technology and footprint to drive future growth
2015 Achievements
MD&A
‰ Completed the integration of F&C Asset Management plc (F&C) and rebranded it as BMO Global Asset Management. This acquisition strengthens the position of BMO Global Asset Management as a globally significant money manager, adding scale, capabilities and resources to its asset management platform and providing attractive cross-selling opportunities.
‰ Launched tablet application with retail online banking to provide self-directed clients with a seamless “One Bank” experience, as well as launched the BMO Market Pro platform to cater to clients who are active traders.
‰ Continued to onboard, train and expand our sales force in strategically important segments.
2016 Focus
‰ Selectively invest in our sales force and continue to enhance technology to drive revenue growth.
Wealth Management
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
Adjusted Net Income
($ millions)
2015
2014
2013
Net interest income
Non-interest revenue (1)
642
5,121
560
4,778
558
3,658
Total revenue (1)
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
5,763
5,338
4,216
1,254
1,505
Revenue, net of CCPB
Provision for (recovery of) credit losses
Non-interest expense
4,509
7
3,357
3,833
(3)
2,840
3,449
3
2,351
Income before income taxes
Provision for income taxes
1,145
295
996
216
1,095
268
850
37
68
780
16
47
827
–
27
Reported net income
Acquisition integration costs (2)
Amortization of acquisition-related intangible assets (3)
Adjusted net income
955
843
955
854
2013
($ billions)
465.7
Assets under administration 357.6
379.6
414.5
398.0
Assets under management 8.9
13.3
8.0
17.6
18.2
16.9
14.8
16.6
(10.2)
0.7
58.3
71.5
2.70
5,688
23,784
14,502
27,377
465,742
397,959
6,477
(5.7)
(1.3)
26.6
11.2
20.8
19.1
18.4
19.9
5.8
(7.9)
53.2
71.9
2.65
4,181
21,169
12,897
24,912
414,547
379,606
6,649
57.8
56.7
3.5
18.9
6.0
5.7
28.4
29.3
(2.5)
13.2
55.8
67.1
2.87
2,884
19,399
11,909
23,337
357,594
194,158
6,012
194.2
2013
720
658
53
73
3,028
2,629
5,834
886
585
199
220
2,687
2,510
4,947
2014
2015
2015 Net Revenue by Line of Business
(%)
28% BMO Nesbitt Burns
4% BMO InvestorLine
24% BMO’s Private Banking
Businesses
34% BMO Global Asset
Management
10% BMO Insurance
806
652
99
118
3,242
2,938
6,010
(1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
(2) F&C acquisition integration costs before tax amounts of $46 million in 2015 and $20 million in 2014 are included in non-interest expense.
(3) Before tax amounts of $88 million in 2015, $62 million in 2014 and $36 million in 2013 are included in non-interest expense.
56 BMO Financial Group 198th Annual Report 2015
2015
Assets under Management and Administration
854
U.S. Business Select Financial Data (US$ in millions)
Total revenue
Non-interest expense
Reported net income
Adjusted net income
Average earning assets
Average current loans and acceptances
Average deposits
2014
767
Key Performance Metrics and Drivers
Net income growth (%)
Adjusted net income growth (%)
Revenue growth (%) (1)
Revenue growth, net of CCPB
Non-interest expense growth (%)
Adjusted non-interest expense growth (%)
Return on equity (%)
Adjusted return on equity (%)
Operating leverage (%) (1)
Adjusted operating leverage, net of CCPB (%)
Efficiency ratio (%) (1)
Adjusted efficiency ratio, net of CCPB (%)
Net interest margin on average earning assets (%)
Average common equity
Average earning assets
Average current loans and acceptances
Average deposits
Assets under administration
Assets under management
Full-time equivalent employees
843
Financial Review
Business Environment, Outlook and Challenges
Growth in the Canadian economy slowed in the first half of 2015, and it is estimated that GDP will grow 1.1% in fiscal 2015, while the United States
GDP is expected to grow approximately 2.5%. Canadian and U.S. stock markets continued to perform well in the first half of the year, but experienced declines in the second half. We recorded growth in client assets despite the softer equity markets towards the end of the year as a result of our strategic focus on enhancing the client experience, product innovation and sales force investments. The Bank of Canada reduced interest rates twice and the Federal Reserve held interest rates steady in 2015, putting pressure on our brokerage net interest income for much of the year. The overall investment climate was unfavourable during the latter part of the year, which was reflected in low levels of client trading activity.
Moderate growth of 2.0% is expected in the Canadian economy in 2016, and we anticipate that a sustained level of higher activity in equity markets will continue to positively affect both transaction volumes and asset levels. The Bank of Canada is expected to hold interest rates steady in
2016, before shifting to a tightening stance in early 2017, while the Federal Reserve is expected to slowly increase interest rates in 2016.
Changing demographics, particularly in the retirement, mass affluent and high net worth sectors, will continue to drive the wealth management industry over the longer term. Tailoring our offering for key client segments, enhancing our team-based client service model to provide a holistic approach that supports clients as they move through different life stages and keeping pace with advances in technology, are ways in which we can continue to meet our clients’ evolving needs.
We have experienced significant growth, both organically and through strategic acquisitions. Our F&C acquisition further strengthens our position as a globally significant money manager and supports our plans to offer truly global services to our clients across our international footprint.
The Canadian and U.S. economic environment in fiscal 2015 and the outlook for fiscal 2016 are discussed in more detail in the Economic
Developments and Outlook section on page 30.
Caution
This Wealth Management section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 57
MD&A
Wealth Management net income was $850 million, up $70 million or 9% from a year ago. Adjusted net income, which excludes the amortization of acquisition-related intangible assets and acquisition integration costs, was $955 million, up $112 million or 13% from a year ago.
Adjusted net income in traditional wealth was $715 million, up $158 million or 28% from a year ago, due to good growth from the businesses, a gain on the sale of BMO’s U.S. retirement services business, as well as the benefit from the full year contribution from the acquired F&C business.
Adjusted net income in insurance was $240 million compared to $286 million a year ago, primarily due to higher taxes in the current year and higher actuarial benefits in the prior year.
Revenue was $5,763 million, up $425 million or 8% from a year ago. Revenue was $4,509 million on a basis that nets CCPB with insurance revenue, up $676 million or 18% from the prior year. Revenue in traditional wealth was $4,057 million, up $687 million or 20% primarily due to good growth in client assets, including the full year contribution from the acquired F&C business. Insurance revenue, net of CCPB, was $452 million, compared to $463 million a year ago, due to higher actuarial benefits in the prior year. The stronger U.S. dollar increased revenue by $133 million or 4%.
The provision for credit losses was $7 million compared to a $3 million net recovery a year ago.
Non-interest expense was $3,357 million, up $517 million or 18%. Adjusted non-interest expense was $3,223 million, up $465 million or 17%, of which 4% is due to the stronger U.S. dollar, 9% is due to the inclusion of F&C results for two additional quarters and 4% was primarily due to higher revenue-based costs.
Assets under management and administration grew by $70 billion or 9% from a year ago to $864 billion, driven by favourable foreign exchange movements and market appreciation.
Net income in Wealth Management U.S. businesses was US$99 million. Adjusted net income in Wealth Management U.S. businesses was
US$118 million, up $45 million or 59% from a year ago, due to a gain on sale of BMO’s U.S. retirement services business in the current year and higher costs related to the settlement of a legal matter in the prior year.
MANAGEMENT’S DISCUSSION AND ANALYSIS
BMO Capital Markets
BMO Capital Markets is a North American-based financial services provider offering a complete range of products and services to corporate, institutional and government clients. BMO Capital Markets has approximately 2,200 professionals in 29 locations around the world, including 16 offices in North America.
Darryl White
MD&A
Group Head
BMO Capital Markets
Lines of Business
Investment and Corporate Banking offers clients debt and equity capital-raising services, as well as loan origination and syndication, balance sheet management solutions and treasury management services. We provide strategic advice on mergers and acquisitions, restructurings and recapitalizations, as well as valuation and fairness opinions. We also offer trade finance and risk mitigation services to support the international business activities of our clients, and we provide a wide range of banking and other operating services tailored to North American and international financial institutions.
Trading Products offers research and access to global markets for institutional, corporate and retail clients through an integrated suite of sales and trading solutions that include debt, foreign exchange, interest rate, credit, equity, securitization and commodities. We also offer new product development and origination services, as well as risk management (derivatives) advice and services to hedge against fluctuations in a variety of key inputs, including interest rates and commodities prices. In addition, we provide funding and liquidity management to our clients.
Strengths and Value Drivers
‰ Unified coverage approach and integrated distribution creates an exceptional client experience across our North American platform, together with a complementary international presence in select industry sectors.
‰ Innovative ideas and expertise delivered through our top-tier coverage team, dedicated to understanding and meeting our core clients’ needs.
‰ Top-ranked economic equity and fixed income research, sales and trading capabilities with deep expertise in core sectors.
‰ Focus on first-line-of-defence risk management capabilities, enabling effective decision-making in support of our strategy and client experience.
Strategy and Key Priorities
BMO Capital Markets’ aim is to be the lead investment bank that enables our clients to achieve their ambitions. We offer an integrated platform that is differentiated by leading ideas and unified coverage.
Continue to earn leading market share in Canada without taking outsized risk
2015 Achievements
‰ Named 2015 Greenwich Quality Leader for Canadian Equity Sales and Corporate Access, Canadian Mergers and Acquisitions, and Large Corporate
Cash Management and Large Corporate Trade Finance by Greenwich Associates.
‰ Ranked #1 (tied) as a 2015 Greenwich Share Leader for Overall Canadian Fixed Income Market Share by Greenwich Associates.
‰ Ranked #2 as a 2015 Greenwich Share Leader for Canadian Equity Trading and #2 (tied) for Canadian Foreign Exchange Market Share by Greenwich
Associates.
‰ Ranked #3 as a 2015 Greenwich Share Leader for Canadian Equity Research/Advisory Vote Share by Greenwich Associates.
2016 Focus
‰ Continue to earn leading market share in Canada by delivering leading ideas through our top-tier coverage team.
Continue to serve global clients with North American interests and leverage our global leadership in select strategic sectors
2015 Achievements
Completed a reorganization of Trading Products by asset class to further enhance customer experience and North American franchise value.
Named World’s Best Metals & Mining Investment Bank for the sixth consecutive year by Global Finance magazine.
Named Best Supply Chain Finance Bank in North America for the second consecutive year by Trade Finance magazine.
Named Best Bank in Canadian Dollar Foreign Exchange for the fifth consecutive year by FX Week magazine.
Named 2015 Greenwich Quality Leader for Canadian Fixed Income Research by Greenwich Associates.
Acted as joint lead on an issue for KfW Development Bank, attracting strong interest from Asia and Europe that resulted in the largest outstanding sovereigns, supranationals and agencies (SSA) issue in the Canadian market.
‰ BMO served as a co-chair of the TFSA RMB Working Group, which played a crucial role in establishing an offshore renminbi clearing hub in Canada.
The Canadian hub facilitates settlements in renminbi, with the intention of encouraging trade and strengthening ties between Canadian companies and their Chinese business partners. BMO Capital Markets initiated the first renminbi trade to celebrate the hub’s official launch.
‰
‰
‰
‰
‰
‰
58 BMO Financial Group 198th Annual Report 2015
2016 Focus
‰ Leverage our strong North American capabilities and presence in select international markets.
Continue to drive performance in our U.S. client franchise with a greater weighting in corporate banking to further support our clients and the stability of future earnings
‰
‰
‰
‰
‰
‰
2015 Achievements
Continued to leverage our full-service capabilities to gain a competitive advantage against our U.S. mid-market and boutique competitors.
Closed the sale of GKST, our municipal bond trading business, which will allow us to focus resources on our core U.S. fixed income business.
The number of M&A transactions closed this year was up 23%, totalling $13.9 billion.
Named 2014 Mid-Market Equity House of the Year by International Financing Review.
Ranked among Top 20 global investment banks and 12th-largest investment bank in North and South America, based on fees, by Thomson Reuters.
Average lending assets increased 20% in the United States from the prior year.
2016 Focus advantaged. Continue to enhance our risk management, regulatory and compliance practices
2015 Achievements
‰ Investments in our compliance, risk and regulatory infrastructure and processes have improved our capabilities in each of these areas and positioned us well for future regulatory changes.
‰ Compliant with all key regulations, including full implementation of systems for Volcker Rule compliance.
2016 Focus
‰ Continue to enhance our first-line-of-defence risk management, regulatory and compliance practices.
BMO Financial Group 198th Annual Report 2015 59
MD&A
‰ Continue to drive performance in our U.S. platform with a focused strategy and selectively grow our corporate bank where we are competitively
MANAGEMENT’S DISCUSSION AND ANALYSIS
BMO Capital Markets
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
Reported Net Income
($ millions)
2014
2013
Net interest income (teb)
Non-interest revenue
1,334
2,539
1,177
2,543
1,197
2,186
Total revenue (teb)
Provision for (recovery of) credit losses
Non-interest expense
3,873
26
2,486
3,720
(18)
2,351
3,383
(36)
2,082
Income before income taxes
Provision for income taxes (teb)
1,361
329
1,387
310
1,337
297
Reported net income
Amortization of acquisition-related intangible assets (1)
1,032
2
1,077
1
1,040
2
Adjusted net income
MD&A
2015
1,034
1,078
1,042
1,040
1,032
2013
2014
2015
3,720
3,873
2014
2015
69%
66%
64%
31%
34%
36%
2013
2014
2015
Revenue
($ millions)
Key Performance Metrics and Drivers
Trading Products revenue
Investment and Corporate Banking revenue
Net income growth (%)
Revenue growth (%)
Non-interest expense growth (%)
Return on equity (%)
Operating leverage (teb) (%)
Efficiency ratio (teb) (%)
Net interest margin on average earning assets (teb) (%)
Average common equity
Average earning assets
Average assets
Average current loans and acceptances
Average deposits
Full-time equivalent employees
1,077
3,383
2,412
1,461
(4.2)
4.1
5.7
14.9
(1.6)
64.2
0.56
6,538
238,916
290,325
37,416
141,275
2,223
2,257
1,463
3.6
9.9
12.9
19.1
(3.0)
63.2
0.53
5,422
222,471
259,746
30,101
133,405
2,270
2,126
1,257
5.4
4.2
5.0
17.9
(0.8)
61.5
0.59
5,582
202,062
246,702
24,807
121,193
2,163
1,099
890
142
76,630
84,872
10,969
55,942
1,154
887
216
79,958
88,902
9,536
57,754
1,040
823
203
76,984
92,690
8,502
60,116
2013
Revenue by Geography
(%)
Canada and other countries
United States
U.S. Business Select Financial Data (US$ in millions)
Total revenue (teb)
Non-interest expense
Reported net income
Average earning assets
Average assets
Average current loans and acceptances
Average deposits
(1) Before tax amounts of $2 million in 2015, $3 million in 2014 and $2 million in 2013 are included in non-interest expense.
Financial Review
BMO Capital Markets net income decreased $45 million or 4% to $1,032 million as the benefit of the stronger U.S. dollar was more than offset by higher provisions in the current year compared to net recoveries in the prior year. Return on equity of 14.9% declined by 4.2% from the prior year, largely due to higher allocated capital.
Revenue increased $153 million or 4% to $3,873 million. Excluding the impact of the stronger U.S. dollar, revenue was stable year over year as higher trading revenues, including the prior year unfavourable impact of implementing a funding valuation adjustment, and higher lending revenues were offset by lower investment banking fees and reduced securities gains.
Trading Products revenue increased $155 million or 7%. Excluding the impact of the stronger U.S. dollar, revenue increased $69 million or 3%, reflecting higher trading revenues related to stronger client trading activity.
Investment and Corporate Banking revenue was consistent with the prior year. Excluding the impact of the stronger U.S. dollar, revenue decreased $65 million or 4%, as growth in lending revenue was more than offset by lower investment banking client activity and reduced securities gains.
Provision for credit losses was $44 million higher due to higher provisions compared with net recoveries in the prior year.
Non-interest expense increased $135 million or 6% to $2,486 million. Excluding the impact of the stronger U.S. dollar, non-interest expense decreased $7 million primarily due to lower employee-related expenses, partially offset by higher support costs related to a changing business and regulatory environment.
Average assets of $290.3 billion increased $30.6 billion from the prior year. Excluding the impact of the stronger U.S. dollar, average assets increased $16.9 billion. Higher levels of net loans and acceptances due to increases in corporate banking activity and higher repo and derivative financial assets were partially offset by decreases in securities and cash balances.
BMO Capital Markets participated in 1,355 new global issues in 2015, comprised of 571 corporate debt deals, 558 government debt deals and
226 equity transactions, raising $3,650 billion.
60 BMO Financial Group 198th Annual Report 2015
Business Environment, Outlook and Challenges
BMO Capital Markets’ performance in fiscal 2015 reflected our balanced, diversified and client-focused business model, as well as our disciplined approach to risk management in an environment influenced by market factors that contribute to variability in results.
In fiscal 2015, we experienced challenging markets, including a financial crisis in Greece, Bank of Canada rate cuts, volatility in commodities and energy prices at new lows. While market volatility persists, and equity markets remain challenging, our Capital Markets strategy remains constant.
We continue to concentrate on our growth strategy, while leveraging our diversified business model and focusing on the United States as our largest market opportunity and growth engine.
Looking ahead to fiscal 2016, we expect economic growth in the United States to be sustained and healthy, with some improvement anticipated in Canada. Low inflation rates and the decline in unemployment are expected to continue in the United States, with a modest rise anticipated in interest rates. Unemployment rates should hold steady in Canada, as low interest rates, a weak currency and a partial recovery in oil prices provide an offset to a still-challenging global economic backdrop.
The Canadian and U.S. economic environment in fiscal 2015 and the outlook for fiscal 2016 are discussed in more detail in the Economic
Developments and Outlook section on page 30.
MD&A
Caution
This BMO Capital Markets section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 61
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Corporate Services, including Technology and Operations
Corporate Services consists of Corporate Units and Technology and Operations (T&O). Corporate Units provide enterprise-wide expertise and governance support in a variety of areas, including strategic planning, risk management, finance, legal and regulatory compliance, marketing, communications and human resources. T&O manages, maintains and provides governance over information technology, operations services, real estate and sourcing for BMO Financial Group.
The costs of these Corporate Units and T&O services are largely transferred to the three client operating groups (P&C, Wealth Management and
BMO Capital Markets), and only relatively minor amounts are retained in Corporate Services results. As such, Corporate Services adjusted operating results largely reflect the impact of certain asset-liability management activities, the elimination of taxable equivalent adjustments, the results from certain impaired real estate secured assets and purchased loan accounting impacts. Corporate Services reported results in 2013 and prior years reflected a number of items and activities that were excluded from BMO’s adjusted results to help assess BMO’s performance. These adjusting items were not reflective of core operating results. They are itemized in the Non-GAAP Measures section on page 33.
Corporate Services focuses on enterprise-wide priorities that improve service quality and efficiency to deliver an excellent customer experience.
Notable achievements during the year included:
‰ Simplifying and automating our processes for greater efficiency: digitized cheque image capture and digital statements; improved commercial and retail lending systems for quicker customer response and more efficient workflow.
‰ Leveraging data to better serve our customers: building enterprise-level data solutions which both meet regulatory expectations and help us intuitively anticipate customer needs.
‰ Extending the digital experience across all channels: improvements to our mobile and online platforms for security and convenience; improvements to our ABM network in the United States to allow customers to withdraw cash using their mobile device.
‰ Realizing real estate synergies and improving our technology capabilities in channels, products, functions and infrastructure.
‰ Meeting regulatory expectations: continued delivery of programs that meet evolving expectations of our regulators, for example, in credit risk management and risk reporting, stress testing and anti-money laundering.
Financial Review
Corporate Services reported net loss for the year was $408 million, compared with a reported net loss of $194 million a year ago. Reported results in 2015 included certain acquisition integration costs and a $106 million charge, primarily due to restructuring to drive operational efficiencies.
The adjusted net loss for the year was $296 million, compared with an adjusted net loss of $194 million a year ago. Excluding the impact of the group teb adjustment on revenue and taxes, results were lower mainly due to lower purchased loan portfolio revenues and lower credit recoveries.
Adjusted non-interest expense was down modestly.
Corporate Services, including Technology and Operations
(Canadian $ in millions, except as noted)
As at or for the year ended October 31
2015
2014
2013
Net interest income before group teb offset
Group teb offset
(253)
(524)
(62)
(476)
409
(344)
Net interest income (teb)
Non-interest revenue
(777)
281
(538)
147
65
146
Total revenue (teb)
Recovery of credit losses
Non-interest expense (1)
(496)
(36)
613
(391)
(123)
471
211
(175)
802
(1,073)
(665)
(739)
(545)
(416)
(342)
(408)
(194)
(74)
(494)
(36)
459
(296)
14,277
(391)
(123)
471
(194)
14,229
(480)
(405)
456
(135)
13,586
Total revenue (teb)
Recovery of credit losses
Non-interest expense
Provision for (recovery of) income taxes (teb)
(87)
(79)
272
(133)
(31)
(120)
298
(103)
459
(256)
564
38
Reported net income (loss)
(147)
(106)
113
Adjusted total revenue (teb)
Adjusted recovery of credit losses
Adjusted non-interest expense
Adjusted net loss
(87)
(30)
228
(148)
(31)
(117)
298
(105)
(169)
(398)
307
(28)
Loss before income taxes
Recovery of income taxes (teb)
Reported net loss
Adjusted total revenue (teb)
Adjusted recovery of credit losses
Adjusted non-interest expense
Adjusted net loss
Full-time equivalent employees
U.S. Business Select Financial Data (US$ in millions)
(1) Includes restructuring costs in 2015 and 2013 to align our cost structure with the environment.
62 BMO Financial Group 198th Annual Report 2015
Corporate Services Provision for Credit Losses
(Canadian $ in millions)
As at or for the year ended October 31
2014
2013
Impaired real estate loans
Interest on impaired loans
Purchased credit impaired loans
Purchased performing loans (1)
28
17
(86)
5
21
26
(252)
82
(43)
48
(410)
–
Recovery of credit losses, adjusted basis
Purchased performing loans (1)
Decrease in collective allowance
(36)
–
–
(123)
–
–
(405)
240
(10)
Recovery of credit losses, reported basis
(36)
(123)
(175)
Average loans and acceptances
Year-end loans and acceptances
242
182
452
306
972
526
2015
(1) Effective the first quarter of 2014, Corporate Services adjusted results include credit-related items in respect of the purchased performing loan portfolio. Further details are provided in the Non-GAAP
Measures section on page 33.
MD&A
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
Review of Fourth Quarter 2015 Performance
Reported net income was $1,214 million for the fourth quarter of 2015, up $144 million or 13% from the prior year. Adjusted net income was
$1,264 million, up $153 million or 14% from the prior year, with good income growth across all of our operating groups. Adjusted results for the quarter exclude the amortization of acquisition-related intangible assets of $43 million ($33 million after-tax) which were charged to the non-interest expense of the operating groups and acquisition integration costs of $20 million ($17 million after-tax) which were primarily recorded in non-interest expense. Acquisition integration costs related to F&C were charged to Wealth Management and acquisition integration costs related to GE Capital’s
Transportation Finance business were charged to Corporate Services.
Reported EPS of $1.83 and adjusted EPS of $1.90 were both up 17% from the prior year. Return on equity was 12.9% and adjusted return on equity was 13.5%.
Amounts in the rest of this Review of Fourth Quarter 2015 Performance section are stated on an adjusted basis. Summary income statements and data for the quarter and comparative quarters are outlined on page 67.
The combined P&C banking business adjusted net income of $782 million was up 11%. Canadian P&C results increased 7%, driven by higher revenue and strong credit performance, partially offset by higher expenses. U.S. P&C adjusted net income increased 22% on a Canadian dollar basis and increased 3% on a U.S. dollar basis, driven by lower provisions for credit losses. Wealth Management adjusted net income was $271 million, up
8% from a year ago. Adjusted net income in traditional wealth was $214 million, driven by a gain on sale and underlying business growth, despite softer equity markets, partially offset by a legal reserve. Adjusted net income in traditional wealth was up $79 million or 60%. Adjusted net income in insurance was $57 million, compared to $117 million a year ago, primarily due to high actuarial benefits in the prior year. BMO Capital Markets results increased 27% due to higher revenue. Corporate Services adjusted results were better as lower revenue was more than offset by lower expenses, and credit loss recoveries.
Total revenue of $4,984 million increased $344 million or 7% from the fourth quarter a year ago. On a net revenue basis, revenue increased
$377 million or 9%, including the 6% impact of the stronger U.S. dollar. Canadian P&C revenue increased due to higher balances across most products and increased non-interest revenue. U.S. P&C revenue increased 19% on a Canadian dollar basis and was consistent with the prior year on a
U.S. dollar basis as higher loan and deposit volume and mortgage banking revenue were offset by lower net interest margin. Wealth Management results increased on a net revenue basis, with traditional wealth revenue benefitting from a gain on sale and higher fee-based revenue, partially offset by lower brokerage commissions. Net insurance revenue decreased mainly due to high actuarial benefits in the prior year. BMO Capital Markets revenue was up due to higher trading revenue, including the unfavourable impact of implementing a funding valuation adjustment in the prior year and higher securities commissions and fees. Investment and Corporate Banking revenue increased due to higher lending revenue. Both Trading
Products and Investment and Corporate Banking revenue were impacted by lower securities gains. Corporate Services revenue was lower due to a higher group teb adjustment and lower treasury-related revenue.
Net interest income of $2,367 million increased $189 million or 9% from a year ago, due to the impact of the stronger U.S. dollar and volume growth, partially offset by lower net interest margin. BMO’s overall net interest margin decreased by 3 basis points to 1.57%. Average earning assets increased $58 billion or 11% to $597 billion, including a $42 billion increase as a result of the stronger U.S. dollar.
Non-interest revenue increased $188 million or 9% on a net revenue basis to $2,350 million. Excluding the impact of the stronger U.S. dollar, net non-interest revenue increased 3%. Increases in other non-interest revenue and mutual fund revenues were partially offset by lower net insurance revenue, underwriting and advisory fees, and securities gains.
The total provision for credit losses was $128 million, a decrease of $42 million from the prior year, due to net recoveries in Corporate Services and lower provisions in Canadian P&C. There was no net change to the collective allowance in the quarter.
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) were $265 million, down $35 million from the fourth quarter a year ago, when lower long-term interest rates increased our policy benefit liabilities, partially offset by increased underlying business premiums in the current quarter. The decrease was largely offset in revenue.
Adjusted non-interest expense increased $198 million or 7% to $3,032 million. Excluding the impact of the stronger U.S. dollar, adjusted noninterest expense was well controlled, up by $9 million or less than 1%. On a net revenue basis, adjusted operating leverage was positive 1.8% year over year. On a net revenue basis and excluding the impact of the stronger U.S. dollar, adjusted operating leverage was positive 2.6% year over year.
The adjusted efficiency ratio was 60.8%, and was 64.2% on a net revenue basis, improving 110 basis points from the prior year.
The adjusted provision for income taxes of $295 million increased $70 million from a year ago. The adjusted effective tax rate was 18.9% in the current quarter, compared with 16.8% a year ago. The higher adjusted tax rate was primarily due to a higher proportion of income from higher taxrate jurisdictions. On a teb basis, the adjusted effective tax rate for the quarter was 24.7%, compared with 22.6% a year ago.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 63
MANAGEMENT’S DISCUSSION AND ANALYSIS
2014 Financial Performance Review
The preceding discussions in the MD&A focused on our performance in fiscal 2015. This section summarizes our performance in fiscal 2014 relative to fiscal 2013. As noted on page 26, certain prior year data has been reclassified to conform to the presentation in 2015, including restatements arising from transfers between operating groups. In addition, commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Further information on restatements is provided on page 46.
Net Income
MD&A
Net income increased $138 million or 3% to $4,333 million in 2014 and EPS increased $0.24 or 4% to $6.41. Adjusted net income increased
$230 million or 5% to $4,453 million and adjusted EPS increased $0.38 or 6% to $6.59, reflecting strong adjusted net income growth of 11% in
Canadian P&C, 4% growth in BMO Capital Markets and 2% growth in U.S. P&C on a U.S. dollar basis. There was a modest decline in Wealth
Management, due to a $121 million after-tax security gain in the prior year, and lower results in Corporate Services.
Adjusting items are detailed in the Non-GAAP Measures section on page 33.
Return on Equity
Return on equity and adjusted return on equity were 14.0% and 14.4%, respectively, in 2014, compared with 14.9% and 15.0%, respectively, in
2013. There was an increase of $147 million in earnings ($239 million in adjusted earnings) available to common shareholders. In 2014, we held higher levels of average common shareholders’ equity as a result of increased capital expectations for banks internationally. Average common shareholders’ equity increased $2.7 billion from 2013.
Revenue
Revenue increased $1,393 million or 8% to $18,223 million in 2014. Adjusted revenue increased $2,084 million or 13% to $18,223 million. Excluding the impact of the stronger U.S. dollar, adjusted revenue increased $1,761 million or 11%, due to growth in Wealth Management, Canadian P&C and
BMO Capital Markets.
Provisions for Credit Losses
The provision for credit losses was $561 million in 2014, down from $587 million in 2013 and up from $357 million in 2013 on an adjusted basis.
There were no adjusting items in 2014. The increase in adjusted PCL was due to a significant reduction in recoveries on the purchased credit impaired portfolio and the inclusion of provisions on the purchased performing loan portfolio in adjusted PCL in 2014, offset in part by reduced provisions in
Canadian P&C and U.S. P&C.
Non-Interest Expense
Non-interest expense increased $695 million or 7% to $10,921 million in 2014. Adjusted non-interest expense increased $1,006 million or 10% to
$10,761 million. Excluding the impact of the stronger U.S. dollar, adjusted non-interest expense increased 8%, primarily due to continued investment in the business, higher employee-related costs, including severance, increased regulatory costs and the acquired F&C business.
Provision for Income Taxes
The provision for income taxes was $903 million in 2014, compared with $1,055 million in 2013. The reported effective tax rate in 2014 was
17.2%, compared with 20.1% in 2013. The adjusted provision for income taxes was $943 million in 2014, compared with $1,037 million in 2013.
The adjusted effective tax rate in 2014 was 17.5%, compared with 19.7% in 2013. The lower adjusted effective tax rate was mainly attributable to higher tax-exempt income and a lower proportion of income from higher tax-rate jurisdictions.
Canadian P&C
Canadian P&C reported net income of $2,016 million in 2014, up $204 million or 11% from 2013. Revenue increased $385 million or 6% to
$6,405 million. Revenue growth was at or above 6% in each quarter of 2014. Revenue increased $244 million or 6% in our personal banking business and revenue increased $141 million or 7% in our commercial banking business, mainly driven by growth in balances and fees across most products.
Non-interest expense was $3,182 million, up $127 million or 4% from the prior year, primarily due to continued investment in the business, net of expense management.
U.S. P&C
Net income in U.S. P&C of $654 million in 2014 increased $64 million or 11% from 2013, while adjusted net income of $706 million increased
$61 million or 9%. All amounts in the remainder of this section are on a U.S. dollar basis.
Net income of $597 million in 2014 increased $18 million or 3% from the prior year. Adjusted net income of $644 million increased $11 million or 2%. Revenue decreased $52 million or 2% to $2,880 million, as the benefits of strong commercial loan growth were more than offset by the effects of lower net interest margin and reduced mortgage banking revenue. Non-interest expense of $1,899 million increased $7 million. Adjusted non-interest expense of $1,832 million increased $21 million, as we continued to focus on productivity while making selective investments in the business and responding to regulatory changes.
Wealth Management
Wealth Management net income was $780 million in 2014, compared to $827 million in 2013. Adjusted net income was $843 million in 2014, compared to $854 million in 2013. Results in 2014 reflected the contribution from the acquired F&C business and results in 2013 included a
$121 million after-tax security gain. Adjusted net income in traditional wealth was $557 million in 2014, compared to $593 million in 2013, as strong growth from the businesses of $85 million or 18%, including the contribution from the acquired F&C business, was more than offset by the impact of the security gain in the prior year. Adjusted net income in insurance was $286 million, up $25 million or 9%. Wealth Management revenue of
$3,833 million in 2014 increased $384 million or 11% on a basis that nets CCPB with insurance revenue. Revenue in traditional wealth increased
$525 million or 19%, excluding the security gain in the prior year, reflecting growth in client assets and a contribution from the F&C acquisition.
64 BMO Financial Group 198th Annual Report 2015
Insurance revenue, net of CCPB, increased $50 million or 12%, due to continued growth in both the underlying creditor and life insurance businesses of 10% and the impact of beneficial changes in actuarial reserves. The stronger U.S. dollar increased revenue, net of CCPB, by $50 million or 1%.
Insurance claims, commissions and changes in policy benefit liabilities were $1,505 million, up $738 million from the prior year. Non-interest expense was $2,840 million in 2014, up $489 million or 21%. Adjusted non-interest expense was $2,758 million, up $443 million or 19%. The increase was due primarily to the impact of the F&C acquisition and higher revenue-based costs. The stronger U.S. dollar increased expenses by $44 million or 2%.
BMO Capital Markets
Corporate Services
Corporate Services reported and adjusted net loss was $194 million in 2014, compared with a reported net loss of $74 million and an adjusted net loss of $135 million in 2013. Commencing in 2014, the impact from the purchased performing loan portfolio was included in adjusted results.
Adjusted revenue improved $89 million in 2014, mainly due to the inclusion of purchased performing loan revenue of $238 million, partially offset by a higher group teb offset of $132 million. Adjusted recoveries of credit losses of $123 million in 2014 were $282 million lower than the prior year, primarily due to $158 million lower loan recoveries. Adjusted non-interest expense of $471 million in 2014 was up $15 million from the prior year, mainly due to higher technology investments and regulatory-related costs.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 65
MD&A
BMO Capital Markets net income increased $37 million or 4% to $1,077 million in 2014. The increase reflected growth in revenue across both
Investment and Corporate Banking and Trading Products, with good contributions from our U.S. businesses, partially offset by an increase in expenses.
Revenue increased $337 million or 10% to $3,720 million, driven by higher securities gains and increases in trading revenues, lending revenues and investment banking fees, particularly in our U.S. platform. Investment and Corporate Banking revenue increased $206 million, reflecting higher securities gains and higher activity levels, particularly in equity underwriting, as well as growth in lending revenue. Trading Products revenue increased $129 million, reflecting growth in trading revenues, particularly from equity trading and foreign exchange trading related to more favourable market conditions, as well as higher securities commissions and fees. The stronger U.S. dollar increased revenue by $82 million.
Non-interest expense increased $269 million or 13% to $2,351 million, resulting from higher employee-related expenses and increased support costs, both driven by a changing business and regulatory environment, as well as by stronger performance. The stronger U.S. dollar increased expenses by $62 million.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Summary Quarterly Earnings Trends
BMO’s results and performance measures for the past eight quarters are outlined on page 67.
Periodically, certain business lines and units within the business lines are transferred between client operating groups to more closely align
BMO’s organizational structure and its strategic priorities. Comparative figures have been restated to conform to the current presentation.
Over the past two years, we have remained focused on executing our strategic priorities. Economic conditions have weakened in Canada due to the downturn in oil and other resource prices, but have remained healthy in the United States.
Seasonality
MD&A
BMO’s quarterly earnings, revenue and expense are modestly affected by seasonal factors. Since our second fiscal quarter has 89 days (90 in a leap year) and other quarters have 92 days, second-quarter results are lower relative to other quarters because there are fewer calendar days, 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 Wealth Management and BMO Capital Markets. The December holiday season also contributes to a slowdown in some activities.
Canadian P&C
Canadian P&C delivered strong net income performance throughout 2014, moderating in the first half of 2015, with improved performance in the last two quarters. Improved net income in the second half of 2015 has been a result of strong credit performance, moderating expense growth, and stable revenue growth. Revenue growth has been driven by higher balances and non-interest revenue, with relatively stable net interest margins each quarter. Expenses have grown as a result of continued investment in the business net of a continued focus on expense management. Provisions for credit losses have remained relatively low, with particularly strong credit performance over the past two quarters.
U.S. P&C
Results have been improving since the second quarter of 2014 due to lower provisions for credit losses and disciplined expense management in a challenging revenue environment. Results in the fourth quarter of 2015 reflected a slight decline in net income growth due to lower fee income and investments in the business.
Wealth Management
Wealth Management’s overall results have reflected good momentum since the second half of 2013, driven by double-digit organic revenue growth in traditional wealth for nine of the past ten quarters. Traditional wealth operating results have benefitted from the acquired F&C business since the second half of fiscal 2014. Quarterly results in the insurance businesses have been subject to variability, resulting primarily from changes in long-term interest rates and methodology and actuarial assumptions changes.
BMO Capital Markets
BMO Capital Markets delivered good performance in the first three quarters of 2014, leveraging our consistent and diversified strategy, and benefiting from favourable market conditions. In the fourth quarter of 2014 and the first quarter of 2015, we experienced slower activity and were unfavourably affected by credit and funding valuation adjustments. The remainder of the year reflects improved performance in both our Trading Products and
Investment and Corporate Banking businesses, with reduced activity in certain markets in the fourth quarter of 2015.
Provisions for Credit Losses
BMO’s PCL measured as a percentage of loans and acceptances has generally been declining since 2012 and has stabilized in recent quarters.
Corporate Services
Adjusted quarterly net income can vary from quarter to quarter but has been relatively stable in 2014 and 2015, despite reduced benefits from the purchased loan portfolio.
Foreign Exchange
The U.S. dollar strengthened significantly in 2014 and 2015, with the exception of a slight weakening in the third quarter of 2014 and in the second quarter of 2015. A stronger U.S. dollar increases the translated value of U.S.-dollar-denominated revenues, expenses, provisions for (recoveries of) credit losses, income taxes and net income.
Provision for Income Taxes
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 Summary Quarterly Earnings Trends section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
66 BMO Financial Group 198th Annual Report 2015
Summarized Statement of Income and Quarterly Financial Measures
(Canadian $ in millions, except as noted)
Q3-2015
Q2-2015
Q1-2015
Q4-2014
Q3-2014
Q2-2014
Q1-2014
2,367
2,615
2,272
2,554
2,112
2,414
2,219
2,836
2,178
2,462
2,107
2,628
2,063
2,306
2,113
2,366
Total revenue (1)
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
4,982
4,826
4,526
5,055
4,640
4,735
4,369
4,479
265
218
24
747
300
520
328
357
Revenue, net of CCPB
Provision for credit losses – specific (see below)
Provision for (recovery of) credit losses – collective
Non-interest expense
4,717
128
–
3,093
4,608
160
–
2,971
4,502
161
–
3,112
4,308
163
–
3,006
4,340
170
–
2,887
4,215
130
–
2,756
4,041
162
–
2,594
4,122
99
–
2,684
Income before provision for income taxes
Provision for income taxes
1,496
282
1,477
285
1,229
1,139
1,283
1,329
1,285
1,339
230
139
213
203
209
278
Reported net income (see below)
Adjusted net income (see below)
1,214
1,264
1,192
1,230
999
1,146
1,000
1,041
1,070
1,111
1,126
1,162
1,076
1,097
1,061
1,083
Provision for credit losses – specific
Canadian P&C
U.S. P&C
112
42
109
19
143
18
132
40
129
47
129
57
131
52
139
21
Personal and Commercial Banking
Wealth Management
BMO Capital Markets
Corporate Services
154
1
(2)
(25)
128
3
14
15
161
1
5
(6)
172
2
9
(20)
176
(1)
(7)
2
186
(3)
(6)
(47)
183
2
(4)
(19)
160
(1)
(1)
(59)
BMO Financial Group provision for credit losses – specific
128
160
161
163
170
130
162
99
Operating group reported net income
Canadian P&C
U.S. P&C
560
207
556
222
486
206
502
192
526
169
525
161
480
157
485
167
Personal and Commercial Banking
Wealth Management
BMO Capital Markets
Corporate Services
767
243
242
(38)
778
210
273
(69)
692
238
296
(227)
694
159
221
(74)
695
225
191
(41)
686
189
305
(54)
637
192
305
(58)
652
174
276
(41)
BMO Financial Group net income
1,214
1,192
999
1,000
1,070
1,126
1,076
1,061
Operating group adjusted net income
Canadian P&C
U.S. P&C
561
221
557
235
487
219
503
205
527
182
526
174
481
170
486
180
Personal and Commercial Banking
Wealth Management
BMO Capital Markets
Corporate Services
782
271
243
(32)
792
233
274
(69)
706
265
296
(121)
708
186
221
(74)
709
252
191
(41)
700
211
305
(54)
651
198
306
(58)
666
182
276
(41)
BMO Financial Group adjusted net income
Information per Common Share ($)
Dividends declared
Basic earnings per share
Diluted earnings per share
Adjusted diluted earnings per share
Book value
Market price
High
Low
Close
Financial Measures (%)
Dividend yield
Return on equity
Adjusted return on equity
Net interest margin on average earning assets
Adjusted net interest margin on average earning assets
Efficiency ratio (1)
Adjusted efficiency ratio (1)
Adjusted efficiency ratio, net of CCPB
Operating leverage (1)
Adjusted operating leverage, net of CCPB
PCL as a % of average net loans and acceptances
Effective tax rate
Adjusted effective tax rate
Canadian/U.S. dollar as at exchange rate ($)
Canadian/U.S. dollar average exchange rate ($)
Cash and securities-to-total assets
Capital Ratios (%)
Common Equity Tier 1 Ratio
Tier 1 Capital Ratio
Total Capital Ratio
1,264
1,230
1,146
1,041
1,111
1,162
1,097
1,083
0.82
1.83
1.83
1.90
56.31
0.82
1.81
1.80
1.86
55.36
0.80
1.49
1.49
1.71
51.65
0.80
1.47
1.46
1.53
52.98
0.78
1.57
1.56
1.63
48.18
0.78
1.68
1.67
1.73
46.69
0.76
1.61
1.60
1.63
45.94
0.76
1.58
1.58
1.61
45.60
78.50
64.01
76.04
79.43
71.27
72.98
80.76
73.12
78.82
84.39
72.87
72.93
85.71
76.41
81.73
82.79
74.28
81.27
76.68
67.04
75.55
74.69
68.01
68.06
4.3
12.9
13.5
1.57
1.57
62.1
60.8
64.2
0.3
1.8
0.15
18.8
18.9
1.3075
1.3191
27.8
4.5
13.6
14.0
1.55
1.55
61.6
60.5
63.4
(5.9)
1.4
0.20
19.3
19.4
1.3080
1.2671
29.3
4.1
11.4
13.2
1.51
1.51
68.7
64.3
64.7
(16.3)
(2.0)
0.20
18.8
19.8
1.2064
1.2412
30.0
4.4
11.8
12.3
1.55
1.55
59.5
58.4
68.5
0.9
(6.8)
0.21
12.2
12.6
1.2711
1.1923
30.1
3.8
13.1
13.7
1.60
1.60
62.2
61.1
65.3
(4.5)
(5.9)
0.23
16.6
16.8
1.1271
1.1114
30.2
3.8
14.4
14.9
1.58
1.58
58.2
57.2
64.2
6.8
(1.1)
0.18
15.3
15.6
1.0904
1.0807
33.0
4.0
14.3
14.6
1.59
1.59
59.4
58.8
63.5
1.3
1.2
0.22
16.2
16.5
1.0960
1.1029
32.1
4.5
14.2
14.5
1.62
1.62
59.9
59.2
64.3
2.6
(0.3)
0.14
20.8
20.9
1.1138
1.0800
32.3
10.7
12.3
14.4
10.4
11.7
13.7
10.2
11.4
13.5
10.1
11.4
13.4
10.1
12.0
14.3
9.6
11.4
13.3
9.7
11.1
13.0
9.3
10.6
12.4
(1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified.
In the opinion of Bank of Montreal management, information that is derived from unaudited financial information, including information as at and for the 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 the ratios, as well as interim operating results, are not necessarily indicative of actual results for the full fiscal year.
Adjusted results in this section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
BMO Financial Group 198th Annual Report 2015 67
MD&A
Q4-2015
Net interest income
Non-interest revenue (1)
MANAGEMENT’S DISCUSSION AND ANALYSIS
Financial Condition Review
Summary Balance Sheet
(Canadian $ in millions)
As at October 31
2014
2013
2012
2011
47,677
130,918
68,066
334,024
61,196
34,496
143,319
53,555
303,038
54,251
32,607
135,800
39,799
279,294
49,544
26,256
129,441
47,011
253,846
68,130
25,656
122,115
37,970
238,885
75,949
Total assets
MD&A
2015
Assets
Cash and interest bearing deposits with banks
Securities
Securities borrowed or purchased under resale agreements
Net loans and acceptances
Other assets
641,881
588,659
537,044
524,684
500,575
Liabilities and Shareholders’ Equity
Deposits
Other liabilities
Subordinated debt
Capital trust securities
Shareholders’ equity
Non-controlling interest in subsidiaries
438,169
159,383
4,416
–
39,422
491
393,088
155,254
4,913
–
34,313
1,091
368,369
133,500
3,996
–
30,107
1,072
325,235
165,813
4,093
–
28,108
1,435
302,373
164,197
5,348
821
26,353
1,483
Total liabilities and shareholders’ equity
641,881
588,659
537,044
524,684
500,575
Overview
Total assets increased $53.2 billion from the prior year to $641.9 billion, including a $35.8 billion increase due to the stronger U.S. dollar, excluding the impact on derivative financial assets. Total liabilities increased $48.7 billion from October 31, 2014, including a $35.7 billion increase due to the stronger U.S. dollar, excluding the impact on derivative financial liabilities. Derivative financial assets increased $5.6 billion and derivative financial liabilities increased $9.0 billion, primarily due to the increase in the fair value of interest rate and foreign exchange contracts resulting from the decline in interest rates and the strengthening U.S. dollar, respectively. Total equity increased $4.5 billion from October 31, 2014.
Cash and Interest Bearing Deposits with Banks
Cash and interest bearing deposits with banks increased $13.2 billion, primarily reflecting a $6.3 billion increase due to the stronger U.S. dollar and balances held with central banks.
Securities
(Canadian $ in millions)
As at October 31
Trading
Available-for-sale
Held-to-maturity
Other
Total securities
2015
2014
2013
2012
2011
72,460
48,006
9,432
1,020
85,022
46,966
10,344
987
75,159
53,710
6,032
899
70,109
57,340
875
1,117
69,925
51,426
–
764
130,918
143,319
135,800
129,441
122,115
Securities decreased $12.4 billion, primarily reflecting decreases in trading securities related to client-driven activities in BMO Capital Markets.
Securities Borrowed or Purchased Under Resale Agreements
Securities borrowed or purchased under resale agreements increased $14.5 billion, driven by client activities in BMO Capital Markets.
Loans and Acceptances
(Canadian $ in millions)
As at October 31
2015
2014
2013
2012
2011
Residential mortgages
Consumer instalment and other personal
Credit cards
Businesses and governments
Customers’ liability under acceptances
105,918
65,598
7,980
145,076
11,307
101,013
64,143
7,972
120,766
10,878
96,392
63,640
7,870
104,585
8,472
84,211
61,436
7,814
94,072
8,019
81,075
59,445
8,038
84,883
7,227
Gross loans and acceptances
Allowance for credit losses
335,879
(1,855)
304,772
(1,734)
280,959
(1,665)
255,552
(1,706)
240,668
(1,783)
Net loans and acceptances
334,024
303,038
279,294
253,846
238,885
Net loans and acceptances increased $31 billion, including a $16.1 billion increase due to the stronger U.S. dollar. The remaining increase was primarily due to a $12.1 billion increase in loans to businesses and governments across most operating groups and a $3.7 billion increase in residential mortgages primarily in Canadian P&C.
Table 7 on page 124 provides a comparative summary of loans by geographic location and product. Table 9 on page 125 provides a comparative summary of net loans in Canada by province and industry. Loan quality is discussed on pages 96 and 97 and further details on loans are provided in
Notes 4, 6 and 26 on pages 148, 153 and 192 of the financial statements.
68 BMO Financial Group 198th Annual Report 2015
Other Assets
Other assets excluding derivative assets increased $1.4 billion or decreased $0.6 billion excluding the stronger U.S. dollar impact. Other assets includes premises and equipment, goodwill and intangible assets, current and deferred tax assets, accounts receivable and prepaid expenses.
The increase in derivative financial assets is discussed above and is detailed in Note 8 on page 156 of the financial statements.
Deposits
(Canadian $ in millions)
As at October 31
2015
2014
2013
2012
2011
Banks
Businesses and governments
Individuals
27,135
263,618
147,416
18,243
239,139
135,706
20,591
222,346
125,432
18,102
188,103
119,030
20,877
159,209
122,287
Total deposits
438,169
393,088
368,369
325,235
302,373
Other Liabilities
Other liabilities excluding derivative financial liabilities decreased $4.9 billion, or decreased $10.0 billion excluding the stronger U.S. dollar impact, primarily driven by a decrease of $6.8 billion in securities sold but not yet purchased and a $3.4 billion decrease in securities lent or sold under repurchase agreements related to client activities in BMO Capital Markets. The increase in derivative financial liabilities is discussed above.
Further details on the composition of other liabilities are provided in Note 14 on page 167 of the financial statements.
Subordinated Debt
Subordinated debt decreased $0.5 billion. Further details on the composition of subordinated debt are provided in Note 15 on page 168 of the financial statements.
Equity
(Canadian $ in millions)
As at October 31
2015
2014
2013
2012
2011
Share capital
Preferred shares
Common shares
Contributed surplus
Retained earnings
Accumulated other comprehensive income
3,240
12,313
299
18,930
4,640
3,040
12,357
304
17,237
1,375
2,265
12,003
315
15,087
437
2,465
11,957
213
13,456
17
2,861
11,332
113
11,381
666
Total shareholders’ equity
Non-controlling interest in subsidiaries
39,422
491
34,313
1,091
30,107
1,072
28,108
1,435
26,353
1,483
Total equity
39,913
35,404
31,179
29,543
27,836
Total equity increased $4.5 billion. Total shareholders’ equity increased $5.1 billion, partly offset by a decrease in non-controlling interest in subsidiaries of $0.6 billion due to the redemption of BMO BoaTS – Series D. Total shareholders’ equity increased due to an increase of $2.7 billion in accumulated other comprehensive income on translation of net foreign operations as a result of the strengthening U.S. dollar net of hedging impacts and increased retained earnings of $1.7 billion.
The increase in share capital is driven by the issuance of preferred shares, as well as the issuance of common shares under the Shareholder
Dividend Reinvestment and Share Purchase Plan (DRIP) and Stock Option Plan, net of the impact of share repurchases. BMO’s DRIP is described in the Enterprise-Wide Capital Management section that follows. Our Consolidated Statement of Changes in Equity on page 138 provides a summary of items that increase or reduce shareholders’ equity, while Note 17 on page 170 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 the following page.
2011 data has not been restated to reflect the new IFRS standards adopted in 2014.
BMO Financial Group 198th Annual Report 2015 69
MD&A
Deposits increased $45.1 billion, including an increase of $30.5 billion due to the stronger U.S. dollar. The balance of the increase was largely driven by a $6.9 billion increase in deposits by banks, a $4.8 billion increase in deposits by individuals and a $2.9 billion increase in deposits by businesses and governments, reflecting higher levels of wholesale and customer deposits. Further details on the composition of deposits are provided in Note 13 on page 166 of the financial statements and in the Liquidity and Funding Risk section on page 105.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Enterprise-Wide Capital Management
BMO’s Common Equity Tier 1 Ratio of 10.7% is strong and exceeds regulatory requirements.
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:
‰ is appropriate given our target regulatory capital ratios and internal assessment of required Economic Capital;
‰ is consistent with our target credit ratings;
‰ underpins our operating groups’ business strategies; and
‰ supports depositor, investor and regulator confidence, while building long-term shareholder value.
MD&A
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 our Internal Capital Adequacy Assessment Process (ICAAP).
ICAAP is an integrated process that evaluates capital adequacy on both a regulatory and an economic capital basis, and is used to establish capital targets and capital strategies that take into consideration the strategic direction and risk appetite of the enterprise. The capital plan is developed considering the results of our ICAAP and in conjunction with our annual business plan, promoting alignment between our business and risk strategies, regulatory and economic capital requirements and the availability of capital. Enterprise-wide stress testing and scenario analysis are also used to assess the impact of various stress conditions on BMO’s risk profile and capital requirements. The framework seeks to ensure 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 levels. Assessments of actual and forecast capital adequacy are compared to the capital plan throughout the year, and the capital plan is updated as required, based on changes in our business activities, risk profile or operating environment.
BMO uses a combination of regulatory and economic capital to evaluate business performance and considers capital implications in its strategic, tactical and transactional decision-making. By allocating our capital to operating groups and measuring their performance in relation to the capital necessary to support the risks in their business, we seek to optimize our risk-adjusted return to shareholders, while maintaining a well-capitalized position. This approach aims to protect our stakeholders from the risks inherent in our various businesses, while still allowing the flexibility to deploy resources to support the strategic growth activities of our operating groups. We increased the capital allocated to the operating groups in fiscal 2015 given higher capital expectations for the bank. Capital in excess of what is required to support our line of business activities is held in Corporate Services.
Capital Demand
Capital required to support the risks underlying our business activities
Capital adequacy assessment of capital demand and supply
Capital Supply
Capital available to support risks
Management
Actions
For further discussion of the risks underlying our business activities, refer to the Enterprise-Wide Risk Management section on page 86.
Governance
The Board of Directors, either directly or in conjunction with its Risk Review Committee, provides ultimate oversight and approval of capital management, including our Capital Management Corporate Policy framework, capital plan and capital adequacy assessments. The Board regularly reviews BMO’s capital position and key capital management activities, and the Risk Review Committee reviews the ICAAP-determined capital adequacy assessment results. The Balance Sheet and Capital Management Committee provides senior management oversight, including the review and discussion of significant capital management policies, issues and activities and, along with the Risk Management Committee, the capital required to support 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.
Regulatory Capital
Common equity is the most permanent form of capital. Common Equity Tier 1 (CET1) capital is comprised of common shareholders’ equity less deductions for goodwill, intangible assets, defined benefit pension assets, certain deferred tax assets and certain other items. Additional Tier 1 capital primarily consists of preferred shares and innovative hybrid instruments, less certain regulatory deductions. Tier 1 capital is comprised of CET1 capital and Additional Tier 1 capital. Tier 2 capital is primarily comprised of subordinated debentures and a portion of the collective and individual allowances for credit losses, less certain regulatory deductions. Total capital includes Tier 1 and Tier 2 capital.
Regulatory capital requirements for BMO are determined on a Basel III basis. The minimum Basel III capital ratios proposed by the Basel
Committee on Banking Supervision (BCBS) were a 4.5% CET1 Ratio, 6% Tier 1 Capital Ratio and 8% Total Capital Ratio. These ratios are calculated using a five-year transitional phase-in of regulatory adjustments and a nine-year transitional phase-out of non-qualifying capital instruments.
However, guidance issued by the Office of the Superintendent of Financial Institutions Canada (OSFI) required Canadian deposit-taking institutions to meet the 2019 Basel III capital requirements in 2013, other than the phase-out of non-qualifying capital instruments, and OSFI has expected banks to
70 BMO Financial Group 198th Annual Report 2015
attain a target Basel III CET1 Ratio of at least 7% (4.5% minimum plus 2.5% Capital Conservation Buffer) since January 31, 2013 (also referred to as the “all-in” requirements).
In addition, OSFI issued guidance designating the six largest Canadian banks as domestic systemically important banks (D-SIBs), increasing minimum capital ratio requirements by 1% commencing on January 1, 2016. No Canadian banks are currently considered to be globally systemically important. Our practice is to hold capital in addition to these requirements for a number of reasons, including regulatory considerations, market expectations and to provide flexibility for growth.
The fully implemented Basel III requirements and the OSFI “all-in” Basel III requirements are summarized in the following table.
Regulatory Capital Requirements (% of Risk-Weighted Assets)
Common Equity
Tier 1 Ratio (1)
Basel III – Stated 2019 minimum requirements
Plus: Capital Conservation Buffer (2) (effective January 1, 2013)
Tier 1
Capital Ratio
Total
Capital Ratio
Leverage
Ratio (3)
4.5
2.5
6.0
2.5
8.0
2.5
3.0 na Plus: D-SIB Common Equity Surcharge (effective January 1, 2016)
1.0
1.0
1.0
na
OSFI Basel III effective requirements (4)
8.0
9.5
11.5
3.0
OSFI’s Basel III capital rules also require the implementation of BCBS guidance on non-viability contingent capital (NVCC). NVCC provisions require the conversion of the capital instrument into a variable number of common shares in the event that OSFI announces that the bank is, or is about to become, non-viable or if a federal or provincial government in Canada publicly announces that the bank has accepted or agreed to accept a capital injection, or equivalent support, to avoid non-viability.
Under OSFI’s Basel III rules, non-common share capital instruments that do not meet Basel III requirements, including NVCC requirements, are to be grandfathered and phased out over a nine-year period that began on January 1, 2013. OSFI’s guidance also outlines the requirements for redemption of these regulatory capital instruments due to a regulatory capital event.
BMO primarily uses the Advanced Internal Ratings Based (AIRB) Approach to determine credit risk-weighted assets (RWA) in our portfolio.
Credit RWA arising from certain U.S. portfolios are determined using the Standardized Approach. The AIRB Approach utilizes sophisticated techniques to measure RWA at the exposure level based on sound risk management principles, including consideration of estimates of the probability of default, the likely loss given default and 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.
BMO’s market risk RWA are primarily determined using the Internal Models Approach, but the Standardized Approach is used for some exposures.
BMO uses the Advanced Measurement Approach (AMA), a risk-sensitive capital model, along with the Standardized Approach under OSFI rules, to determine capital requirements for operational risk.
OSFI advised banks that it would begin phasing in the Credit Valuation Adjustment (CVA) risk capital charge for Canadian banks in the first quarter of 2014. In 2015, the CVA risk capital charge applicable to CET1 was 64% of the fully implemented charge, and will remain at 64% in 2016.
In addition, starting in the first quarter of fiscal 2015, Canadian banks were expected to maintain a 3% minimum Basel III Leverage Ratio requirement, replacing the Assets-to-Capital Multiple which was discontinued.
In an effort to increase the comparability of capital requirements and to ensure minimum levels of capital across the banking system, BCBS is considering a standardized approach for credit, market and operational risk-weighted assets, including new capital floors based on revised standardized approaches. The current expectation is that the approaches will be settled on during 2016. BCBS is also completing a fundamental review of the trading book risk-weighted assets and released a consultative paper in June 2015 that discussed the appropriate capital to be held for interest rate risk in the banking book. Such changes, if implemented, along with the new impairment model based on expected credit losses under
IFRS 9, could have the effect of increasing the capital that we are required to hold.
A number of other potential regulatory changes are still under discussion with regulators. OSFI may implement a stand-alone or “solo” capital framework that would assess a bank’s stand-alone capital adequacy by reducing such bank’s capital by the portion of its investments in subsidiaries that are not considered available to protect the parent bank depositors and senior creditors under exceptional circumstances. These changes could affect the amount of capital that we hold or are required to hold, or the attractiveness of certain investments in subsidiaries.
In August 2014, Canada’s Department of Finance issued a consultation paper on a Canadian bank resolution framework, including the Canadian bail-in regime and Higher Loss Absorbency (HLA) requirements that would apply to Canadian D-SIBs. In its budget on April 21, 2015, the Government of Canada provided details on the Canadian bail-in regime, stating that it would apply to unsecured, tradable, transferable senior debt with an original term to maturity of greater than or equal to 400 days and that all securities subject to bail-in would be convertible into common shares. The government did not provide details on the timing planned for implementation of the regime, on the amount, or on the period of time within which banks must transition to meet the new HLA requirement. In October 2015, the Federal Reserve Board proposed new rules on Total Loss Absorbing
Capacity (TLAC) for U.S. domestic firms identified by the Board as Global Systemically Important Banks (G-SIBs) and for the U.S. operations of G-SIBs.
In November 2015, the Financial Stability Board issued the final standard for TLAC for G-SIBs. Neither of these rules are expected to apply to BMO, as
BMO is not a G-SIB. With respect to capital supply, in November 2015, BCBS issued a consultative document which proposes a Tier 2 deduction approach for investments in G-SIB TLAC by internationally active banks (both G-SIBs and non G-SIBs).
BMO conducts business through a variety of corporate structures, including subsidiaries and joint ventures. A framework is in place for subsidiaries to appropriately manage their funding and capital.
BMO Financial Group 198th Annual Report 2015 71
MD&A
(1) The minimum 4.5% CET1 Ratio requirement is augmented by the 2.5% Capital Conservation Buffer that can absorb losses during periods of stress. The Capital Conservation Buffer for BMO will be augmented in 2016 with the addition of the 1% Common Equity Surcharge for D-SIBs. If a bank’s capital ratios fall within the range of this combined buffer, restrictions on discretionary distributions of earnings (such as dividends, equity repurchases and discretionary compensation) would ensue, with the degree of such restrictions varying according to the position of the bank’s ratios within the buffer range.
(2) The Capital Conservation Buffer does not include the counter-cyclical capital buffer of up to 2.5% of CET1, which may be required on a national basis by supervisors if they perceive credit growth resulting in systemic risk. If imposed, this additional buffer would be effectively combined with the Capital Conservation Buffer.
(3) A 3% minimum Leverage Ratio has been established by the BCBS. It will be subject to monitoring and analysis during a four-year parallel run test period, which began on January 1, 2013. Depending upon the results of the parallel run testing, there could be subsequent adjustments, which are targeted to be finalized in 2017, with the final Leverage Ratio requirement effective January 1, 2018.
OSFI established a 3% minimum Basel III Leverage Ratio requirement in October 2014.
(4) OSFI’s Basel III “effective requirements” are the capital requirements systemically important Canadian banks must meet in 2016 to avoid being subject to restrictions on discretionary distributions of earnings. na – not applicable
MANAGEMENT’S DISCUSSION AND ANALYSIS
As a bank holding company with total consolidated assets of US$50 billion or more, our subsidiary BMO Financial Corp. (BFC) became subject to the Federal Reserve Board’s (FRB) annual Comprehensive Capital Analysis and Review (CCAR) and mid-year Dodd-Frank Act stress testing (DFAST) requirements starting in fiscal 2014. CCAR requires BFC to test its ability to meet applicable regulatory capital requirements and continue to operate under severe stress. The quantitative and qualitative aspects of BFC’s 2015 CCAR capital plan were subject to supervisory review and the FRB applied its own quantitative tools to evaluate BFC. The FRB announced its decision not to object to BFC’s capital plan in March 2015 and disclosed the results of its quantitative analysis. BFC and its bank subsidiary BMO Harris Bank N.A. (BHB) also disclosed their results under the CCAR supervisory severely adverse scenario. Under DFAST, BFC executes mid-year company-run stress tests. BFC submitted its DFAST stress tests to the FRB and disclosed the results in July 2015.
The Common Equity Tier 1 Ratio reflects Basel III CET1 capital divided by CET1 capital RWA.
The Tier 1 Capital Ratio reflects Basel III Tier 1 capital divided by Tier 1 capital RWA.
The Total Capital Ratio reflects Basel III Total capital divided by Total capital RWA.
MD&A
The Leverage Ratio is defined as Basel III Tier 1 capital divided by the sum of on-balance sheet items and specified off-balance sheet items, net of specified adjustments.
2015 Regulatory Capital Review
BMO’s capital ratios are strong and exceed OSFI’s requirements for large Canadian banks, including the 1% D-SIB Common Equity Surcharge to be implemented in 2016. Our CET1 Ratio was 10.7% at October 31, 2015, compared to 10.1% at October 31, 2014. The CET1 Ratio increased by 60 basis points from the end of fiscal 2014 primarily due to higher capital from accumulated other comprehensive income and retained earnings, partially offset by an increase in RWA. The RWA increase was attributable to foreign exchange rate movements, which we largely hedge as discussed below, higher business volumes and higher market risk, partly offset by methodology changes and changes in book quality.
Our Tier 1 Capital and Total Capital Ratios were 12.3% and 14.4%, respectively, at October 31, 2015, compared to 12.0% and 14.3%, respectively, at October 31, 2014. The Tier 1 and Total Capital Ratios increased by 30 basis points and 10 basis points, respectively, from the end of fiscal 2014 due mainly to the factors impacting the CET1 Ratio discussed above and the issuances of preferred shares, partially offset by Additional Tier 1 instruments redemptions. The increase in the Total Capital Ratio was mainly due to the factors impacting the CET1 and the Tier 1 Ratios, partially offset by the additional 10% phase-out of non-qualifying subordinated debt.
BMO’s Leverage Ratio was 4.2% at October 31, 2015, in excess of the 3% minimum requirement established by OSFI.
On September 10, 2015, we announced the signing of an agreement to acquire GE Capital’s Transportation Finance business. The acquisition is expected to reduce BMO’s CET1 Ratio by approximately 70 basis points on closing in the first quarter of 2016.
BMO’s investments in foreign operations are primarily denominated in U.S. dollars. The foreign exchange impact of U.S.-dollar-denominated RWA and U.S.-dollar-denominated capital deductions may result in variability in the bank’s capital ratios. BMO may enter into hedging arrangements to reduce the impact of foreign exchange movements on its capital ratios and did so during 2015.
Regulatory Capital (All-in basis (1))
(Canadian $ in millions)
As at October 31
2015
2014
Common Equity Tier 1 capital: instruments and reserves
Directly issued qualifying common share capital plus related stock surplus
Retained earnings
Accumulated other comprehensive income (and other reserves)
Goodwill and other intangibles (net of related tax liability)
Other common equity Tier 1 capital deductions
12,612
18,930
4,640
(7,752)
(2,802)
12,661
17,237
1,375
(6,875)
(1,977)
Common Equity Tier 1 capital (CET1)
25,628
22,421
2,150
1,987
1,200
3,332
9
9
7
7
Additional Tier 1 capital: instruments
Directly issued qualifying Additional Tier 1 instruments plus related stock surplus
Directly issued capital instruments subject to phase-out from Additional Tier 1
Additional Tier 1 instruments (and CET1 instruments not otherwise included) issued by subsidiaries and held by third parties
(amount allowed in group AT1) of which: instruments issued by subsidiaries subject to phase-out
Total regulatory adjustments applied to Additional Tier 1 capital
(358)
(358)
Additional Tier 1 capital (AT1)
3,788
4,181
Tier 1 capital (T1 = CET1 + AT1)
29,416
26,602
1,034
3,548
1,002
4,027
46
46
590
80
80
266
(50)
(50)
Tier 2 capital: instruments and provisions
Directly issued qualifying Tier 2 instruments plus related stock surplus
Directly issued capital instruments subject to phase-out from Tier 2
Tier 2 instruments (and CET1 and AT1 instruments not included) issued by subsidiaries and held by third parties
(amount allowed in group Tier 2) of which: instruments issued by subsidiaries subject to phase-out
Collective allowances
Total regulatory adjustments to Tier 2 capital
Tier 2 capital (T2)
Total capital (TC = T1 + T2)
5,168
5,325
34,584
31,927
(1) “All-in” regulatory capital assumes that all Basel III regulatory adjustments are applied effective January 1, 2013, and that the capital value of instruments that no longer qualify as regulatory capital under Basel III rules is being phased out at a rate of 10% per year from January 1, 2013 to January 1, 2022.
72 BMO Financial Group 198th Annual Report 2015
Our CET1 capital and Tier 1 capital were $25.6 billion and $29.4 billion, respectively, at October 31, 2015, up from $22.4 billion and $26.6 billion, respectively, at October 31, 2014. CET1 capital increased due to higher accumulated other comprehensive income, primarily driven by foreign exchange movement due to our investment in foreign operations, retained earnings growth, the issuance of common shares through the Shareholder
Dividend Reinvestment and Share Purchase Plan (DRIP) and the exercise of stock options, partially offset by higher deductions and share repurchases.
The increase in Tier 1 capital since October 31, 2014 was attributable to the growth in CET1 capital and issuance of preferred shares, partially offset by the Additional Tier 1 instruments redemptions, as outlined below in the Capital Management Activities section.
Total capital was $34.6 billion at October 31, 2015, up from $31.9 billion at October 31, 2014, attributable to the growth in Tier 1 capital mentioned above, partially offset by the additional 10% phase-out of non-qualifying subordinated debt, as mentioned above.
Risk-Weighted Assets
(Canadian $ in millions)
As at October 31
2014
91,489
31,954
1,765
3,902
81,340
33,644
1,612
4,186
8,427
7,889
4,569
11,053
1,968
1,369
8,415
2,456
16,255
8,874
7,618
6,541
4,000
9,826
1,604
1,362
7,359
3,098
14,946
8,251
Total Credit Risk
Market Risk
Operational Risk
200,385
10,262
28,538
185,387
9,002
27,703
CET1 Capital Risk-Weighted Assets
Additional CVA adjustment, prescribed by OSFI, for Tier 1 Capital
239,185
286
222,092
336
Tier 1 Capital Risk-Weighted Assets
Additional CVA adjustment, prescribed by OSFI, for Total Capital
239,471
245
222,428
503
Total Capital Risk-Weighted Assets
239,716
222,931
(1) The scaling factor is applied to the risk-weighted assets amounts for credit risk under the AIRB Approach.
Credit Risk RWA (CET1 basis) were $200.4 billion at October 31, 2015, up from $185.4 billion at October 31, 2014. The increase was largely due to foreign exchange movement and business growth, partially offset by changes in methodology and higher book quality. Market Risk RWA were
$10.3 billion at October 31, 2015, up from $9.0 billion at October 31, 2014, attributable to an increase in client facilitation positions and market variables, partially offset by methodology and policy changes. Operational Risk RWA were $28.5 billion at October 31, 2015, up from $27.7 billion at
October 31, 2014, largely due to growth in the bank’s average gross income.
Risk Capital Review
Economic capital is a measure of 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 severely adverse situations arise, and allows returns to be measured on a basis that considers the risks undertaken. Economic capital is calculated for various types of risk – credit, market (trading and non-trading), operational and business – based on a one-year time horizon using a defined confidence level.
Risk-weighted assets (RWA) is a measure of the bank’s exposures weighted by risk and is calculated in accordance with the Regulatory Capital rules using a combination of Advanced approach models and Standardized approaches. RWA is calculated for credit, market (trading) and operational risk categories based on OSFI’s prescribed rules.
BMO Financial Group 198th Annual Report 2015 73
MD&A
2015
Credit Risk
Wholesale
Corporate, including specialized lending
Corporate small and medium-sized enterprises
Sovereign
Bank
Retail
Residential mortgages, excluding home equity line of credit
Home equity line of credit
Qualifying revolving retail
Other retail, excluding small and medium-sized enterprises
Retail small and medium-sized enterprises
Equity
Trading book
Securitization
Other credit risk assets – non-counterparty managed assets
Scaling factor for credit risk assets under AIRB Approach (1)
MANAGEMENT’S DISCUSSION AND ANALYSIS
Economic Capital and RWA by Operating Group and Risk Type
(As at October 31, 2015)
BMO Financial Group
Personal and
Commercial
Banking
Wealth
Management
BMO Capital
Markets
Corporate
Services
Credit
72%
22%
60%
67%
Market
11%
39%
20%
6%
Operational/Other
17%
39%
20%
27%
133,419
10,291
47,361
9,312
98
10,165
5,231
7,785
Operating Groups
MD&A
Economic Capital by Risk Type (%)
RWA by Risk Type
(Canadian $ in millions)
Credit
Market
Operational
15,523
Capital Management Activities
On December 2, 2014, we announced our intention, and subsequently obtained the approval of OSFI and the Toronto Stock Exchange (TSX), to initiate a normal course issuer bid (NCIB) to purchase up to 15 million of BMO’s common shares on the TSX for the purpose of cancellation. During fiscal 2015, we purchased 8 million shares under our NCIB share repurchase program. The current NCIB is set to expire on January 31, 2016.
On December 1, 2015, we announced our intention, subject to the approval of OSFI and the TSX, to initiate a new NCIB for up to 15 million of
BMO’s common shares, commencing on or about February 1, 2016, after the expiry of the current NCIB. Once approvals are obtained, the share repurchase program will permit BMO to purchase its common shares on the TSX for the purpose of cancellation. Maintaining an NCIB is part of BMO’s capital management strategy. The timing and amount of any purchases under the program are subject to regulatory approvals and to management discretion based on factors such as market conditions and capital adequacy.
During 2015, BMO issued 1.5 million common shares through the DRIP and the exercise of stock options.
On December 31, 2014, we redeemed all of our $600 million BMO Capital Trust Securities – Series D (BMO BOaTS – Series D). On February 25,
2015, we redeemed all of our $400 million Non-cumulative 5-Year Rate Reset Class B Preferred Shares, Series 23. On April 22, 2015, we redeemed all of our $500 million Subordinated Debentures, Series C Medium-Term Notes, Second Tranche. On May 25, 2015, we redeemed all of our $350 million
Non-cumulative Perpetual Class B Preferred Shares, Series 13.
On June 5, 2015, we completed our offering of Non-cumulative 5-Year Rate Reset Class B Preferred Shares Series 33. We issued 8 million shares for aggregate proceeds of $200 million.
On July 29, 2015, we completed our offering of Non-cumulative Perpetual Class B Preferred Shares Series 35. We issued 6 million shares for aggregate proceeds of $150 million.
On October 16, 2015, we completed our offering of Non-cumulative Perpetual Class B Preferred Shares Series 36. We issued 600,000 shares for aggregate proceeds of $600 million.
On November 27, 2015, BMO announced its intention to redeem the $450 million of outstanding BMO Capital Trust Securities – Series E (BMO
BOaTS – Series E) on December 31, 2015.
If an NVCC trigger event were to occur, our NVCC capital instruments, Non-cumulative 5-Year Rate Reset Class B Preferred Shares, Series 27,
Series 29, Series 31, Series 33 and Series 36, Non-cumulative Perpetual Class B Preferred Shares, Series 35, and Series H Medium-Term Notes,
Tranche 1, would be converted into BMO common shares pursuant to automatic conversion formulas with a conversion price based on the greater of:
(i) a floor price of $5.00, and (ii) the current market price of our common shares at the time of the trigger event (10-day weighted average). Based on a floor price of $5.00, these NVCC capital instruments would convert into 730 million BMO common shares, assuming no accrued interest and no declared and unpaid dividends.
Further details are provided in Notes 15, 16 and 17 on pages 168, 169 and 170 of the financial statements.
74 BMO Financial Group 198th Annual Report 2015
Outstanding Shares and Securities Convertible into Common Shares
As at November 25, 2015
2015
2014
2013
643
$3.24
$3.08
$2.94
–
–
250
250
157
143
–
–
–
290
500
400
300
200
150
600
–
$0.56
$1.31
$1.45
$0.85
$0.60
–
–
$0.34
$0.98
$1.00
$0.98
$0.95
$0.45
$0.41
–
–
$1.13
$1.31
$1.45
$0.85
$0.64
$0.41
$0.81
$1.35
$0.98
$0.59
$0.46
$0.31
–
–
–
$0.33
$1.13
$1.31
$1.45
$1.19
$0.17
$1.63
$1.63
$1.35
$0.98
–
–
–
–
–
–
$1,000
na
na
na
$
$
$
$
$
$
$
$
$
$
$
Dividends declared per share
6.9
5.1
(1) Redeemed in February 2013.
(2) Redeemed in May 2015.
(3) In August 2013, approximately 5.7 million Series 16 Preferred Shares were converted into Series 17 Preferred Shares on a one-for-one basis.
(4) Redeemed in February 2014.
(5) Redeemed in May 2014.
(6) Redeemed in February 2015.
(7) Note 15 on page 168 of the financial statements includes details on the Series H Medium-Term Notes, Tranche 1. na – not applicable
Note 17 on page 170 of the financial statements includes details on share capital.
Dividends
Dividends declared per common share in fiscal 2015 totalled $3.24. Annual dividends declared represented 51.1% of reported net income and 48.0% of adjusted net income available to common shareholders on a last twelve months basis.
Our target dividend payout range (common share dividends as a percentage of net income available to shareholders, less preferred share dividends, based on adjusted earnings over the last twelve months) is 40% to 50%, which is consistent with our objective of maintaining flexibility to execute on our growth strategies, and takes into consideration the higher capital expectations resulting from the Basel III rules. BMO’s target dividend payout range seeks to provide shareholders with stable income, while ensuring sufficient earnings are retained to support anticipated business growth, fund strategic investments and provide for a sound capital level.
At year end, BMO’s common shares provided a 4.3% annual dividend yield based on the year-end closing share price and dividends declared in the last four quarters. On December 1, 2015, BMO announced that the Board of Directors had declared a quarterly dividend on common shares of
$0.84 per share, up $0.02 per share or 2% from the prior quarter and up $0.04 per share or 5.0% from a year ago. The dividend is payable on
February 26, 2016 to shareholders of record on February 1, 2016.
Common shareholders may elect to have their cash dividends reinvested in common shares of BMO in accordance with the DRIP. In the first quarter of 2015, common shares to supply the DRIP were issued from treasury without discount. Starting in the second quarter of 2015, common shares for the DRIP were purchased on the open market.
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 as “eligible dividends”, unless indicated otherwise.
Caution
This Enterprise-Wide Capital Management section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
BMO Financial Group 198th Annual Report 2015 75
MD&A
Common shares
Class B Preferred shares
Series 5 (1)
Series 13 (2)
Series 14
Series 15
Series 16 (3)
Series 17 (3)
Series 18 (4)
Series 21 (5)
Series 23 (6)
Series 25
Series 27
Series 29
Series 31
Series 33
Series 35
Series 36
Medium-Term Notes
Series H (7)
Stock options
– vested
– non-vested
Number of shares or dollar amount
(in millions)
MANAGEMENT’S DISCUSSION AND ANALYSIS
Select Financial Instruments
The Financial Stability Board (FSB) issued a report in 2012 encouraging enhanced disclosure related to financial instruments that market participants had come to regard as carrying higher risk. An index of the disclosures recommended by the Enhanced Disclosure Task Force of the FSB and where these disclosures appear in our Annual Report or Supplementary Financial Information is provided on page 84.
Caution
Given continued uncertainty in the capital markets environment, our capital markets instruments could experience valuation gains and losses due to changes in market value. This section, Select Financial Instruments, contains forward-looking statements. Please see the Caution Regarding ForwardLooking Statements on page 30.
MD&A
Consumer Loans
In Canada, our Consumer Lending portfolio is comprised of three main asset classes: Real Estate Secured Lending (including residential mortgages and home equity products), instalment/other personal loans (including indirect automobile loans) and credit card loans. We do not have any subprime or
Alt-A mortgage or home equity loan programs, nor do we purchase subprime or Alt-A loans from third-party lenders.
In the United States, the Consumer Lending portfolio is primarily comprised of three asset classes: residential first mortgages, home equity products and indirect automobile loans. We have a small portfolio of first mortgage and home equity loans outstanding that had subprime or Alt-A characteristics at the date of authorization (e.g., low credit score or limited documentation). These programs have been discontinued. Balances outstanding and amounts in arrears 90 days or more at year end were not significant.
In both Canada and the United States, consumer lending products are underwritten to prudent standards relative to credit scores, loan-to-value ratios, and capacity assessment, and are generally based upon documented and verifiable income.
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 exposure to leveraged finance loans, which represent 1.6% of our total assets, with $10.4 billion outstanding at
October 31, 2015, up approximately $1.9 billion from a year ago. Of this amount, $351 million or 3.4% of leveraged finance loans were classified as impaired ($179 million or 2.1% in 2014).
BMO-Sponsored Securitization Vehicles
BMO sponsors various vehicles that fund assets originated by either BMO (through a bank securitization vehicle) or its customers (several Canadian customer securitization vehicles and one U.S. customer securitization vehicle). We earn fees for providing services related to the customer securitization vehicles, including liquidity, distribution and financial arrangement fees for supporting the ongoing operations of the vehicles.
These fees totalled approximately $89 million in 2015 and $66 million in 2014.
Canadian Customer Securitization Vehicles
The customer securitization vehicles we sponsor in Canada provide our customers with access to financing either directly from BMO or in the asset-backed commercial paper (ABCP) markets. Customers sell their assets into these vehicles, which then issue ABCP to either investors or BMO to fund the purchases. In all cases, the sellers remain responsible for the servicing of the transferred assets and are first to absorb any losses realized on the assets.
Our exposure to potential losses relates to our investment in ABCP issued by the vehicles, derivative contracts we have entered into with the vehicles and the liquidity support we provide to ABCP purchased by investors. 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.
Two of these customer securitization vehicles are funded in the market, while a third is funded directly by BMO. BMO does not control these entities and therefore they are not consolidated. Further information on the consolidation of customer securitization vehicles is provided in Note 7 on page 154 of the financial statements. There were no material mortgage loans with subprime or Alt-A characteristics held in any of the customer securitization vehicles at year end. No losses have been recorded on any of BMO’s exposures to these vehicles.
BMO’s investment in the ABCP of the market-funded vehicles totalled $21 million at October 31, 2015 ($10 million in 2014).
BMO provided liquidity support facilities to the market-funded vehicles totalling $5.0 billion at October 31, 2015 ($4.6 billion in 2014).
This amount comprised part of our commitments outlined in Note 26 on page 192 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 automobile-related receivables and Canadian insured residential mortgages. These two asset classes represent 86% (85% in 2014) of the aggregate assets of these vehicles. U.S. Customer Securitization Vehicle
We sponsor a U.S. ABCP multi-seller vehicle that we consolidate under IFRS. 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 28 (30 in 2014) individual securitization transactions with an average facility size of US$174 million (US$136 million in 2014). The size of the pools ranged from US$1 million to US$700 million at October 31, 2015. There were no residential mortgages classified as subprime or Alt-A held in this ABCP multi-seller vehicle.
The vehicle holds exposures secured by a variety of asset classes, including mid-market corporate loans, student loans and automobile loans.
The vehicle had US$4.1 billion of commercial paper outstanding at October 31, 2015 (US$2.6 billion in 2014). 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. BMO provides committed liquidity support facilities to the vehicle, with the undrawn amount totalling US$5.4 billion at October 31, 2015 (US$4.6 billion in 2014).
76 BMO Financial Group 198th Annual Report 2015
Sectors of Interest: Oil and Gas, Mining
Our risks related to the Oil and Gas sector are further outlined in the Top and Emerging Risks That May Affect Future Results section on page 87.
As at October 31, 2015, BMO’s Oil and Gas outstanding loans were $6.7 billion or 2.0% of total loans and up approximately $0.7 billion from a year ago. Of this amount, $102 million of oil and gas sector loans were classified as impaired ($1 million in 2014). The majority of oil and gas lending is to Exploration and Development companies at 66%, followed by Pipelines at 18%, Services at 14% and Manufacturing and Refining at 2%, with approximately half of these loans having an internal rating that maps to investment grade.
As at October 31, 2015, BMO’s loans in respect to the mining sectors were $1.3 billion or 0.4% of total loans and up approximately $0.2 billion from a year ago. Of this amount, $4 million of mining sector loans were classified as impaired ($12 million in 2014). Quarrying represents 12% of the total and of the remaining Metal/Non-Metal Mining, approximately half have an internal rating that maps to investment grade.
Off-Balance Sheet Arrangements
BMO enters into a number of off-balance sheet arrangements in the normal course of operations.
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 cause a significant number of our customers to fail to perform in accordance with the terms of their contracts with us.
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 avoid undue concentrations in any geographic region or industry.
The maximum amount payable by BMO in relation to these credit instruments was approximately $124 billion at October 31, 2015 ($99 billion in
2014). 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 our customers will utilize the facilities related to these instruments. It also does not take into account any amounts that could be recovered under recourse and collateral provisions. Further information on these instruments can be found in Note 26 on page 192 of the financial statements.
For the credit commitments outlined in the preceding paragraphs, in the absence of an event that triggers a default, early termination by BMO may result in a breach of contract.
Structured Entities (SEs)
Our interests in SEs are discussed primarily on page 76 in the BMO-Sponsored Securitization Vehicles section and in Note 7 on page 154 of the financial statements. Under IFRS, we consolidate our bank securitization vehicles, U.S. customer securitization vehicle, credit protection vehicle, and certain capital and funding vehicles. We do not consolidate our Canadian customer securitization vehicles, structured finance vehicles, certain capital and funding vehicles, and various BMO managed and non-BMO managed investment funds.
Guarantees
Guarantees include contracts under which 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 contracts or instruments (including, but not limited to, credit default swaps), as well as indemnification agreements.
The maximum amount payable by BMO in relation to these guarantees was $30 billion at October 31, 2015 ($31 billion in 2014). 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 us to make any payments. It also does not take into account any amounts that could be recovered through recourse and collateral provisions.
For a more detailed discussion of these agreements, please see Note 26 on page 192 of the financial statements.
Caution
This Off-Balance Sheet Arrangements section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
BMO Financial Group 198th Annual Report 2015 77
MD&A
Credit Instruments
MANAGEMENT’S DISCUSSION AND ANALYSIS
Critical Accounting Estimates
The most significant assets and liabilities for which we must make estimates include: allowance for credit losses; financial instruments measured at fair value; pension and other employee future benefits; impairment of securities; income taxes and deferred tax assets; goodwill and intangible assets; purchased loans; insurance-related liabilities; and contingent liabilities. We make judgments in assessing whether substantially all risks and rewards have been transferred in respect of transfers of financial assets and whether we control SEs. These judgments are discussed in Notes 6 and 7, respectively, on pages 153 and 154 of the financial statements. Note 18 on page 172 of the financial statements discusses the judgments made in determining the fair value of financial instruments. If actual results differ from the estimates we make, the impact would be recorded in future periods. We have established detailed policies and control procedures that are intended to ensure the judgments we make in determining the estimates 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.
For a more detailed discussion of the use of estimates, please see Note 1 on page 140 of the financial statements.
MD&A
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 10 years prior to 2015, our average annual ratio has ranged from a high of 0.88% in 2009 to a low of 0.09% in 2006. This ratio varies with changes in the economy and credit conditions. If we were to apply these high and low ratios to average net loans and acceptances in 2015, our provision for credit losses would range from $288 million to $2,818 million and our allowance for credit losses would range from $1,728 million to $4,258 million. Our provision for credit losses in 2015 was $612 million and our allowance for credit losses as at October 31, 2015 was $2,052 million. Additional information on the process and methodology for determining the allowance for credit losses can be found in the discussion of Credit and Counterparty Risk on page 94 as well as in Note 4 on page 148 of the financial statements.
Financial Instruments Measured at Fair Value
BMO records certain securities and derivatives at their fair value, and certain liabilities are designated at fair value. Fair value represents our estimate of the amount we would receive, or would be required to pay in the case of a 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, 2015, as well as a sensitivity analysis of our Level 3 financial instruments, is disclosed in Note 18 on page 172 of the financial statements.
Our valuation models use general assumptions and market data, and therefore do not reflect the specific risks and other factors that could affect a particular instrument’s fair value. 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. 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 and other items, including 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. We also incorporate an estimate of the implicit funding costs borne by BMO for over-the-counter derivative positions (the funding valuation adjustment).
The methodologies used for calculating these adjustments are reviewed on an ongoing basis to ensure that they remain appropriate. Significant changes in methodologies are made only when we believe that the change will result in better estimates of fair value.
Valuation Adjustments
(Canadian $ in millions)
As at October 31
2015
2014
Credit risk
Funding risk
Liquidity risk
Other
100
60
57
–
53
39
59
2
Total
217
153
Valuation adjustments increased in 2015, primarily driven by the widening of credit spreads, lower interest rates, and the appreciation of the
U.S. dollar.
Pension and Other Employee Future Benefits
Our pension and other employee future benefits expense is calculated by our independent actuaries using assumptions determined by management.
If actual experience differs from the assumptions used, the difference is recognized in other comprehensive income.
Pension and other employee future benefits expense and the related obligations are sensitive to changes in discount rates. We determine discount rates at each year end for all our 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 23 on page 184 of the financial statements.
78 BMO Financial Group 198th Annual Report 2015
Impairment of Securities
Income Taxes and Deferred Tax Assets
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 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 deferred tax assets and liabilities. If our interpretations differ from those of tax authorities or if the timing of reversals is not as expected, our provision for income taxes could increase or decrease in future periods. The amount of any such increase or decrease cannot be reasonably estimated.
Deferred tax assets are recognized only when it is probable that sufficient taxable profit will be available in future periods against which deductible temporary differences may be utilized. We are required to assess whether it is probable that our deferred income tax asset will be realized prior to its expiration and, based on all the available evidence, determine if any portion of our deferred income tax asset should not be recognized.
The factors used to assess the probability of realization are our past experience of income and capital gains, our forecast of future net income before taxes, available tax planning strategies that could be implemented to realize the deferred income tax asset, and the remaining expiration period of tax loss carryforwards. Changes in our assessment of these factors could increase or decrease our provision for income taxes in future periods.
If income tax rates increase or decrease in future periods in a jurisdiction, our provision for income taxes for future periods will increase or decrease accordingly. Furthermore, our deferred tax assets and liabilities will increase or decrease as income tax rates decrease or increase, respectively, and will result in either an income tax charge or a recovery. A 1% decrease in the U.S. federal tax rate from 35% to 34% would reduce our deferred tax asset by about $58 million and would result in a corresponding income tax charge.
Additional information regarding our accounting for income taxes is included in Note 24 on page 189 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 recoverable amount of each business unit to verify that the recoverable amount of the business unit is greater than its carrying value. If the carrying value were to exceed the recoverable amount of the business unit, an impairment calculation would be performed. The recoverable amount of an asset is the higher of its fair value less costs to sell and its value in use.
Fair value less costs to sell was used to perform the impairment test in all periods. In determining fair value less costs to sell, we employ a discounted cash flow model, consistent with that used when we acquire businesses. This model is dependent on assumptions related to revenue growth, discount rates, synergies achieved on acquisition and the availability of comparable acquisition data. Changes in any of these assumptions would 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, 2015, the estimated fair value of each of our business units was greater than its carrying value.
Definite-lived 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. We test definite-lived intangible assets for impairment when circumstances indicate the carrying value may not be recoverable. During the year ended October 31, 2015, we recorded $1 million in impairment of definite-lived intangibles ($nil for 2014). Indefinite life intangible assets are tested annually for impairment. If any intangible assets are determined to be impaired, we write them down to their recoverable amount, the higher of value in use and fair value less costs to sell, when this is less than the carrying value. No such impairment was identified for the years ended October 31, 2015 and 2014. Additional information regarding the composition of goodwill and intangible assets is included in Note 11 on page 164 of the financial statements.
Purchased Loans
Significant judgment and assumptions were applied to determine the fair value of the Marshall & Ilsley Corporation (M&I) loan portfolio. Loans were identified as either purchased performing loans or purchased credit impaired loans (PCI loans), both of which were recorded at fair value at the time of acquisition. The determination of fair value involved estimating the expected cash flows to be received and determining the discount rate to be applied to the cash flows from the loan portfolio. In determining the discount rate, we considered various factors, including our cost to raise funds in the current market, the risk premium associated with the loans and the cost to service the portfolios. PCI loans are those where the timely collection of principal and interest was no longer reasonably assured as at the date of acquisition. We regularly evaluate what we expect to collect on PCI loans.
Changes in expected cash flows could result in the recognition of impairment or a recovery through the provision for credit losses. Estimating the timing and amount of cash flows requires significant management judgment regarding key assumptions, including the probability of default, severity of loss, timing of payment receipts and valuation of collateral. All of these factors are inherently subjective and can result in significant changes in cash flow estimates over the term of a loan.
BMO Financial Group 198th Annual Report 2015 79
MD&A
We have investments in securities issued or guaranteed by Canadian, U.S. and other governments, corporate debt and equity securities, mortgage-backed securities and collateralized mortgage obligations, which are classified as either available-for-sale securities, held-to-maturity securities or other securities. We review held-to-maturity, 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 there is objective evidence that the estimated future cash flows will be reduced and the impact can be reliably measured. We consider evidence such as delinquency or default, bankruptcy, restructuring or other evidence of deterioration in the creditworthiness of the issuer, or the absence of an active market. 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 to differ.
We do not record impairment write-downs on debt securities when impairment is due to changes in market rates, if future contractual cash flows associated with the debt security are still expected to be recovered.
At the end of 2015, there were total unrealized losses of $152 million related to available-for-sale securities for which cost exceeded fair value and an impairment write-down had not been recorded. Of this amount, $5 million related to available-for-sale securities for which cost had exceeded fair value for 12 months or more. These unrealized losses resulted from changes in market interest rates and not from deterioration in the creditworthiness of the issuer.
Additional information regarding our accounting for available-for-sale securities, held-to-maturity securities and other securities and the determination of fair value is included in Note 3 on page 144 and Note 18 on page 172 of the financial statements.
MANAGEMENT’S DISCUSSION AND ANALYSIS
The purchased performing loans are subject to the same credit review processes we apply to loans we originate. Additional information regarding purchased loans is provided in Note 4 on page 148 of the financial statements.
Insurance-Related Liabilities
Insurance claims and policy benefit liabilities represent current claims and estimates for future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method, which incorporates best-estimate assumptions for mortality, morbidity, policy lapses, surrenders, future investment yields, policy dividends, administration costs and margins for adverse deviation. These assumptions are reviewed at least annually and updated to reflect actual experience and market conditions. The most significant impact on the valuation of a liability would be the result of a change in the assumption for future investment yields. If the assumed yield were to increase by one percentage point, net income would increase by approximately $66 million. A reduction of one percentage point would lower net income by approximately $65 million.
See the Insurance Risk section on page 114 for further discussion of the impact of changing rates on insurance earnings.
MD&A
Provisions
BMO and its subsidiaries are involved in various legal actions in the ordinary course of business.
Provisions are recorded at the best estimate of the amount required to settle any obligation related to these legal actions as at the balance sheet date, taking into account the risks and uncertainties surrounding the obligation. Factors included in making the assessment include a case-bycase assessment of specific facts and circumstances, our past experience and opinions of legal experts. Management and internal and external experts are involved in estimating any amounts that may be required. The actual costs of resolving these claims may be substantially higher or lower than the amount of the provisions.
Additional information regarding provisions is provided in Note 26 on page 192 of the financial statements.
Transfers of Financial Assets and Consolidation of Structured Entities
We sell Canadian mortgage loans to third-party Canadian securitization programs, including the Canadian Mortgage Bond program, and directly to third-party investors under the National Housing Act Mortgage-Backed Securities program. We assess whether substantially all of the risk and rewards of the loans have been transferred to determine if they qualify for derecognition. Since we continue to be exposed to substantially all of the prepayment, interest rate and/or credit risk associated with the securitized loans, they do not qualify for derecognition. We continue to recognize the loans and recognize the related cash proceeds as secured financing in our Consolidated Balance Sheet. Additional information concerning the transfer of financial assets is included on page 76, as well as in Note 6 on page 153 of the financial statements.
In the normal course of business, BMO enters into arrangements with SEs. We are required to consolidate SEs if we determine that we control the SEs. We control an SE when we have power over the entity, exposure or rights to variable returns from our investment and the ability to exercise power to affect the amount of our returns. Additional information concerning BMO’s interests in SEs is included on pages 76 and 77, as well as in
Note 7 on page 154 of the financial statements.
Caution
This Critical Accounting Estimates section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements.
Changes in Accounting Policies in 2015
BMO adopted the following new or amended standards in 2015: IAS 36 Impairment of Assets; IAS 32 Financial Instruments: Presentation; IFRIC 21
Levies; and early adopted the own credit provisions of IFRS 9 Financial Instruments. The adoption of the own credit provisions of IFRS 9, which were adopted prospectively, resulted in a $120 million gain, net of taxes being recorded in other comprehensive income instead of net income related to the change in fair value of deposit and annuity liabilities due to changes in our credit spread. The adoption of the other new or amended standards did not have a significant impact on our financial statements. The impact of these accounting policy changes is discussed in Note 1 on page 140 of the financial statements.
Future Changes in Accounting Policies
BMO monitors the potential changes to IFRS proposed by the International Accounting Standards Board (IASB) and analyzes the effect that any such changes to the standards may have on BMO’s financial reporting and accounting policies. New standards and amendments to existing standards that will be effective for BMO in the future are described in Note 1 on page 140 of the financial statements.
Adoption of IFRS 9 Financial Instruments
As a result of an announcement from our regulator OSFI, we will be adopting IFRS 9 Financial Instruments effective November 1, 2017. IFRS 9 addresses the classification, measurement and impairment of financial instruments. The impairment requirements of IFRS 9 are expected to have the largest impact on the bank and will result in the earlier recognition in the credit cycle of provisions for credit losses and a higher initial collective loan loss allowance when the standard is implemented as an adjustment to retained earnings. We do not expect significant changes to the accounting for the specific loan loss allowance or the specific provision for credit losses.
IFRS 9 utilizes an expected credit loss model which will result in lifetime credit losses being recognized in the collective allowance if there is a significant deterioration in lifetime credit quality, regardless of whether there has been a credit event. The expected credit loss model requires the recognition of credit losses based on a 12-month time horizon for performing loans and requires the recognition of lifetime expected credit losses for loans that experience a significant deterioration in credit risk since inception. The expected loss calculations are required to incorporate forwardlooking macroeconomic information in determining the final provision.
80 BMO Financial Group 198th Annual Report 2015
The classification requirements will result in unrealized gains and losses on equity securities currently classified as available-for-sale being recognized in profit or loss going forward, as opposed to being recognized in other comprehensive income. Additionally, based on the results of the business model and cash flow characteristics test, certain investments in debt securities may be reclassified from the current amortized cost or available-for-sale categories to fair value through profit or loss or from available-for-sale into amortized cost.
In order to meet the requirement to adopt IFRS 9, we have established an enterprise-wide project. We are currently evaluating the impact of adoption on our financial results.
Transactions with Related Parties
BMO Financial Group 198th Annual Report 2015 81
MD&A
In the ordinary course of business, we provide banking services to our key management personnel and their affiliated entities, joint ventures and equity-accounted investees on the same terms that we offer to our customers for those services. Key management personnel are defined as those persons having authority and responsibility for planning, directing and/or controlling the activities of an entity, being the directors and most senior executives of the bank.
Details of our investments in joint arrangements and associates and the compensation of key management personnel are disclosed in Note 29 on page 197 of the financial statements. We also offer employees a subsidy on annual credit card fees.
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 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, 2015, by Bank of Montreal’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, 2015, 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. MD&A
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 IFRS and the requirements of the Securities and Exchange Commission (SEC) in the United States, as applicable. Management is responsible for establishing and maintaining adequate internal control over financial reporting for Bank of Montreal.
Bank of Montreal’s internal control over financial reporting includes policies and procedures designed to provide assurance that records are maintained in reasonable detail to accurately and fairly reflect the transactions and dispositions of the assets of Bank of Montreal; and to provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with IFRS and the requirements of the SEC in the United States, as applicable, that receipts and expenditures of Bank of Montreal are being made only in accordance with authorizations by management and directors of Bank of Montreal, and that any unauthorized acquisition, use or disposition of Bank of Montreal’s assets which could have a material effect on the financial statements is prevented or detected in a timely manner.
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 related policies or procedures may deteriorate.
Bank of Montreal’s management, under the supervision of the CEO and the CFO, has evaluated the effectiveness of 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 in May 2013 (2013 COSO Framework). Based on this evaluation, management has concluded that internal control over financial reporting was effective as at October 31, 2015.
At the request of Bank of Montreal’s Audit and Conduct Review Committee, KPMG LLP (Shareholders’ Auditors), an independent registered public accounting firm, has conducted an audit of the effectiveness of our internal control over financial reporting based on the 2013 COSO Framework.
The audit report concludes that, in KPMG’s opinion, Bank of Montreal maintained, in all material respects, effective internal control over financial reporting as at October 31, 2015, in accordance with the criteria established in the 2013 COSO Framework. This audit report appears on page 134.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting in fiscal 2015 that have materially affected, or are reasonably likely to materially affect, the adequacy and effectiveness of our internal control over financial reporting.
82 BMO Financial Group 198th Annual Report 2015
Shareholders’ Auditors’ Services and Fees
Review of Shareholders’ Auditors
In 2015, we completed our periodic comprehensive review of the shareholders’ auditors. The comprehensive review was based on the recommendations of the Chartered Professional Accountants of Canada and the Canadian Public Accountability Board. The review focused on (1) the shareholders’ auditors’ independence, objectivity and professional skepticism; (2) quality of the engagement team; and (3) quality of communications and interactions with the shareholders’ auditors. As a result of this review the ACRC was satisfied with the performance of the shareholders’ auditors.
Independence of the shareholders’ auditors is overseen by the ACRC in accordance with the bank’s Auditor Independence Policy, as outlined below. The ACRC also ensures that the lead audit partner rotates out of that role after five consecutive years and does not return to that role for a further five years.
Pre-Approval Policies and Procedures
As part of BMO Financial Group’s corporate governance practices, the ACRC oversees the application of BMO’s Corporate Policy limiting the services provided by the shareholders’ auditors that are not related to their role as auditors. The ACRC pre-approves the types of services (“permitted services”) that can be provided by the shareholders’ auditors, as well as the annual audit plan, which includes fees for specific types of services.
For permitted services that are not included in the pre-approved annual audit plan, confirmation to proceed with the engagement is obtained and the services to be provided are presented to the ACRC for ratification at its next meeting. All services must comply with our Auditor Independence Policy, as well as professional standards and securities regulations governing auditor independence.
Shareholders’ Auditors’ Fees
Aggregate fees paid to the Shareholders’ Auditors during the fiscal years ended October 31, 2015 and 2014 were as follows:
Fees ($ millions) (1)
2015
2014
Audit fees
Audit-related fees (2)
Tax fees
All other fees (3)
17.1
2.2
0.1
2.3
17.3
1.9
–
1.2
Total
21.7
20.4
(1) The classification of fees is based on applicable Canadian securities laws and U.S. Securities and
Exchange Commission definitions.
(2) Audit-related fees for 2015 and 2014 relate to fees paid for accounting advice, specified procedures on our Proxy Circular and other specified procedures.
(3) All other fees for 2015 and 2014 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. They also include costs of translation services.
BMO Financial Group 198th Annual Report 2015 83
MD&A
The Audit and Conduct Review Committee (ACRC) is responsible for the appointment, compensation and oversight of the shareholders’ auditors and conducts an annual assessment of the shareholders’ auditors’ performance and effectiveness considering factors such as: (i) the quality of services provided by the shareholders’ auditors’ engagement team during the audit period; (ii) the relevant qualifications, experience and geographical reach to serve BMO; (iii) the quality of communications received from the shareholders’ auditors; and (iv) the shareholders’ auditors’ independence, objectivity and professional skepticism.
The Board believes that it has robust review processes in place to monitor audit quality and oversee the work of the shareholders’ auditors, including the lead partner, which include:
‰ annually reviewing the shareholders’ auditors’ audit plan, including a consideration of the impact of business risks on the audit plan and an assessment of the reasonableness of the audit fee;
‰ monitoring the execution of the audit plan, with emphasis on the more complex and risky areas of the audit;
‰ reviewing and evaluating the audit findings, including in camera sessions;
‰ evaluating audit quality and performance, including recent Canadian Public Accountability Board and Public Company Accounting Oversight Board inspection reports on the shareholders’ auditors and their peer firms;
‰ reviewing qualifications of their senior engagement team members with the shareholders’ auditors;
‰ soliciting the opinion of the bank’s management and internal auditors on the performance of the engagement team; and
‰ at a minimum, holding quarterly meetings with the ACRC Chair and the lead audit partner to discuss audit issues independently of management.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Enhanced Disclosure Task Force
On October 29, 2012, the Enhanced Disclosure Task Force (EDTF) of the Financial Stability Board published its first report, Enhancing the Risk Disclosures of Banks. We support the recommendations issued by the EDTF for the provision of high-quality, transparent risk disclosures. Disclosures related to the EDTF recommendations are detailed below.
General
1
Present all risk-related information in the Annual Report, Supplementary Financial Information and Supplementary Regulatory
Capital Disclosure, and provide an index for easy navigation.
Annual Report: Risk-related information is presented in the Enterprise-Wide Risk Management section on pages 86 to 117.
An index for the MD&A is provided on page 26. An index for the notes to the financial statements is provided on page 140.
MD&A
Supplementary Financial Information: An index is provided in our Supplementary Financial Information.
2
Define the bank’s risk terminology and risk measures and present key parameters used.
Annual Report: Specific risk definitions and key parameters underpinning BMO’s risk reporting are provided on pages 94 to 117.
A glossary of financial terms (including risk terminology) can be found on pages 202 to 203.
3
Discuss top and emerging risks for the bank.
Annual Report: BMO’s top and emerging risks are discussed on pages 87 to 89.
4
Outline plans to meet new key regulatory ratios once the applicable rules are finalized.
Annual Report: We outline BMO’s plans to meet new regulatory ratios on pages 71 to 73 and 110.
Risk Governance
5
Summarize the bank’s risk management organization, processes, and key functions.
Annual Report: BMO’s risk management organization, processes and key functions are summarized on pages 89 to 93.
6
Describe the bank’s risk culture.
Annual Report: BMO’s risk culture is described on page 90.
7
Describe key risks that arise from the bank’s business model and activities.
Annual Report: A diagram of BMO’s risk exposure by operating segment is provided on page 74.
8
Describe the use of stress testing within the bank’s risk governance and capital frameworks.
Annual Report: BMO’s stress testing process is described on page 93.
Capital Adequacy and Risk-Weighted Assets (RWA)
9
Provide minimum Pillar 1 capital requirements.
10
Summarize information contained in the composition of capital templates adopted by the Basel Committee.
11
Present a flow statement of movements in regulatory capital, including changes in Common Equity Tier 1, Additional Tier 1, and Tier 2 capital.
Annual Report: Basel III Pillar 1 capital requirements are described on pages 70 to 72.
Supplementary Financial Information: Basel III regulatory capital is disclosed on page 34.
Annual Report: An abridged version of the Basel III regulatory capital template is provided on page 72.
Supplementary Financial Information: Basel III Pillar 3 disclosure is provided on pages 34 to 36 and 38. A Main Features template can be found on BMO’s website at www.bmo.com under Investor Relations and Regulatory Filings.
Supplementary Financial Information: Regulatory capital flow statement is provided on page 39.
12
Discuss capital planning within a more general discussion of management’s strategic planning.
13
Provide granular information to explain how RWA relate to business activities.
14
Present a table showing the capital requirements for each method used for calculating RWA.
15
Tabulate credit risk in the banking book for Basel asset classes.
16
Present a flow statement that reconciles movements in RWA by credit risk and market risk.
17
Describe the bank’s Basel validation and back-testing process.
Annual Report: BMO’s capital planning process is discussed under Capital Management Framework on page 70.
Annual Report: A diagram of BMO’s risk exposure, including RWA by operating group, is provided on page 74.
Annual Report: Regulatory capital requirement, as a percentage of RWA, is outlined on page 71.
Information about significant models used to determine RWA is provided on pages 95 to 96.
Supplementary Financial Information: A table showing RWA by model approach and by risk type is provided on page 38.
Supplementary Financial Information: Wholesale and retail credit exposures by internal rating grades are provided on page 46.
Supplementary Financial Information: RWA flow statements are provided on page 40, with a reconciliation on page 37.
Annual Report: BMO’s Basel validation and back-testing process for credit and market risk is described on page 113.
Supplementary Financial Information: A table showing Exposure at Default and RWA by model approach and asset class is provided on page 38. A table showing estimated and actual loss parameters is provided on page 48.
84 BMO Financial Group 198th Annual Report 2015
Liquidity
18
Describe how the bank manages its potential liquidity needs and the liquidity reserve held to meet those needs.
Annual Report: BMO’s potential liquidity needs and the liquidity reserve held to meet those needs are described on pages 105 to 106.
Funding
19
Summarize encumbered and unencumbered assets in a table by balance sheet category.
Annual Report: An Asset Encumbrance table is provided on page 107.
Additional collateral requirements in the event of downgrades by rating agencies are disclosed in Note 8 on pages 158 to 159 of the financial statements.
Supplementary Financial Information: The Asset Encumbrance table by currency is provided on page 33.
20
Tabulate consolidated total assets, liabilities and off-balance sheet commitments by remaining contractual maturity.
Annual Report: A Contractual Maturity table is presented in Note 30 on pages 198 to 201 of the financial statements.
21
Discuss the bank’s sources of funding and describe the bank’s funding strategy.
Annual Report: BMO’s sources of funding and funding strategy are described on pages 108 to 109.
MD&A
A table showing the composition and maturity of wholesale funding is provided on page 109.
Market Risk
22
Provide a breakdown of balance sheet positions into trading and non-trading market risk measures.
Annual Report: A table linking balance sheet items to market risk measures is provided on page 103.
23
Provide qualitative and quantitative breakdowns of significant trading and non-trading market risk measures.
Annual Report: Trading market risk exposures are described and quantified on pages 100 to 102.
Structural (non-trading) market risk exposures are described and quantified on pages 103 to 104.
24
Describe significant market risk measurement model validation procedures and back-testing and how these are used to enhance the parameters of the model.
Annual Report: Market risk measurement model validation procedures and back-testing for trading market risk and structural (non-trading) market risk are described on page 113.
25
Describe the primary risk management techniques employed by the bank to measure and assess the risk of loss beyond reported risk measures.
Annual Report: The use of stress testing, scenario analysis and stressed VaR for market risk management is described on pages 100 to 101.
Credit Risk
26
Provide information about the bank’s credit risk profile.
Annual Report: Information about BMO’s credit risk profile is provided on pages 96 to 97 and in Notes 4 and 5 on pages 148 to 153 of the financial statements, respectively.
Supplementary Financial Information: Tables detailing credit risk information are provided on pages 20 to 29 and 42 to 49.
27
Describe the bank’s policies related to impaired loans and renegotiated loans.
Annual Report: Impaired and renegotiated loan policies are described in Note 4 on pages 148 and 150, respectively, of the financial statements.
28
Provide reconciliations of impaired loans and the allowance for credit losses.
Annual Report: Continuity schedules for gross impaired loans and allowance for credit losses are provided on page 97 and in Note 4 on pages 149 to 150 of the financial statements.
29
Provide a quantitative and qualitative analysis of the bank’s counterparty credit risk that arises from its derivative transactions.
Annual Report: Quantitative disclosures on collateralization agreements for over-the-counter (OTC) derivatives are provided on page 99 and qualitative disclosures are provided on page 94.
Supplementary Financial Information: Quantitative disclosures for OTC derivatives are provided on page 32.
30
Provide a discussion of credit risk mitigation.
Annual Report: A discussion of BMO’s credit and counterparty risk management is provided on pages 94 to 95. Collateral management discussions are provided on page 94 and in Notes 8 and 26 on pages 161 and 193, respectively, of the financial statements.
Supplementary Financial Information: The Exposures Covered by Credit Risk Mitigation table is provided on page 42.
Other Risks
31
Describe other risks and discuss how each is identified, governed, measured and managed.
Annual Report: A diagram illustrating the risk governance process that supports BMO’s risk culture is provided on page 89.
Other risks are discussed on pages 111 to 117.
32
Discuss publicly known risk events related to other risks, where material or potentially material loss events have occurred.
Annual Report: Other risks are discussed on pages 111 to 117.
BMO Financial Group 198th Annual Report 2015 85
MANAGEMENT’S DISCUSSION AND ANALYSIS
Enterprise-Wide Risk Management
As a diversified financial services company actively providing banking, wealth management, capital market and insurance services, we are exposed to a variety of risks that are inherent in carrying out our business activities. A disciplined and integrated approach to managing risk is therefore fundamental to the success of our operations. Our risk management framework provides independent risk oversight across the enterprise and is essential to building competitive advantage.
Surjit Rajpal
MD&A
Chief Risk Officer
BMO Financial Group
Strengths and Value Drivers
‰
‰
‰
‰
Disciplined approach to risk-taking.
Comprehensive and consistent risk frameworks that address all risk types.
Risk appetite and metrics that are clearly articulated and integrated into strategic planning and the ongoing management of businesses and risk.
Sustained mindset of continuous improvement that drives consistency and efficiency in the management of risk.
Challenges
‰ The heightened pace, volume and complexity of regulatory requirements.
‰ Balancing risk and return in an uncertain economic and geopolitical environment.
‰ The evolving technology improvements required to meet customer expectations and the need to anticipate and respond to cyber threats.
Priorities
‰ Address increased complexity by streamlining risk management activities and by simplifying processes and ensuring consistent practices across different business lines.
‰ Support greater integration of risk in the business, while managing the high rate of change with more dynamic assessment and monitoring of the risks that are being taken.
‰ Continue to enhance our risk management infrastructure through greater integration of our systems, data and models to ensure ongoing alignment of these critical elements.
2015 Accomplishments
‰
‰
‰
‰
‰
Leveraged our capital processes to enhance our risk appetite and limit framework through further alignment with our businesses’ capacity to bear risk.
Developed and embedded our stress testing capabilities in business management processes and provided additional risk insights.
Continued to improve our risk culture as evidenced by internal and external surveys.
Fulfilled rising regulatory expectations, evidenced by improvements in stress testing, market risk measurement and anti-money laundering.
Continued to develop the next generation of our risk infrastructure by integrating, automating and upgrading foundational capabilities.
Gross Impaired
Loan Formations ($ millions)
Provision for
Credit Losses ($ millions)
Gross Impaired
Loan Balances* ($ millions)
3,101
Total Allowance for
Credit Losses* ($ millions)
2,976
2,449
2,544
2,142
2,048
1,921
1,959
1,259
1,221
1,360
1,498
761
597
561 561
470
612 612
357
447
3
2012
2013
2014
2015
2012
2013
2014
2015
2012
(10)
2013
2014
2015
Collective provision
Specific provisions
Adjusted specific provisions
Level of new impaired loan formations was 10% lower year over year, reflecting decreases in formations in both Canada and the United States.
Gross impaired loans were 4% lower year over year; excluding the impact of stronger U.S. dollar
GIL were 13% lower.
* Excludes purchased credit impaired loans.
The total provision for credit losses was 9% higher year over year, reflecting lower recoveries in Corporate Services and higher provisions in Capital Markets partially offset by reduced provisions in the P&C business.
444
374
357
2012
2013
2014
2015
Collective allowance
Specific allowances
The total allowance for credit losses increased 7% year over year primarily due to the stronger U.S. dollar, and remains adequate. * Excludes allowances related to Other
Credit Instruments.
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 2015 annual consolidated financial statements. They present required disclosures as set out by the International Accounting Standards Board in IFRS 7, Financial Instruments – Disclosures, which permits cross-referencing between the notes to the financial statements and the MD&A. See Note 1 on page 140 and Note 5 on page 151 of the financial statements.
Adjusted results in this Enterprise-Wide Risk Management section are non-GAAP and are discussed in the Non-GAAP Measures section on page 33.
86 BMO Financial Group 198th Annual Report 2015
Overview
At BMO, we believe that risk management is every employee’s responsibility. We are guided by five core principles that inform our approach to managing risk across the enterprise.
Our Approach to Risk Management
‰
‰
‰
‰
‰
Understand and manage.
Protect our reputation.
Diversify. Limit tail risk.
Maintain strong capital and liquidity.
Optimize risk return.
Risks That May Affect Future Results
Top and Emerging Risks That May Affect Future Results
We are exposed to a variety of continually changing risks that have the potential to affect our business and financial condition. An essential mandate of our risk management process is to proactively identify, assess, monitor and manage a broad spectrum of top and emerging risks. Our top and emerging risk identification process consists of several forums for discussion with the Board, senior management and business thought leaders, combining both bottom-up and top-down approaches to considering risk. Our assessment of top and emerging risks is used to develop action plans and stress tests of our exposure to certain events.
In 2015, particular attention was given to the following top and emerging risks:
Slow Global Economic Growth
Concerns about global growth outside of North America could be triggered by a variety of disparate possible causes, ranging from disruption in
China or other emerging markets to conflicts in the Middle East, North Africa and Europe. These could result in market volatility spikes, lower commodity prices, currency devaluations, rapid changes in capital flows, regional credit crises and disruption of the social fabric, and higher levels of uncertainty that reduce growth, employment, trade and business investment. In the short run, market shocks can impact our Capital Markets business, while over a longer period of time the broader impact could be felt through reduced North American economic growth and weaker credit quality in our internationally exposed customers.
BMO benefits from an integrated North American strategy in diverse industries, with limited direct lending exposure outside the region and with a footprint that partially acts as a natural hedge to commodity price and foreign exchange movements, wherein price declines/rises often have offsetting impacts across different North American regions. We actively monitor sources of global growth and continually assess our portfolio and business strategies against developments. We stress test our business plans and capital adequacy against severely adverse scenarios arising outside North America and develop contingency plans and mitigation strategies to react to and offset such possible adverse political and/or economic developments.
Further information on our direct and indirect European exposures is provided in the Select Geographic Exposures section on page 98.
Information and Cyber Security Risk
Information security is integral to BMO’s business activities, brand and reputation. Given our pervasive use of the internet and reliance on advanced digital technologies, particularly the mobile and online banking platforms that serve our customers, BMO faces heightened information security risks, including the threat of hacking, identity theft and corporate espionage, as well as the possibility of denial of service resulting from efforts targeted at causing system failure and service disruption. BMO proactively invests in defences and procedures to prevent, detect, respond to and manage cyber security threats. These include regular benchmarking and review of best practices, evaluation of the effectiveness of our key controls and development of new controls, as needed, and ongoing investments in both technology and human resources to protect BMO, third parties that we interact with, and our customers against these attacks. BMO also works with critical cyber security and software suppliers to bolster our internal resources and technology capabilities in order to ensure BMO remains resilient in the face of any such attacks in a rapidly evolving threat landscape.
Protracted Low Oil Prices
The significant decline in oil and gas prices has challenged many companies in the sector and has resulted in wide-ranging actions by affected companies to increase efficiency, reduce costs, limit capital outflows, sell assets and raise equity. Should oil and gas prices stay at a low level for a prolonged period of time there will be greater challenges for the industry, with a deterioration of borrower repayment capacity and of borrower ratings. The oil industry’s response to low prices has indirect negative impacts on commercial businesses and consumers in the oil-producing regions, particularly in Alberta.
Low oil prices have resulted in quite different outcomes for other sectors and regions within the BMO footprint as lower oil prices have led to a lower Canadian dollar and lower input costs for many consumers and businesses. Benefits of the lower oil price have shown through in the upturn of
Canadian manufacturing output and non-oil exports and we expect those positive trends to strengthen into 2016. Overall, lower oil prices are a net positive for global and U.S. demand, and for Canadian non-energy exports.
BMO Financial Group 198th Annual Report 2015 87
MD&A
Our integrated and disciplined approach to risk management is fundamental to the success of our operations. All elements of our risk management framework work together in support of prudent and measured risk-taking, while striking an appropriate balance between risk and return.
Our Enterprise Risk and Portfolio Management (ERPM) group develops our risk appetite, risk policies and limits, and provides independent review and oversight across the enterprise on risk-related issues to achieve prudent and measured risk-taking that is integrated with our business strategy.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Business Disruptors
The financial services industry is undergoing rapid change as technology enables non-traditional new entrants to compete in certain segments of the banking market, in some cases with reduced regulation. New entrants may use new technologies, advanced data and analytic tools, lower cost to serve, reduced regulatory burden and/or faster processes to challenge traditional banks. For example, new business models have been observed in retail payments, consumer and commercial lending, foreign exchange and low cost investment advisory services. While we closely monitor business disruptors, we also continue to adapt by making investments, including improving our mobile banking capabilities, building new branch formats, and refining our credit decisioning tools. We further mitigate this risk by providing our customers with access to banking services across different channels, focusing on improving customer loyalty and trust, using our own advanced data and analytical tools and leveraging current and future partnerships. However, matching the pace of innovation exhibited by new and differently-situated competitors may require us and policy-makers to adapt with greater pace.
MD&A
Other Factors That May Affect Future Results
General Economic and Market Conditions in the Countries in which We Conduct Business
We conduct business in Canada, the United States and a number of other countries. Factors such as the general health of capital and/or credit markets, including liquidity, level of business activity, volatility and stability, could have a material impact on our business. As well, interest rates, foreign exchange rates, consumer saving and spending, housing prices, consumer borrowing and repayment, business investment, government spending and the rate of inflation 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 overall revenue and earnings.
For example, elevated consumer debt and housing price appreciation in some Canadian regions could create a vulnerability to higher credit losses for the bank in the event of a general economic downturn or other negative catalyst.
Regulatory Requirements
The financial services industry is highly regulated, and we have experienced further changes in regulatory requirements as governments and regulators around the world continue major reforms intended to strengthen the stability of the financial system. As a result, there is the potential for higher capital requirements and increased regulatory costs which could lower our returns. We monitor developments to ensure BMO is wellpositioned to respond to and implement any required changes. Failure to comply with applicable regulatory and legal requirements may result in litigation, financial losses, regulatory sanctions, enforcement actions, an inability to execute our business strategies, a decline in investor confidence and harm to our reputation. Refer to the Legal and Regulatory Risk and Enterprise-Wide Capital Management sections on pages 114 and 70 for a more complete discussion of our legal and regulatory risk.
Fiscal, Tax, Monetary and Interest Rate Policies
Our earnings are affected by fiscal, tax, monetary, regulatory and other economic policies in Canada, the United States and other jurisdictions.
Such policies may have the effect of increasing or reducing competition and uncertainty in the markets. Such policies may also adversely affect our customers and counterparties in the countries in which we operate, contributing to a greater risk of default by these customers and counterparties.
As well, expectations in the bond and money markets related to inflation and central bank monetary policy have an effect 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 page 100 for a more complete discussion of our interest rate risk exposures. Changes in tax rates and tax policy can also have an impact on our earnings and, as discussed in the Critical Accounting Estimates section, a reduction in income tax rates could lower the value of our deferred tax asset.
Acquisitions and Strategic Plans
We conduct thorough due diligence before completing an acquisition. However, it is possible that we could make an acquisition that subsequently does not perform in line with our financial or strategic objectives. Our ability to successfully complete an acquisition may be subject to regulatory and shareholder approvals and we may not be able to determine when, if or on what terms, the necessary approvals will be granted. Changes in the competitive and economic environment, as well as other factors, may result in lower revenue, while higher than anticipated integration costs and failure to realize expected cost savings after an acquisition could also adversely affect our earnings. Integration costs may increase as a result of higher regulatory costs related to an acquisition, unanticipated costs that were not identified in the due diligence process or demands on management time that are more significant than anticipated, as well as unexpected delays in implementing certain plans that in turn lead to delays in achieving full integration. 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.
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. In addition, our ability to execute our strategic plans is dependent to a large extent on our ability to attract, develop and retain key executives, and there is no assurance we will continue to be able to do so.
Level of Competition
The level of competition among financial services companies is high. Furthermore, non-financial companies have increasingly been offering products and services traditionally provided by banks. Customer loyalty and retention can be influenced by a number of factors, including service levels, prices for products and services, our reputation and the actions of our competitors. Also, laws and regulations enacted by regulatory authorities in the United
States and other jurisdictions in which we operate may provide advantages to our international competitors that could affect our ability to compete.
Changes in these factors or any subsequent loss of market share could adversely affect our earnings.
Currency Rates
The Canadian dollar equivalents of our revenues, expenses, assets and liabilities denominated in currencies other than the Canadian dollar are subject to fluctuations in the value of the Canadian dollar relative to those currencies. Changes in the value of the Canadian dollar relative to the U.S. dollar could affect the earnings of our small business, corporate and commercial clients in Canada. A strengthening of the U.S. dollar could increase the value of our risk-weighted assets, lowering our capital ratios. Refer to the Foreign Exchange section on page 37, the Enterprise-Wide Capital
Management section on page 70 and the Market Risk section on page 100 for a more complete discussion of our foreign exchange risk exposures.
88 BMO Financial Group 198th Annual Report 2015
Changes to Our Credit Ratings, Capital and Funding Markets
Credit ratings are important to our ability to raise both capital and funding in order to support our business operations. Maintaining strong credit ratings allows us to access capital markets at competitive pricing. Should our credit ratings experience a material downgrade, our costs of funding would likely increase significantly and our access to funding and capital through capital markets could be reduced. In part, given changes in the regulatory environment, capital and funding markets have been less liquid than previously. Reduced market liquidity could impact the valuation of bank securities and the availability and pricing of bank funding. A material downgrade of our ratings could also have other consequences, including those set out in Note 8 on page 156 of the financial statements.
Legal Proceedings
We are subject to litigation arising in the ordinary course of business. The unfavourable resolution of any such 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 certain legal and regulatory proceedings we currently face is provided in Note 26 on page 192 of the financial statements.
Critical Accounting Estimates and Accounting Standards
We prepare our financial statements in accordance with International Financial Reporting Standards (IFRS). Changes that the International Accounting
Standards Board makes from time to time to these standards, which govern the preparation of our financial statements, can be difficult to anticipate and may materially affect how we record and report our financial results. Significant accounting policies and future changes in accounting policies are discussed in Note 1 on page 140 of the financial statements.
The application of IFRS requires management to make significant judgments and estimates that can affect the dates on which certain assets, liabilities, revenues and expenses are recorded in our financial statements, as well as 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 could be affected for the period during which any such new information or change in circumstances became apparent, and the extent of the impact could be significant. More information is included in the discussion of Critical Accounting Estimates on page 78.
Accuracy and Completeness of Customer and Counterparty Information
When deciding whether to extend credit or enter into other transactions with customers or 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 may also 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 or counterparties are materially misleading.
Caution
This Risks That May Affect Future Results section and the remainder of this Enterprise-Wide Risk Management section contain forward-looking statements.
Other factors beyond our control that may affect our future results are noted in the Caution Regarding Forward-Looking Statements on page 30.
We caution that the preceding discussion of risks that may affect future results is not exhaustive.
Framework and Risks
Enterprise-Wide Risk Management Framework
Our enterprise-wide risk management framework operates at all levels of the bank and consists of our three-lines-of-defence operating model and our risk appetite framework, underpinned by our risk governance structure, and our strong risk culture.
3 Lines of
Defence
Operating
Model
Risk Appetite
Framework
Enterprise-Wide
Risk Management
Framework
Risk
Culture
Risk
Governance
BMO Financial Group 198th Annual Report 2015 89
MD&A
Operational and Infrastructure Risks
As a large enterprise conducting business in multiple jurisdictions, we are exposed to many operational risks that can have a significant impact.
Such risks include the risk of fraud by employees or others, unauthorized transactions by employees and operational or human error. Given the large 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, or of services and products provided by third parties, including any of our financial, accounting or other data processing systems, could lead to financial loss and damage our reputation. In addition, despite the contingency plans we have in place, our ability to conduct business may be adversely affected by a disruption to the infrastructure that supports both our operations and the communities in which we do business, including but not limited to disruption caused by public health emergencies or terrorist acts.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Risk Types
The framework provides for management of each individual risk type: credit and counterparty, market, liquidity and funding, operational, model, insurance, legal and regulatory, business, strategic, reputation, and environmental and social. We have identified risk types with a potentially material impact on our business and we consider those based upon their materiality and our ability to manage and mitigate those risks.
Credit and
Counterparty
Market
Liquidity and Funding
Operational
Model
Insurance
Legal and
Regulatory
Business
Strategic
Reputation
Environmental and Social
MD&A
Risk Principles
Within the framework, risk-taking and risk management activities across the enterprise are guided by our Risk Principles:
‰ management of risk is a responsibility at all levels of the organization;
‰ material risks to which the enterprise is exposed are identified, measured, managed, monitored and reported;
‰ risk identification and measurement will include both qualitative and quantitative elements, including views of risk relative to the external operating environment and stress testing and scenario analysis;
‰ decision-making is based on a clear understanding of risk, accompanied by robust metrics and analysis; and
‰ an Economic Capital methodology is employed to measure and aggregate risk across all risk types and business activities in order to facilitate the incorporation of risk into business returns.
Three Lines of Defence
Our framework is anchored in the three-lines-of-defence approach to managing risk, which is fundamental to our operating model, as described below:
Three Lines of Defence
Responsibilities
First Line:
‰ Operating groups, which own the risks in their operations
‰
‰
‰
‰
‰
Second Line:
‰ Enterprise Risk and Portfolio
Management (ERPM) group
‰ Corporate Support Areas (CSAs)
‰ Provide independent oversight, effective challenge and independent assessment of risks and risk
Own, measure and manage all risks in their lines of business.
Identify, monitor, quantify and report risks arising from their operating activities and initiatives.
Establish appropriate internal control structures in accordance with our risk management framework.
Pursue suitable business opportunities within their established risk appetite.
Act within their delegated risk-taking authority as set out in established corporate policies. management practices.
‰ Set enterprise risk management policies and establish infrastructure, processes and practices that identify, assess, manage and monitor all significant risks across the enterprise.
‰ Independently assess, quantify, monitor, manage, mitigate and report all significant risks.
Third Line:
‰ Corporate Audit Division
‰ Provide an independent assessment of the effectiveness of internal control within the enterprise, including risk management and governance processes that support the enterprise, its objectives and the Board of Directors’ discharge of its responsibilities.
Risk Culture
At BMO, we believe that risk management is the responsibility of every employee within the organization. This key tenet shapes and influences our risk culture and is evident in the actions and behaviours of our employees and leaders as they identify, interpret and discuss risks, and make choices and decisions that balance risks and opportunities and seek to optimize risk-adjusted returns. Our risk culture is deeply rooted within our policies, business processes, risk management frameworks, risk appetite, limits and tolerances, capital management and compensation practices, and is evident in every aspect of how we operate across the enterprise.
Our risk culture is grounded in a “Being BMO” risk management approach that encourages openness, constructive challenge and personal accountability. Timely and transparent information sharing is key to how we engage stakeholders in key decisions and strategy discussions, thereby bringing rigour and discipline to decision-making. This not only leads to the timely identification, escalation and resolution of issues, but also encourages open communication, independent challenge and a clear understanding of the key risks faced by our organization, so that our employees are equipped and empowered to make decisions and take action in a coordinated and consistent manner, supported by a strong monitoring and control framework. Our governance and leadership forums, committee structures and learning curriculums also reinforce and foster our risk culture.
Certain elements of our risk culture that are embedded throughout the enterprise include:
‰ Risk appetite – promotes a clear understanding of the most prevalent risks that our businesses face and facilitates alignment of business strategies within our risk appetite, leading to sound business decision-making and execution, supported by a strong monitoring framework.
‰ Communication and escalation channels – encourages information sharing and engagement between ERPM and the operating groups, leading to greater transparency and open and effective communication. We also foster and encourage a culture in which concerns about potential or emerging risks are escalated to senior management so that they can be evaluated and appropriately addressed.
‰ Compensation philosophy – pay is aligned with prudent risk-taking to ensure that compensation rewards the appropriate use of capital and does not encourage excessive risk-taking.
‰ Training and education – our programs are designed to foster a deep understanding of BMO’s capital and risk management frameworks across the enterprise, providing employees and management with the tools and awareness they need to fulfill their responsibilities for independent oversight regardless of their position in the organization. Our education strategy has been developed in partnership with BMO’s Institute for Learning, our risk management professionals, external risk experts and teaching professionals.
‰ Rotation programs – two-way rotation allows employees to transfer between ERPM and the operating groups, thereby effectively embedding our strong risk culture across the enterprise.
90 BMO Financial Group 198th Annual Report 2015
Risk Governance
Our enterprise-wide risk management framework is founded on a governance approach that includes a robust committee structure and a comprehensive set of corporate policies and limits, each of which is approved by the Board of Directors or its committees, as well as specific corporate standards and operating procedures. Our corporate policies outline frameworks and objectives for every significant risk type, in order to ensure that risks to which the enterprise is exposed are appropriately identified, managed, measured, monitored and reported in accordance with our risk appetite. Specific policies govern key risks such as credit, market, liquidity and funding, model, and operational risks. This enterprise-wide risk management framework is governed at all levels through a hierarchy of committees and individual responsibilities as outlined in the diagram below.
Our risk management framework is reviewed on a regular basis by the Risk Review Committee of the Board of Directors in order to provide guidance for the governance of our risk-taking activities. In each of our operating groups, management monitors governance activities, controls, and management processes and procedures. Management also oversees their effective implementation within our overall risk management framework.
Individual governance committees establish and monitor further risk management limits, consistent with and subordinate to the Board-approved limits.
Risk Governance Framework
MD&A
Board of Directors
Risk Review
Committee
Audit and Conduct Review
Committee
Chief Executive Officer
Risk Management Committee
Balance Sheet and Capital
Management
Reputation
Risk
Management
Operational
Risk
Management
Model
Risk
Management
First Line of Defence
Operating Groups
Second Line of Defence
Enterprise Risk and
Portfolio Management
Corporate Support
Areas/Groups
Third Line of Defence
Corporate Audit Group
Appropriate risk governance frameworks, including our three lines of defence, are in place in all our material businesses and entities:
Board of Directors is responsible for supervising the management of the business and affairs of BMO. The Board, either directly or through its committees, is responsible for oversight in the following areas: strategic planning, defining risk appetite, the identification and management of risk, capital management, fostering 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, compliance with risk-related regulatory requirements and the evaluation of the Chief
Risk Officer. Our risk management framework is reviewed on a regular basis by the RRC in order to provide guidance for the governance of our risk-taking activities.
Audit and Conduct Review Committee of the Board of Directors assists the Board in fulfilling its oversight responsibilities for the integrity of BMO’s financial reporting, the effectiveness of BMO’s internal controls and the performance of its internal and external audit functions.
Chief Executive Officer (CEO) is directly accountable to the Board for all of BMO’s risk-taking activities. The CEO is supported by the Risk
Management Committee and its sub-committees, as well as ERPM.
Chief Risk Officer (CRO) reports directly to the CEO and is head of
ERPM. The CRO is responsible for providing independent review and oversight of enterprise-wide risks and leadership on risk issues, developing and maintaining a risk management framework and fostering a strong risk culture across the enterprise.
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 provides risk oversight and governance at the highest levels of management. This committee is chaired by the CRO and its members include the heads of our operating groups, CEO and CFO.
RMC Sub-Committees have oversight responsibility for the risk implications and balance sheet impacts of management strategies, governance practices, risk measurement, model risk management and contingency planning. RMC and its sub-committees provide oversight of the processes whereby the risks assumed across the enterprise are identified, measured, managed, monitored and reported in accordance with policy guidelines, and are held within limits and risk tolerances.
Enterprise Risk and Portfolio Management (ERPM) as the risk management second line of defence, provides comprehensive risk management oversight. It promotes consistency in risk management practices and standards across the enterprise. ERPM supports a disciplined approach to risk-taking in fulfilling its responsibilities for independent transactional approval and portfolio management, policy formulation, risk reporting, stress testing, modelling, vetting and risk education. This approach seeks to meet enterprise objectives and to ensure that risks assumed are consistent with BMO’s risk appetite.
Operating Groups are responsible for identifying, measuring, managing, monitoring and reporting risk within their respective lines of business.
They exercise business judgment and seek to ensure that effective policies, processes and internal controls are in place and that significant risk issues are reviewed with ERPM. Individual governance committees and ERPM establish and monitor further risk management limits that are consistent with and subordinate to the Board-approved limits.
BMO Financial Group 198th Annual Report 2015 91
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Risk Appetite Framework
Our Risk Appetite Framework consists of our Risk Appetite Statement, key risk metrics and corporate policies, standards and guidelines, including the related limits, concentration levels and controls defined therein. Our risk appetite defines the amount of risk that BMO is willing to assume given our guiding principles and capital capacity, and thus supports sound business initiatives, appropriate returns and targeted growth. Our risk appetite is integrated into our strategic and capital planning processes and performance management system. On an annual basis, senior management recommends our Risk Appetite Statement and key risk metrics to the RMC and the Board of Directors for approval. Our Risk Appetite Statement is articulated and applied consistently across the enterprise, with key enterprise businesses and entities articulating their own risk appetite statements within this framework. Among other things, our risk appetite requires:
‰ that everything we do is guided by principles of honesty, integrity and respect, as well as high ethical standards;
‰ taking only those risks that are transparent, understood, measured, monitored and managed;
‰ maintaining strong capital, liquidity and funding positions that meet or exceed regulatory requirements and the expectations of the market;
‰ new products and initiatives are subject to rigorous review and approval and new acquisitions must provide a good strategic, financial and cultural fit, and have a high likelihood of creating value for our shareholders;
‰ setting capital limits based on our risk appetite and strategy and having our lines of business optimize risk-adjusted returns within those limits;
‰ maintaining a robust recovery framework that enables an effective and efficient response in a severe crisis;
‰ using Economic Capital, regulatory capital and stress testing methodologies to understand our risks and guide our risk-return assessments;
‰ targeting an investment grade credit rating at a level that allows competitive access to funding;
‰ limiting exposure to low-frequency, high-severity events that could jeopardize BMO’s credit ratings, capital position or reputation;
‰ incorporating risk measures and risk-adjusted returns into our performance management system and including an assessment of performance against our risk appetite and return objectives in compensation decisions;
‰ maintaining effective policies, procedures, guidelines, compliance standards and controls, training and management that guide the business practices and risk-taking activities of all employees so that they help optimize risk-adjusted returns and adhere to all legal and regulatory obligations and thus protect BMO’s reputation; and
‰ protecting the assets of BMO and BMO’s clients by maintaining a system of effective limits and strong operational risk controls.
Risk Limits
Our risk limits are shaped by our risk principles, reflect our risk appetite, and inform our business strategies and decisions. In particular, we consider risk diversification, exposure to loss and risk-adjusted returns when setting limits. These limits are reviewed and approved by the Board of Directors and/or management committees and include:
‰ Credit and Counterparty Risk – limits on group and single-name exposures and material country, industry, and portfolio/product segments;
‰ Market Risk – limits on economic value and earnings exposures to stress scenarios;
‰ Liquidity and Funding Risk – limits on minimum levels of liquid assets and maximum levels of asset pledging and wholesale funding, as well as guidelines approved by senior management related to liability diversification, financial condition, and credit and liquidity exposure appetite;
‰ Insurance Risk – limits on policy exposure and reinsurance arrangements; and
‰ Model Risk – limits on potential capital erosion due to model mis-estimation, data shortcomings, or the use of unvalidated models.
The Board of Directors, after considering recommendations from the RRC and the RMC, annually reviews and approves key risk limits and in turn delegates them to the CEO. The CEO then delegates more specific authorities to the senior executives of the operating groups (first line of defence), who are responsible for the management of risk in their respective areas, and the CRO (second line of defence). 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. The criteria whereby these authorities may be further delegated throughout the organization, as well as the requirements relating to documentation, communication and monitoring of delegated authorities, are set out in corporate policies and standards.
Risk Identification, Review and Approval
Risk identification is an essential step in recognizing key inherent risks that we face, understanding the potential for loss and then acting to mitigate these risks. A Risk Register is maintained to comprehensively identify and manage key risks, supporting the implementation of the bank’s Risk
Appetite Framework and assisting in identifying the primary risk categories for which Economic Capital is reported and stress capital consumption is estimated. Our enterprise and ad-hoc stress testing processes have been developed to assist in identifying and evaluating these risks. Risk review and approval processes are established based on the nature, size and complexity of the risks involved. Generally, this involves a formal review and approval by either an individual or a committee, independent of the originator. Delegated authorities and approvals by category are outlined below.
Portfolio transactions – transactions are approved through risk assessment processes for all types of transactions at all levels of the enterprise, which include operating group recommendations and ERPM approval of credit risk, and transactional and position limits for market risk.
Structured transactions – new structured products and transactions with significant legal, regulatory, accounting, tax or reputation risk are reviewed by the Reputation Risk Management Committee or the Trading Products Risk Committee, as appropriate.
Investment initiatives – documentation of risk assessments is formalized through our investment spending approval process, which is reviewed and approved by Corporate Support areas.
New products and services – policies and procedures for the approval of new or modified products and services offered to our customers are reviewed and approved by Corporate Support areas, as well as by other senior management committees, including the Operational Risk Committee and Reputation Risk Management Committee, as appropriate.
92 BMO Financial Group 198th Annual Report 2015
Risk Monitoring
Enterprise-level risk transparency and monitoring and associated reporting are critical process components of our risk management framework and corporate culture, that allow senior management, committees and the Board of Directors to effectively exercise their business management, risk management and oversight responsibilities at enterprise, operating group and key legal entity levels. Internal reporting includes a synthesis of the key risks and associated metrics that the enterprise currently faces. Our reporting highlights our most significant risks, including assessments of our top and emerging risks, to provide the Board of Directors, its committees and any other appropriate executive and senior management committees with timely, actionable and forward-looking risk reporting. This reporting includes supporting metrics and material to facilitate assessment of these risks relative to our risk appetite and the relevant limits established within our Risk Appetite Framework.
On a regular basis, reporting on risk issues is also provided to stakeholders, including regulators, external rating agencies and our shareholders, as well as to others in the investment community.
Risk-Based Capital Assessment
Stress Testing
Stress testing is a key element of our risk and capital management frameworks. It informs our strategy, business planning and decision-making processes. Governance of the stress testing framework resides with senior management, including the Enterprise Stress Testing Steering Committee.
This committee is comprised of business, risk and finance executives and is accountable for the oversight of BMO’s stress testing framework and for reviewing and challenging enterprise stress test results. Stress testing and enterprise-wide scenarios associated with the Internal Capital Adequacy
Assessment Process (ICAAP), including recommended actions that the organization would likely take to manage the impact of the stress event, are presented to senior management and the RRC. Stress testing associated with the Comprehensive Capital Analysis and Review (CCAR) and the mid-year
Dodd-Frank Capital Stress Test (DFAST) – which are U.S. regulatory requirements for BMO Financial Corp. – and other regulatory stress tests are similarly governed within the applicable entities. Stress testing specific risks, businesses or exposures, so called “ad hoc stress testing”, is also conducted in conjunction with business decision processes, including strategy development, in risk assessments and is reviewed by the RMC and/or RRC as appropriate. Enterprise Stress Testing
Enterprise stress testing supports our internal capital adequacy assessment and target-setting through analysis of the potential effects of lowfrequency, high-severity events on our balance sheet, earnings, liquidity and capital positions. Scenario selection is a multi-step process that considers the enterprise’s material and idiosyncratic risks and the potential impact of new or emerging risks, as well as the macroeconomic environment, on our risk profile. Scenarios may be defined by senior management, the Board of Directors or regulators, and are developed in conjunction with the
Economics group. To the extent not prescribed by a regulator, the Economics group translates the scenarios into macroeconomic and market variables that include but are not limited to GDP growth, yield curve estimates, unemployment, housing starts, real estate prices, stock index growth and changes in corporate profits. The scenarios are then used by our operating, risk and finance groups to estimate future losses and financial performance. Quantitative models and qualitative approaches are utilized to assess the impact of changes in the macroeconomic environment on our income statement and balance sheet and the resilience of our capital over a forecast horizon. Stress test results, including mitigating actions, are benchmarked and challenged by relevant business units and senior management, including the Enterprise Stress Testing Steering Committee and RMC.
Ad Hoc Stress Testing
Through our stress testing framework, we embed stress testing in our strategy, business planning and decision-making at various levels of our organization. Ad hoc stress testing is conducted regularly by our operating and risk groups to support risk identification, business analysis and strategic decision-making. Such stress testing is used as a tool to assess the potential longer term impacts of risks arising in a changing environment, such as a material and sustained period of low oil prices.
BMO Financial Group 198th Annual Report 2015 93
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Two measures of risk-based capital are used by BMO: Economic Capital and Regulatory Capital. Both are aggregate measures of the risk that we take on in pursuit of our financial targets and enable us to evaluate risk-adjusted returns. Our operating model provides for the direct management of each type of risk, as well as the management of all risks on an integrated basis. Measuring the economic profitability of transactions or portfolios incorporates a combination of both expected and unexpected losses to assess the extent and correlation of risk before authorizing new exposures. Both expected and unexpected loss measures for a transaction or a portfolio reflect current market conditions, the inherent risk in the position and, as appropriate, credit quality. Risk-based capital methods and model inputs are reviewed and/or recalibrated on an annual basis, as applicable. Our risk-based capital models provide a forward-looking estimate of the difference between our maximum potential loss in economic (or market) value and our expected loss, measured over a specified time interval and using a defined confidence level.
MANAGEMENT’S DISCUSSION AND ANALYSIS
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.
Credit and counterparty risk underlies every lending activity that BMO enters into, and also arises in the transacting of trading and other capital markets products, the holding of investment securities and the activities related to securitization. Credit risk is the most significant measurable risk
BMO faces. Proper management of credit risk is essential to our success, since the failure to effectively manage credit risk could have an immediate and significant impact on our earnings, financial condition and reputation.
MD&A
Credit and Counterparty Risk Governance
The objective of our credit risk management framework is to ensure all material credit risks to which the enterprise is exposed are identified, measured, managed, monitored and reported. The RRC has oversight of the management of all risks faced by the enterprise, including the credit risk management framework. BMO’s credit risk management framework incorporates governing principles which are defined in a series of corporate policies and standards, and which flow through to more specific guidelines and procedures. These are reviewed on a regular basis and modified when necessary to keep them current and consistent with BMO’s risk appetite. The structure, limits, collateral requirements, monitoring, reporting and ongoing management of our credit exposures are all governed by these credit risk management principles.
Lending officers in the operating groups are accountable for recommending credit decisions based on the completion of appropriate due diligence, and they assume ownership of the risks. Credit officers in ERPM approve these credit decisions and are accountable for providing an objective assessment of the lending recommendations and independent oversight of the risks assumed by the lending officers. All of these experienced and skilled individuals are subject to a rigorous lending qualification process and operate in a disciplined environment with clear delegation of decision-making authority, including individually delegated lending limits, which are reviewed annually. 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. Corporate Audit Division reviews and tests management processes and controls and samples credit transactions in order to assess adherence to credit terms and conditions, as well as to governing policies, standards and procedures. All credit risk exposures are subject to regular monitoring. Performing accounts are reviewed on a regular basis, with most commercial and corporate accounts reviewed at least annually. The frequency of review increases 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, when appropriate. In addition, regular portfolio and sector reviews are carried out, including stress testing and scenario analysis based on current, emerging or prospective risks.
Reporting is provided at least quarterly to the Board and senior management committees in order to keep them informed of developments in our credit risk portfolios, including changes in credit risk concentrations and significant emerging credit risk issues, and to allow appropriate actions to be taken where necessary.
Credit and Counterparty Risk Management
Collateral Management
Collateral is used for credit and/or counterparty risk mitigation purposes to minimize losses that would otherwise be incurred upon the occurrence of a default. Depending on the type of borrower, the assets available and the structure and term of the credit obligations, collateral can take various forms. 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 a periodic basis, collateral is subject to regular revaluation specific to asset type.
For loans, the value of collateral is initially established at the time of origination, and the frequency of revaluation is dependent on the type of collateral. Credit officers in ERPM provide independent oversight of collateral documentation and valuation. For collateral in the form of investorowned commercial real estate, a full external appraisal of the property is obtained at the time of loan origination, except where the loan is below a specified threshold amount, in which case an internal evaluation and a site inspection are conducted. Internal evaluation methods may consider tax assessments, purchase price, real estate listing or realtor opinion. The case for an updated appraisal is reviewed annually, with consideration given to the borrower risk rating, existing tenants and lease contracts, as well as current market conditions. In the event a loan is classified as impaired, depending on its size, a current external appraisal, evaluation or restricted use appraisal is obtained and updated every 12 months while the loan is classified as impaired. For residential real estate that has a loan-to-value (LTV) ratio of less than 80%, an external property appraisal is routinely obtained at the time of loan origination. In certain low LTV ratio cases, BMO may use an external service provided by Canada Mortgage and Housing
Corporation to assist in determining whether a full property appraisal is necessary. For high LTV ratio (greater than 80%) insured mortgages, BMO obtains the value of the property through available means and the default insurer confirms the value.
Collateral for our trading products is primarily comprised of cash and high-quality liquid securities (U.S. and Canadian treasury securities, U.S. agency securities and Canadian provincial government securities) that are monitored and margined on a daily basis. Collateral is obtained under the contractual terms of standardized industry documentation. With limited exceptions, we utilize the International Swaps and Derivatives Association Inc.
(ISDA) Master Agreement with a Credit Support Annex (CSA) to document our collateralized trading relationships with our counterparties for noncentrally cleared over-the-counter (OTC) derivatives. CSAs entitle a party to demand collateral (or other credit support) when its OTC derivatives exposure to the other party exceeds an agreed amount (threshold). Collateral transferred can include an independent amount (initial margin) and/or variation margin. CSAs contain, among other things, provisions setting out acceptable collateral types and how they are to be valued (discounts are often applied to the market values), as well as thresholds, whether or not the collateral can be re-pledged by the recipient and how interest is to be calculated. To document our contractual trading relationships with our counterparties for repurchase transactions, we utilize master repurchase agreements and for securities lending transactions, we utilize master securities lending agreements.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
94 BMO Financial Group 198th Annual Report 2015
Portfolio Management
BMO’s credit risk governance policies set an acceptable level of diversification. Limits may be used for several portfolio dimensions, including industry, specialty segments (e.g., hedge funds and leveraged lending), country, product and single-name concentrations. At year end, our credit assets consisted of a well-diversified portfolio comprised of millions of clients, the majority of them consumers and small to medium-sized businesses. The diversification of our credit exposure may be supplemented by the purchase or sale of insurance through guarantees or credit default swaps.
Wrong-way Risk
Wrong-way risk occurs when exposure to a counterparty is highly correlated with the credit quality of collateral or another intended mitigant of the risk from that counterparty. There is specific wrong-way risk, which arises when the counterparty and the market risk factors affecting that mitigant display a high correlation, and general wrong-way risk, which arises when the credit quality of the counterparty, for non-specific reasons, is highly correlated with macroeconomic or other factors that affect the value of the mitigant. Our procedures require that specific wrong-way risk be identified in transactions and accounted for in the calculation of risk. Stress testing of wrong-way risk is conducted monthly and can be used to identify existing/emerging concentrations of general wrong-way risk in our portfolios.
Credit and Counterparty Risk Measurement
Exposure at Default (EAD) represents an estimate of the outstanding amount of a credit exposure at the time a default may occur. 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.
Probability of Default (PD) represents the likelihood that a borrower or counterparty will go into default over a one-year time horizon, estimated at a high confidence level.
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 EAD, LGD and PD.
Under OSFI rules, there are three approaches available for the measurement of credit risk: Standardized, Foundation Internal Ratings Based and
Advanced Internal Ratings Based (AIRB). Subject to a transitional floor based on the Standardized Approach, we apply the AIRB Approach for calculations of credit risk in our portfolios, including portfolios of our subsidiary BMO Financial Corp. The Standardized Approach is currently being used for measurements related to the acquired M&I portfolio, while we continue to execute our plan to transition this portfolio to the AIRB Approach.
Risk Rating Systems
BMO’s risk rating systems are designed to assess and measure the risk of any exposure. The rating systems differ for retail (consumer and small business) and wholesale (corporate and commercial) portfolios.
Credit risk measures are validated and back-tested regularly – quarterly in the case of retail models and annually in the case of wholesale models.
Please refer to pages 112 and 113 for a discussion of our model risk mitigation processes.
Retail (Consumer and Small Business)
The retail portfolios are made up of a diversified group of individual customer accounts and include residential mortgages, personal loans, credit cards and small business loans. These loans are managed in pools of homogeneous risk exposures. For these pools, 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 retail risk rating system assesses the borrower’s risk based on a narrow range of likely expected conditions, primarily more recent in nature, including delinquency, loan-to-value ratio and loan utilization rate. Product lines within each of the retail risk areas are separately modelled so the risk-based parameters capture the distinct nature of each product. A final segmentation then sorts each exposure within a product line into homogeneous pools of retail risk that reflect common risk-based parameters. Each pool is assigned a unique combination of PD, LGD and EAD parameters that captures its segment-specific credit risk.
The retail risk rating system is designed to generate estimates of the value of credit risk parameters as accurately as possible but is subject to uncertainty. During the calibration process, adjustments are made at the parameter level for each segment to account for this uncertainty. The retail parameters are tested quarterly and calibrated on an annual basis to incorporate additional data points in the parameter estimation process, ensuring that the most recent experience is incorporated.
Retail Credit Probability of Default Bands by Risk Rating
Risk profile
Probability of default band
Exceptionally low
Very low
Low
Medium
High
Default
≤ 0.05%
> 0.05% to 0.20%
> 0.20% to 0.75%
> 0.75% to 7.00%
> 7.00% to 99.99%
100%
Wholesale (Corporate, Commercial and Sovereign)
Within wholesale portfolios, we utilize an enterprise-wide risk rating framework that is applied to all of our sovereign, bank, corporate and commercial counterparties. One key element of this framework is the assignment of appropriate borrower or counterparty risk ratings (BRRs). A suite of general and sector-specific risk rating models have been developed within each asset class to capture the key quantitative and qualitative risk
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 95
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We quantify credit risk at both the individual borrower or counterparty and the portfolio level. In order to limit earnings volatility, manage expected credit losses and minimize unexpected losses, credit risk is assessed and measured using the following risk-based parameters:
MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
factors associated with borrowers in different industries and portfolios. Risk ratings are assigned using the appropriate internal model. BRRs are assessed and assigned at the time of loan origination and reviewed at least annually. More frequent reviews are conducted for borrowers with higher risk ratings, borrowers that trigger a review through a rating change or that experience covenant breaches, and borrowers requiring or requesting changes to credit facilities. The assigned ratings are mapped to a PD over a one-year time horizon. As a borrower migrates between risk ratings, the
PD associated with the borrower changes.
BMO employs a master scale with 14 BRRs above default, and PDs are assigned to each grade within an asset class to reflect the long-run average of one-year default rates. PD estimates are updated periodically based on internal default experience over a period of more than five years that covers at least one full economic cycle, supplemented by external benchmarking, as applicable.
BMO also assigns an LGD estimate to each separate facility provided to a borrower at the time of origination. LGD estimates are a measure of the potential economic loss that would be incurred for a facility if the borrower were to default during a period of economic distress. The LGD estimate provides an inverse measure of the protection against loss afforded by the assigned collateral, as applicable, and considers the supporting structural elements of the facility, including seniority, margin arrangements, and product and sectoral characteristics. LGD models have been developed for each asset class using internal data that covers a period of more than seven years, capturing a full economic cycle, and are supplemented by external data, when necessary.
As demonstrated in the table below, our internal risk rating system corresponds in a logical manner to those of external rating agencies.
Wholesale Borrower Risk Rating Scale
BMO rating
Description of risk
Moody’s Investors Service implied equivalent
Standard & Poor’s implied equivalent
Acceptable
I-1 to I-3
I-4 to I-5
I-6 to I-7
S-1 to S-2
S-3 to S-4
Undoubted to minimal
Modest
Average
Acceptable
Marginal
Aaa to Aa3
A1 to Baa1
Baa2 to Baa3
Ba1 to Ba2
Ba3 to B1
AAA to AAA+ to BBB+
BBB to BBBBB+ to BB
BB- to B+
Problem
P-1
P-2 to P-3
Deteriorating
Watchlist
B2
B3 to Ca
B
B- to CC
Default/default and impaired C
D
Default and impaired
T1, D-1 to D-4
Credit Quality Information
Portfolio Review
Total enterprise-wide outstanding credit exposures were $623 billion at October 31, 2015, comprised of $358 billion in Canada, $236 billion in the
United States and $29 billion in other jurisdictions. This represents an increase of $76 billion or 14% from the prior year.
BMO’s loan book continues to be well-diversified by industry and geographic region and, consistent with the prior year, the consumer portfolio represented the majority of loans. Gross loans and acceptances increased by $31 billion or 10% from the prior year (5% excluding the impact of the stronger U.S. dollar) to $336 billion at October 31, 2015. Excluding the impact of the stronger U.S. dollar, the geographic mix of our Canadian and U.S. portfolios was relatively consistent with the prior year, and represented 66.6% and 30.1% of total loans, respectively, compared with 70.0% and
26.3% in 2014. The consumer loan portfolio represented 53.4% of the total portfolio, a modest decrease from 56.8% in 2014. Approximately 88% of the Canadian consumer portfolio and 97% of the U.S. consumer portfolio is secured. Business and government loans represented 46.6% of the total portfolio, up from 43.2% in 2014, primarily due to the stronger U.S. dollar. Our loan portfolio is well-diversified by industry and we continue to proactively monitor industry sectors that we consider warrant closer attention, including Canadian consumer loans and U.S. and Canadian direct and indirect oil and gas exposures.
Further details on our loan book, including detailed breakdowns by industry and geographic region, can be found in Tables 7 to 15 on pages 124 to 130 and in Note 5 on page 151 of the financial statements. Details related to our credit exposures are discussed in Note 4 on page 148 of the financial statements.
Real Estate Secured Lending
Residential mortgage and home equity line of credit (HELOC) exposures continue to be of interest in the current environment. BMO regularly performs stress testing on its residential mortgage and HELOC portfolios to evaluate the potential effects of high-impact events. These stress tests incorporate scenarios ranging from moderately to severely adverse. The credit losses forecast in these tests vary with the severity of the scenario and are considered to be manageable.
Provision for Credit Losses (PCL)
Total PCL was $612 million in the current year, up 9% from $561 million in 2014. Detailed discussion of our PCL, including historical trends in PCL, is provided on page 42, in Table 15 on page 130 and in Note 4 on page 148 of the financial statements.
Gross Impaired Loans (GIL)
Total GIL decreased by $89 million or 4% from 2014 to $1,959 million in 2015, with the decrease being attributed to Canada. Excluding the impact of the stronger U.S. dollar, GIL were 13% lower. GIL as a percentage of gross loans and acceptances also decreased over the prior year from 0.67% in
2014 to 0.58% in 2015.
Factors contributing to the change in GIL are outlined in the table below. Loans classified as impaired during the year decreased from
$2,142 million in 2014 to $1,921 million in 2015. On a geographic basis, the United States accounted for the majority of impaired loan formations, comprising 55.6% of total formations in 2015, compared with 56.8% in 2014. Further details on the breakdown of impaired loans by geographic region and industry can be found in Table 11 on page 126 and in Note 4 on page 148 of the financial statements.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
96 BMO Financial Group 198th Annual Report 2015
Changes in Gross Impaired Loans and Acceptances (1)
(Canadian $ in millions, except as noted)
For the year ended October 31
2015
2014
2013
GIL, beginning of year
Classified as impaired during the year
Transferred to not impaired during the year
Net repayments
Amounts written off
Recoveries of loans and advances previously written off
Disposals of loans
Foreign exchange and other movements
2,048
1,921
(556)
(700)
(704)
–
(252)
202
2,544
2,142
(669)
(1,059)
(801)
–
(220)
111
2,976
2,449
(728)
(1,058)
(939)
–
(343)
187
GIL, end of year
1,959
2,048
2,544
0.58
0.67
0.91
GIL as a % of gross loans and acceptances
(1) GIL excludes purchased credit impaired loans.
Changes in Allowance for Credit Losses (1)
(Canadian $ in millions, except as noted)
For the year ended October 31
Specific ACL, beginning of year
Specific PCL (charge to income statement)
Recoveries of amounts written off in previous years
Write-offs
Foreign exchange and other movements
2015
424
612
456
(1,065)
(35)
2014
485
561
624
(1,149)
(97)
2013
476
597
772
(1,297)
(63)
392
424
Collective ACL, beginning of year
Collective PCL (charge to income statement)
Foreign exchange and other movements
1,542
–
118
1,485
–
57
1,460
(10)
35
Collective ACL, end of year
1,660
1,542
1,485
Specific ACL, end of year
485
Total ACL
2,052
1,966
1,970
Comprised of:
Loans
Specific allowance for other credit instruments
Collective allowance for other credit instruments
1,855
35
162
1,734
50
182
1,665
41
264
ACL as a % of GIL (2)
103.0
93.6
75.8
(1) Includes allowances related to other credit instruments that are included in other liabilities.
(2) Ratio excludes specific allowances for other credit instruments that are included in other liabilities.
BMO Financial Group 198th Annual Report 2015 97
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Allowance for Credit Losses (ACL)
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 collective allowances for credit losses. Specific allowances reduce the aggregate carrying value of credit assets for which there is evidence of deterioration in credit quality. We also maintain a collective allowance in order to cover any impairment in the existing loan portfolio that cannot yet be associated with individually identified impaired loans. Our approach to establishing and maintaining the collective allowance is based on the requirements of IFRS, in conjunction with guidelines issued by our regulator,
OSFI. Our collective allowance methodology groups loans on the basis of similar credit risk characteristics, and applies quantitative and qualitative factors to determine the appropriate level for the collective allowance. The quantitative component of the methodology measures long-run expected losses based on the PD, LGD and EAD risk parameters used to estimate risk-based capital. For commercial and corporate loans, key determinants of incurred but not identified losses include the underlying risk rating of the borrower, industry sector, credit product and amount and quality of collateral held. For consumer and small business loans, exposures are pooled based on similar risk characteristics and the levels of incurred but not identified losses are determined from the long-run default and historical loss experience of each pool. The qualitative component of the methodology reflects management’s judgment with respect to current and near-term macroeconomic and business conditions, portfolio-specific considerations, credit quality trends, changes in lending practices and model factors. We review the collective allowance on a quarterly basis.
BMO maintains the allowance for credit losses at a level that we consider adequate to absorb credit-related losses. As at October 31, 2015, our
ACL was $2,052 million, comprised of specific allowances of $392 million and collective allowance of $1,660 million. This includes specific allowance of $35 million and collective allowance of $162 million related to undrawn commitments and letters of credit that are considered other credit instruments and recorded in other liabilities. Total ACL increased slightly year over year by $86 million, primarily due to the impact of the stronger
U.S. dollar. Our coverage ratios are trending positively, with ACL as a percentage of GIL increasing year over year.
The collective allowance increased by $118 million from 2014 to $1,660 million in 2015 due to the impact of the stronger U.S. dollar.
The collective allowance remains adequate and at year end represented 0.83% of credit risk-weighted assets, consistent with the prior year.
Factors contributing to the change in ACL are outlined in the table below. Further details on changes in ACL by country and portfolio can be found in Tables 12 and 13 on page 128 and in Note 4 on page 148 of the financial statements.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Select Geographic Exposures
BMO’s geographic exposures are subject to a country risk management framework that incorporates economic and political assessments and management of exposure within limits based on product, entity and the country of ultimate risk. We closely monitor our European exposure, and our risk management processes incorporate stress tests as appropriate to assess our potential risk. Our exposure to European countries, as at October 31,
2015, including Greece, Ireland, Italy, Portugal and Spain (GIIPS), is set out in the tables that follow.
The table below outlines total net portfolio exposures for funded lending, securities (inclusive of credit default swap (CDS) activity), repo-style transactions and derivatives. Funded lending is detailed by counterparty type, as well as by total commitments compared to the funded amount, in the table on page 99. There has been a reduction in our exposures since October 31, 2014.
European Exposure by Country and Counterparty (1)
(Canadian $ in millions)
As at October 31, 2015
Securities (3)(4)
Repo-style transactions and derivatives (5)(6)
Total
Bank
Corporate
Sovereign
Total
Bank
Corporate
Sovereign
Total
Total net exposure GIIPS
Greece
Ireland (7)
Italy
Portugal
Spain
–
8
2
–
63
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
2
2
–
4
–
19
5
–
–
–
–
–
–
–
–
21
7
–
4
–
29
9
–
67
Total – GIIPS
Country
MD&A
Funded lending (2)
73
–
–
–
–
8
24
–
32
105
Eurozone (excluding GIIPS)
Germany
Netherlands
Finland
Other (8)
72
245
1
322
15
520
–
–
1
13
–
–
1,158
131
324
188
1,174
664
324
188
13
9
5
66
–
15
–
21
–
–
–
8
13
24
5
95
1,259
933
330
605
Total – Eurozone (excluding GIIPS)
640
535
14
1,801
2,350
93
36
8
137
3,127
Rest of Europe
Denmark
Norway
United Kingdom
Other (8)
6
26
387
104
248
897
70
2
–
–
49
–
453
–
324
169
701
897
443
171
4
–
713
19
–
–
8
8
–
–
1
–
4
–
722
27
711
923
1,552
302
Total – Rest of Europe
523
1,217
49
946
2,212
736
16
1
753
3,488
1,236
1,752
63
2,747
4,562
837
76
9
922
6,720
Bank
Corporate
Sovereign
Total – All of Europe (9)
As at October 31, 2014
Funded lending (2)
Securities (3)
Total
Repo-style transactions and derivatives (5)(6)
Bank
Corporate
Sovereign
Total
Total net exposure Country
Total
Total – GIIPS
129
–
–
–
–
55
7
–
62
191
Total – Eurozone (excluding GIIPS)
551
711
53
1,872
2,636
379
49
7
435
3,622
Total – Rest of Europe
1,162
2,254
44
537
2,835
714
14
2
730
4,727
Total – All of Europe (9)
1,842
2,965
97
2,409
5,471
1,148
70
9
1,227
8,540
(1) BMO has the following indirect exposures to Europe as at October 31, 2015:
– Collateral of €958 million to support trading activity in securities (€108 million from GIIPS) and €82 million of cash collateral held.
– Guarantees of $1.3 billion ($17 million to GIIPS).
(2) Funded lending includes loans (primarily trade finance).
(3) Securities include cash products, insurance investments and traded credit.
(4) BMO’s total net notional CDS exposure (embedded as part of the securities exposure in this table) to Europe was $153 million, with no net single-name* CDS exposure to GIIPS countries as at
October 31, 2015 (*includes a net position of $119 million (bought protection) on a CDS Index, of which 20% is comprised of GIIPS domiciled entities).
(5) Repo-style transactions are primarily with bank counterparties for which BMO holds collateral ($16 billion for Europe as at October 31, 2015).
(6) Derivatives amounts are marked-to-market, incorporating transaction netting where master netting agreements with counterparties have been entered into, and collateral offsets for counterparties where a Credit Support Annex is in effect.
(7) Does not include Irish subsidiary reserves we are required to maintain with the Irish Central Bank of $76 million as at October 31, 2015.
(8) Includes countries with less than $300 million net exposure, with $25 million exposure to the Russian Federation as at October 31, 2015.
(9) Of our total net direct exposure to Europe, approximately 93% was to counterparties in countries with a rating of Aaa/AAA from at least one of Moody’s and S&P.
98 BMO Financial Group 198th Annual Report 2015
European Lending Exposure by Country and Counterparty (9)
Lending (2)
(Canadian $ in millions)
Country
Funded lending as at October 31, 2015
As at October 31, 2015
As at October 31, 2014
Corporate
Sovereign
Commitments
Funded
Commitments
Funded
GIIPS
Greece
Ireland (7)
Italy
Portugal
Spain
–
–
2
–
53
–
8
–
–
10
–
–
–
–
–
–
27
2
–
75
–
8
2
–
63
–
103
69
–
62
–
8
69
–
52
Total – GIIPS
55
18
–
104
73
234
129
Eurozone (excluding GIIPS)
Germany
Netherlands
Finland
Other (8)
17
30
1
182
54
215
–
140
1
–
–
–
79
346
1
622
72
245
1
322
99
559
–
517
85
239
–
227
Total – Eurozone (excluding GIIPS)
230
409
1
1,048
640
1,175
551
6
26
30
31
–
–
357
73
–
–
–
–
6
26
459
287
6
26
387
104
12
15
701
1,044
12
15
497
638
Rest of Europe
Denmark
Norway
United Kingdom
Other (8)
Total – Rest of Europe
93
430
–
778
523
1,772
1,162
Total – All of Europe (9)
378
857
1
1,930
1,236
3,181
1,842
Refer to footnotes in the table on page 98.
Derivative Transactions
The following table represents the notional amounts of our over-the-counter (OTC) derivative contracts, comprised of those which are centrally cleared and settled through a designated clearing house and those which are non-centrally cleared. The notional amounts of our derivatives represent the amount to which a rate or price is applied in order to calculate the amount of cash that must be exchanged under the contract. Notional amounts do not represent assets or liabilities and therefore are not recorded in our Consolidated Balance Sheet. The fair values of OTC derivative contracts are recorded in our Consolidated Balance Sheet.
Over-the-Counter Derivatives (1) (Notional amounts)
(Canadian $ in millions)
As at October 31
Non-centrally cleared
Centrally cleared
Total
2015
2014
2015
2014
2015
2014
Interest Rate Contracts
Swaps
Forward rate agreements
Purchased options
Written options
690,375
2,563
21,344
24,154
814,178
34,713
19,267
22,955
2,269,412
430,181
–
–
1,861,499
326,771
–
–
2,959,787
432,744
21,344
24,154
2,675,677
361,484
19,267
22,955
Total interest rate contracts
738,436
891,113
2,699,593
2,188,270
3,438,029
3,079,383
Foreign Exchange Contracts
Cross-currency swaps
Cross-currency interest rate swaps
Forward foreign exchange contracts
Purchased options
Written options
76,083
339,467
393,098
28,297
28,960
51,616
279,119
299,480
37,245
36,913
–
–
–
–
–
–
–
–
–
–
76,083
339,467
393,098
28,297
28,960
51,616
279,119
299,480
37,245
36,913
Total foreign exchange contracts
865,905
704,373
–
–
865,905
704,373
Commodity Contracts
Swaps
Purchased options
Written options
11,929
6,172
4,103
13,559
8,526
4,166
–
–
–
–
–
–
11,929
6,172
4,103
13,559
8,526
4,166
Total commodity contracts
22,204
26,251
–
–
22,204
26,251
Equity Contracts
47,114
48,702
–
–
47,114
48,702
5,611
9,385
6,507
10,232
1,054
–
2,294
1,751
6,665
9,385
8,801
11,983
14,996
16,739
1,054
4,045
16,050
20,784
1,688,655
1,687,178
2,700,647
2,192,315
4,389,302
3,879,493
Credit Default Swaps
Purchased
Written
Total credit default swaps
Total
(1) Certain comparative figures have been reclassified to conform with the current year’s presentation.
BMO Financial Group 198th Annual Report 2015 99
MD&A
Bank
MANAGEMENT’S DISCUSSION AND ANALYSIS
Market Risk
Market risk is the potential for adverse changes in the value of BMO’s assets and liabilities resulting from changes in market variables such as interest rates, foreign exchange rates, equity and commodity prices and their implied volatilities, and credit spreads, and includes the risk of credit migration and default in our trading book.
BMO incurs market risk in its trading and underwriting activities and structural banking activities. The magnitude and importance of these activities to the enterprise, along with the relative uncertainty of daily changes to market variables, require a strong and balanced market risk structure that incorporates appropriate and defensible governance, management and measurement.
MD&A
Trading and Underwriting Market Risk Governance
As part of our enterprise-wide risk management framework, we apply comprehensive governance and management processes to our market risktaking activities. The RRC has oversight of the management of market risk and approves the Market Risk Corporate Policy, along with limits governing market risk exposures. The RMC, which recommends the Market Risk Corporate Policy for approval, regularly reviews and discusses significant market risk issues and positions, and provides senior management oversight. These committees are informed 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, as well as other relevant market risk issues. In addition, all individuals authorized to conduct trading and underwriting activities on behalf of BMO are appropriately notified of BMO’s risk-taking governance, authority structure, procedures and processes, are given access to and guidance on the relevant corporate policies and standards, and are expected to adhere to those standards.
Trading and Underwriting Market Risk Management
We have strong, independent risk oversight within a policy framework that mandates comprehensive controls for the management of market risk.
We monitor an extensive range of risk metrics, including Value at Risk (VaR), Stressed Value at Risk (SVaR), stress and scenario tests, risk sensitivities and operational metrics. We apply a comprehensive set of limits to these metrics, with appropriate monitoring, reporting and escalation of limit breaches. Risk profiles of our trading and underwriting activities are maintained within our risk appetite, and are monitored and reported to traders, management, senior executives and Board committees. Further key controls include the independent valuation of financial assets and liabilities, as well as compliance with a model risk management framework to mitigate model risk.
BMO’s Market Risk group also provides oversight of structural market risk, which is managed by BMO’s Corporate Treasury group and described on page 103.
Valuation Product Control
Within the Market Risk group, the Valuation Product Control (VPC) group is responsible for the independent valuation of all trading and available-forsale (AFS) portfolios within Capital Markets Trading Products and Corporate Treasury, to confirm that they are materially accurate by:
‰ developing and maintaining valuation adjustment policies and procedures in accordance with regulatory requirements and IFRS;
‰ establishing official rate sources for valuation of all portfolios; and
‰ providing an independent review of portfolios where prices supplied by traders are used for valuation.
Trader valuations are reviewed to determine whether they align with an independent assessment of the market value of the related portfolio. If the valuation difference exceeds the prescribed tolerance threshold, a valuation adjustment is recorded in accordance with our accounting policy and regulatory requirements. Prior to the final month-end general ledger close, the Valuation Operating Committee, comprised of key stakeholders from the lines of business, Market Risk, Capital Markets Finance, Treasury and the Chief Accountant’s Group, reviews all valuation adjustments that are proposed by the VPC group.
The Valuation Steering Committee is BMO’s senior management valuation committee. It meets at least monthly to address the more challenging material valuation issues related to BMO’s portfolios, approves valuation methodology changes and acts as a key forum for discussing positions categorized as Level 3 for financial reporting purposes and their inherent uncertainty.
At a minimum, the following are considered when determining appropriate valuation adjustments: credit valuation adjustments, closeout costs, uncertainty, funding valuation adjustments, and liquidity and model risk. Also, a fair value hierarchy is used to categorize the inputs used in the valuation of securities, liabilities, derivative assets and derivative liabilities. Level 1 inputs consist of quoted market prices, Level 2 inputs consist of results from models that use observable market information and Level 3 inputs consist of results from models for which observable market information is not available. Details of Level 1, Level 2 and Level 3 fair value measurements can be found in Note 18 on page 172 of the financial statements. Trading and Underwriting Market Risk Measurement
To capture the multi-dimensional aspects of market risk effectively, a number of metrics are used, including VaR, SVaR, stress testing, sensitivities, position concentrations, market and notional values and revenue losses.
Value at Risk (VaR) is measured for specific classes of risk in BMO’s trading and underwriting activities related to interest rates, foreign exchange rates, credit spreads, equity and commodity prices and their implied volatilities. This measure calculates the maximum loss likely to be experienced in the trading and underwriting portfolios, measured at a 99% confidence level over a specified holding period.
Stressed Value at Risk (SVaR) is measured for specific classes of risk in BMO’s trading and underwriting activities related to interest rates, foreign exchange rates, credit spreads, equity and commodity prices and their implied volatilities, where model inputs are calibrated to historical data from a period of significant financial stress. This measure calculates the maximum loss likely to be experienced in the trading and underwriting portfolios, measured at a 99% confidence level over a specified holding period.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
100 BMO Financial Group 198th Annual Report 2015
Total Trading Value at Risk (VaR) Summary (1)
2014
2015
As at or for the year ended October 31
(pre-tax Canadian $ equivalent in millions)
Year-end
Average
High
Low
(0.3)
(3.3)
(0.4)
(3.3)
(1.8)
Year-end
Commodity VaR
Equity VaR
Foreign exchange VaR
Interest rate VaR
Credit VaR
Diversification
(0.4)
(6.9)
(2.6)
(10.5)
(2.7)
9.8
(0.5)
(6.3)
(1.6)
(6.6)
(5.7)
9.7
(1.4)
(15.8)
(4.8)
(11.6)
(8.2)
nm
(0.5)
(3.2)
(0.5)
(5.8)
(5.5)
7.4
Total Trading VaR
(13.3)
(11.0)
(17.7)
(6.9)
(8.1)
High
Low
(0.5)
(7.2)
(0.8)
(7.9)
(4.7)
nm
Total Trading Stressed Value at Risk (SVaR) Summary (1)(2)
As at or for the year ended October 31
(pre-tax Canadian $ equivalent in millions)
2014
2015
Year-end
Average
Commodity SVaR
Equity SVaR
Foreign exchange SVaR
Interest rate SVaR
Credit SVaR
Diversification
(0.7)
(17.6)
(2.2)
(10.4)
(5.2)
15.0
(1.0)
(12.4)
(3.0)
(10.9)
(16.0)
21.0
(1.8)
(22.4)
(8.4)
(15.7)
(24.5)
Total Trading SVaR
(21.1)
(22.3)
(29.3)
nm
nm
(17.4)
Year-end
(3.2)
(14.0)
(0.7)
(11.2)
(13.6)
20.6
(22.1)
(1) One-day measure using a 99% confidence interval. Losses are in brackets and benefits are presented as positive numbers.
(2) Stressed VaR is produced weekly. nm – not meaningful
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 101
MD&A
Although it is a valuable indicator of risk, VaR should always be viewed in the context of its limitations. Among the limitations of VaR is the 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. Generally, market liquidity horizons are reviewed for suitability and updated where appropriate for relevant risk metrics. Scenario analysis and probabilistic stress testing are performed daily to determine the potential impact of unusual and/or unexpected market changes on our portfolios. As well, historical and event stresses are tested on a weekly basis, including tests of scenarios such as the stock market crash of 1987 and the collapse of Lehman Brothers in 2008. Ad hoc analyses are run to examine our sensitivity to low-frequency, high-severity hypothetical scenarios. Scenarios are amended, added or removed to better reflect changes in underlying market conditions. The results are reported to the lines of business, the RMC and the RRC on a regular basis. Stress testing is limited by the fact that not all downside scenarios can be predicted and effectively modelled. Neither VaR nor stress testing should be viewed as a definitive predictor of the maximum amount of losses that could occur in any one day, because these measures are based on models and estimates (such as confidence levels) and their results 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 appropriate stakeholders. BMO has a robust governance process in place to ensure adherence to delegated market risk limits. Amounts exceeding those limits are reported to senior management on a timely basis for resolution and appropriate action.
In addition, we measure the market risk for trading and underwriting portfolios that meet regulatory criteria for trading book capital treatment using the Internal Models Approach. For trading and underwriting portfolios covered by the Internal Models Approach, VaR is computed using BMO’s
Trading Book VaR model. This is a Monte Carlo scenario simulation model, and its results are used for market risk management and reporting of exposures. The model computes one-day VaR results using a 99% confidence level, and those results reflect the historic correlations between the different classes of market risk factors.
We use a variety of methods to verify the integrity of our risk models, including the application of back-testing against hypothetical losses.
This process assumes there are no changes in the previous day’s closing positions and then isolates the effects of each day’s price movements against those closing positions. Models are validated by assessing how often the calculated hypothetical losses exceed the VaR measure over a defined period. This testing result is in line with defined regulatory expectations, and its results confirm the reliability of our models. The volatility data and correlations that underpin our models are updated monthly, so that VaR measures reflect current conditions.
Our models are used to determine market risk Economic Capital for each of our lines of business and to determine regulatory capital. For capital calculation purposes, the longer holding periods and/or higher confidence levels that are used are not the same as those employed in day-to-day risk management. Under the Model Risk Corporate Policy, models are subject to review by our Model Validation group prior to use. The Model Risk
Corporate Policy outlines minimum requirements for the identification, assessment, monitoring and management of models and model risk across the enterprise, and is described on page 112.
Total Trading VaR increased year over year from client facilitation activities, the recent impact of more volatile historical data used for VaR calculation and changes in market rates. Average Trading VaR is up moderately year over year. Beginning in the fourth quarter, market risk associated with changes in the fair value of non-derivative liabilities attributable to fluctuations in our credit risk is no longer reflected in our VaR calculation to better reflect our associated net risk position, resulting in a drop in Credit VaR and SVaR. Total Trading SVaR reduced moderately year over year, with reductions in Credit SVaR offset by reduced diversification.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Trading Net Revenue
The charts below present daily net revenue plotted against total trading VaR, along with a representation of daily net revenue distribution. During the current year, the largest loss occurred on June 30, and was the result of normal trading activity and valuation adjustments. The largest gain occurred on February 27, and was primarily due to normal trading and underwriting activity.
Frequency Distribution of Daily Net Revenues
November 1, 2014 to October 31, 2015 ($ millions)
Frequency in number of days
20
15
10
5
0
(2) (1) 0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 31 32 34 35 37
Daily net revenues (pre-tax)
Trading Net Revenues versus Value at Risk
November 1, 2014 to October 31, 2015 ($ millions)
40
30
20
10
(10)
(20)
Daily Revenues
Total Trading VaR
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
102 BMO Financial Group 198th Annual Report 2015
Oct 19
Sep 03
Jul 22
Jun 09
Apr 27
Mar 13
Dec 15
Jan 29
0
Nov 03
MD&A
25
Linkages between Balance Sheet Items and Market Risk Disclosures
The table below presents items reported in our Consolidated Balance Sheet that are subject to market risk, comprised of balances that are subject to either traded risk or non-traded risk measurement techniques.
As at October 31, 2014
As at October 31, 2015
Subject to market risk
Subject to market risk
(Canadian $ in millions)
Assets Subject to Market Risk
Cash and cash equivalents
Interest bearing deposits with banks
Securities
Trading
Available-for-sale
Derivative instruments
Other assets
Traded risk (1)
Non-traded risk (2)
Not subject to market risk
Consolidated
Balance Sheet
Traded risk (1)
Non-traded risk (2)
Not subject to market risk
40,295
7,382
–
1,212
40,295
6,170
–
–
28,386
6,110
–
930
28,386
5,180
–
–
Interest rate
Interest rate
72,460
65,066
7,394
–
85,022
78,997
6,025
–
48,006
–
48,006
–
46,966
–
46,966
–
9,432
1,020
–
–
9,432
1,020
–
–
10,344
987
–
–
10,344
987
–
–
Interest rate, credit spread
Interest rate, credit spread
Interest rate
Equity
68,066
–
68,066
–
53,555
–
53,555
–
Interest rate
334,024
–
334,024
–
303,038
–
303,038
–
38,238
35,924
2,314
–
32,655
31,627
1,028
–
22,958
21,596
Interest rate, foreign exchange
Interest rate, foreign exchange
Interest rate
–
7,787
13,809
588,659 111,554
463,296
13,809
–
393,088
7,639
385,449
–
2,732
–
33,657
32,312
1,345
–
–
11,307
–
10,878
–
10,878
–
Interest rate, foreign exchange
Interest rate, foreign exchange
Interest rate
21,226
21,226
–
–
27,348
27,348
–
–
Interest rate
39,891
44,320
4,416
–
–
–
39,891
44,218
4,416
–
102
–
39,695
43,676
4,913
–
–
–
39,695
43,263
4,913
–
413
–
Interest rate
Interest rate
Interest rate
601,968
70,562
531,304
102
553,255
67,299
485,543
413
–
8,195
14,763
Total Assets
641,881 102,202
524,916
14,763
Liabilities Subject to Market Risk
Deposits
438,169
9,429
428,740
Derivative instruments
42,639
39,907
Acceptances
Securities sold but not yet purchased Securities lent or sold under repurchase agreements
Other liabilities
Subordinated debt
11,307
Total Liabilities
(1) Primarily comprised of BMO’s balance sheet items that are subject to the trading and underwriting risk management framework and fair valued through profit or loss.
(2) Primarily comprised of BMO’s balance sheet items that are subject to the structural balance sheet and insurance risk management framework, or are available-for-sale securities.
Certain comparative figures have been reclassified to conform to the current year’s presentation.
Structural (Non-Trading) 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 Governance
The RRC has oversight of the management of structural market risk, annually approves the structural market risk strategy and limits, and regularly reviews structural market risk positions. The RMC and Balance Sheet and Capital Management Committee (BSCMC) regularly review structural market risk positions and provide senior management oversight.
In addition to Board-approved limits on earnings and economic value exposure, more granular management limits are in place to guide day-to-day management of this risk. BMO’s Corporate Treasury group is responsible for the ongoing management of structural market risk across the enterprise, with independent oversight provided by the Market Risk group.
Structural Market Risk Measurement
Interest Rate Risk
Structural interest rate risk arises when changes in interest rates affect the cash flows, earnings and values of assets and liabilities from our banking activities. The objective of structural interest rate risk management is to maintain high-quality earnings and maximize sustainable product spreads.
Structural interest rate risk is primarily comprised of interest rate mismatch risk and product embedded option risk.
Interest rate mismatch risk arises when there are differences in the scheduled maturities, repricing dates or reference rates of assets, liabilities and derivatives. The net interest rate mismatch, representing residual assets funded by common shareholders’ equity, is managed to a target profile through interest rate swaps and securities.
Product embedded option risk arises when product features allow customers to alter cash flows, such as scheduled maturity or repricing dates, usually in response to changes in market conditions. Product embedded options include loan prepayments, deposit redemption privileges and committed rates on unadvanced mortgages. Product embedded options are generally managed to low risk levels through a dynamic hedging process or with purchased options.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 103
MD&A
Held-to-maturity
Other
Securities borrowed or purchased under resale agreements
Loans and acceptances (net of allowance for credit losses)
Main risk factors for non-traded risk balances Consolidated
Balance Sheet
MANAGEMENT’S DISCUSSION AND ANALYSIS
Structural interest rate risk is measured using simulations, earnings sensitivity and economic value sensitivity analysis, stress testing and gap analysis, in addition to other traditional risk metrics.
Earnings Sensitivity is a measure of the impact of potential changes in interest rates on the projected 12-month after-tax net income of a portfolio of assets, liabilities and off-balance sheet positions in response to prescribed parallel interest rate movements.
MD&A
Economic Value Sensitivity is a measure of the impact of potential changes in interest rates on the market value of a portfolio of assets, liabilities and off-balance sheet positions in response to prescribed parallel interest rate movements.
The models used to measure structural interest rate risk project changes in interest rates and predict how customers would likely react to these changes. For customer loans and deposits with scheduled maturity and repricing dates (such as mortgages and term deposits), our models measure the extent to which customers are likely to use embedded options to alter those scheduled terms. For customer loans and deposits without scheduled maturity and repricing dates (such as credit card loans and chequing accounts), we measure our exposure using models that adjust for elasticity in product pricing and reflect historical and forecasted trends in balances. Structural market risk models by their nature have inherent uncertainty as they reflect potential anticipated pricing and customer behaviours which may differ from actual experience. The models have been developed using statistical analysis and are validated and periodically updated through regular model vetting, back-testing processes and ongoing dialogue with the lines of business. Models developed to predict customer behaviour are also used in support of product pricing.
Structural interest rate earnings and economic value sensitivity to an immediate parallel increase or decrease of 100 and 200 basis points in the yield curve are disclosed in the following table. The interest rate gap position is disclosed in Note 20 on page 180 of the financial statements.
During the year, we updated our approach to quantify the potential impact of changing interest rates on structural earnings and value sensitivities. The new approach reflects a more refined estimate of expected deposit pricing as interest rates change. There were no other significant changes in our structural market risk management framework during the year.
Structural economic value sensitivity to rising rates primarily reflects a lower market value for fixed-rate loans. Structural economic value sensitivity to falling rates primarily reflects the reduced ability to price deposits lower in the low-rate environment. Structural earnings exposure to falling interest rates primarily reflects the risk of fixed and floating rate loans repricing at lower rates and the more limited ability to reduce deposit pricing as rates fall. The asset-liability profile at the end of the year resulted in a structural earnings benefit from interest rate increases and structural earnings exposure to interest rate decreases. The realized earnings impact may differ from that shown depending on a number of factors, including customer and competitor actions and the pace at which interest rates change.
Structural Balance Sheet Interest Rate Sensitivity (1) (2) (3) (4) (5)
As at October 31, 2014
As at October 31, 2015
(Canadian $ in millions)
100 basis point increase
100 basis point decrease
200 basis point increase
200 basis point decrease
Earnings sensitivity over the next
Economic value
12 months sensitivity (After tax)
(Pre-tax)
(647.6)
107.3
(1,722.3)
(288.5)
143.5
(62.0)
185.4
(87.8)
Economic value sensitivity (Pre-tax)
(715.1)
405.2
(1,579.4)
320.5
Earnings sensitivity over the next
12 months
(After tax)
64.7
(62.6)
85.8
(68.1)
(1) We enhanced our approach to quantify the potential impact of changing interest rates on structural earnings and value sensitivities in 2015. Positions as at October 31, 2014 have not been restated to the new approach.
(2) Earnings and value sensitivities to falling interest rates assume Canadian and U.S. central banks do not decrease overnight interest rates below nil. The scenarios with decreasing interest rates therefore limit the decrease in Canadian and U.S. short-term interest rates to 50 basis points (100 basis points in 2014) and 25 basis points, respectively, for shorter terms in 2015 and 2014. Longer-term interest rates do not decrease below the assumed level of short-term interest rates.
(3) Certain non-trading AFS holdings are managed under the bank’s trading risk framework.
(4) Losses are in brackets and benefits are presented as positive numbers.
(5) For BMO’s Insurance businesses, a 100 basis point increase in interest rates at October 31, 2015, results in an increase in earnings after tax of $66 million and an increase in economic value before tax of $511 million ($71 million and $385 million, respectively, at October 31, 2014). A 100 basis point decrease in interest rates at October 31, 2015, results in a decrease in earnings after tax of
$63 million and a decrease in economic value before tax of $414 million ($63 million and $414 million, respectively, at October 31, 2014). These impacts are not reflected in the table above.
Foreign Exchange Risk
Structural foreign exchange risk arises primarily from translation risk related to the net investment in our U.S. operations and from transaction risk associated with our U.S.-dollar-denominated net income.
Translation risk represents the impact that changes in foreign exchange rates can have on BMO’s reported shareholders’ equity and capital ratios. When the Canadian dollar appreciates relative to the U.S. dollar, unrealized translation losses on our net investment in foreign operations, net of related book value hedging activities, are reported in other comprehensive income in shareholders’ equity. In addition, the Canadian dollar equivalent of U.S.-dollar-denominated risk-weighted assets and regulatory capital deductions decreases. The reverse is true when the Canadian dollar depreciates relative to the U.S. dollar. Consequently, we may adjust the hedge of our net investment in foreign operations such that translation risk is not expected to materially impact our capital ratios.
Transaction risk represents the impact that fluctuations in the Canadian/U.S. dollar exchange rate may have on the Canadian dollar equivalent of
BMO’s U.S.-dollar-denominated results. Exchange rate fluctuations will affect future results measured in Canadian dollars and the impact on those results is a function of the periods during which revenues, expenses and provisions for credit losses arise. Hedging positions may be taken to partially offset the pre-tax effects of Canadian/U.S. dollar exchange rate fluctuations. If future results are consistent with results in 2015, each one cent increase (decrease) in the Canadian/U.S. dollar exchange rate would be expected to increase (decrease) adjusted net income before income taxes for the year by $10 million, in the absence of hedging transactions. Refer to the Foreign Exchange section on page 37 for a more complete discussion of the effects of changes in exchange rates on the bank’s results.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
104 BMO Financial Group 198th Annual Report 2015
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 the safety and soundness of the enterprise, depositor confidence and earnings stability. 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.
Liquidity and Funding Risk Governance
Liquidity and Funding Risk Management
BMO’s Liquidity and Funding Risk Management Framework is defined and authorized under Board-approved corporate policies and managementapproved standards. These policies and standards outline key management principles, liquidity and funding metrics and related limits and guidelines, as well as roles and responsibilities for the management of liquidity and funding risk across the enterprise.
BMO has robust limits and guidelines in place in order to manage liquidity and funding risk. Limits establish the enterprise-level risk appetite for our key Net Liquidity Position (NLP) measure, secured and unsecured funding appetite, for both trading and structural activities, and risk appetite for enterprise pledging activity. Guidelines establish the tolerance for concentrations of maturities, requirements for diversifying counterparty liabilities and limits for business pledging activity. Guidelines have also been established for the size and type of uncommitted and committed credit and liquidity facilities that may be outstanding in order to ensure liquidity and funding risk is appropriately managed. An enterprise-wide contingency plan that will facilitate effective management in the event of a disruption is also in place. Early warning indicators identified in the contingency plan are regularly monitored to identify early signs of growing liquidity risk in the market or risks specific to BMO.
BMO subsidiaries include regulated and foreign legal entities and branches, and as a result, movements of funds between companies in the corporate group are subject to, among other things, the liquidity, funding and capital adequacy requirements of the subsidiaries. As such, liquidity and funding positions are managed on both a consolidated and key legal entity basis. Liquidity and funding risk management policies and limits are in place for key legal entities which are informed by the legal and regulatory requirements that apply to each entity, and positions are regularly reviewed at the legal entity level to ensure compliance with applicable requirements.
BMO employs fund transfer pricing and liquidity transfer pricing practices in order to ensure the appropriate economic signals for the pricing of products for customers are provided to the lines of business and to assess the performance of each business. These practices capture both the cost of funding assets and the value of deposits under normal operating conditions, as well as the cost of supplemental liquid assets held to support contingent liquidity requirements.
Liquidity and Funding Risk Measurement
A key component of liquidity risk management is the measurement of liquidity risk under stress. BMO uses the NLP as a key measure of liquidity risk.
The NLP represents the amount by which liquid assets exceed potential funding needs under a severe combined enterprise-specific and systemic stress scenario. Potential funding needs may arise from obligations to repay retail, commercial and wholesale deposits that are withdrawn or not renewed, fund drawdowns on available credit and liquidity lines, or the requirement to pledge collateral due to ratings downgrades or as a result of market volatility, as well as the continuing need to fund assets and strategic investments. Potential funding needs are quantified by applying factors to various business activities based on management’s view of the relative liquidity risk of each activity. These factors vary by depositor classification
(e.g., retail, small business, non-financial corporate or wholesale counterparties) and deposit type (e.g., insured, uninsured, operational or nonoperational deposits), as well as by commitment type (e.g., uncommitted or committed credit or liquidity facilities by counterparty type). The stress scenario also considers the time horizon over which liquid assets can be monetized and the related haircuts that may occur as a result of market stress. These funding needs are assessed under severe systemic and enterprise-specific stress scenarios and a combination thereof. BMO focuses on maintaining a Net Liquidity Position sufficient to withstand each scenario.
Stress testing results are compared against BMO’s stated risk tolerance and are considered in management decisions on setting limits or guidelines and internal liquidity transfer pricing, and they also help to shape the design of business plans and contingency plans. The Liquidity and
Funding Risk Management Framework is also integrated with enterprise-wide stress testing.
In addition to the NLP, we regularly monitor positions against the limits and guidelines noted in the Liquidity and Funding Risk Management section above. This includes required regulatory metrics such as the Liquidity Coverage Ratio (LCR) and Net Cumulative Cash Flow (NCCF).
Unencumbered Liquid Assets
Unencumbered liquid assets include high-quality assets that are marketable, can be pledged as security for borrowings, and can be converted to cash in a time frame that meets our liquidity and funding requirements. Liquid assets are primarily held in our trading businesses, as well as in supplemental liquidity pools that are maintained for contingent liquidity risk management purposes. The amounts of liquidity recognized for different
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 105
MD&A
The RRC has oversight of the management of liquidity and funding risk, annually approves applicable policies, limits and the contingency plan, and regularly reviews liquidity and funding positions. BMO’s Corporate Treasury group recommends the Liquidity and Funding Risk Management
Framework and the related risk appetite, limits and guidelines, monitors compliance with policy requirements and assesses the impact of market events on liquidity requirements on an ongoing basis. The RMC and BSCMC provide senior management oversight and also review and discuss significant liquidity and funding policies, issues and action items that arise in the pursuit of our strategic priorities.
The Corporate Treasury group and the operating groups are responsible for the ongoing management of liquidity and funding risk across the enterprise. Enterprise Market Risk Management provides oversight, independent risk assessment and effective challenge of liquidity and funding management across the organization.
MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
asset classes under our management framework are subject to haircuts reflecting management’s view of the liquidity value of those assets in a stress scenario. Liquid assets in the trading businesses include cash on deposit with central banks and short-term deposits with other financial institutions, highly-rated debt and equity securities and short-term reverse repurchase agreements. Supplemental liquidity pool assets are predominantly comprised of cash on deposit with central banks and securities and short-term reverse repurchase agreements of highly-rated Canadian federal and provincial and U.S. federal government and agency debt. Substantially all supplemental liquidity pool assets meet the definition of liquid assets under
Basel III. Approximately 75% of the supplemental liquidity pool is held at the parent bank level in Canadian- and U.S.-dollar-denominated assets, with the majority of the remaining supplemental liquidity pool held at BMO Harris Bank in U.S.-dollar-denominated assets. The size of the supplemental liquidity pool is highly integrated with our measurement of liquidity risk, as its size is calibrated to meet the potential funding needs, outside of our trading businesses, in the parent bank and BMO Harris Bank and to meet BMO’s target NLP for each entity. To meet local regulatory requirements, certain of our legal entities maintain their own minimum liquidity positions. There may be legal and regulatory restrictions on our ability to use liquid assets held in one legal entity to support the liquidity requirements of another legal entity.
In the ordinary course of business, BMO may encumber a portion of cash and securities holdings as collateral in support of trading activities and our participation in clearing and payment systems in Canada and abroad. In addition, BMO may receive liquid assets as collateral and may re-pledge these assets in exchange for cash or as collateral for trading activities. Net unencumbered liquid assets, defined as on-balance sheet assets such as
BMO-owned cash and securities and securities borrowed or purchased under resale agreements, plus other off-balance sheet eligible collateral received, less collateral encumbered, totalled $188.5 billion at October 31, 2015, compared with $171.0 billion at October 31, 2014. The increase in unencumbered liquid assets was primarily due to the impact of the stronger U.S. dollar. Net unencumbered liquid assets are primarily held at the parent bank level, at our U.S. legal entity BMO Harris Bank, and in our Canadian and international broker/dealer operations. In addition to liquid assets, BMO has access to the Bank of Canada’s lending assistance programs, the Federal Reserve Bank discount window in the United States and
European Central Bank standby liquidity facilities. We do not consider central bank facilities to be a source of available liquidity when assessing BMO’s liquidity position.
In addition to cash and securities holdings, BMO may also pledge other assets, including mortgages and loans, to raise long-term secured funding. As part of the Liquidity and Funding Risk Management Framework, a Pledging of Assets Corporate Policy is in place that sets out the framework and pledging limits for financial and non-financial assets.
BMO’s total encumbered assets and unencumbered liquid assets are summarized in the table below. See Note 26 on page 192 of the financial statements for further information on pledged assets.
Liquid Assets
As at October 31,
2014
As at October 31, 2015
(Canadian $ in millions)
Cash and cash equivalents
Deposits with other banks
Securities and securities borrowed or purchased under resale agreements Sovereigns / Central banks / Multilateral development banks Mortgage-backed securities and collateralized mortgage obligations Corporate debt
Corporate equity
Total securities and securities borrowed or purchased under resale agreements
NHA mortgage-backed securities (reported as loans at amortized cost) (4)
Carrying value/onbalance sheet assets (1)
Other cash and securities received
Total gross assets (2)
Encumbered assets Net unencumbered assets (3)
Net unencumbered assets (3)
40,295
7,382
–
–
40,295
7,382
2,232
–
38,063
7,382
26,749
6,110
103,793
15,742
119,535
70,962
48,573
41,770
19,371
17,584
58,236
1,179
6,332
17,897
20,550
23,916
76,133
2,194
1,472
40,733
18,356
22,444
35,400
16,046
24,026
41,600
198,984
41,150
240,134
115,361
124,773
123,442
21,834
–
21,834
3,589
18,245
14,680
Total liquid assets
268,495
41,150
309,645
121,182
188,463
170,981
Other eligible assets at central banks (not included above) (5)
Undrawn credit lines granted by central banks
110,703
–
–
–
110,703
–
764
–
109,939
–
108,804
–
Total liquid assets and other sources
379,198
41,150
420,348
121,946
298,402
279,785
(1) The carrying values outlined in this table are consistent with the carrying values in BMO’s balance sheet as at October 31, 2015.
(2) Gross assets include on-balance sheet and off-balance sheet assets.
(3) Net unencumbered liquid assets are defined as on-balance sheet assets, such as BMO-owned cash and securities and securities borrowed or purchased under resale agreements, plus other off-balance sheet eligible collateral received, less encumbered assets.
(4) Under IFRS, NHA mortgage-backed securities that include mortgages owned by BMO as the underlying collateral are classified as loans. Unencumbered NHA mortgage-backed securities have liquidity value and are included as liquid assets under BMO’s liquidity and funding management framework. This amount is shown as a separate line item, NHA mortgage-backed securities.
(5) Represents loans currently lodged at central banks that could potentially be used to access central bank funding. Loans available for pledging as collateral do not include other sources of additional liquidity that may be realized from the loan portfolio, including incremental securitization, covered bond issuances and Federal Home Loan Bank (FHLB) advances.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
106 BMO Financial Group 198th Annual Report 2015
Asset Encumbrance
Encumbered (2)
Net unencumbered
Total gross assets (1)
Pledged as collateral Other encumbered Other unencumbered (3)
Available as collateral (4)
Cash and deposits with other banks
Securities (5)
Loans and acceptances
Other assets
Derivative instruments
Premises and equipment
Goodwill
Intangible assets
Current tax assets
Deferred tax assets
Other assets
47,677
261,968
312,190
–
94,367
43,928
2,232
24,583
1,594
397
8,302
156,729
45,048
134,716
109,939
38,238
2,285
6,069
2,208
561
3,162
8,673
–
–
–
–
–
–
–
–
–
–
–
–
–
–
38,238
2,285
6,069
2,208
561
3,162
8,673
–
–
–
–
–
–
–
61,196
–
–
61,196
–
Total assets
683,031
138,295
28,409
226,624
289,703
As at October 31, 2014
Total gross assets (1)
Pledged as collateral Other encumbered Other unencumbered (3)
Available as collateral (4)
34,496
253,961
285,186
–
85,374
37,060
1,637
30,465
2,722
417
7,939
136,600
32,442
130,183
108,804
32,655
2,276
5,353
2,052
665
3,019
8,231
–
–
–
–
–
–
–
–
–
–
–
–
–
–
32,655
2,276
5,353
2,052
665
3,019
8,231
–
–
–
–
–
–
–
54,251
–
–
54,251
–
627,894
122,434
34,824
199,207
271,429
Total other assets
Encumbered (2)
Cash and deposits with other banks
Securities (5)
Loans and acceptances
Other assets
Derivative instruments
Premises and equipment
Goodwill
Intangible assets
Current tax assets
Deferred tax assets
Other assets
Total other assets
Total assets
Net unencumbered
(1) Gross assets include on-balance sheet and off-balance sheet assets.
(2) Pledged as collateral refers to the portion of on-balance sheet assets and other cash and securities received that is pledged through repurchase agreements, securities lent, derivative contracts, minimum required deposits at central banks and requirements associated with participation in clearing houses and payment systems. Other encumbered assets include assets which are restricted from use for legal or other reasons, such as restricted cash and short sales.
(3) Other unencumbered assets include select liquid asset holdings that management believes are not readily available to support BMO’s liquidity requirements. These include cash and securities of
$8.7 billion as at October 31, 2015, which include securities held in BMO’s insurance subsidiary and credit protection vehicle, significant equity investments, and certain investments held in our merchant banking business. Other unencumbered assets also include mortgages and loans that may be securitized to access secured funding.
(4) Loans included as available as collateral represent loans currently lodged at central banks that could potentially be used to access central bank funding. Loans available for pledging as collateral do not include other sources of additional liquidity that may be realized from the loan portfolio, including incremental securitization, covered bond issuances and FHLB advances.
(5) Includes securities, securities borrowed or purchased under resale agreements and NHA mortgage-backed securities (reported as loans at amortized cost).
BMO’s LCR is summarized in the table on the following page. The average month-end LCR for the quarter ended October 31, 2015 of 130% is calculated as the ratio of the stock of High-Quality Liquid Assets (HQLA) to total net stressed cash outflows over the next 30 calendar days. The average LCR ratio is up from 128% from last quarter mainly due to the increase in HQLA. While banks are required to maintain an LCR greater than
100% in normal conditions, banks are also expected to be able to utilize their HQLA in a period of stress, which may result in an LCR below 100% during that period. BMO’s HQLA are primarily comprised of cash, highly-rated debt issued or backed by governments, highly-rated covered bonds and non-financial corporate debt and non-financial equities that are part of a major stock index. Net cash flows include outflows from deposits, secured and unsecured wholesale funding, commitments and potential collateral requirements offset by permitted inflows from loans, securities lending activities and other non-HQLA debt maturing over a 30-day horizon. OSFI prescribed weights are applied to cash flows and HQLA to arrive at the weighted values and the LCR. The LCR is only one measure of a bank’s liquidity position and does not fully capture all of the bank’s liquid assets or the funding alternatives that may be pursued in a period of stress. BMO’s total liquid assets are shown in the Liquid Assets table on page 106.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 107
MD&A
(Canadian $ in millions)
As at October 31, 2015
MANAGEMENT’S DISCUSSION AND ANALYSIS
Liquidity Coverage Ratio
For the quarter ended
July 31, 2015
For the quarter ended October 31, 2015
Total unweighted value
(average) (1) (2)
Total weighted value
(average) (2) (3)
Total weighted value
(average) (2) (3)
*
134.6
125.8
142.2
85.7
56.5
138.0
8.3
2.6
5.7
78.0
8.0
2.5
5.5
79.3
59.9
48.1
30.0
*
118.5
16.7
3.1
98.7
0.9
253.1
14.9
33.1
30.0
9.5
23.9
5.8
3.1
15.0
–
5.4
14.2
32.7
32.4
8.7
22.0
5.1
3.1
13.8
–
5.1
*
125.1
123.1
93.1
7.7
4.0
11.9
5.6
4.0
12.5
7.4
4.8
104.8
21.5
24.7
Total adjusted value (4)
(Canadian $ in billions, except as noted)
Total adjusted value (4)
134.6
103.6
125.8
98.4
130
128
MD&A
High-Quality Liquid Assets
Total high-quality liquid assets (HQLA)
Cash Outflows
Retail deposits and deposits from small business customers, of which:
Stable deposits
Less stable deposits
Unsecured wholesale funding, of which:
Operational deposits (all counterparties) and deposits in networks of cooperative banks Non-operational deposits (all counterparties)
Unsecured debt
Secured wholesale funding
Additional requirements, of which:
Outflows related to derivatives exposures and other collateral requirements
Outflows related to loss of funding on debt products
Credit and liquidity facilities
Other contractual funding obligations
Other contingent funding obligations
Total cash outflows
Cash Inflows
Secured lending (e.g. reverse repos)
Inflows from fully performing exposures
Other cash inflows
Total cash inflows
Total HQLA
Total net cash outflows
Liquidity Coverage Ratio (%)
* Disclosure is not required under the LCR disclosure standard.
(1) Unweighted values are calculated at market value (for HQLA) or as outstanding balances maturing or callable within 30 days (for inflows and outflows).
(2) Average calculated based on month-end values during the quarter.
(3) Weighted values are calculated after the application of the weights prescribed under the OSFI Liquidity Adequacy Requirements (LAR) Guideline for HQLA and cash inflows and outflows.
(4) Adjusted values are calculated based on total weighted values after applicable caps as defined by the LAR Guideline.
Funding Strategy
Our funding philosophy requires that secured and unsecured wholesale funding used to support loans and less liquid assets must be longer term
(typically maturing in two to ten years) to better match the term to maturity of these assets. Wholesale secured and unsecured funding for liquid trading assets is generally shorter term (maturing in one year or less), is aligned with the liquidity of the assets being funded, and is subject to limits on aggregate maturities that are permitted across different time periods. Supplemental liquidity pools are funded with a mix of wholesale term funding.
BMO maintains a large and stable base of customer deposits that, in combination with our strong capital base, is a source of strength. It supports the maintenance of a sound liquidity position and reduces our reliance on wholesale funding. Customer deposits totalled $261.9 billion at the end of the year, up from $238.7 billion in 2014, primarily due to the impact of the stronger U.S. dollar and deposit growth. BMO also receives deposits to facilitate certain trading activities, receives non-marketable deposits from corporate and institutional customers and issues structured notes primarily to retail investors. These deposits and notes totalled $45.6 billion as at October 31, 2015.
Total wholesale funding outstanding, largely consisting of negotiable marketable securities, was $159.5 billion at October 31, 2015, with
$42.4 billion sourced as secured funding and $117.1 billion sourced as unsecured funding. Wholesale funding outstanding increased from
$143.8 billion at October 31, 2014, primarily due to the impact of the stronger U.S. dollar. The mix and maturities of BMO’s wholesale term funding are outlined in the table below. Additional information on deposit maturities can be found in Note 30 on page 198 of the financial statements.
BMO maintains a sizeable portfolio of unencumbered liquid assets, totalling $188.5 billion as at October 31, 2015, that can be monetized to meet potential funding requirements, as described in the Unencumbered Liquid Assets section above.
Diversification of our wholesale funding sources is an important part of our overall liquidity management strategy. BMO’s wholesale funding activities are well-diversified by jurisdiction, currency, investor segment, instrument and maturity profile. BMO maintains ready access to long-term wholesale funding through various borrowing programs, including a European Note Issuance Program, Canadian and U.S. Medium-Term Note Programs,
Canadian and U.S. mortgage securitizations, Canadian credit card securitizations, covered bonds and Canadian and U.S. senior (unsecured) deposits.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
108 BMO Financial Group 198th Annual Report 2015
BMO’s wholesale funding plan ensures sufficient funding capacity is available to execute business strategies. The funding plan considers expected maturities, as well as asset and liability growth projected for our businesses in our forecasting and planning process, and assesses funding needs against available potential funding sources. The funding plan is reviewed annually by the RRC and is regularly updated during the year to incorporate actual results and updated forecast information.
Customer Deposits
Customer Deposits-andCapital-to-Customer-Loans
Ratio (%)
98.6
94.6
($ billions)
94.7
94.5
262
239
221
204
MD&A
2012
2013
2015
2014
2012
Our large customer base and strong capital position reduce our reliance on wholesale funding.
2013
2014
2015
Customer deposits provide a strong funding base.
Wholesale Funding Maturities (1)
Less than
1 month
1 to 3 months 3 to 6 months 6 to 12 months Subtotal less than
1 year
1 to 2 years Over
2 years
Total
Deposits from banks
Certificates of deposit and commercial paper
Bearer deposit notes
Asset-backed commercial paper (ABCP)
Senior unsecured medium-term notes
Senior unsecured structured notes (2)
Covered bonds and securitizations
Mortgage securitizations
Covered bonds
Credit card securitizations
Subordinated debt (3)
Other (4)
415
5,753
249
1,406
1,308
17
576
29,143
1,637
1,829
2,131
476
917
17,349
901
2,131
1,212
30
819
5,547
115
–
8,195
199
2,727
57,792
2,902
5,366
12,846
722
975
360
–
–
10,636
153
–
–
–
–
20,210
2,115
3,702
58,152
2,902
5,366
43,692
2,990
–
–
–
–
–
789
1,961
–
–
–
–
–
437
–
–
1,321
–
1,538
–
–
2,110
1,961
1,975
–
–
2,781
2,615
1,135
602
1,308
12,197
8,038
1,101
5,050
1,798
17,088
12,614
4,211
5,652
3,106
Total
9,148
38,542
22,977
17,734
88,401
20,565
50,509
159,475
Of which:
Secured
Unsecured
1,406
7,742
4,579
33,963
2,568
20,409
2,859
14,875
11,412
76,989
7,839
12,726
23,134
27,375
42,385
117,090
Total (5)
9,148
38,542
22,977
17,734
88,401
20,565
50,509
159,475
(Canadian $ in millions)
As at October 31, 2015
(1) Wholesale unsecured funding refers to funding through the issuance of marketable, negotiable instruments. Wholesale funding excludes repo transactions and bankers’ acceptances, which are disclosed in the contractual maturity table in Note 30 on page 198 of the financial statements, and excludes ABCP issued by certain ABCP conduits that are not consolidated for financial reporting purposes. (2) Primarily issued to institutional investors.
(3) Includes certain subordinated debt instruments reported as deposits or other liabilities for accounting purposes. Subordinated debt is reported in this table in accordance with recommended Enhanced
Disclosure Task Force disclosures.
(4) Refers to Federal Home Loan Banks advances.
(5) Total wholesale funding consists of Canadian-dollar-denominated funding of $47.5 billion and U.S.-dollar and other foreign-denominated funding of $112 billion as at October 31, 2015.
Material presented in a blue-tinted font above is an integral part of the 2015 annual consolidated financial statements (see page 86).
BMO Financial Group 198th Annual Report 2015 109
MANAGEMENT’S DISCUSSION AND ANALYSIS
Regulatory Developments
OSFI’s Liquidity Adequacy Requirements Guideline outlines the approach and methodology for a number of liquidity metrics and tools used to monitor and assess the adequacy of Canadian banks’ liquidity, including the LCR, NCCF and others. The LCR and NCCF were implemented in January 2015.
The Net Stable Funding Ratio (NSFR) was finalized by the Basel Committee on Banking Supervision in 2015 and is expected to come into force on
January 1, 2018.
As mentioned on page 71 in the Enterprise-Wide Capital Management section, in August 2014, Canada’s Department of Finance issued a consultation paper on a Canadian bank resolution framework, including bail-in and Higher Loss Absorbency requirements. The Enterprise-Wide Capital
Management section also discusses the recently released new rules proposed by the Federal Reserve Board for Total Loss Absorbing Capacity (TLAC) and the Financial Stability Board final standard for TLAC for Global Systemically Important Banks.
MD&A
Credit Ratings
The credit ratings assigned to BMO’s short-term and senior long-term debt securities by external rating agencies are important in the raising of both capital and funding to support our business operations. Maintaining strong credit ratings allows us to access capital markets at competitive pricing levels. Should our credit ratings experience a material downgrade, our costs of funding would likely increase significantly and our access to funding and capital through capital markets could be limited. A material downgrade of our ratings could have additional consequences, including those set out in Note 8 on page 156 of the financial statements.
The credit ratings assigned to BMO’s senior debt by rating agencies are indicative of high-grade, high-quality issues. Moody’s, Standard & Poor’s
(S&P) and DBRS have a negative outlook on the ratings of BMO and other Canadian banks in response to the federal government’s proposed bail-in regime for senior unsecured debt, while Fitch has a stable outlook on BMO’s long-term credit ratings.
As at October 31, 2015
Rating agency
Moody’s
S&P
Fitch
DBRS
(1) As at October 31, 2015, NVCC subordinated debt is rated Baa1 by Moody’s, BBB by S&P and A(low) by DBRS.
110 BMO Financial Group 198th Annual Report 2015
Short-term debt
P-1
A-1
F1+
R-1 (high)
Senior longterm debt
Aa3
A+
AAAA
Subordinated debt (1)
A3
BBB+
A+
AA (low)
Outlook
Negative
Negative
Stable
Negative
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.
BMO is exposed to potential losses arising from a variety of operational risks, including process failure, theft and fraud, regulatory non-compliance, business disruption, information security breaches and exposure related to outsourcing, as well as damage to physical assets. Operational risk is inherent in all our business activities, including the processes and controls used to manage all of the risks we face. While operational risk can never be fully eliminated, it can be managed to reduce exposure to financial loss, reputational harm or regulatory sanctions.
Operational Risk Governance
Operational Risk Management
The ORMF defines the processes we use to identify, measure, manage, mitigate, monitor and report key operational risk exposures. A primary objective of the ORMF is to ensure that our operational risk profile is consistent with our risk appetite and supported by adequate capital. Executing our ORMF strategy also involves continuing to embed our risk culture by promoting greater awareness and understanding of operational risk within our first line of defence through training and communication. In addition, we continue to invest in resources to further strengthen our second line of defence capabilities.
Consistent with the management of risk across the organization, we employ the three lines of defence approach to operational risk.
The operating groups, as the first line of defence, are responsible for the day-to-day management of operational risk in a manner consistent with our enterprise-wide principles. Independent risk management oversight is provided by the Operational Risk Management function, Corporate Support areas and Operational Risk Officers (OROs). OROs independently assess group operational risk profiles, identify material exposures and potential weaknesses in controls, and recommend appropriate mitigation strategies and actions as the second line of defence. The Corporate Audit Division verifies our adherence to policies and procedures and highlights opportunities to strengthen our process as the third line of defence. Corporate
Support areas develop tools and processes for the management of specific operational risks across the enterprise. Corporate Operational Risk
Management establishes the ORMF and the necessary governance framework, with the operating group CROs providing governance and oversight for their respective business units.
The key programs, methodologies and processes we have developed to support the framework are highlighted below:
‰ Risk Control Assessment (RCA) is an established process used by our operating groups to identify the key risks associated with their businesses and the controls required for risk mitigation. The RCA process provides a forward-looking view of the impact of the business environment and internal controls on operating group risk profiles, enabling the proactive prevention, mitigation and management of risk. On an aggregate basis, RCA results also provide an enterprise-level view of operational risks relative to risk appetite, so that key risks can be appropriately managed and mitigated.
‰ Process Risk Assessment (PRA) provides a deeper insight in identifying key risks and controls in our business processes and can span multiple business units. The PRA process enables a greater understanding of our key processes, which facilitates more effective oversight and ensures risks are appropriately mitigated.
‰ BMO’s initiative assessment and approval process is used to assess, document and approve qualifying initiatives when new business, services and products are developed or existing services and products are enhanced. The process ensures that due diligence, approval, monitoring and reporting requirements are appropriately addressed at all levels of the organization.
‰ Key Risk Indicators (KRIs) provide an early indication of any adverse changes in risk exposure. Operating groups and Corporate Support areas identify metrics related to their material operational risks. These KRIs are used in monitoring operational risk profiles and their overall relation to our risk appetite, and are linked to thresholds that trigger management action.
‰ Internal loss data serves as an important means of assessing our operational risk exposure and identifying opportunities for future risk prevention measures. Under this process, internal loss data is analyzed and benchmarked against external data. Material trends are regularly reported to the
ORC, RMC and RRC to ensure preventative and corrective action can be taken where appropriate. BMO is a member of the Operational Risk Data
Exchange Association, the American Bankers Association and other international and national associations of banks that share loss data information anonymously to assist in risk identification, assessment and modelling.
‰ BMO’s operational risk management training programs ensure employees are qualified and equipped to execute the ORMF strategy consistently, effectively and efficiently.
‰ Effective business continuity management ensures that we have the capability to sustain, manage and recover critical operations and processes in the event of a business disruption, thereby minimizing any adverse effects on our customers and other stakeholders.
‰ BMO’s Corporate Risk & Insurance team provides a second level of mitigation for certain operational risk exposures. We purchase insurance in amounts that are expected to provide adequate protection against unexpected material loss and where insurance is required by law, regulation or contractual agreement.
BMO Financial Group 198th Annual Report 2015 111
MD&A
Operational risk management is governed by a robust committee structure supported by a comprehensive set of policies, standards and operating guidelines. The Operational Risk Committee (ORC), a sub-committee of the RMC, is the main decision-making committee for all operational risk management matters and has responsibility for the oversight of operational risk strategy, management and governance. The ORC provides advice and guidance to the lines of business on operational risk assessments, measurement and mitigation, and related monitoring of change initiatives. The ORC also oversees the development of policies, standards and operating guidelines that give effect to the governing principles of the Operational Risk
Management Framework (ORMF). These governance documents incorporate industry leading practices and are reviewed on a regular basis to ensure they are current and consistent with our risk appetite.
Regular analysis and reporting of our enterprise operational risk profile to the various committees (ORC, RMC and RRC) are important elements of our ORMF. Enterprise reporting provides an integrated view of top and emerging risks, trends in loss data, capital consumption, key risk indicators and operating group portfolio profiles. We continue to invest in our reporting platforms to support timely and comprehensive reporting capabilities that enhance risk transparency and facilitate the proactive management of operational risk exposures.
MANAGEMENT’S DISCUSSION AND ANALYSIS
BMO uses the Advanced Measurement Approach (AMA), a risk-sensitive capital model, along with the Standardized Approach under OSFI rules, to determine capital requirements for managing operational risk. The AMA Capital Model uses a loss distribution approach along with the four elements required to support the measurement of our operational risk exposure. Internal loss data and external loss data are used as inputs to our AMA Capital
Model, and are grouped based on attributes into cells which include operating group, business activity or event type. Minimum enterprise operational risk capital is determined at a specific upper confidence limit of the enterprise total loss distribution (99.9% quantile for regulatory capital and 99.95% quantile for Economic Capital). Business Environment and Internal Control Factors are used for post-modelling adjustments, and these are subject to regular review in order to identify and understand risk drivers and to ensure consistency in application across the organization. Scenarios are used to verify the distributions and correlations used to model capital and to provide management with a better understanding of low-frequency, high-severity events and to assess enterprise preparedness for events that could create risks that exceed our risk appetite. We also use scenario analysis as part of our stress testing program, which measures the potential impact of plausible operational events on our operations and capital, and allows us to manage tail risk exposure to low-frequency, high-severity events and to validate operational risk capital adequacy.
MD&A
Model Risk
Model risk is the potential for adverse consequences following decisions based on incorrect or misused model outputs. These adverse consequences can include financial loss, poor business decision-making or damage to reputation.
Models are quantitative tools that apply statistical, economic and other quantitative techniques and assumptions to process input data into quantitative estimates. BMO uses models that range from very simple models for straightforward estimates to highly sophisticated models that value complex transactions or provide a broad range of forward-looking estimates.
The outputs from these models are used to inform business, risk and capital management decision-making and to assist in making daily lending, trading, underwriting, funding, investment and operational decisions. For example, BMO uses models as a core risk management tool, to measure exposure to specific risks through stress testing, to value and price transactions, to evaluate credit, market and operational risk regulatory capital requirements and to measure risks on an integrated basis using Economic Capital.
Quantitative tools provide important insights and are beneficial when used within a framework to control and mitigate model risk. In addition to applying judgment to evaluate the reliability of model outputs, BMO mitigates model risk by maintaining strong controls over the development, validation, implementation and use of models across all model categories.
Model Risk Management
Risk is inherent in models because model outputs are estimates that rely on statistical techniques and data to simulate reality. Model risk also arises from potential misuse. Model risk is governed at BMO by the enterprise-wide Model Risk Management Framework, which operates throughout the model life cycle.
Model Use &
Monitoring
Model Development & Validation
1
Model Identification and Design
8
2
Outcomes
Analysis
Data
Management
7
Model
Life Cycle
Ongoing
Monitoring
3
Model
Development
6
4
Model Use
Model
Validation
5
Implementation
Model Governance
This framework sets out end-to-end model risk governance throughout the model life cycle and helps to ensure that model risk remains consistent with BMO’s enterprise-wide risk appetite. The framework includes BMO’s Model Risk Corporate Policy, Model Risk Corporate Standard and
Model Risk Guidelines, which outline explicit principles for managing model risk, detail model risk processes and clearly define the roles and responsibilities of all stakeholders throughout the model life cycle. Model owners, developers and users are the first line of defence, model validators and the Model Governance group are the second line of defence, and Corporate Audit Division is the third line of defence.
The Model Governance group is responsible for the administration of the Model Risk Management Framework, the effectiveness of our model processes and the overall management of model risk. The Model Risk Management Committee, a cross-functional group representing all key stakeholders across the enterprise (model owners, users, developers and validators and the Model Governance group), meets regularly to help direct the bank’s use of models, to oversee the development, implementation and maintenance of the Model Risk Management Framework and to discuss requirements governing the enterprise’s models.
112 BMO Financial Group 198th Annual Report 2015
Model Development and Validation
Models are developed, implemented and used to meet specific business objectives, including applicable regulatory requirements. Model owners, in consultation with model developers and other stakeholders, determine the design, objectives, intended use and desired functionality of models, and have overall responsibility for ensuring models comply with bank policies and approved terms of use. Model developers assist the model owners by proposing model solutions, identifying data availability and limitations and developing and implementing models for their intended purposes.
They do so by engaging model owners and other key stakeholders in the development and implementation processes, and by evaluating and documenting alternatives and model characteristics, outputs, strengths and weaknesses. Our independent Model Validation group reviews model development outputs to evaluate whether a proposed model is conceptually and statistically sound, achieves its objectives and is fit for its intended use without creating material model risk. Observations are made to guide model owners, users and developers, remediation of material deficiencies may be required and unless an exception is obtained in accordance with bank policy, approval from our Model Validation group is required before a model is used.
Model Use and Monitoring
Model Validation, Outcome Analysis and Back-Testing
Once the models are validated, approved and in use, they are subject to ongoing validation, which includes ongoing monitoring and outcomes analysis. As a key component of the outcomes analysis, back-testing measures model outputs against actual observed outcomes. This analysis is used to confirm the validity and performance of each model over time, and helps to ensure that appropriate controls are in place to address identified issues and enhance a model’s overall performance.
Credit Risk – The Credit Risk Model Validation Guidelines are an important subset of BMO’s Model Risk Corporate Policy. These guidelines include clear and detailed requirements for the back-testing of all credit risk rating models.
The process for back-testing the Probability of Default (PD) model computation includes comparing PD estimates generated by credit risk models against the actual or realized default rates across all obligor ratings. This process also includes testing for statistical evidence that default rates accurately capture sampling variability over time.
The comprehensive validation of a risk rating system involves various prescribed tests and analyses that measure discriminatory power, calibration and dynamic properties, with support from migration analysis. Additional tests or analyses are used to validate borrower risk rating grades and probability of default.
As with any analysis, judgment is applied in determining various factors, such as data limitations, which may affect the overall relevance of a given validation approach or interpretation of statistical analysis. Similar back-testing is applied to the Loss Given Default (LGD) and Exposure at
Default (EAD) model computations.
Annual validations of all material models in use are conducted to ensure they perform as intended and to confirm they continue to be fit for use.
An annual review includes a qualitative assessment conducted by model developers and a quantitative validation conducted by the Model Validation group, with all conclusions reported to senior management.
Trading and Underwriting Market Risk – All internal models used to calculate regulatory capital and Economic Capital for trading and underwriting market risk have their Value at Risk (VaR) results back-tested regularly. The bank’s internal VaR model is back-tested daily, and the one-day 99% confidence level VaR at the local and consolidated BMO levels is compared against the realized theoretical Profit & Loss (P&L) calculation, which is the daily change in portfolio value that would occur if the portfolio composition remained unchanged. If the theoretical P&L is negative and its absolute value is greater than the previous day’s VaR, a back-testing exception occurs. Each exception is investigated, explained and documented, and the back-testing results are reviewed by the Board and our regulators. This process monitors the quality and accuracy of the internal VaR model results and assists in refining overall risk measurement procedures.
Structural Market Risk – Back-testing of our structural market risk models is performed monthly and reported quarterly. For products with a scheduled term, such as mortgages and term deposits, the model-predicted prepayments or redemptions are compared against the actual outcomes observed. For products without a scheduled term, such as credit card loans and chequing accounts, the modelled balance run-off profiles are compared against actual balance trends.
The variances between model predictions and the actual outcomes experienced are measured against pre-defined risk materiality thresholds.
To ensure variances are within the tolerance range, actions such as model review and parameter recalibration are taken. Performance is assessed by analyzing model overrides and tests conducted during model development, such as back-testing and sensitivity testing.
BMO Financial Group 198th Annual Report 2015 113
MD&A
Model owners and other model users are accountable for using the models appropriately for business decision-making and for the proper care and maintenance of models throughout the model life cycle. The development and validation processes provide guidance to ensure that models can be used effectively within an appropriate range of use, that model limitations are known and that model risk mitigants are implemented. When in use, models are subject to ongoing monitoring, including outcomes analysis and periodic reviews. Ongoing monitoring and outcomes analysis are part of evaluation processes to confirm the continuing validity and adequate performance of each model over time. These techniques and other controls are used to mitigate potential issues and to help ensure continuing acceptable model performance. All models in use are subject to periodic scheduled reviews, with the frequency based on a model’s risk rating, and to earlier reviews if business judgment, triggers or other ongoing monitoring tools indicate that model performance may be inadequate. Scheduled reviews require the model owner and developers to assess a model’s continuing suitability for use and such assessment is subject to independent review by our Model Validation group.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Insurance Risk
Insurance risk is the potential for risk of loss due to actual experience being different from that assumed when an insurance product was designed and priced. It generally entails inherent unpredictability that can arise from assuming long-term policy liabilities or from the uncertainty of future events. Insurance risk is inherent in all our insurance products, including annuities and life, accident and sickness, and creditor insurance, as well as in our reinsurance business.
MD&A
Insurance risk consists of:
‰ Claims risk – the risk that the actual magnitude or frequency of claims will differ from those assumed in the pricing or underwriting process, including mortality risk, morbidity risk, longevity risk and catastrophe risk;
‰ Policyholder behaviour risk – the risk that the behaviour of policyholders related to premium payments, withdrawals or loans, policy lapse and surrenders, and other voluntary terminations will differ from the behaviour assumed in the pricing calculations; and
‰ Expense risk – the risk that actual expenses associated with acquiring and administering policies and processing claims will exceed the expenses assumed in the pricing calculations.
BMO’s risk governance practices ensure effective independent oversight and control of risk within the insurance business. BMO’s Insurance Risk
Management Framework comprises the identification, assessment, management and reporting of risks. The framework includes: the risk appetite statement and key risk metrics; insurance risk policies and processes, including limits; capital requirements; stress testing; risk reports; and the Own
Risk and Solvency Assessment. All of these are overseen by internal risk committees and the insurance companies’ Boards of Directors. The Insurance
Risk Management Committee for BMO Insurance oversees and reports on risk management activities on a quarterly basis to the insurance companies’
Boards of Directors. Senior management within the various lines of business is responsible for managing insurance risk, with oversight provided by the CRO, BMO Insurance, who reports to the CRO, Wealth Management.
A robust product approval process is a cornerstone of the framework for identifying, assessing and mitigating risks associated with new insurance products or changes to existing products. This process, combined with guidelines and practices for underwriting and claims management, promotes the effective identification, measurement and management of insurance risk. Reinsurance, which involves transactions that transfer insurance risk to independent reinsurance companies, is also used to manage our exposure to insurance risk by diversifying risk and limiting claims.
Legal and Regulatory Risk
Legal and regulatory risk is the potential for loss or harm that arises from legislation, contracts, non-contractual rights and obligations, and disputes. This includes the risks of failing to: comply with the law (in letter or in spirit) or maintain standards of care; implement legislative or regulatory requirements; enforce or comply with contractual terms; assert non-contractual rights; effectively manage disputes; and act in a manner so as to maintain our reputation.
BMO’s success relies in part on our ability to prudently manage our exposure to legal and regulatory risk. The financial services industry is highly regulated, and we anticipate more intense scrutiny from our supervisors in the oversight process and strict enforcement of regulatory requirements as governments and regulators around the world continue major reforms intended to strengthen the stability of the financial system. The current environment is one in which banks globally have recently been subject to fines of unprecedented levels in relation to a number of regulatory and market conduct issues. As rulemaking and supervisory expectations evolve, we are monitoring developments to enable BMO to respond to and implement any required changes.
Under the direction of the General Counsel, the Legal and Compliance Group (LCG) maintains enterprise-wide frameworks that serve to identify, measure, manage, monitor and report on legal and regulatory risk. LCG also works with operating groups and Corporate Support areas to identify legal and regulatory requirements, trends and potential risks, recommend mitigation strategies and actions, and oversee litigation involving BMO.
Another area of focus for legal and compliance risk management and operating groups is the oversight of fiduciary risk related to BMO’s businesses that provide products or services giving rise to fiduciary duties to clients. Of particular importance are the policies and practices that address the responsibilities of a business to a client, including service requirements and expectations, client suitability determinations, and disclosure obligations and communications.
Physical protection and protecting our employees, customers, information and assets from criminal risk, including acts by employees against
BMO, external parties acting against BMO and acts by external parties using BMO to engage in unlawful conduct such as fraud, theft, violence, cyber-crime, bribery, and corruption, is a top priority. The management of criminal risk at BMO has been transformed through the implementation of a robust Criminal Risk Management Framework, which prevents, detects, responds to and reports on criminal risk using a three-lines-of-defence approach and through enhanced centralized management and oversight.
As governments around the world seek to curb corruption to counter its negative effects on political stability, sustainable economic development, international trade and investment and in other areas, BMO’s Anti-Corruption Office, through its global program and framework, has articulated the key principles and activities required to oversee compliance with anti-corruption legislation in jurisdictions where BMO operates, including providing guidance so that corrupt practices can be identified and avoided and ensuring that allegations of corrupt activity are rigorously investigated.
Under the direction of the Chief Anti-Money Laundering Officer, the Anti-Money Laundering Office is responsible for the governance, oversight and assessment of the principles and procedures established by the enterprise to ensure compliance with regulatory requirements and risk parameters related to anti-money laundering, anti-terrorist financing and sanctions measures. International regulators continue to focus on anti-money laundering and other related measures, to heighten their expectations concerning the quality and efficacy of anti-money laundering and related programs and to penalize institutions that fail to meet these expectations.
All of these frameworks reflect the three-lines-of-defence operating model described previously. The operating groups and Corporate Support areas manage day-to-day risks in compliance with corporate policies and standards, while LCG teams specifically aligned with each of the operating groups provide advice and independent legal and regulatory risk management oversight.
114 BMO Financial Group 198th Annual Report 2015
Heightened regulatory and supervisory scrutiny has had a significant impact on how we conduct business. Working with the operating groups and other Corporate Support areas, LCG continues to diligently assess and analyze the implications of regulatory changes, and devotes substantial resources to implementing the systems and processes required to comply with new regulations while also helping the operating groups meet BMO customers’ needs and demands.
We continue to respond to other global regulatory developments, including capital and liquidity requirements under the Basel Committee on
Banking Supervision (BCBS) global standards (Basel III), over-the-counter (OTC) derivatives reform, consumer protection measures and specific financial reforms, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). For additional discussion on regulatory developments relating to capital management and liquidity and funding risk, please refer to the Enterprise-Wide Capital Management section starting on page 70 and the Liquidity and Funding Risk section starting on page 105.
Cross-Border Resolution and Bail-in – As mentioned on page 71 in the Enterprise-Wide Capital Management section, in August 2014, Canada’s
Department of Finance issued a consultation paper on a Canadian bank resolution framework, including bail-in and Higher Loss Absorbency requirements. The Enterprise-Wide Capital Management section also discusses the recently released new rules proposed by the Federal Reserve Board for Total Loss Absorbing Capacity (TLAC) and the Financial Stability Board final standard for TLAC for Global Systemically Important Banks.
Indirect Auto Lenders – The Consumer Financial Protection Bureau, which enforces certain U.S. federal consumer finance laws, is closely scrutinizing indirect auto lenders to focus on compliance, including with fair lending laws.
Regulatory Capital Rule Changes – In an effort to increase the comparability of capital requirements and to ensure minimum levels of capital across the banking system, BCBS is considering a standardized approach for credit, market and operational risk-weighted assets, including new capital floors based on revised standardized approaches. The current expectation is that the approaches will be settled on during 2016. BCBS is also completing a fundamental review of the trading book risk-weighted assets and released a consultative paper in June 2015 that discussed the appropriate capital to be held for interest rate risk in the banking book. Such changes, if implemented, along with the new impairment model based on expected credit losses under IFRS 9, could have the effect of increasing the capital that we are required to hold.
FBO Rule – In February 2014, the Federal Reserve Board approved a final rule for strengthening supervision and regulation of foreign banking organizations (FBO Rule) that implements Dodd-Frank’s enhanced prudential standards and early remediation requirements for the U.S. operations of non-U.S. banks, such as BMO. The FBO Rule establishes new requirements relating to risk-based capital, leverage limits, liquidity standards, risk management frameworks, concentration and credit exposure limits, resolution planning and credit exposure reporting. On December 29, 2014, we submitted to the Federal Reserve Board an outline of our implementation plan for meeting these requirements by the effective date (July 1, 2016).
BMO is preparing for the impact of the FBO Rule on its operations.
Federal Budget Proposal – The 2015 Federal budget and the July 31, 2015 technical release proposed tax rules for synthetic equity arrangements
(the 2015 Proposals). Assuming the new Federal government reintroduces the 2015 Proposals, these proposals would, in certain circumstances, deny any deduction for dividends that are paid or become payable after October 2015, unless the arrangement is grandfathered, in which case the proposed tax rules would apply to dividends paid or that become payable after April 2017. BMO is currently assessing the impact of this proposal, which has the potential to increase our effective tax rate.
Risk Governance Framework – In September 2014, the Office of the Comptroller of Currency issued guidelines that establish heightened standards for large national banks with average total consolidated assets of US$50 billion or more, including BMO Harris Bank N.A. The guidelines set forth minimum standards for the design and implementation of a bank’s risk governance framework and minimum standards for oversight of that framework by a bank’s board of directors. The framework must ensure the bank’s risk profile is easily distinguished and separate from the parent for risk management purposes. A bank’s board of directors is responsible for informed oversight of, and providing credible challenge to, management’s risk management recommendations and decisions. BMO is required to comply by April 2016, and is implementing a plan to prepare to comply with this guidance.
BMO Financial Group 198th Annual Report 2015 115
MD&A
Dodd-Frank – Dodd-Frank reforms include heightened consumer protection, revised regulation of the OTC derivatives markets, restrictions on proprietary trading and the ownership and sponsorship of private investment funds by banks and their affiliates (referred to as the Volcker Rule), imposition of heightened prudential standards and broader application of leverage and risk-based capital requirements. Dodd-Frank rulemaking will continue over the next several years. The conformance date for the Volcker Rule, which prohibits banking entities active in the United States and their affiliates from certain proprietary trading and specified relationships with private investment funds, was July 21, 2015. U.S. regulators previously extended until July 21, 2016, the time that banking entities have to conform their investments in and relationships with private investment funds in place before December 31, 2013. They also indicated that during the course of 2015 they would issue a further such conformance extension to
July 21, 2017. BMO completed a significant review of our operations and developed policies and procedures to meet the July 21, 2015 deadline.
We now have systems in place to assess, monitor, and report on Volcker Rule compliance across the enterprise. In addition, under Dodd-Frank, most
OTC derivatives are now subject to a comprehensive regulatory regime. Certain derivatives are now required to be centrally cleared and traded on an exchange and are subject to reporting and business conduct requirements. In Canada, OTC derivative transactions must now be reported to designated trade repositories. Capital and margin requirements relating to derivatives are currently being considered by international regulators, and margin requirements for non-centrally cleared derivatives have been adopted by U.S. regulators. The U.S. Securities and Exchange Commission (SEC) has adopted rules for security-based swap dealers and other participants in the security-based swap market, including registration requirements. The date or dates for registration, which depend on additional SEC rulemaking, have not been set. BMO is preparing for the impact of such requirements.
MANAGEMENT’S DISCUSSION AND ANALYSIS
The General Counsel and the Chief Compliance Officer (CCO) regularly report to the ACRC of the Board and senior management on the effectiveness of our Enterprise Compliance Program (ECP) which, using a risk-based approach, identifies, assesses and manages compliance with applicable legal and regulatory requirements. The ECP directs operating groups and Corporate Support areas to maintain compliance policies, procedures and controls to meet these requirements. Under the direction of the CCO, LCG identifies and reports on gaps and deficiencies, and tracks remedial action plans. The
Chief Anti-Money Laundering Officer also regularly reports to the ACRC.
All BMO employees are required to annually complete legal and regulatory training on topics such as anti-corruption, anti-money laundering and privacy. This is done in conjunction with our Code of Conduct training, which tests employees’ knowledge and understanding of how they are required to behave as employees of BMO.
Business Risk
MD&A
Business risk arises from the specific business activities of a company and the effects these could have on its earnings.
Business risk encompasses the potential causes of earnings volatility that are distinct from credit, market or operational risk factors. The management of business risk identifies and addresses factors related to the risk that volumes will decrease or margins will shrink without the company having the ability to compensate for this decline by cutting 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 arising from changes in business volumes and cost structures, among other factors.
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 as a result of inaction, ineffective strategies or poor implementation of strategies.
Strategic risk arises from external risks inherent in the business environment within which BMO operates, as well as the risk of potential loss if BMO is unable to address those external risks effectively. While external strategic risks – including economic, geo-political, regulatory, technological, social and competitive risks – cannot be controlled, the likelihood and magnitude of their impact can be mitigated through an effective strategic risk management framework and certain of these risks, including economic, geo-political and regulatory risks, can be assessed through stress testing.
BMO’s Office of Strategic Management (OSM) oversees our strategic planning processes and works with the lines of business, along with Risk,
Finance and other Corporate Support areas, to identify, monitor and mitigate strategic risk across the enterprise. Our rigorous strategic risk management framework encourages a consistent approach to the development of strategies and incorporates financial information linked to financial commitments. The OSM works with the lines of business and key corporate stakeholders during the strategy development process to promote consistency and adherence to strategic management standards, including considering the results from stress testing as an input into strategic decision-making, as appropriate. The potential impacts of changes in the business environment, such as broad industry trends and the actions of competitors, are considered as part of this process and inform strategic decisions within each of our lines of business. Enterprise and group strategies are reviewed with the Executive Committee and the Board of Directors annually in interactive sessions that challenge assumptions and strategies in the context of current and potential future business environments.
Performance objectives established through the strategic management process are monitored regularly and reported upon quarterly, using both leading and lagging indicators of performance, so that strategies can be reviewed and adjusted where necessary. Regular strategic and financial updates are also monitored closely to identify any significant emerging risk issues.
Reputation Risk
Reputation risk is the potential for a negative impact on BMO that results from the deterioration of BMO’s reputation. Potential negative impacts include revenue loss, a decline in customer loyalty, litigation, regulatory sanction or additional oversight, and a decline in BMO’s share price.
BMO’s reputation is one of its most valuable assets. By protecting and maintaining our reputation, we can increase shareholder value, reduce our cost of capital and improve employee engagement and customer loyalty.
Our reputation is built on our commitment to high standards of business conduct and ethics.
Rooted in our values, BMO’s Code of Conduct provides our employees and directors with guidance on expected behaviour and is the foundation for an ethical culture.
We believe that active, ongoing and effective management of reputation risk is best achieved by considering reputation risk issues in the course of strategy development, strategic and operational implementation, and transactional or initiative decision-making, as well as in day-to-day decision-making. Reputation risk is also managed through our corporate governance practices and enterprise risk management framework.
The Reputation Risk Management Committee reviews instances of significant or heightened reputation risk to BMO.
116 BMO Financial Group 198th Annual Report 2015
Environmental and Social Risk
Environmental and social risk is the potential for loss or damage to BMO’s reputation resulting from environmental or social concerns related to
BMO or its customers. Environmental and social risk is often associated with credit, operational and reputation risk.
BMO Financial Group 198th Annual Report 2015 117
MD&A
In order to manage our business responsibly, we consider factors that can give rise to environmental or social risk. This consideration is embedded in our Board-approved Code of Conduct. BMO’s Supplier Code of Conduct outlines the principles we expect our suppliers to uphold – our standards for integrity, fair dealing and sustainability. Environmental and social risk management activities are overseen by the Environmental, Social and
Governance (ESG) group and the Environmental Sustainability (ES) group, with support from our lines of business and other Corporate Support areas.
BMO’s Sustainability Council, which is comprised of executives representing various areas of the organization, provides insight and guidance for our environmental and social initiatives.
Environmental and social risk covers a broad spectrum of issues, such as climate change, biodiversity and ecosystem health, pollution, waste and the unsustainable use of water and other resources, as well as risks to the livelihoods, health, rights and cultural heritage of communities. We work with external stakeholders to understand the impact of our operations and financing decisions in the context of these issues, and we use this understanding to determine the consequences for our businesses. As part of our enterprise risk management framework, we evaluate the environmental and social impact of our clients’ operations, as well as the impact of their industry sectors. Environmental and social risks associated with credit transactions are managed within BMO’s credit and counterparty risk management framework. BMO has also developed and implemented specific financing guidelines on environmental and social risk for specific lines of business. Enhanced due diligence is applied to transactions with clients operating in environmentally sensitive industry sectors.
BMO applies the Equator Principles, a voluntary credit risk management framework for determining, assessing and managing environmental and social risk in project finance transactions. These principles have been integrated into our credit risk management framework. We are also a signatory to and participate in the Carbon Disclosure Project, which provides corporate disclosure on greenhouse gas emissions and climate change management. BMO implemented ESG training for BMO Capital Markets employees as part of a program to instill a consistent understanding of environmental and social risk across the enterprise. The training includes identification of emerging issues, an overview of BMO’s due diligence procedures and tools to assist employees in identifying and managing environmental, social and governance risks. We review our environmental and social risk policies and procedures on a periodic basis.
BMO is a signatory to the UN Principles for Responsible Investment, a framework designed to encourage sustainable investing through the integration of ESG issues into investment, decision-making and ownership practices.
The ESG group is responsible for coordinating the development and maintenance of an enterprise-wide strategy to meet BMO’s overarching environmental and social responsibilities. The ES group is responsible for establishing and maintaining an environmental management system that is aligned to ISO 14001, and for setting objectives and targets related to the bank’s own operations. BMO’s operating groups, Procurement and Strategic
Sourcing, and Corporate Real Estate are responsible for putting appropriate operating procedures in place. To ensure that we are informed of emerging issues, we participate in global forums with our peers, maintain an open dialogue with our internal and external stakeholders, and continuously monitor and evaluate policy and legislative changes in the jurisdictions where we operate. We publicly report our environmental and social performance and targets in our annual Environmental, Social and Governance (ESG) Report and Public Accountability Statement (PAS), and on our Corporate Responsibility website. Selected environmental and social indicators in the ESG Report and PAS are assured by a third party.
SUPPLEMENTAL INFORMATION
Supplemental Information
Certain comparative figures have been reclassified to conform to the current period’s presentation and for changes in accounting policies. Refer to
Note 1 of the consolidated financial statements. In addition, on November 1, 2011, BMO’s financial statements have been reported in accordance with
IFRS. Results for years prior to 2011 have not been restated and are presented in accordance with Canadian GAAP as defined at that time (CGAAP).
As a result of these changes, certain growth rates and compound annual growth rates (CAGR) may not be meaningful.
Adjusted results in this section are non-GAAP measures. Refer to the Non-GAAP Measures section on page 33.
Table 1: Shareholder Value and Other Statistical Information
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
Market Price per Common Share ($)
High
Low
Close
84.39
64.01
76.04
85.71
67.04
81.73
73.90
56.74
72.62
61.29
53.15
59.02
63.94
55.02
58.89
65.71
49.78
60.23
54.75
24.05
50.06
63.44
35.65
43.02
72.75
60.21
63.00
70.24
56.86
69.45
Common Share Dividends
Dividends declared per share ($)
Dividend payout ratio (%)
Dividend yield (%)
Dividends declared ($ millions)
Supplemental Information
As at or for the year ended October 31
3.24
49.2
4.3
2,087
3.08
47.8
3.8
1,991
2.94
47.5
4.0
1,904
2.82
46.0
4.8
1,820
2.80
57.1
4.8
1,690
2.80
58.6
4.6
1,571
2.80
90.6
5.6
1,530
2.80
73.9
6.5
1,409
2.71
64.8
4.3
1,354
2.26
43.0
3.3
1,133
15.5
16.7
17.1
17.0
11.5
28.8
4.2
10.8
5.2
1.9
17.4
2.4
5.9
4.5
26.4
Total Shareholder Return (%)
Five-year average annual return
Three-year average annual return
One-year return
9.5
13.5
(3.0)
1.8
(5.3)
25.1
0.9
(5.6)
(27.9)
14.2
6.6
(5.8)
19.1
15.6
24.1
Common Share Information
Number outstanding (in thousands)
End of year
Average basic
Average diluted
Number of shareholder accounts
Book value per share ($)
Total market value of shares ($ billions)
Price-to-earnings multiple
Price-to-adjusted earnings multiple
Market-to-book value multiple
642,583
644,916
647,162
53,481
56.31
48.9
11.6
10.9
1.35
649,050
645,860
648,475
55,610
48.18
53.0
12.8
12.4
1.70
644,130
648,476
649,806
56,241
43.22
46.8
11.8
11.7
1.66
650,730
644,407
648,615
59,238
39.41
38.4
9.7
9.9
1.47
639,000
591,403
607,068
58,769
36.76
37.6
12.2
11.5
1.49
566,468
559,822
563,125
36,612
34.09
34.1
12.7
12.5
1.77
551,716
540,294
542,313
37,061
31.95
27.6
16.3
12.5
1.57
504,575
502,062
506,697
37,250
32.02
21.7
11.4
9.2
1.34
498,563 500,726
499,950 501,257
508,614 511,173
37,165 38,360
28.29
28.89
31.4
34.8
15.3
13.5
11.6
13.4
2.23
2.40
Balances
As at assets
Average daily assets
Average daily net loans and acceptances
641,881
664,391
320,081
588,659
593,928
292,098
537,044
555,431
266,107
524,684
543,931
246,129
500,575
469,934
215,414
411,640
398,474
171,554
388,458
438,548
182,097
416,050
397,609
175,079
366,524 319,978
360,575 309,131
165,783 153,282
12.5
13.3
0.66
0.70
1.84
1.96
0.05
14.0
14.4
0.72
0.74
1.85
1.91
0.05
14.9
15.0
0.74
0.75
1.93
1.94
0.05
15.9
15.5
0.75
0.73
1.96
1.92
0.05
15.1
16.0
0.65
0.68
1.70
1.79
0.04
14.9
15.0
0.71
0.71
1.74
1.76
0.05
9.9
12.9
0.41
0.52
0.97
1.25
0.04
13.0
16.2
0.50
0.61
1.07
1.32
0.04
14.4
19.0
0.59
0.78
1.20
1.58
0.04
19.2
19.3
0.86
0.87
1.71
1.71
0.04
30,669
14,316
1,368
30,587
14,845
1,346
30,303
14,694
634
30,797
14,963
512
31,351
15,184
440
29,821
7,445
363
29,118
6,732
323
29,529
7,256
288
28,944
6,595
288
27,922
6,785
234
46,353
46,778
45,631
46,272
46,975
37,629
36,173
37,073
35,827
34,941
939
592
4
934
615
4
933
626
4
930
638
3
920
688
3
910
321
3
900
290
5
983
292
5
977
243
4
963
215
4
1,535
1,553
1,563
1,571
1,611
1,234
1,195
1,280
1,224
1,182
3,442
1,319
3,016
1,322
2,900
1,325
2,596
1,375
2,235
1,366
2,076
905
2,030
636
2,026
640
1,978
583
1,936
547
4,761
4,338
4,225
3,971
3,601
2,981
2,666
2,666
2,561
2,483
Return on Equity and Assets
Return on equity (%)
Adjusted return on equity (%)
Return on average assets (%)
Adjusted return on average assets (%)
Return on average risk-weighted assets (%) (1)
Adjusted return on average risk-weighted assets (%) (1)
Average equity to average total assets (%)
Other Statistical Information
Employees (2)
Canada
United States
Other
Total
Bank branches
Canada
United States
Other
Total
Automated banking machines
Canada
United States
Total
2010 and prior based on CGAAP.
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Beginning in 2008, return on average risk-weighted assets has been calculated under the Basel II guidelines; for all prior periods, return on average risk-weighted assets has been calculated using the
Basel I methodology.
(2) Reflects full-time equivalent number of employees, comprising full-time and part-time employees and adjustments for overtime hours.
118 BMO Financial Group 198th Annual Report 2015
Table 2: Summary Income Statement and Growth Statistics
($ millions, except as noted)
For the year ended October 31
2015
2014
2013
2012
2011
5-year
CAGR
10-year
CAGR
Income Statement – Reported Results
Net interest income
Non-interest revenue
8,970
10,419
8,461
9,762
8,677
8,153
8,937
8,166
7,474
7,587
7.5
8.2
6.5
7.1
Revenue
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
19,389
1,254
18,223
1,505
16,830
767
17,103
1,174
15,061
1,118
7.9
4.1
6.8
22.0
Revenue, net of CCPB
Provision for credit losses
Non-interest expense
18,135
612
12,182
16,718
561
10,921
16,063
587
10,226
15,929
764
10,135
13,943
1,212
8,741
8.2
6.3
Income before provision for income taxes
Provision for income taxes
5,341
936
5,236
903
5,250
1,055
5,030
874
Net income
4,405
4,333
4,195
4,370
35
4,277
56
4,405
Income Statement – Adjusted Results
Net interest income
Non-interest revenue
nm
9.8
6.8
3,990
876
8.4 nm 4.8
0.7
4,156
3,114
8.8
6.3
4,130
65
4,082
74
3,041
73
9.2
6.2
nm
nm
4,333
4,195
4,156
3,114
8.8
6.3
8,971
10,420
8,461
9,762
8,020
8,119
8,158
7,882
7,248
7,612
7.5
8.2
6.5
7.1
Revenue
Insurance claims, commissions and changes in policy benefit liabilities (CCPB) (1)
19,391
1,254
18,223
1,505
16,139
767
16,040
1,174
14,860
1,118
7.9
4.1
6.8
22.0
Revenue, net of CCPB
Provision for credit losses
Non-interest expense
18,137
612
11,819
16,718
561
10,761
15,372
357
9,755
14,866
470
9,410
13,742
1,108
8,453
8.2
6.3
nm
nm
9.3
6.6
Income before provision for income taxes
Provision for income taxes
5,706
1,025
5,396
943
5,260
1,037
4,986
927
4,181
906
9.6
8.2
5.2
(0.1)
Adjusted net income
4,681
4,453
4,223
4,059
3,275
9.9
7.0
4,646
35
4,397
56
4,158
65
3,985
74
3,202
73
9.8
6.9
nm
nm
4,681
4,453
4,223
4,059
3,275
9.9
7.0
6.59
6.57
7.00
6.44
6.41
6.59
6.19
6.17
6.21
6.13
6.10
5.95
4.90
4.84
5.10
6.6
6.7
7.8
3.4
3.6
4.5
1.7
5.1
2.5
6.2
3.3
5.4
3.9
6.1
0.9
4.1
1.1
4.4
33.5
23.9
26.0
16.7
8.0
12.3
1.9
6.0
na
na
na
na
na
na
na
na
Attributable to bank shareholders
Attributable to non-controlling interest in subsidiaries
Net income
Attributable to bank shareholders
Attributable to non-controlling interest in subsidiaries
Adjusted net income
Earnings per Share (EPS) ($)
Basic
Diluted
Adjusted diluted
Year-over-Year Growth-Based Statistical Information (%)
Net income growth
Adjusted net income growth
Diluted EPS growth
Adjusted diluted EPS growth
Five-year and ten-year CAGR based on CGAAP in 2010 and 2005, respectively, and on IFRS in 2015. 2011 growth rates based on CGAAP in 2010 and IFRS in 2011.
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Beginning in 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified. nm – not meaningful na – not applicable
BMO Financial Group 198th Annual Report 2015 119
Supplemental Information
nm
SUPPLEMENTAL INFORMATION
Table 3: Revenue and Revenue Growth
($ millions, except as noted)
For the year ended October 31
2015
2014
2013
2012
2011
5-year
CAGR
10-year
CAGR
6.5
Net Interest Income
Year-over-year growth (%)
8,970
6.0
8,461
(2.5)
8,677
(2.9)
8,937
19.6
7,474
19.9
7.5 na na
Adjusted Net Interest Income
Year-over-year growth (%)
8,971
6.0
8,461
5.5
8,020
(1.7)
8,158
12.6
7,248
16.2
7.5
6.5
na
na
579,471
1.55
1.55
1.68
1.38
528,786
1.60
1.60
1.74
1.41
485,191
1.79
1.65
1.82
1.74
461,018
1.94
1.77
1.89
2.01
404,195
1.85
1.79
1.99
1.61
11.8
9.1
na
na
na
na
na
na
na
na
953
1,077
987
737
460
1,500
1,385
706
171
172
1,762
509
934
1,002
949
680
462
1,246
1,073
744
162
179
2,008
323
846
916
849
603
461
971
832
659
285
172
1,212
347
825
929
1,025
544
441
967
665
600
152
153
1,509
356
1,215
834
549
593
689
496
633
512
189
130
1,401
346
Total Non-Interest Revenue
Year-over-year growth (%)
Non-interest revenue as a % of total revenue
10,419
6.7
53.7
9,762
19.7
53.6
8,153
(0.2)
48.4
8,166
7.6
47.7
Adjusted Non-Interest Revenue
Year-over-year adjusted non-interest revenue growth (%)
Adjusted non-interest revenue as a % of total adjusted revenue
10,420
6.8
53.7
9,762
20.2
53.6
8,119
3.0
50.3
Total Revenue
Year-over-year total revenue growth (%)
19,389
6.4
18,223
8.3
Total Revenue, net of CCPB (2)
Year-over-year total revenue growth, net of CCPB (%)
18,135
8.5
Total Adjusted Revenue
Year-over-year total adjusted revenue growth (%)
Total Adjusted Revenue, net of CCPB (2)
Year-over-year total adjusted revenue growth, net of CCPB (%)
Supplemental Information
Net Interest Margin (1)
Average earning assets
Net interest margin (%)
Adjusted net interest margin (%)
Canadian dollar net interest margin (%)
U.S. dollar and other currencies net interest margin (%)
Non-Interest Revenue
Securities commissions and fees
Deposit and payment service charges
Trading revenues
Lending fees
Card fees
Investment management and custodial fees
Mutual fund revenues
Underwriting and advisory fees
Securities gains, other than trading
Foreign exchange, other than trading
Insurance income (2)
Other revenues
(2.4)
6.1
14.4
5.2
14.6
33.4
20.3
9.7
(1.4)
3.9
7.1
8.9
3.3
17.3
12.2
7.1
nm
nm
13.0
5.5
17.8
5.9
20.0
1.6
7,587
7.9
50.4
8.2
7.1
na
na
na
na
7,882
3.6
49.1
7,612
8.3
51.2
8.2
7.1
na
na
na
na
16,830
(1.6)
17,103
13.6
15,061
13.5
7.9
6.8
na
na
16,718
4.1
16,063
0.8
15,929
14.2
13,943
13.9
8.2
6.3
na
na
19,391
6.4
18,223
12.9
16,139
0.6
16,040
7.9
14,860
12.0
7.9
6.8
na
na
18,137
8.5
16,718
8.7
15,372
3.4
14,866
8.2
13,742
12.3
8.2
6.3
na
na
Five-year and ten-year CAGR based on CGAAP in 2010 and 2005, respectively, and on IFRS in 2015. 2011 growth rates based on CGAAP in 2010 and IFRS in 2011.
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Net interest margin is calculated based on average earning assets.
(2) Beginning in 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified. na – not applicable nm – not meaningful
120 BMO Financial Group 198th Annual Report 2015
Table 4: Non-Interest Expense and Expense-to-Revenue Ratio
($ millions, except as noted)
For the year ended October 31
2015
2014
2013
2012
2011
5-year
CAGR
10-year
CAGR
3,910
2,102
1,069
3,388
1,946
908
3,259
1,686
897
3,148
1,657
808
2,646
1,560
621
11.3
7.6
11.4
7.5
5.1
6.5
Total employee compensation
7,081
6,242
5,842
5,613
4,827
10.2
6.6
Premises and equipment
Rental of real estate
Premises, furniture and fixtures
Property taxes
Computers and equipment (1)
462
287
39
1,349
415
261
39
1,193
416
377
37
1,003
400
368
36
1,071
360
310
30
878
7.7
1.3
6.5
13.2
8.9
1.2
(1.5)
5.8
2,137
1,908
1,833
1,875
1,578
9.7
nm
411
314
45
595
605
994
382
289
39
622
542
897
346
291
39
527
514
834
331
301
46
593
491
885
231
259
51
624
382
789
15.2
6.5
(3.1)
8.2
12.1
7.8
10.0
(8.4)
9.4
9.4
7.0
Non-Interest Expense
Employee compensation
Salaries
Performance-based compensation
Employee benefits
Total premises and equipment (1)
Other expenses
Amortization of intangible assets (1)
Communications
Business and capital taxes
Professional fees
Travel and business development
Other
Total other expenses
nm
2,771
2,551
2,647
2,336
9.2
8.4
12,182
11.5
10,921
6.8
10,226
0.9
10,135
15.9
8,741
14.7
9.8
6.8
na
na
Total Adjusted Non-Interest Expense
Year-over-year total adjusted non-interest expense growth (%)
11,819
9.8
10,761
10.3
9,755
3.7
9,410
11.3
8,453
11.5
9.3
6.6
na
na
Non-interest expense-to-revenue ratio (Efficiency ratio) (%)
Adjusted non-interest expense-to-revenue ratio (Efficiency ratio) (%)
Efficiency ratio, net of CCPB (2)
Adjusted efficiency ratio, net of CCPB (2)
62.8
60.9
67.2
65.2
59.9
59.1
65.3
64.4
60.8
60.4
63.7
63.5
59.3
58.7
63.6
63.3
58.0
56.9
62.7
61.5
na
na
na
na
na
na
na
na
Government Levies and Taxes (3)
Government levies other than income taxes
Payroll levies
Property taxes
Provincial capital taxes
Business taxes
Harmonized sales tax, GST and other sales taxes
Sundry taxes
312
39
33
10
319
2
252
39
27
9
273
2
249
37
30
7
262
1
250
36
37
9
249
2
203
30
44
7
235
1
12.3
6.5
(6.1)
7.4
16.9 nm nm
Total government levies other than income taxes
715
602
586
583
520
12.2
5.2
Provision for income taxes
Total Government Levies and Taxes
Total government levies and taxes as a % of income available to pay government levies and taxes
Effective income tax rate (%)
Adjusted effective income tax rate (%)
7.5
(1.5)
(10.5)
3.3
9.7
936
903
1,055
874
876
nm
0.7
1,651
1,505
1,641
1,457
1,396
8.7
2.4
23.1
17.5
18.0
25.0
17.2
17.5
28.7
20.1
19.7
26.6
17.4
18.6
31.0
22.0
21.7
na
na
na
na
na
na
Five-year and ten-year CAGR based on CGAAP in 2010 and 2005, respectively, and on IFRS in 2015. 2011 growth rates based on CGAAP in 2010 and IFRS in 2011.
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(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, but not for years prior to 2007. As such, 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 6.5% over ten years. Together, total premises and equipment expense and the amortization of intangible assets increased at a compound annual growth rate of 7.4% over ten years.
(2) This ratio is calculated excluding insurance claims, commissions and changes in policy benefit liabilities (CCPB).
(3) Government levies are included in various non-interest expense categories. na – not applicable nm – not meaningful
BMO Financial Group 198th Annual Report 2015 121
Supplemental Information
2,964
Total Non-Interest Expense
Year-over-year total non-interest expense growth (%)
SUPPLEMENTAL INFORMATION
Table 5: Average Assets, Liabilities and Interest Rates
2014
2015
($ millions, except as noted)
For the year ended October 31
Assets
Canadian Dollar
Deposits with other banks
Securities
Securities borrowed or purchased under resale agreements
Loans
Residential mortgages
Non-residential mortgages
Personal and credit cards
Businesses and governments
Total loans
Supplemental Information
Total Canadian dollar
U.S. Dollar and Other Currencies
Deposits with other banks
Securities
Securities borrowed or purchased under resale agreements
Loans
Residential mortgages
Non-residential mortgages
Personal and credit cards
Businesses and governments
Total loans
Total U.S. dollar and other currencies
Average balances Average interest rate (%)
Interest income/ expense
21
1,257
266
1,632
94,234
23,027
1.52
1.32
1.03
2.83
3.71
4.89
3.94
2,663
229
2,699
1,710
90,134
6,276
55,719
40,250
198,941
3.67
7,301
320,864
2.76
8,845
48,031
54,733
44,010
0.53
1.20
0.14
8,631
4,619
17,071
79,678
3.39
2.51
3.19
3.26
2013
Average
balances
Average interest rate (%)
Interest income/ expense
25
1,244
238
2,461
83,605
22,309
1.28
1.78
1.19
32
1,492
265
3.08
4.08
5.13
4.29
2,779
256
2,860
1,726
81,693
6,285
54,845
37,380
3.15
4.29
4.97
4.62
2,576
269
2,728
1,725
192,379
3.96
7,621
180,203
4.05
7,298
311,272
2.93
9,128
288,578
3.15
9,087
253
655
60
38,815
53,921
32,629
0.63
1.11
0.12
245
601
38
35,093
48,488
32,578
0.61
1.32
0.17
213
640
57
293
116
545
2,598
7,753
4,860
15,812
61,402
3.37
2.48
3.32
3.46
261
121
524
2,123
8,897
5,558
14,862
47,821
4.31
3.01
3.59
4.57
383
167
533
2,185
Average balances Average interest rate (%)
Interest income/ expense
1,984
90,322
29,617
1.04
1.39
0.90
94,119
6,176
55,219
43,427
109,999
3.23
3,552
89,827
3.37
3,029
77,138
4.24
3,268
256,773
1.76
4,520
215,192
1.82
3,913
193,297
2.16
4,178
Other non-interest bearing assets
86,754
Total All Currencies
Total assets and interest income
67,464
73,556
664,391
2.01
13,365
593,928
2.20
13,041
555,431
2.39
13,265
Liabilities
Canadian Dollar
Deposits
Banks
Businesses and governments
Individuals
7,883
96,713
94,031
0.43
1.16
0.88
34
1,121
832
5,416
98,090
89,007
0.39
1.38
0.97
21
1,353
863
5,921
88,603
82,248
0.34
1.53
0.96
20
1,352
788
Total deposits
Securities sold but not yet purchased and securities lent or sold (1)
Subordinated debt and other interest bearing liabilities
198,627
40,637
25,713
1.00
1.63
2.96
1,987
661
760
192,513
40,713
24,712
1.16
1.74
3.11
2,237
710
769
176,772
36,077
28,004
1.22
1.96
3.25
2,160
708
911
Total Canadian dollar
264,977
1.29
3,408
257,938
1.44
3,716
240,853
1.57
3,779
U.S. Dollar and Other Currencies
Deposits
Banks
Businesses and governments
Individuals
19,377
169,793
47,671
0.27
0.32
0.20
53
546
95
19,048
145,355
41,675
0.23
0.34
0.22
44
494
90
17,135
123,129
40,694
0.33
0.32
0.29
56
392
119
Total deposits
Securities sold but not yet purchased and securities lent or sold (1)
Subordinated debt and other interest bearing liabilities
236,841
41,792
5,749
0.29
0.20
3.61
694
85
208
206,078
33,650
4,901
0.30
0.21
3.34
628
72
164
180,958
33,486
4,325
0.31
0.30
3.32
567
99
143
Total U.S. dollar and other currencies
284,382
0.35
987
244,629
0.35
864
218,769
0.37
809
Other non-interest bearing liabilities
78,130
Total All Currencies
Total liabilities and interest expense
Shareholders’ equity
627,489
36,902
0.70
4,395
561,706
32,222
0.82
4,580
526,145
29,286
0.87
4,588
Total Liabilities, Interest Expense and Shareholders’ Equity
664,391
0.66
4,395
593,928
0.77
4,580
555,431
0.83
4,588
59,139
Net interest margin
– based on earning assets
– based on total assets
Net interest income based on total assets
1.55
1.35
Adjusted net interest margin
– based on earning assets
– based on total assets
Adjusted net interest income based on total assets
1.55
1.35
66,523
1.60
1.42
1.79
1.56
8,461
8,970
1.60
1.42
8,971
8,677
1.65
1.44
8,461
8,020
(1) For the years ended October 31, 2015, 2014 and 2013, the maximum amount of securities lent or sold under repurchase agreements at any month end amounted to $57,385 million, $50,138 million and $53,898 million, respectively.
122 BMO Financial Group 198th Annual Report 2015
Table 6: Volume/Rate Analysis of Changes in Net Interest Income
2015/2014
($ millions)
For the year ended October 31
Assets
Canadian Dollar
Deposits with other banks
Securities
Securities borrowed or purchased under resale agreements
Loans
Residential mortgages
Non-residential mortgages
Personal and credit cards
Businesses and governments
2014/2013
Increase (decrease) due to change in
Increase (decrease) due to change in
Average balance Average rate Total
Average balance Average rate Total
4
(438)
(35)
(7)
(248)
(27)
(115)
(27)
(161)
(17)
266
–
44
132
(63)
(13)
88
(131)
203
(13)
132
1
(549)
(320)
442
(119)
323
250
(533)
(283)
629
(588)
41
58
9
13
(51)
45
9
7
54
22
23
72
–
10
(111)
(19)
33
(39)
(19)
30
(6)
42
632
2
1
(21)
(156)
32
(5)
21
476
(49)
(21)
34
620
(73)
(26)
(43)
(682)
(122)
(47)
(9)
(62)
698
(174)
524
584
(824)
(240)
778
(171)
607
679
(944)
(265)
1,028
(704)
324
1,308
(1,532)
(224)
9
(19)
49
3
(213)
(80)
12
(232)
(31)
(2)
145
65
3
(143)
10
1
2
75
Total deposits
Securities sold but not yet purchased and securities lent or sold
Subordinated debt and other interest bearing liabilities
39
(1)
31
(290)
(47)
(40)
(251)
(48)
(9)
208
91
(107)
(130)
(89)
(34)
78
2
(141)
Change in Canadian dollar interest expense
69
(377)
(308)
192
(253)
(61)
U.S. Dollar and Other Currencies
Deposits
Banks
Businesses and governments
Individuals
1
83
13
9
(31)
(8)
10
52
5
6
71
3
(18)
31
(32)
(12)
102
(29)
Total deposits
Securities sold but not yet purchased and securities lent or sold
Subordinated debt and other interest bearing liabilities
97
17
28
(30)
(4)
15
67
13
43
80
–
19
(19)
(28)
1
61
(28)
20
Change in U.S. dollar and other currencies interest expense
142
(19)
123
99
(46)
53
Total All Currencies
Change in total interest expense (b)
211
(396)
(185)
291
(299)
(8)
Change in total net interest income (a - b)
817
(308)
509
1,017
(1,233)
(216)
Total loans
Change in Canadian dollar interest income
U.S. Dollar and Other Currencies
Deposits with other banks
Securities
Securities borrowed or purchased under resale agreements
Loans
Residential mortgages
Non-residential mortgages
Personal and credit cards
Businesses and governments
Total loans
Change in U.S. dollar and other currencies interest income
Total All Currencies
Change in total interest income (a)
Liabilities
Canadian Dollar
Deposits
Banks
Businesses and governments
Individuals
(9)
66
(41)
(4)
14
27
123
(4)
(26)
136
(238)
(23)
(135)
(153)
229
BMO Financial Group 198th Annual Report 2015 123
Supplemental Information
(11)
190
8
5
(52)
68
SUPPLEMENTAL INFORMATION
Table 7: Net Loans and Acceptances –
Segmented Information (1) (5) (6)
($ millions)
As at October 31
Consumer
Residential mortgages
Credit cards
Consumer instalment and other personal loans
Total consumer
Total businesses and governments Canada
2014
United States
Other countries
2013
2012
2011
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
96,975
7,427
92,972 88,677
7,476 7,413
76,729
7,381
68,190
7,564
8,905
553
7,980
496
7,646
457
7,416
433
7,945
474
–
–
–
–
–
–
–
–
–
–
49,181
48,955 49,195
47,955
45,584 16,098 15,088 14,364 13,419 13,802
206
1
–
–
–
153,583 149,403 145,285 132,065 121,338 25,556 23,564 22,467 21,268 22,221
206
1
–
–
–
2015
50,737 75,430 56,389 45,842 42,955 41,209 10,975
11,145 8,954 5,748 4,649
Total loans and acceptances, net of specific allowances
223,355 213,299 203,252 185,134 172,075 100,986 79,953 68,309 64,223 63,430 11,181
Collective allowance
(857)
(795)
(791)
(705)
(687)
(803) (747) (694) (755) (765)
–
11,146 8,954 5,748 4,649
–
–
–
–
Total net loans and acceptances 222,498 212,504 202,461 184,429 171,388 100,183 79,206 67,615 63,468 62,665 11,181
11,146 8,954 5,748 4,649
69,772
63,896 57,967
53,069
Table 8: Net Impaired Loans and Acceptances –
Segmented Information (6)
Supplemental Information
($ millions, except as noted)
As at October 31
Canada
United States
Other countries
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
159
168
157
182
178
173
303
369
335
221
–
–
–
–
–
Consumer
Residential mortgages
Consumer instalment and other personal loans
117
136
100
64
101
316
309
274
275
128
–
–
–
–
–
Total consumer
Businesses and governments
276
220
304
247
257
253
246
377
279
433
489
613
612
507
643
944
610
1,271
349
1,108
–
4
–
4
–
3
–
25
–
2
Total impaired loans and acceptances, net of specific allowances Collective allowance
496
(857)
551
(795)
510
(791)
623
(705)
712
(687)
1,587
(694)
1,881
(755)
1,457
(765)
4
–
4
–
3
–
25
–
2
–
Total net impaired loans and acceptances (NIL)
(361)
(244)
(281)
(82)
25
299
372
893
1,126
692
4
4
3
25
2
Condition Ratios (1)
NIL as a % of net loans and acceptances (2) (3)
(0.16)
(0.12)
(0.14)
(0.04)
0.01
0.30
0.48
1.34
1.81
1.15
0.04
0.04
0.03
0.43
0.04
0.18
0.32
0.20
0.39
0.18
0.43
0.19
0.66
0.23
0.85
1.92
0.82
2.60
0.90
2.87
2.08
2.87
2.99
1.57
2.69
–
0.04
–
0.04
–
0.03
–
0.43
–
0.04
NIL as a % of net loans and acceptances (2) (3) (4)
Consumer
Businesses and governments
1,102 1,119
(803) (747)
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Certain balances and ratios (coverage, condition and performance) for fiscal 2012 were restated in 2013 to conform to the current period’s presentation.
(2) Aggregate balances are net of specific and collective allowances; the consumer and businesses and governments categories are stated net of specific allowances only. Includes collective allowances related to off-balance sheet instruments and undrawn commitments, which are reported in Other Liabilities. Excludes specific allowances for Other Credit Instruments, which are included in Other
Liabilities.
(3) Ratio is presented including purchased portfolios and prior periods have been restated.
(4) Certain condition and performance ratios for 2013 and 2012 were restated in 2014 to conform to the current period’s presentation.
(5) Fiscal 2013, 2012 and 2011 balances were reclassified in 2014 to conform to the current period’s presentation.
(6) Certain balances for fiscal 2014 and 2013 were restated in 2015 to conform to the current period’s presentation.
124 BMO Financial Group 198th Annual Report 2015
Table 9: Net Loans and Acceptances –
Segmented Information (1) (2) (3) (4)
($ millions)
As at October 31
2014
2013
2012
2011
59,386
13,361
36,486
89,460
43,612
39,579
13,065
35,647
84,498
42,043
37,251
11,244
33,746
80,726
38,825
37,920
11,801
35,650
69,014
34,431
33,533
10,638
28,489
68,556
32,162
31,543
179,345 172,968 167,752 153,333 143,559
Total net loans and acceptances in Canada
222,498
212,504
202,461
184,429
171,388
20,597
3,544
14,096
10,243
9,891
815
16,187
1,309
6,667
3,735
1,984
859
28,384
31,220
1,874
4,772
17,636
3,101
12,580
8,281
9,155
831
13,612
1,085
5,943
2,532
1,670
587
22,114
24,096
2,076
6,131
17,606
2,934
10,229
7,345
8,380
729
11,250
959
3,908
2,152
1,309
631
18,321
19,019
1,719
6,272
18,720
2,539
9,084
6,821
7,312
513
9,870
662
3,466
2,109
1,170
592
14,992
15,113
1,295
7,514
20,468
2,460
7,829
5,854
6,653
564
9,368
683
3,477
2,009
842
529
13,872
14,709
810
6,468
156,177
131,430
112,763
101,772
96,595
2014
2013
2012
2011
105,880 100,952
7,980
7,972
96,323
7,870
84,145
7,814
76,135
8,038
64,044
63,559
61,374
2015
65,485
156,177 131,430 112,763 101,772
96,595
335,522 304,398 280,515 255,105 240,154
(1,660) (1,542) (1,485) (1,460) (1,452)
333,862 302,856 279,030 253,645 238,702
Total
2015
2014
2013
2012
2011
332
471
526
517
399
433
445
374
339
229
765
837
916
758
900
1,200
856
1,673
628
1,543
1,602
1,674
2,100
2,529
2,171
(1,660)
(1,542)
(1,485)
Net Businesses and Governments Loans by Industry
Commercial real estate
Construction (non-real estate)
Retail trade
Wholesale trade
Agriculture
Communications
Manufacturing
Mining
Oil and gas
Transportation
Utilities
Forest products
Service industries
Financial institutions
Government
Other
(1,460) (1,452)
(58)
132
615
1,069
719
(0.02)
0.04
0.22
0.42
0.30
0.43
0.54
0.53
0.58
0.54
1.07
0.56
1.67
0.44
1.63
Table 10: Net Impaired Loans and Acceptances –
Segmented Information (2) (4)
($ millions)
As at October 31
2015
2014
2013
2012
2011
Net Impaired Businesses and Governments Loans
Commercial real estate
Construction (non-real estate)
Retail trade
Wholesale trade
Agriculture
Communications
Manufacturing
Mining
Oil and gas
Transportation
Utilities
Forest products
Service industries
Financial institutions
Government
Other
87
83
55
47
129
13
102
3
100
30
14
9
107
48
–
10
159
84
38
35
103
59
100
2
1
7
–
13
145
9
2
1
379
32
74
64
118
–
74
5
30
23
–
19
246
–
61
75
803
51
68
58
131
5
126
5
1
41
6
24
263
–
68
23
637
45
98
32
135
7
87
3
2
42
2
36
169
181
1
66
837
758
1,200
1,673
1,543
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Certain balances and ratios (coverage, condition and performance) for fiscal 2012 were restated in 2013 to conform to the current period’s presentation. (2) Fiscal 2013, 2012 and 2011 balances were reclassified in 2014 to conform to the current period’s presentation.
(3) Fiscal 2014 Canadian regional balances were reclassified in 2015 to conform to the current period’s presentation.
(4) Excludes specific allowances for Other Credit Instruments, which are included in Other Liabilities.
BMO Financial Group 198th Annual Report 2015 125
Supplemental Information
2015
Net Loans and Acceptances by Province
Atlantic provinces
Quebec
Ontario
Prairie provinces
British Columbia and territories
Total
SUPPLEMENTAL INFORMATION
Table 11: Changes in Gross Impaired Loans –
Segmented Information (6)
($ millions)
Canada
United States
Other countries
As at October 31
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
Gross impaired loans and acceptances (GIL), beginning of year
Consumer
Businesses and governments
398
344
348
406
338
548
371
586
412
540
678
623
702
1,081
646
1,401
388
1,326
309
1,551
–
5
–
7
–
43
–
14
–
82
742
754
886
957
952
1,301
1,783
2,047
1,714
1,860
5
7
43
14
82
617
231
643
285
584
294
533
352
573
424
526
542
529
685
637
931
764
1,416
333
661
–
5
–
–
–
3
–
36
–
1
848
928
878
885
997
1,068
1,214
1,568
2,180
994
5
–
3
36
1
Total GIL, beginning of year
Additions to impaired loans and acceptances
Consumer
Businesses and governments
Total additions
Reductions to impaired loans and acceptances (1)
Consumer
Businesses and governments
Total reductions due to net repayments and other
Supplemental Information
Write-offs
Consumer
Businesses and governments
Total write-offs
Gross impaired loans and acceptances, end of year
Consumer
Businesses and governments
(479) (431) (416) (386) (413)
(151) (224) (274) (314) (242)
(432)
(239)
(321)
(859)
(243)
(973)
(45)
(880)
7
(597)
–
(5)
–
(2)
–
(36)
–
(6)
–
(40)
(630) (655) (690) (700) (655)
(671) (1,180) (1,216)
(925)
(590)
(5)
(2)
(36)
(6)
(40)
(177) (162) (158) (180) (201)
(142) (123) (162) (76) (136)
(215)
(169)
(232)
(284)
(338)
(278)
(461)
(461)
(261)
(289)
–
(1)
–
–
–
(3)
–
(1)
–
(29)
(319) (285) (320) (256) (337)
(384)
(516)
(616)
(922)
(550)
(1)
–
(3)
(1)
(29)
359
282
398
344
348
406
338
548
371
586
557
757
678
623
702
1,081
646
1,401
388
1,326
–
4
–
5
–
7
–
43
–
14
641
742
754
886
957
1,314
1,301
1,783
2,047
1,714
4
5
7
43
14
Condition Ratios
GIL as a % of Gross Loans (2)
Consumer
Businesses and governments
0.23
0.40
0.27
0.54
0.24
0.68
0.26
1.00
0.31
1.15
2.18
1.01
2.87
1.10
3.12
2.34
3.03
3.28
1.74
3.20
–
0.04
–
0.04
–
0.10
–
0.91
–
0.30
Total Loans and Acceptances
0.29
0.35
0.37
0.47
0.56
1.30
1.62
2.60
3.20
2.69
0.04
0.04
0.10
0.91
0.30
un
un
un
un
un
un
un
un
un
un
un
un
un
un
un
Total GIL, end of year
GIL as a % of equity and allowance for credit losses (3) (4) (5)
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1)
(2)
(3)
(4)
(5)
(6)
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.
Certain balances and ratios (coverage, condition and performance) for fiscal 2012 were restated in 2013 to conform to the current period’s presentation.
Ratio is presented including purchased portfolios and prior periods have been restated.
Effective in 2011, total equity includes non-controlling interest in subsidiaries. In addition, geographic allocations are not available, as equity is not allocated on a country of risk basis.
Certain condition and performance ratios for 2013 and 2012 were restated in 2014 to conform to the current period’s presentation.
GIL excludes Purchased Credit Impaired Loans.
un – unavailable
126 BMO Financial Group 198th Annual Report 2015
Total
2015
2014
2013
2012
2011
1,076
972
1,050
1,494
984
1,992
759
1,926
721
2,173
2,048
2,544
2,976
2,685
2,894
1,143
778
1,172
970
1,221
1,228
1,297
1,804
906
1,086
1,921
2,142
2,449
3,101
1,992
(911) (752) (659)
(431)
(395) (1,085) (1,283) (1,200)
(406)
(879)
(1,306) (1,837) (1,942) (1,631) (1,285)
(394)
(407)
(496)
(443)
(641)
(538)
(462)
(454)
(704)
(801)
(939) (1,179)
(916)
916
1,043
1,076
972
1,050
1,494
984
1,992
759
1,926
1,959
2,048
2,544
2,976
2,685
0.51
0.67
0.62
0.74
0.63
1.32
0.64
1.95
0.53
1.99
0.58
0.67
0.91
1.17
1.12
4.67
5.49
7.68
9.46
Supplemental Information
(392)
(312)
8.98
BMO Financial Group 198th Annual Report 2015 127
SUPPLEMENTAL INFORMATION
Table 12: Changes in Allowance for Credit Losses –
Segmented Information (3)
($ millions, except as noted)
Canada
United States
Other countries
As at October 31
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
Allowance for credit losses (ACL), beginning of year
Consumer
Businesses and governments
615
371
602
433
518
450
464
468
454
473
333
646
278
653
291
659
270
797
145
859
–
1
–
4
–
18
–
12
–
42
Total ACL, beginning of year
986
1,035
968
932
927
979
931
950
1,067
1,004
1
4
18
12
42
Provision for credit losses
Consumer
Businesses and governments
412
149
436
97
521
133
543
90
527
152
122
202
262
(70) (172) (327)
401
(267)
350
184
–
(1)
–
(2)
–
(2)
–
(3)
–
(1)
561
533
654
633
679
52
30
(65)
134
534
(1)
(2)
(2)
(3)
(1)
111
13
99
15
81
(1)
91
4
80
1
151
181
102
408
95
597
125
626
61
99
–
–
–
–
–
–
–
–
–
–
124
114
80
95
81
332
510
692
751
160
–
–
–
–
–
(521)
(143)
(500)
(122)
(507)
(160)
(563) (587)
(76) (136)
(232) (242) (347)
(168) (285) (280)
(492)
(461)
(289)
(289)
–
(1)
–
–
–
(3)
–
(1)
–
(29)
(664)
(622)
(667)
(639) (723)
(400) (527) (627)
(953)
(578)
(1)
–
(3)
(1)
(29)
(3)
(2)
(22)
(52)
(11)
11
(5)
(74)
Total provision for credit losses
Recoveries
Consumer
Businesses and governments
Total recoveries
Write-offs
Consumer
Businesses and governments
Supplemental Information
Total write-offs
Other, including foreign exchange rate changes Consumer
Businesses and governments
Total Other, including foreign exchange rate changes
ACL, end of year
Consumer
Businesses and governments
Total ACL, end of year
–
(17)
(36)
(10)
(22)
19
68
(7)
42
(23)
4
(13)
(36)
3
(56)
–
1
–
(1)
–
(9)
–
10
–
–
(53)
(32)
87
35
(19)
(49)
(53)
1
(1)
(9)
10
–
614
388
615
371
602
433
518
450
464
468
393
657
333
646
278
653
291
659
270
797
–
–
–
1
–
4
–
18
–
12
1,002
986
1,035
968
932
1,050
979
931
950
1,067
–
1
4
18
12
–
(29)
Allocation of Write-offs by Market
Consumer
Businesses and governments
Allocation of Recoveries by Market
Consumer
Businesses and governments
(521)
(143)
111
13
99
15
81
(1)
91
4
80
1
un
Net write-offs as a % of average loans and acceptances (1) (2)
(500)
(122)
(507)
(160)
(563) (587)
(76) (136)
un
un
un
un
(232) (242) (347)
(168) (285) (280)
(492)
(461)
(289)
(289)
–
(1)
–
–
–
(3)
–
(1)
151
181
102
408
95
597
125
626
61
99
–
–
–
–
–
–
–
–
–
–
un
un
un
un
un
un
un
un
un
un
Table 13: Allocation of Allowance for Credit Losses –
Segmented Information (4)
($ millions, except as noted)
Canada
As at October 31
United States
Other countries
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
2015
2014
2013
2012
2011
17
20
27
36
38
21
41
42
30
34
–
–
–
–
–
66
74
64
55
54
47
25
17
7
5
–
–
–
–
–
83
62
–
94
97
–
91
153
–
91
172
–
92
153
–
68
144
35
66
116
50
59
137
41
37
129
29
39
218
45
–
–
–
–
1
–
–
4
–
–
18
–
–
12
–
145
857
191
795
244
791
263
705
245
687
247
803
232
747
237
694
195
755
302
765
–
–
1
–
4
–
18
–
12
–
Allowance for credit losses
1,002
986
1,035
968
932
1,050
979
931
950
1,067
–
1
4
18
12
Coverage Ratios
Allowance for credit losses as a % of gross impaired loans and acceptances (GIL) (1)
Total
Consumer
Businesses and governments
156.3
23.1
22.0
132.9
23.6
28.2
137.3
26.2
37.7
109.3
27.0
31.3
97.4
24.8
26.1
77.2
12.2
19.0
71.4
9.9
18.5
49.9
8.4
12.7
45.0
5.7
9.2
59.6
10.1
16.4
–
–
–
20.0
–
20.0
57.1
–
57.1
41.9
–
41.9
85.7
–
85.7
Consumer
Residential mortgages
Consumer instalment and other personal loans
Total consumer
Businesses and governments
Off-balance sheet
Total specific allowances
Collective allowance
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1)
(2)
(3)
(4)
Ratio is presented including purchased portfolios and prior periods have been restated.
Certain balances and ratios (coverage, condition and performance) for fiscal 2012 were restated in 2013 to conform to the current period’s presentation.
Fiscal 2013, 2012 and 2011 balances were reclassified in 2014 to conform to the current period’s presentation.
Certain balances for fiscal 2014 and 2013 were restated in 2015 to conform to the current period’s presentation.
un – unavailable
128 BMO Financial Group 198th Annual Report 2015
Total
2015
2014
2013
2012
2011
948
1,018
880
1,090
809
1,127
734
1,277
599
1,374
1,966
1,970
1,936
2,011
1,973
534
78
638
(77)
783
(196)
944
(180)
612
561
587
764
1,212
262
194
201
423
176
596
216
630
141
100
456
624
772
846
241
(753)
(312)
(742)
(407)
(854) (1,055)
(443) (538)
877
335
(876)
(454)
(1,065) (1,149) (1,297) (1,593) (1,330)
(29)
(11)
(34)
6
(30)
(62)
(7)
(78)
83
(40)
(28)
(92)
(85)
1,007
1,045
948
1,018
880
1,090
809
1,127
734
1,277
2,052
1,966
1,970
1,936
Supplemental Information
16
67
2,011
(753)
(312)
(742)
(407)
(854) (1,055)
(443) (538)
(876)
(454)
262
194
201
423
176
596
216
630
141
100
0.19
0.18
0.20
0.30
0.51
2015
2014
2013
2012
2011
38
61
69
66
72
113
99
81
62
59
151
206
35
160
214
50
150
294
41
128
319
29
131
383
45
392
1,660
424
1,542
485
1,485
476
1,460
559
1,452
2,052
1,966
1,970
1,936
2,011
103.0
16.5
19.8
93.6
14.9
22.0
75.8
14.3
19.7
64.1
13.1
16.0
73.2
17.3
19.9
Total
BMO Financial Group 198th Annual Report 2015 129
SUPPLEMENTAL INFORMATION
Table 14: Specific Allowances for Credit Losses –
Segmented Information (2)
($ millions)
As at October 31
2015
2014
2013
2012
2011
17
8
23
19
6
9
38
1
2
5
–
2
33
3
–
40
13
16
8
10
8
–
33
10
–
2
–
9
100
2
–
3
46
26
13
25
9
–
36
3
1
4
–
11
59
29
1
31
79
22
17
6
11
1
67
–
2
2
1
15
75
8
1
12
136
19
15
8
8
–
37
–
3
9
–
14
51
63
2
18
206
214
294
319
383
($ millions)
For the year ended October 31
2015
2014
2013
2012
2011
Consumer
Residential mortgages
Cards
Consumer instalment and other personal loans
11
272
225
77
268
251
129
305
313
132
355
387
109
376
291
Total consumer
508
596
747
874
776
Businesses and Governments
Commercial real estate
Construction (non-real estate)
Retail trade
Wholesale trade
Agriculture
Communications
Manufacturing
Mining
Oil and gas
Transportation
Utilities
Forest products
Service industries
Financial institutions
Government
Other
(37)
–
8
19
3
13
67
2
25
(4)
–
–
(29)
8
(2)
31
(141)
7
1
29
15
–
44
7
–
10
–
(1)
80
(34)
(3)
(49)
(185)
36
(4)
10
8
(6)
2
2
–
(9)
–
3
(37)
(15)
(6)
51
(108)
(14)
–
(16)
4
(5)
25
(1)
–
5
–
7
23
(29)
–
(4)
132
21
7
(1)
7
(9)
47
–
1
8
–
4
76
45
–
12
Total businesses and governments
104
(35)
(150)
(113)
350
Total specific provisions
Collective provision for credit losses
612
–
561
–
597
(10)
761
3
1,126
86
Total provision for credit losses
612
561
587
764
1,212
0.19
0.19
0.22
0.31
0.56
0.30
0.05
0.37
(0.06)
0.49
(0.18)
0.62
(0.15)
0.57
0.45
0.19
0.19
0.23
0.31
0.52
Businesses and Governments Specific
Allowances by Industry
Commercial real estate
Construction (non-real estate)
Retail trade
Wholesale trade
Agriculture
Communications
Manufacturing
Mining
Oil and gas
Transportation
Utilities
Forest products
Service industries
Financial institutions
Government
Other
Supplemental Information
Total specific allowances for credit losses on businesses and governments loans (1)
Table 15: Provision for Credit Losses –
Segmented Information (2)
Performance Ratios (%)
PCL-to-average net loans and acceptances (3) (4)
PCL-to-segmented average net loans and acceptances (4)
Consumer
Businesses and governments
Specific PCL-to-average net loans and acceptances
2011 has not been restated to reflect the new IFRS standards adopted in 2014. The adoption of new IFRS standards in 2015 only impacted our results prospectively.
(1) Amounts for 2015 exclude specific allowances of $4 million related to Other Credit Instruments (2014 – $23 million, 2013 – $21 million, 2012 – $19 million, 2011 – $43 million) included in
Other Liabilities.
(2) Fiscal 2013, 2012 and 2011 balances were reclassified in 2014 to conform to the current period’s presentation.
(3) Ratio is presented including purchased portfolios and prior periods have been restated.
(4) Certain balances and ratios (coverage, condition and performance) for fiscal 2012 were restated in 2013 to conform to the current period’s presentation.
130 BMO Financial Group 198th Annual Report 2015
Table 16: Risk-Weighted Assets
Basel III
Exposure at Default
($ millions)
As at October 31
Standardized Advanced
Approach Approach
2015 Standardized
Advanced
Total
Approach Approach (2)
19,583 218,409 237,992
2015 Standardized Advanced
Total
Approach Approach
16,890 179,737 196,627
64,398
81,340
59,821
67,740
33,513
–
63
328
33,644
1,549
3,858
33,644
1,612
4,186
90,303
41,337
28,895
93,601
42,432
28,895
1,736
809
–
5,882
5,732
4,000
7,618
6,541
4,000
17,824
20,023
1,519
8,307
9,826
292
3,262
3,554
–
1,924
1,924
122 133,942 134,064
– 28,115 28,115
231
–
122
–
1,373
1,362
7,237
3,098
1,604
1,362
7,359
3,098
–
14,946
14,946
8,251
8,251
72,229
91,489
64,525
75,496
35,308
–
94
341
31,954
1,671
3,561
31,954
1,765
3,902
–
124
326
59,821
67,616
33,187
3,425 104,031 107,456
592 42,665 43,257
– 32,109 32,109
1,740
416
–
6,687
7,473
4,569
8,427
7,889
4,569
3,298
1,095
–
2,557
23,195
1,624
9,429
11,053
2,199
277
2,890
3,167
–
1,965
1,965
165 150,876 151,041
– 29,178 29,178
210
–
165
–
1,758
1,369
8,250
2,456
1,968
1,369
8,415
2,456
–
16,255
16,255
8,874
8,874
64,525
75,324
34,964
20,638
–
20,329
20,329
–
–
2014
Total
16,942
19,260
–
172
344
Risk-weighted assets
2014 Standardized
Advanced
Total
Approach Approach (2)
–
30,746
30,746
–
–
–
–
–
–
Total Credit Risk
Market Risk
Operational Risk
27,115 797,903 825,018
–
–
–
–
–
–
23,850
1,142
4,033
176,535 200,385
9,120 10,262
24,505 28,538
24,346 716,709 741,055
–
–
–
–
–
–
21,750
1,719
3,791
163,637 185,387
7,283
9,002
23,912 27,703
Common Equity Tier 1 (CET 1) Capital
Risk-Weighted Assets
27,115 797,903 825,018
29,025
210,160 239,185
24,346 716,709 741,055
27,260
194,832 222,092
Additional Credit Valuation
Adjustment (CVA), prescribed by
OSFI, for Tier 1 Capital
–
–
–
Tier 1 Capital Risk-Weighted Assets
Additional CVA, prescribed by OSFI, for Total Capital
–
29,025
–
–
–
Total Capital Risk-Weighted Assets
–
29,025
286
286
–
–
–
245
245
–
27,260
210,446 239,471
–
–
–
–
27,260
210,691 239,716
336
336
195,168 222,428
503
503
195,671 222,931
(1) The scaling factor is applied to the risk-weighted assets amounts for credit risk under the AIRB Approach.
(2) In calculating the AIRB credit risk RWA for certain portfolios in BMO Financial Corp., a transitional floor based on the Standardized Approach was applied until Q3 2015.
Table 17: Average Deposits
2014
2015
2013
Average balance Average rate paid (%)
Average balance Average rate paid (%)
Average balance Average rate paid (%)
Deposits Booked in Canada
Demand deposits – interest bearing
Demand deposits – non-interest bearing
Payable after notice
Payable on a fixed date
18,910
31,762
76,458
120,764
0.36
–
0.57
1.35
16,469
26,702
76,903
118,094
0.45
–
0.70
1.44
16,050
24,400
71,820
100,118
0.47
–
0.67
1.63
Total deposits booked in Canada
247,894
0.86
238,168
0.97
212,388
1.03
Deposits Booked in the United States and Other Countries
Banks located in the United States and other countries
Governments and institutions in the United States and other countries
Other demand deposits
Other deposits payable after notice or on a fixed date
11,183
13,902
16,109
146,380
0.28
0.39
0.01
0.31
8,195
12,095
12,744
127,389
0.28
0.36
0.02
0.38
9,308
9,283
9,305
117,446
0.35
0.42
0.03
0.39
($ millions, except as noted)
Total deposits booked in the United States and other countries
187,574
0.29
160,423
0.35
145,342
0.36
Total average deposits
435,468
0.62
398,591
0.72
357,730
0.76
As at October 31, 2015, 2014 and 2013: deposits by foreign depositors in our Canadian bank offices amounted to $37,477 million, $30,622 million and $19,248 million, respectively; total deposits payable after notice included $29,104 million, $33,109 million and $33,014 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 $25,956 million, $17,738 million and $19,044 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.
BMO Financial Group 198th Annual Report 2015 131
Supplemental Information
Credit Risk
Wholesale
Corporate, including specialized lending Corporate small and medium-sized enterprises
Sovereign
Bank
Retail
Residential mortgages, excluding home equity line of credit
Home equity line of credit
Qualifying revolving retail
Other retail, excluding small and medium-sized enterprises Retail small and medium-sized enterprises Equity
Trading book
Securitization
Other credit risk assets – noncounterparty managed assets
Scaling factor for credit risk assets under AIRB Approach (1)
Exposure at Default
Risk-weighted assets
Statement of Management’s Responsibility for Financial Information
Management of Bank of Montreal (the “bank”) is responsible for the preparation and presentation of the annual consolidated financial statements,
Management’s Discussion and Analysis (“MD&A”) and all other information in the Annual Report.
The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board and meet the applicable requirements of the Canadian Securities Administrators (“CSA”) and the
Securities and Exchange Commission (“SEC”) in the United States. The financial statements also comply with the provisions of the Bank Act (Canada) and related regulations, including interpretations of IFRS by our regulator, the Office of the Superintendent of Financial Institutions Canada.
The MD&A has been prepared in accordance with the requirements of securities regulators, including National Instrument 51-102, Continuous
Disclosure Obligations of the CSA, as well as Item 303, Management’s Discussion and Analysis of Financial Condition and Results of Operations of
Regulation S-K under the United States Securities Act of 1933 and the Securities Exchange Act of 1934, and their related published requirements.
The consolidated financial statements and information in the MD&A necessarily include amounts based on informed judgments and estimates of the expected effects of current events and transactions with appropriate consideration to materiality. In addition, in preparing the financial information we must interpret the requirements described above, make determinations as to the relevancy of information to be included, and make estimates and assumptions that affect reported information. The MD&A also includes information regarding the impact of current transactions and events, sources of liquidity and capital resources, operating trends, and risks and uncertainties. Actual results in the future may differ materially from our present assessment of this information because events and circumstances in the future may not occur as expected.
The financial information presented in the bank’s Annual Report is consistent with that in the consolidated financial statements.
In meeting our responsibility for the reliability and timeliness of financial information, we maintain and rely on a comprehensive system of internal controls, including organizational and procedural controls, disclosure controls and procedures, and internal control over financial reporting.
Our system of internal controls includes written communication of our policies and procedures governing corporate conduct and risk management; comprehensive business planning; effective segregation of duties; delegation of authority and personal accountability; escalation of relevant information for decisions regarding public disclosure; careful selection and training of personnel; and accounting policies that we regularly update.
Our internal controls are designed to provide reasonable assurance that transactions are authorized, assets are safeguarded and proper records are maintained, and that we are in compliance with all regulatory requirements. The system of internal controls is further supported by a compliance function, which is designed to ensure that we and our employees comply with securities legislation and conflict of interest rules, and by an internal audit staff, who conduct periodic audits of all aspects of our operations.
As of October 31, 2015, we, as the bank’s Chief Executive Officer and Chief Financial Officer, have determined that the bank’s internal control over financial reporting is effective. We have certified Bank of Montreal’s annual filings with the CSA and with the SEC pursuant to National
Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings and the Securities Exchange Act of 1934.
In order to provide their audit opinions on our consolidated financial statements and on the bank’s internal control over financial reporting, the
Shareholders’ Auditors audit our system of internal controls over financial reporting and conduct work to the extent that they consider appropriate.
Their audit opinion on the bank’s internal control over financial reporting as of October 31, 2015 is set forth on page 134.
The Board of Directors, based on recommendations from its Audit and Conduct Review Committee, reviews and approves the financial information contained in the Annual Report, including the MD&A. The Board of Directors and its relevant committees oversee management’s responsibilities for the preparation and presentation of financial information, maintenance of appropriate internal controls, compliance with legal and regulatory requirements, management and control of major risk areas, and assessment of significant and related party transactions.
The Audit and Conduct Review Committee, which is comprised entirely of independent directors, is also responsible for selecting the
Shareholders’ Auditors and for reviewing the qualifications, independence and performance of both the Shareholders’ Auditors and internal audit.
The Shareholders’ Auditors and the bank’s Chief Auditor have full and free access to the Board of Directors, its Audit and Conduct Review Committee and other relevant committees to discuss audit, financial reporting and related matters.
The Office of the Superintendent of Financial Institutions Canada conducts examinations and inquiries into the affairs of the bank as are deemed necessary to ensure that the provisions of the Bank Act, with respect to the safety of the depositors, are being duly observed and that the bank is in sound financial condition.
William A. Downe
Chief Executive Officer
132 BMO Financial Group 198th Annual Report 2015
Thomas E. Flynn
Chief Financial Officer
Toronto, Canada
December 1, 2015
Independent Auditors’ Report of Registered Public
Accounting Firm
To the Shareholders and Board of Directors of Bank of Montreal
We have audited the accompanying consolidated financial statements of Bank of Montreal (the “Bank”), which comprise the consolidated balance sheets as at October 31, 2015 and October 31, 2014, the consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the years in the three-year period ended October 31, 2015, and notes, comprising a summary of significant accounting policies and other explanatory information.
Management’s Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International
Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements.
The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Bank as at
October 31, 2015 and October 31, 2014, and its consolidated financial performance and its consolidated cash flows for each of the years in the threeyear period ended October 31, 2015 in accordance with International Financial Reporting Standards as issued by the International Accounting
Standards Board.
Other Matter
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Bank’s internal control over financial reporting as of October 31, 2015, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 1, 2015 expressed an unmodified
(unqualified) opinion on the effectiveness of the Bank’s internal control over financial reporting.
Chartered Professional Accountants, Licensed Public Accountants
December 1, 2015
Toronto, Canada
BMO Financial Group 198th Annual Report 2015 133
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Bank of Montreal
We have audited Bank of Montreal’s (the “Bank”) internal control over financial reporting as of October 31, 2015, based on criteria established in
Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Bank’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included under the heading “Management’s Annual Report on Disclosure Controls and Procedures and Internal Control over Financial Reporting” in the accompanying Management’s Discussion and Analysis. Our responsibility is to express an opinion on the Bank’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, 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.
In our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of October 31, 2015, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also have audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of the Bank as at October 31, 2015 and 2014, the consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the years in the three-year period ended October 31, 2015, and notes, comprising a summary of significant accounting policies and other explanatory information, and our report dated December 1, 2015 expressed an unmodified (unqualified) opinion on those consolidated financial statements.
Chartered Professional Accountants, Licensed Public Accountants
December 1, 2015
Toronto, Canada
134 BMO Financial Group 198th Annual Report 2015
Consolidated Statement of Income
For the Year Ended October 31 (Canadian $ in millions, except as noted)
2014
2015
Interest, Dividend and Fee Income
Loans
Securities (Note 3)
Deposits with banks
$
11,263
1,912
190
$
10,997
1,862
182
2013
$
10,951
2,132
182
13,365
13,041
13,265
2,681
171
1,543
2,865
150
1,565
2,727
145
1,716
4,395
4,580
4,588
Net Interest Income
8,970
8,461
8,677
Non-Interest Revenue
Securities commissions and fees
Deposit and payment service charges
Trading revenues
Lending fees
Card fees
Investment management and custodial fees
Mutual fund revenues
Underwriting and advisory fees
Securities gains, other than trading (Note 3)
Foreign exchange, other than trading
Insurance revenue
Other
953
1,077
987
737
460
1,500
1,385
706
171
172
1,762
509
934
1,002
949
680
462
1,246
1,073
744
162
179
2,008
323
846
916
849
603
461
971
832
659
285
172
1,212
347
Interest Expense
Deposits
Subordinated debt
Other liabilities
10,419
9,762
8,153
19,389
Total Revenue
18,223
16,830
561
587
1,254
1,505
767
Non-Interest Expense
Employee compensation (Notes 22 and 23)
Premises and equipment (Note 9)
Amortization of intangible assets (Note 11)
Travel and business development
Communications
Business and capital taxes
Professional fees
Other
7,081
2,137
411
605
314
45
595
994
6,242
1,908
382
542
289
39
622
897
5,842
1,833
346
514
291
39
527
834
12,182
10,921
10,226
5,341
936
5,236
903
5,250
1,055
Income Before Provision for Income Taxes
Provision for income taxes (Note 24)
Net Income
$
Attributable to:
Bank shareholders
Non-controlling interest in subsidiaries (Notes 16 and 17)
4,405
$
4,333
$
4,277
56
4,370
35
4,195
4,130
65
Net Income
$
4,405
$
4,333
$
4,195
Earnings Per Share (Canadian $) (Note 25)
Basic
Diluted
$
6.59
6.57
$
6.44
6.41
$
6.19
6.17
The accompanying notes are an integral part of these consolidated financial statements.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
William A. Downe
Chief Executive Officer
Philip S. Orsino
Chairman, Audit and Conduct Review Committee
BMO Financial Group 198th Annual Report 2015 135
Consolidated Financial Statements
612
Insurance Claims, Commissions and Changes in Policy Benefit Liabilities (Note 14)
Provision for Credit Losses (Note 4)
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statement of Comprehensive Income
For the Year Ended October 31 (Canadian $ in millions)
Net Income
2014
2015
$
Other Comprehensive Income (Loss)
Items that may subsequently be reclassified to net income
Net change in unrealized gains (losses) on available-for-sale securities
Unrealized gains (losses) on available-for-sale securities arising during the year (1)
Reclassification to earnings of (gains) in the year (2)
4,405
$
4,333
2013
$
4,195
(166)
(65)
Consolidated Financial Statements
Net of income tax (provision) recovery of $63 million, $(22) million and $9 million for the year ended, respectively.
Net of income tax provision of $24 million, $37 million and $22 million for the year ended, respectively.
Net of income tax (provision) recovery of $(188) million, $(79) million and $12 million for the year ended, respectively.
Net of income tax provision of $14 million, $28 million and $45 million for the year ended, respectively.
Net of income tax recovery of $167 million, $144 million and $146 million for the year ended, respectively.
Net of income tax (provision) recovery of $(51) million, $63 million and $(126) million for the year ended, respectively.
Net of income tax provision of $43 million for the year ended October 31, 2015.
The accompanying notes are an integral part of these consolidated financial statements.
136 BMO Financial Group 198th Annual Report 2015
(150)
1,378
(415)
741
(409)
963
332
200
120
(125)
–
298
–
(125)
298
938
3,265
$
Attributable to:
Bank shareholders
Non-controlling interest in subsidiaries (Notes 16 and 17)
Total Comprehensive Income
149
320
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(25)
(125)
2,705
Total Comprehensive Income
247
(98)
3,187
(482)
Other Comprehensive Income
(60)
471
Items that will not be reclassified to net income
Gains (losses) on remeasurement of pension and other employee future benefit plans (6)
Gains on remeasurement of own credit risk on financial liabilities designated at fair value (Note 1) (7)
(49)
528
(57)
Net gain on translation of net foreign operations
Unrealized gains on translation of net foreign operations
Unrealized (losses) on hedges of net foreign operations (5)
(10)
(50)
(231)
Net change in unrealized gains (losses) on cash flow hedges
Gains (losses) on cash flow hedges arising during the year (3)
Reclassification to earnings of (gains) on cash flow hedges (4)
28
(77)
7,670
$
7,670
420
$
5,215
56
7,635
35
$
5,271
$
5,271
4,615
4,550
65
$
4,615
Consolidated Balance Sheet
As at October 31 (Canadian $ in millions)
Assets
Cash and Cash Equivalents (Note 2)
2014
2015
$
40,295
$
28,386
7,382
6,110
72,460
48,006
9,432
1,020
85,022
46,966
10,344
987
130,918
143,319
68,066
53,555
Loans (Notes 4 and 6)
Residential mortgages
Consumer instalment and other personal
Credit cards
Businesses and governments
105,918
65,598
7,980
145,076
101,013
64,143
7,972
120,766
Customers‘ liability under acceptances
Allowance for credit losses (Note 4)
324,572
11,307
(1,855)
293,894
10,878
(1,734)
334,024
303,038
38,238
2,285
6,069
2,208
561
3,162
8,673
32,655
2,276
5,353
2,052
665
3,019
8,231
Interest Bearing Deposits with Banks (Note 2)
Securities (Note 3)
Trading
Available-for-sale
Held-to-maturity
Other
Securities Borrowed or Purchased Under Resale Agreements (Note 4)
Other Assets
Derivative instruments (Note 8)
Premises and equipment (Note 9)
Goodwill (Note 11)
Intangible assets (Note 11)
Current tax assets
Deferred tax assets (Note 24)
Other (Note 12)
54,251
61,196
$
641,881
$
588,659
Liabilities and Equity
Deposits (Note 13)
Banks
Businesses and governments
Individuals
$
27,135
263,618
147,416
$
18,243
239,139
135,706
438,169
393,088
42,639
11,307
21,226
39,891
102
265
43,953
33,657
10,878
27,348
39,695
235
178
43,263
159,383
155,254
4,416
4,913
Equity
Share capital (Note 17)
Contributed surplus
Retained earnings
Accumulated other comprehensive income
15,553
299
18,930
4,640
15,397
304
17,237
1,375
Total shareholders‘ equity
Non-controlling interest in subsidiaries (Notes 16 and 17)
39,422
491
34,313
1,091
Total Equity
39,913
35,404
Other Liabilities
Derivative instruments (Note 8)
Acceptances (Note 14)
Securities sold but not yet purchased (Note 14)
Securities lent or sold under repurchase agreements (Note 14)
Current tax liabilities
Deferred tax liabilities (Note 24)
Other (Note 14)
Subordinated Debt (Note 15)
Total Liabilities and Equity
$
641,881
$
588,659
The accompanying notes are an integral part of these consolidated financial statements.
BMO Financial Group 198th Annual Report 2015 137
Consolidated Financial Statements
Total Assets
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statement of Changes in Equity
For the Year Ended October 31 (Canadian $ in millions)
Preferred Shares (Note 17)
Balance at beginning of year
Issued during the year
Redeemed during the year
Balance at End of Year
2014
2015
$
2013
3,040 $
950
(750)
2,265 $
1,200
(425)
2,465
–
(200)
3,240
3,040
2,265
Common Shares (Note 17)
Balance at beginning of year
Issued under the Shareholder Dividend Reinvestment and Share Purchase Plan (Note 17)
Issued under the Stock Option Plan (Note 22)
Repurchased for cancellation (Note 17)
12,357
58
51
(153)
12,003
223
131
–
11,957
130
116
(200)
Balance at End of Year
12,313
12,357
12,003
Contributed Surplus
Balance at beginning of year
Stock option expense/exercised (Note 22)
Foreign exchange on redemption of preferred shares
Other
304
–
–
(5)
315
(7)
–
(4)
213
(5)
107
–
Balance at End of Year
299
304
315
Retained Earnings
Balance at beginning of year
Net income attributable to bank shareholders
Dividends – Preferred shares (Note 17)
– Common shares (Note 17)
Preferred shares redeemed during the year (Note 17)
Common shares repurchased for cancellation (Note 17)
Share issue expense
17,237
4,370
(117)
(2,087)
(3)
(465)
(5)
15,087
4,277
(120)
(1,991)
–
–
(16)
13,456
4,130
(120)
(1,904)
–
(475)
–
Balance at End of Year
18,930
17,237
15,087
Accumulated Other Comprehensive Income on Available-for-Sale Securities
Balance at beginning of year
Unrealized gains (losses) on available-for-sale securities arising during the year (1)
Reclassification to earnings of (gains) in the year (2)
205
28
(77)
265
(10)
(50)
Balance at End of Year
(75)
156
205
Accumulated Other Comprehensive Income on Cash Flow Hedges
Balance at beginning of year
Gains (losses) on cash flow hedges arising during the year (3)
Reclassification to earnings of (gains) in the year (4)
141
528
(57)
(8)
247
(98)
142
(25)
(125)
Balance at End of Year
Consolidated Financial Statements
156
(166)
(65)
612
141
Accumulated Other Comprehensive Income on Translation of Net Foreign Operations
Balance at beginning of year
Unrealized gains on translation of net foreign operations
Unrealized (losses) on hedges of net foreign operations (5)
1,368
3,187
(482)
405
1,378
(415)
73
741
(409)
Balance at End of Year
4,073
1,368
405
Accumulated Other Comprehensive Income on Pension and Other Post-Employment Plans
Balance at beginning of year
Gains (losses) on remeasurement of pension and other employee future benefit plans (6)
(8)
(290)
200
(165)
(125)
(463)
298
Balance at End of Year
(90)
(290)
(165)
Accumulated Other Comprehensive Income on Own Credit Risk on Financial Liabilities
Designated at Fair Value
Balance at beginning of year
Gains on remeasurement of own credit risk on financial liabilities designated at fair value (Note 1) (7)
–
120
Balance at End of Year
Total Accumulated Other Comprehensive Income
Total Shareholders‘ Equity
Non-controlling Interest in Subsidiaries
Balance at beginning of year
Net income attributable to non-controlling interest
Dividends to non-controlling interest
Redemption of securities of a subsidiary (Note 17)
Redemption of capital trust securities (Note 16)
Acquisitions (Note 10)
Other
Balance at End of Year
Total Equity
(1) Net of income tax (provision) recovery of $63 million, $(22) million and $9 million for the year ended, respectively.
(2) Net of income tax provision of $24 million, $37 million and $22 million for the year ended, respectively.
(3) Net of income tax (provision) recovery of $(188) million, $(79) million and $12 million for the year ended, respectively.
(4) Net of income tax provision of $14 million, $28 million and $45 million for the year ended, respectively.
(5) Net of income tax recovery of $167 million, $144 million and $146 million for the year ended, respectively.
(6) Net of income tax (provision) recovery of $(51) million, $63 million and $(126) million for the year ended, respectively.
(7) Net of income tax provision of $43 million for the year ended October 31, 2015.
The accompanying notes are an integral part of these consolidated financial statements.
138 BMO Financial Group 198th Annual Report 2015
–
–
–
–
120
–
–
4,640
1,375
437
$ 39,422
$
$
1,072
56
(52)
–
–
22
(7)
1,091
35
(37)
–
(600)
–
2
$
35,404
30,107
1,435
65
(73)
(359)
–
–
4
1,091
491
$ 39,913
34,313
1,072
$
31,179
Consolidated Statement of Cash Flows
For the Year Ended October 31 (Canadian $ in millions)
Cash Flows from Operating Activities
Net Income
Adjustments to determine net cash flows provided by (used in) operating activities
Impairment write-down of securities, other than trading (Note 3)
Net (gain) on securities, other than trading (Note 3)
Net (increase) decrease in trading securities
Provision for credit losses (Note 4)
Change in derivative instruments – (Increase) decrease in derivative asset
– Increase (decrease) in derivative liability
Amortization of premises and equipment (Note 9)
Amortization of intangible assets (Note 11)
Net decrease in deferred income tax asset
Net increase (decrease) in deferred income tax liability
Net decrease in current income tax asset
Net increase (decrease) in current income tax liability
Change in accrued interest – (Increase) decrease in interest receivable
– Increase (decrease) in interest payable
Changes in other items and accruals, net
Net increase in deposits
Net (increase) in loans
Net increase (decrease) in securities sold but not yet purchased
Net increase (decrease) in securities lent or sold under repurchase agreements
Net (increase) decrease in securities borrowed or purchased under resale agreements
2014
2015
$
4,405
$
4,333
2013
$
4,195
11,444
(48)
(406)
1,000
1,200
(425)
–
–
(16)
133
–
(1,851)
(52)
(397)
(1,354)
–
–
(200)
(359)
–
–
122
(675)
(1,896)
(73)
(465)
(4,832)
(461)
(16,996)
5,267
16,740
(179)
(345)
–
519
(24,674)
11,698
17,184
(355)
(382)
(956)
302
(32,007)
13,233
17,288
(361)
(254)
140
4,026
3,034
(1,659)
5,484
2,396
1,480
11,909
28,386
Net Cash Provided by (Used in) Financing Activities
(2,927)
(390)
4,103
(500)
950
(753)
–
(600)
(5)
51
(618)
(2,135)
(37)
Cash Flows from Financing Activities
Net (decrease) in liabilities of subsidiaries
Proceeds from issuance (maturities) of Covered Bonds (Note 13)
Proceeds from issuance (repayment) of subordinated debt (Note 15)
Proceeds from issuance of preferred shares (Note 17)
Redemption of preferred shares (Note 17)
Redemption of securities of a subsidiary (Note 17)
Redemption of capital trust securities (Note 16)
Share issue expense
Proceeds from issuance of common shares (Note 17)
Common shares repurchased for cancellation (Note 17)
Cash dividends paid
Cash dividends paid to non-controlling interest
17
(302)
(4,392)
587
20,240
(19,195)
348
346
203
(65)
389
21
122
(129)
(364)
35,739
(21,665)
(1,221)
(12,090)
8,660
2,333
Net Cash Provided by (Used in) Operating Activities
8
(170)
(8,470)
561
(2,822)
1,402
365
382
241
(42)
546
(226)
(36)
160
4,094
9,814
(15,207)
4,429
9,073
(11,362)
2,038
26,348
6,433
19,915
66
Cash Flows from Investing Activities
Net (increase) decrease in interest bearing deposits with banks
Purchases of securities, other than trading
Maturities of securities, other than trading
Proceeds from sales of securities, other than trading
Premises and equipment – net (purchases)
Purchased and developed software – net (purchases)
Acquisitions (Note 10)
Net Cash Provided by (Used in) Investing Activities
Effect of Exchange Rate Changes on Cash and Cash Equivalents
Net increase in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Year
Cash and Cash Equivalents at End of Year
$
40,295
$
28,386
$
26,348
Represented by:
Cash and deposits with banks (Note 2)
Cheques and other items in transit, net (Note 2)
$
38,818
1,477
$
27,056
1,330
$
24,938
1,410
$
40,295
$
28,386
$
26,348
$
$
$
4,476
641
13,306
$
$
$
4,407
264
12,849
$
$
$
4,708
577
13,283
Supplemental Disclosure of Cash Flow Information
Net cash provided by operating activities includes:
Amount of interest paid in the year
Amount of income taxes paid in the year
Amount of interest and dividend income received in the year
The accompanying notes are an integral part of these consolidated financial statements.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
BMO Financial Group 198th Annual Report 2015 139
Consolidated Financial Statements
12
(183)
15,613
612
(6,178)
9,320
378
411
226
76
298
(141)
53
(113)
4,791
7,967
(15,600)
(7,049)
(4,625)
(7,940)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation
Bank of Montreal (“the bank”) is a chartered bank under the Bank Act (Canada) and is a public company incorporated in Canada. We are a highly diversified financial services company and provide a broad range of personal and commercial banking, wealth management and investment banking products and services. The bank’s head office is at 129 rue Saint Jacques, Montreal, Quebec. Its executive offices are at 100 King Street West, 1 First
Canadian Place, Toronto, Ontario. Our common shares are listed on the Toronto Stock Exchange and the New York Stock Exchange.
We have prepared these consolidated financial statements in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). We also comply with interpretations of IFRS by our regulator, the Office of the Superintendent of Financial Institutions Canada (“OSFI”).
Our consolidated financial statements have been prepared on a historic cost basis, except the revaluation of the following items: assets and liabilities held for trading; available-for-sale financial assets; financial instruments designated at fair value through profit or loss; financial assets and financial liabilities designated as hedged items in qualifying fair value hedge relationships; cash-settled share-based payment liabilities; defined benefit pension and other employee future benefit liabilities; and insurance-related liabilities.
These consolidated financial statements were authorized for issue by the Board of Directors on December 1, 2015.
Basis of Consolidation
These consolidated financial statements are inclusive of the financial statements of our subsidiaries as at October 31, 2015. We conduct business through a variety of corporate structures, including subsidiaries, joint ventures, structured entities (“SEs”) and associates. Subsidiaries are those entities where we exercise control through our ownership of the majority of the voting shares. Joint ventures are those entities where we exercise joint control through an agreement with other shareholders. We also hold interests in SEs, which we consolidate where we control the SE. These are more fully described in Note 7. All of the assets, liabilities, revenues and expenses of our subsidiaries and consolidated SEs are included in our consolidated financial statements. All intercompany transactions and balances are eliminated on consolidation.
We hold investments in associates, where we exert significant influence over operating, investing and financing decisions (generally companies in which we own between 20% and 50% of the voting shares). These are accounted for using the equity method. The equity method is also applied to our investments in joint ventures. Under the equity method of accounting, investments are initially recorded at cost, and the carrying amount is increased or decreased to recognize our share of investee net income or loss, including other comprehensive income or loss. The investment is recorded as securities, other, in our Consolidated Balance Sheet and our share of the net income or loss is recorded in interest, dividend and fee income, securities, in our Consolidated Statement of Income. Any other comprehensive income amounts are reflected in the relevant section of our
Statement of Comprehensive Income.
Non-controlling interest in subsidiaries is presented in our Consolidated Balance Sheet as a separate component of equity that is distinct from our shareholders’ equity. The net income attributable to non-controlling interest in subsidiaries is presented separately in our Consolidated Statement of
Income.
Specific Accounting Policies
To facilitate a better understanding of our consolidated financial statements, we have disclosed our significant accounting policies throughout the following notes with the related financial disclosures by major caption:
Note
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Topic
Basis of Presentation
Cash and Interest Bearing Deposits with Banks
Securities
Loans, Customers’ Liability under Acceptances and
Allowance for Credit Losses
Risk Management
Transfer of Assets
Structured Entities
Derivative Instruments
Premises and Equipment
Acquisitions
Goodwill and Intangible Assets
Other Assets
Deposits
Other Liabilities
Subordinated Debt
Capital Trust Securities
Page
140
144
144
148
151
153
154
156
163
163
164
166
166
167
168
169
Note
17
18
19
20
21
22
23
24
25
26
27
28
29
30
Topic
Equity
Fair Value of Financial Instruments
Offsetting of Financial Assets and Financial Liabilities
Interest Rate Risk
Capital Management
Employee Compensation – Share-Based Compensation
Employee Compensation – Pension and Other Employee
Future Benefits
Income Taxes
Earnings Per Share
Commitments, Guarantees, Pledged Assets, Provisions and
Contingent Liabilities
Operating and Geographic Segmentation
Significant Subsidiaries
Related Party Transactions
Contractual Maturities of Assets and Liabilities and
Off-Balance Sheet Commitments
Page
170
172
180
180
181
182
184
189
191
192
194
196
197
198
Notes
Translation of Foreign Currencies
We conduct business in a variety of foreign currencies and present our consolidated financial statements in Canadian dollars, which is our functional currency. Monetary assets and liabilities, as well as non-monetary assets and liabilities measured at fair value that are denominated in foreign currencies, are translated into Canadian dollars at the exchange rate in effect at the balance sheet date. Non-monetary assets and liabilities not measured at fair value are translated into Canadian dollars at historical rates. Revenues and expenses denominated in foreign currencies are translated using the average exchange rate for the year.
Unrealized gains and losses arising from translating our net investment in foreign operations into Canadian dollars, net of related hedging activities and applicable income taxes, are included in our Consolidated Statement of Comprehensive Income within net gain (loss) on translation of net foreign operations. When we dispose of a foreign operation such that control, significant influence or joint control is lost, the cumulative amount of the translation gain (loss) and any applicable hedging activities and related income taxes are reclassified to our Consolidated Statement of Income
140 BMO Financial Group 198th Annual Report 2015
as part of the gain or loss on disposition. All other foreign currency translation gains and losses are included in foreign exchange, other than trading, in our Consolidated Statement of Income as they arise.
Foreign currency translation gains and losses on available-for-sale debt securities that are denominated in foreign currencies are included in foreign exchange, other than trading, in our Consolidated Statement of Income. Foreign currency translation gains and losses on available-for-sale equity securities that are denominated in foreign currencies are included in accumulated other comprehensive income on available-for-sale securities in our Consolidated Statement of Changes in Equity.
From time to time, we enter into foreign exchange hedge contracts to reduce our exposure to changes in the value of foreign currencies.
Realized and unrealized gains and losses that arise on the mark-to-market of foreign exchange contracts related to economic hedges are included in non-interest revenue in our Consolidated Statement of Income. Changes in the fair value of forward contracts that qualify as accounting hedges are recorded in our Consolidated Statement of Comprehensive Income within net change in unrealized gains (losses) on cash flow hedges, with the spot/ forward differential (the difference between the foreign currency exchange rate at the inception of the contract and the rate at the end of the contract) recorded in interest income (expense) over the term of the hedge.
Dividend and Fee Income
Dividend Income
Dividend income is recognized when the right to receive payment is established. This is the ex-dividend date for listed equity securities.
Fee Income
Fee income (including commissions) is recognized based on the services or products for which the fee is paid. See Note 4 for the accounting treatment for lending fees.
Investment management and custodial fees are based primarily on the balance of assets under management and assets under administration as at the period end, respectively, for services provided.
Securities commissions and fees and underwriting and advisory fees are recorded as revenue when the related services are completed. Deposit and payment service charges and insurance fees are recognized over the period in which the related services are provided. Card fees primarily include interchange income, late fees, cash advance fees and annual fees. Card fees are recorded as billed, except for annual fees, which are recorded evenly throughout the year.
Use of Estimates and Judgments
The preparation of the consolidated financial statements requires management to use estimates and assumptions that affect the carrying amounts of certain assets and liabilities, certain amounts reported in net income and other related disclosures.
The most significant assets and liabilities for which we must make estimates include allowance for credit losses; financial instruments measured at fair value; pension and other employee future benefits; impairment of securities; income taxes and deferred taxes, purchased loans; goodwill; insurance-related liabilities; provisions and transfers of financial assets and consolidation of structured entities. We make judgments in assessing whether substantially all risks and rewards have been transferred in respect of transfers of financial assets and whether we control SEs. These judgments are discussed in Notes 6 and 7, respectively. If actual results were to differ from the estimates, the impact would be recorded in future periods. We have 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 our 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.
Additional information regarding the allowance for credit losses is included in Note 4.
Financial Instruments Measured at Fair Value
Fair value measurement techniques are used to value various financial assets and financial liabilities and are used in performing impairment testing on certain non-financial assets. A detailed discussion of our fair value measurement techniques is included in Note 3 and Note 18.
Pension and Other Employee Future Benefits
Our pension and other employee future benefits expense is calculated by our independent actuaries using assumptions determined by management.
If actual experience were to differ from the assumptions used, we would recognize this difference in other comprehensive income.
Pension and other employee future benefits expense, plan assets and defined benefit obligations are also sensitive to changes in discount rates.
We determine discount rates at each year end for all of our plans using high-quality Aa rated corporate bonds with terms matching the plans’ specific cash flows.
Additional information regarding our accounting for pension and other employee future benefits is included in Note 23.
BMO Financial Group 198th Annual Report 2015 141
Notes
Impairment of Securities
We have investments in securities issued or guaranteed by Canadian, U.S. and other governments, corporate debt and equity securities, mortgagebacked securities and collateralized obligations, which are classified as either available-for-sale securities, held-to-maturity securities or other securities. We review held-to-maturity, available-for-sale and other securities at each quarter-end reporting period to identify and evaluate investments that show indications of possible impairment.
For held-to-maturity, available-for-sale and other securities, impairment losses are recognized if there is objective evidence of impairment as a result of an event that reduces the estimated future cash flows from the security and the impact can be reliably estimated. Objective evidence of impairment includes default or delinquency by a debtor, restructuring of an amount due to us on terms that we would not otherwise consider, indications that a debtor or issuer will enter bankruptcy, or the disappearance of an active market for a security. In addition, for equity securities, a significant or prolonged decline in the fair value of a security below its cost is objective evidence of impairment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The decision to record a write-down, the amount and the period in which it is recorded could change if management’s assessment of these factors changes. We do not record impairment write-downs on debt securities when impairment is due to changes in market interest rates if future contractual cash flows associated with the debt security are still expected to be recovered.
Additional information regarding our accounting for held-to-maturity, available-for-sale and other securities, and the determination of fair value is included in Note 3 and Note 18.
Income Taxes and Deferred Tax Assets
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 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 deferred tax assets and liabilities. If our interpretations differ from those of tax authorities or if the timing of reversals is not as expected, our provision for income taxes could increase or decrease in future periods. The amount of any such increase or decrease cannot be reasonably estimated.
Deferred tax assets are recognized only when it is probable that sufficient taxable profit will be available in future periods against which deductible temporary differences may be utilized. We are required to assess whether it is probable that our deferred income tax assets will be realized prior to expiration and, based on all the available evidence, determine if any portion of our deferred income tax assets should not be recognized. The factors used to assess the probability of realization are our past experience of income and capital gains, forecast of future net income before taxes, available tax planning strategies that could be implemented to realize the deferred income tax asset, and the remaining expiration period of tax loss carryforwards. Changes in our assessment of these factors could increase or decrease our provision for income taxes in future periods. Additional information regarding our accounting for income taxes is included in Note 24.
Goodwill and Intangible Assets
For the purpose of impairment testing, goodwill is allocated to our groups of cash-generating units (“CGUs”), which represent the lowest level within the bank at which goodwill is monitored for internal management purposes. Impairment testing is performed at least annually, by comparing the carrying values and the recoverable amounts of the CGUs to which goodwill has been allocated to determine whether the recoverable amount of each group is greater than its carrying value. If the carrying value of the group were to exceed its recoverable amount, an impairment calculation would be performed. The recoverable amount of a CGU is the higher of its fair value less costs to sell and the value in use.
Fair value less costs to sell is used to perform the impairment test. In determining fair value less costs to sell, we employ a discounted cash flow model consistent with those used when we acquire businesses. This model is dependent on assumptions related to revenue growth, discount rates, synergies achieved on acquisition and the availability of comparable acquisition data. Changes in any of these assumptions would affect the determination of fair value for each of the business units in a different manner. Management must exercise its judgment and make assumptions in determining fair value less costs to sell, and differences in judgment and assumptions could affect the determination of fair value and any resulting impairment write-down. As at October 31, 2015, the estimated fair value of each of our business units was greater than its carrying value.
Additional information regarding goodwill and intangible assets is included in Note 11.
Definite life 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. We test definite life intangible assets for impairment when circumstances indicate the carrying value may not be recoverable. Indefinite life intangible assets are tested annually for impairment. If any intangible assets are determined to be impaired, we write them down to their recoverable amount, the higher of value in use and fair value less costs to sell, when this is less than the carrying value. No such impairment was identified for the years ended October 31, 2015 and 2014.
Notes
Purchased Loans
Significant judgment and assumptions were applied to determine the fair value of the Marshall & Ilsley Corporation (“M&I”) loan portfolio. Loans were identified as either purchased performing loans or purchased credit impaired loans (PCI loans), both of which were recorded at fair value at the time of acquisition. The determination of fair value involved estimating the expected cash flows to be received and determining the discount rate to be applied to the cash flows from the loan portfolio. In determining the discount rate, we considered various factors, including our cost to raise funds in the current market, the risk premium associated with the loans and the cost to service the portfolios. PCI loans are those where the timely collection of principal and interest was no longer reasonably assured as at the date of acquisition. We regularly evaluate what we expect to collect on PCI loans.
Changes in expected cash flows could result in the recognition of impairment or a recovery through the provision for credit losses. Estimating the timing and amount of cash flows requires significant management judgment regarding key assumptions, including the probability of default, severity of loss, timing of payment receipts and valuation of collateral. All of these factors are inherently subjective and can result in significant changes in cash flow estimates over the term of the loan.
Insurance-Related Liabilities
Insurance claims and policy benefit liabilities represent current claims and estimates of future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method, which incorporates best-estimate assumptions for mortality, morbidity, policy lapses, surrenders, future investment yields, policy dividends, administration costs and margins for adverse deviation. These assumptions are reviewed at least annually and updated to reflect actual experience and market conditions. The most significant impact on the valuation of a liability would result from a change in the assumption for future investment yields.
Additional information regarding insurance-related liabilities is included in Note 14.
Provisions
The bank and its subsidiaries are involved in various legal actions in the ordinary course of business.
Provisions are recorded at the best estimate of the amounts required to settle any obligations related to these legal actions as at the balance sheet date, taking into account the risks and uncertainties associated with the obligation. Factors considered in making the assessment include: a case-by-case assessment of specific facts and circumstances, our past experience and opinions of legal experts. Management and
142 BMO Financial Group 198th Annual Report 2015
external experts are involved in estimating any provisions. The actual costs of resolving these claims may be substantially higher or lower than the amounts of the provisions.
Additional information regarding provisions is provided in Note 26.
Transfer of Financial Assets and Consolidation of Structured Entities
We sell Canadian mortgage loans to third-party Canadian securitization programs, including the Canadian Mortgage Bond program, and directly to third-party investors under the National Housing Act Mortgage-Backed Securities program. We assess whether substantially all of the risks and rewards of the loans have been transferred to determine if they qualify for derecognition. Since we continue to be exposed to substantially all of the repayment, interest rate and/or credit risk associated with the securitized loans, they do not qualify for derecognition. We continue to recognize the loans and the related cash proceeds as secured financing in our Consolidated Balance Sheet. We also use securitization vehicles to securitize our
Canadian credit card loans in order to obtain alternate sources of funding. The structure of these vehicles limits the activities they can undertake and the types of assets they can hold, and the vehicles have limited decision-making authority. The vehicles issue term asset-backed securities to fund their activities. We control and consolidate these vehicles, as we have the key decision-making powers necessary to obtain the majority of the benefits of their activities.
For most of our subsidiaries, control is determined based on holding the majority of the voting rights. For certain investments in limited partnerships, we exercise judgment in determining if we control an entity. Based on an assessment of our interests and rights, we have determined that we do not control certain entities, even though we may have an ownership interest greater than 50%. This may be the case when we are not the general partner in an arrangement and the general partner’s rights most significantly affect the returns of the entity. Additionally, we have determined that we control certain entities despite having an ownership interest less than 50%. This may be the case when we are the general partner in an arrangement and the general partner’s rights most significantly affect the returns of the entity.
Structured entities are discussed in greater detail in Note 7 and transferred assets are discussed in greater detail in Note 6.
Changes in Accounting Policies
Effective November 1, 2014, we adopted the following new and amended accounting pronouncements issued by the IASB.
Own Credit
We early adopted the own credit provisions of IFRS 9 Financial Instruments. The provisions require that for financial liabilities designated at fair value through profit or loss, such as deposits and insurance investment contracts, changes in fair value attributable to our credit risk be presented in other comprehensive income rather than net income, unless doing so would create or enlarge an accounting mismatch in net income. Changes in fair value not attributable to our credit risk continue to be recorded in net income. The provisions were adopted prospectively and resulted in a $120 million gain, net of taxes, being recorded in other comprehensive income rather than net income.
Levies
We adopted the IFRS Interpretations Committee Interpretation 21 Levies (“IFRIC 21”). IFRIC 21 provides guidance on when to recognize a liability to pay a levy imposed by a government in accordance with legislation. The adoption of IFRIC 21 did not have a significant impact on our consolidated financial statements.
Impairment of Assets
We adopted the amendments to IAS 36 Impairment of Assets. The amendments address the disclosure of information about the recoverable amount of impaired assets if that amount is based on fair value less cost of disposal. The adoption of the amendments did not have an impact on disclosure in our consolidated financial statements.
Offsetting of Financial Assets and Financial Liabilities
We adopted the amendments to IAS 32 Financial Instruments: Presentation. The amendments clarify that an entity has a current legally enforceable right of offset if that right is not contingent on a future event, and that right is enforceable both in the normal course of business and in the event of default, insolvency or bankruptcy of the entity and all counterparties. The adoption of the amendments did not have an impact on our consolidated financial statements.
Future Changes in IFRS
Revenue
In May 2014, the IASB issued IFRS 15 Revenue from Contracts with Customers (“IFRS 15”), which replaces the existing standards for revenue recognition. The new standard establishes a framework for the recognition and measurement of revenues generated from contracts with customers,
BMO Financial Group 198th Annual Report 2015 143
Notes
Financial Instruments
In July 2014, the IASB issued IFRS 9 Financial Instruments (“IFRS 9”), which addresses impairment, classification, measurement, and hedge accounting.
IFRS 9 introduces a new single impairment model for financial assets. The new model is based on expected credit losses and will result in credit losses being recognized regardless of whether a loss event has occurred. The expected credit loss model will apply to most financial instruments not measured at fair value, with the most significant impact being to loans. The expected credit loss model requires the recognition of credit losses based on a 12-month time horizon for performing loans, and requires the recognition of lifetime expected credit losses for loans that have experienced a significant deterioration in credit risk since inception. The expected loss calculations are required to incorporate forward looking macro-economic information in determining the final provision.
The new standard requires that we classify assets based on our business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. Financial assets are to be measured at fair value through profit or loss unless certain conditions are met which permit measurement at amortized cost or fair value through other comprehensive income. As noted above in Changes in Accounting Policies, we early adopted the requirements for financial liabilities regarding own credit risk.
IFRS 9 also introduces a new hedge accounting model that expands the scope of hedged items and risks eligible for hedge accounting and aligns hedge accounting more closely with risk management. The new model no longer specifies quantitative measures for effectiveness testing and does not permit hedge de-designation.
In order to meet the requirement to adopt IFRS 9, we have established an enterprise-wide project. We are currently evaluating the impact of adoption which is effective November 1, 2017.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
except for items such as financial instruments, insurance contracts and leases. The standard also requires additional disclosures about the nature, amount, timing and uncertainty of revenues and cash flows arising from transactions with our customers. The IASB deferred the effective date of
IFRS 15 to November 1, 2018. We are currently assessing the impact of the standard on our future financial reporting.
Note 2: Cash and Interest Bearing Deposits with Banks
(Canadian $ in millions)
2015
2014
Cash and deposits with banks (1)
Cheques and other items in transit, net
38,818
1,477
27,056
1,330
Total cash and cash equivalents
40,295
28,386
(1) Includes deposits with the Bank of Canada, the U.S. Federal Reserve and other central banks.
Cheques and Other Items in Transit, Net
Cheques and other items in transit are recorded at cost and represent the net position of the uncleared cheques and other items in transit between us and other banks.
Cash Restrictions
Some of our foreign operations are required to maintain reserves or minimum balances with central banks in their respective countries of operation, amounting to $2,232 million as at October 31, 2015 ($1,638 million in 2014).
Interest Bearing Deposits with Banks
Deposits with banks are recorded at amortized cost and include acceptances we have purchased that were issued by other banks. Interest income earned on these deposits is recorded on an accrual basis.
Note 3: Securities
Securities are divided into four types, each with a different purpose and accounting treatment. The types of securities we hold are as follows:
Trading securities are securities that we purchase for resale over a short period of time. We report these securities at their fair value and record the transaction costs and changes in fair value in our Consolidated Statement of Income in trading revenues.
Notes
Securities Designated at Fair Value
Securities designated at fair value through profit or loss are financial instruments that are accounted for at fair value, with changes in fair value recorded in income provided they meet certain criteria. Securities designated at fair value through profit or loss must have reliably measurable fair values and satisfy one of the following criteria: (1) the designation eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the gains and losses on a different basis; (2) the securities are part of a group of financial instruments that is managed and evaluated on a fair value basis; or (3) the securities are hybrid financial instruments with embedded derivatives that would significantly modify their cash flow. Securities must be designated on initial recognition, and the designation is irrevocable. If these securities were not designated at fair value, they would be accounted for as available-for-sale securities with unrealized gains and losses recorded in other comprehensive income.
We designate certain securities held by our insurance subsidiaries that support our insurance liabilities at fair value through profit or loss, since the actuarial calculation of insurance liabilities is based on the fair value of the investments supporting them. This designation aligns the accounting result with the way the portfolio is managed on a fair value basis. The change in fair value of the securities is recorded in non-interest revenue, insurance revenue, and the change in fair value of the liabilities is recorded in insurance claims, commissions and changes in policy benefit liabilities.
The fair value of these investments as at October 31, 2015 of $6,961 million ($6,599 million as at October 31, 2014) is recorded in securities, trading, in our Consolidated Balance Sheet. The impact of recording these investments at fair value through profit or loss was an increase in non-interest revenue, insurance revenue of $8 million for the year ended October 31, 2015 (increase of $379 million in 2014).
We designate certain investments held in our merchant banking business at fair value through profit or loss, which aligns the accounting result with the way the portfolio is managed. The fair value of these investments as at October 31, 2015 of $365 million ($467 million in 2014) is recorded in securities, other, in our Consolidated Balance Sheet. The impact of recording these investments at fair value through profit or loss was a decrease in non-interest revenue, securities gains, other than trading of $30 million in our Consolidated Statement of Income for the year ended October 31, 2015
(decrease of $36 million in 2014).
Available-for-sale securities consist of debt and equity securities that may be sold in response to or in anticipation of changes in interest rates and resulting prepayment risk, changes in credit risk, changes in foreign currency risk, changes in funding sources or terms, or to meet liquidity needs.
Available-for-sale securities are initially recorded at fair value plus transaction costs. They are subsequently measured at fair value, with unrealized gains and losses recorded in unrealized gains (losses) on available-for-sale securities in our Consolidated Statement of Comprehensive
Income until the security is sold. Gains and losses on disposal and impairment losses are recorded in our Consolidated Statement of Income in noninterest revenue, securities gains, other than trading. Interest income earned and dividends received on available-for-sale securities are recorded in our Consolidated Statement of Income in interest, dividend and fee income, securities.
Investments held by our insurance operations are classified as available-for-sale securities, except for those investments that support the policy benefit liabilities on our insurance contracts, which are designated at fair value through profit or loss, as discussed above. Interest and other fee income on the insurance available-for-sale securities is recognized when earned in our Consolidated Statement of Income in non-interest revenue, insurance revenue.
Held-to-maturity securities are debt securities that we have the intention and ability to hold to maturity. These securities are initially recorded at fair value plus transaction costs and subsequently measured at amortized cost using the effective interest method. Gains and losses on disposal and impairment losses are recorded in our Consolidated Statement of Income in securities gains (losses), other than trading. Interest income earned
144 BMO Financial Group 198th Annual Report 2015
and amortization of premiums or discounts on the debt securities are recorded in our Consolidated Statement of Income in interest, dividend and fee income, securities.
Other securities are investments in companies where we exert significant influence over operating, investing and financing decisions (generally companies in which we own between 20% and 50% of the voting shares) and certain securities held by our merchant banking business.
We account for all of our securities transactions using settlement date accounting in our Consolidated Balance Sheet. Changes in fair value between the trade date and settlement date are recorded in net income, except for those related to available-for-sale securities, which are recorded in other comprehensive income.
Impairment Review
For available-for-sale, held-to-maturity and other securities, impairment losses are recognized if there is objective evidence of impairment as a result of an event that reduces the estimated future cash flows from the security and the impact can be reliably estimated.
For equity securities, a significant or prolonged decline in the fair value of a security below its cost is considered to be objective evidence of impairment. The impairment loss on available-for-sale securities is the difference between the security’s amortized cost and its current fair value, less any previously recognized impairment losses. The impairment loss on held-to-maturity securities is the difference between a security’s carrying amount and the present value of its estimated future cash flows discounted at the original effective interest rate.
If there is objective evidence of impairment, a write-down is recorded in our Consolidated Statement of Income in securities gains, other than trading. For debt securities, a previous impairment loss is reversed through net income if an event occurs after the impairment was recognized that can be objectively attributed to an increase in fair value, to a maximum of the original impairment charge. Reversals of impairment losses on held-tomaturity securities are recorded to a maximum of the amortized cost of the investment before the original impairment charge. For equity securities, previous impairment losses are not reversed through net income, and any subsequent increases in fair value are recorded in other comprehensive income. As at October 31, 2015, we had 682 available-for-sale securities (565 in 2014) with unrealized losses totalling $152 million (unrealized losses of
$35 million in 2014). Of these available-for-sale securities, 69 have been in an unrealized loss position continuously for more than one year (203 in
2014), amounting to an unrealized loss position of $5 million (unrealized loss position of $20 million in 2014). Unrealized losses on these instruments, excluding corporate equities, resulted from changes in interest rates and not from deterioration in the creditworthiness of the issuers.
We expect full recovery of these available-for-sale securities and have determined that there is no significant impairment. The table on page 147 details unrealized gains and losses as at October 31, 2015 and 2014.
We did not own any securities issued by a single non-government entity where the book value, as at October 31, 2015 or 2014, was greater than
10% of our shareholders’ equity.
Fair Value Measurement
For traded securities, quoted market value is considered to be fair value. Quoted market value is based on bid prices. For securities where market quotes are not available, we use estimation techniques to determine fair value. A discussion of fair value measurement is included in Note 18.
Notes
BMO Financial Group 198th Annual Report 2015 145
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Canadian $ in millions, except as noted)
2015
2014
Within
1 year
1 to 3 years 3 to 5 years 5 to 10 years Over 10 years Total
Total
Trading Securities
Issued or guaranteed by:
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Mortgage-backed securities and collateralized mortgage obligations
Corporate debt
Corporate equity
6,472
700
270
98
98
107
1,415
–
2,183
1,146
1,300
129
251
272
782
–
797
1,077
781
80
53
68
713
–
2,451
1,546
394
248
7
41
949
–
1,951
2,282
507
132
2
3
5,428
37,727
13,854
6,751
3,252
687
411
491
9,287
37,727
10,462
7,196
6,165
711
223
702
11,831
47,732
Total trading securities
9,160
6,063
3,569
5,636
48,032
72,460
85,022
215
214
0.56
2,318
2,329
1.00
4,685
4,741
1.62
550
550
1.80
138
136
1.99
7,906
7,970
1.43
10,420
10,501
1.52
53
53
0.71
314
317
1.22
1,636
1,640
1.55
2,861
2,888
2.24
26
27
3.67
4,890
4,925
1.93
4,063
4,104
1.96
50
52
0.05
332
331
1.03
938
945
1.45
430
426
1.77
–
–
–
1,750
1,754
1.41
1,094
1,093
1.21
1,234
1,235
0.56
1,227
1,236
1.05
1,159
1,168
1.86
1,151
1,180
2.30
1,255
1,266
1.61
6,026
6,085
1.27
5,761
5,815
1.04
2,381
2,382
0.77
2,137
2,141
1.26
748
753
1.33
138
136
0.37
–
–
–
5,404
5,412
1.03
6,116
6,132
1.32
–
–
–
399
404
1.24
2,595
2,600
1.62
–
–
–
–
–
–
2,994
3,004
1.68
3,031
3,054
1.90
4
4
3.42
4
4
1.74
29
30
1.69
476
481
1.97
8,652
8,669
1.05
9,165
9,188
1.10
6,872
6,895
0.92
2,533
2,537
1.45
2,270
2,280
1.66
2,412
2,421
2.06
646
670
3.16
48
47
3.50
7,909
7,955
1.85
7,577
7,666
1.83
Total cost or amortized cost
–
–
–
6,470
–
–
–
9,001
–
–
–
14,202
–
–
–
6,252
1,648
1,713
2.37
11,767
1,648
1,713
2.37
47,692
1,582
1,706
2.25
46,516
Total fair value
6,477
9,042
14,298
6,331
11,858
48,006
46,966
0.98
1.29
1.60
2.21
1.32
1.47
1.48
325
325
2,005
2,015
–
–
–
–
–
–
2,330
2,340
2,432
2,442
Available-for-Sale Securities
Issued or guaranteed by:
Canadian federal government
Amortized cost
Fair value
Yield (%)
Canadian provincial and municipal governments
Amortized cost
Fair value
Yield (%)
U.S. federal government
Amortized cost
Fair value
Yield (%)
U.S. states, municipalities and agencies
Amortized cost
Fair value
Yield (%)
Other governments
Amortized cost
Fair value
Yield (%)
Mortgage-backed securities and collateralized mortgage obligations – Canada
Amortized cost
Fair value
Yield (%)
Mortgage-backed securities and collateralized mortgage obligations – U.S.
Amortized cost
Fair value
Yield (%)
Corporate debt
Amortized cost
Fair value
Yield (%)
Corporate equity
Amortized cost
Fair value
Yield (%)
Yield (%)
Term to maturity
Held-to-Maturity Securities
Issued or guaranteed by:
Canadian federal government
Amortized cost
Fair value
Canadian provincial and municipal governments
Amortized cost
Fair value
Mortgage-backed securities and collateralized mortgage obligations (1)
Amortized cost
Fair value
Total cost or amortized cost
485
486
1,216
1,219
510
507
321
347
–
–
2,532
2,559
2,532
2,558
347
349
1,157
294
294
3,515
354
357
864
–
–
321
3,575
3,635
3,575
4,570
4,635
9,432
5,380
5,490
10,344
Total fair value
1,160
3,528
864
347
3,635
9,534
10,490
3
3
7
7
55
55
13
13
942
2,651
1,020
2,729
987
2,306
Other Securities
Carrying value
Fair value
Notes
Total carrying value or amortized cost of securities
16,790
18,586
18,690
12,222
64,316
130,604
142,869
Total securities value
16,797
18,627
18,786
12,301
64,407
130,918
143,319
Total by Currency (in Canadian $ equivalent)
Canadian dollar
U.S. dollar
Other currencies
11,230
3,984
1,583
11,041
6,912
674
12,446
6,269
71
8,885
3,416
–
38,973
25,007
427
82,575
45,588
2,755
94,126
46,580
2,613
Total securities
16,797
18,627
18,786
12,301
64,407
130,918
143,319
(1) These amounts are supported by insured mortgages or issued by U.S. agencies and government-sponsored enterprises.
Yields in the table above are calculated using the cost of the security and the contractual interest or stated dividend rates associated with each security, adjusted for any amortization of premiums and discounts. Tax effects are not taken into consideration. The term to maturity included in the table above is based on the contractual maturity date of the security. Actual maturities could differ, as issuers may have the right to call or prepay obligations. Securities with no maturity date are included in the over 10 years category.
146 BMO Financial Group 198th Annual Report 2015
Unrealized Gains and Losses
(Canadian $ in millions)
2014
2015
Amortized cost Gross unrealized gains
Gross unrealized losses
Fair value 7,970
4,925
1,754
6,085
5,412
3,004
9,188
7,955
1,713
10,420
4,063
1,094
5,761
6,116
3,031
6,872
7,577
1,582
82
44
2
57
17
24
35
95
129
1
3
3
3
1
1
12
6
5
10,501
4,104
1,093
5,815
6,132
3,054
6,895
7,666
1,706
48,006
46,516
485
35
46,966
Amortized cost Gross unrealized gains
Gross unrealized losses
Fair value 7,906
4,890
1,750
6,026
5,404
2,994
9,165
7,909
1,648
78
68
9
65
11
22
35
61
117
14
33
5
6
3
12
12
15
52
47,692
466
152
Issued or guaranteed by:
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Mortgage-backed securities and collateralized mortgage obligations – Canada (1)
Mortgage-backed securities and collateralized mortgage obligations – U.S.
Corporate debt
Corporate equity
Total
(1) These amounts are supported by insured mortgages.
Unrealized Losses
Available-for-sale
securities in an unrealized loss position for
(Canadian $ in millions)
Less than 12 months
Gross
unrealized losses Issued or guaranteed by:
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Mortgage-backed securities and collateralized mortgage obligations –
Canada (1)
Mortgage-backed securities and collateralized mortgage obligations –
U.S.
Corporate debt
Corporate equity
Total
2015
12 months or longer
Gross
Fair unrealized value losses
Available-for-sale securities in an unrealized loss position for
Less than
12 months
Total
Fair value Gross unrealized losses
Fair value Gross unrealized losses
2014
12 months or longer
Gross
Fair unrealized value losses
Total
Fair value Gross unrealized losses
Fair value 14
33
5
3
3
2,579
2,773
759
1,271
1,677
–
–
–
3
–
–
–
–
859
543
14
33
5
6
3
2,579
2,773
759
2,130
2,220
1
–
3
–
–
666
280
579
916
158
–
3
–
3
1
–
487
–
732
1,003
1
3
3
3
1
666
767
579
1,648
1,161
12
1,415
–
–
12
1,415
1
657
–
–
1
657
10
15
52
2,728
2,726
305
2
–
–
622
22
–
12
15
52
3,350
2,748
305
5
1
4
1,969
822
40
7
5
1
1,630
773
27
12
6
5
3,599
1,595
67
152 18,279
15
6,087
20
4,652
35
10,739
147 16,233
5 2,046
(1) These amounts are supported by insured mortgages.
Income from securities has been included in our consolidated financial statements as follows:
(Canadian $ in millions)
2015
2014
2013
1,016
504
167
225
954
570
152
186
1,265
610
47
210
1,912
1,862
2,132
Reported in Consolidated Statement of Income:
Interest, Dividend and Fee Income (1)
Trading securities (2)
Available-for-sale securities
Held-to-maturity securities
Other securities
Non-Interest Revenue
Available-for-sale securities
Gross realized gains
Gross realized losses
Unrealized gain on investment reclassified from equity to available-for-sale
Other securities, net realized and unrealized gains (losses)
Impairment write-downs
116
(18)
–
85
(12)
304
(167)
–
33
(8)
90
(3)
191
24
(17)
Securities gains (losses), other than trading (1)
171
162
285
Trading securities, net realized and unrealized gains (losses) (1) (2)
Total income from securities
92
340
2,175
2,364
(1,273)
1,144
Certain comparative figures have been reclassified to conform with the current year’s presentation and for changes in accounting policies.
BMO Financial Group 198th Annual Report 2015 147
Notes
(1) The following amounts of income related to our insurance operations were included in non-interest revenue, insurance revenue in our Consolidated Statement of Income:
(2) Interest, dividend and fee income of $282 million for the year ended October 31, 2015 ($263 million in 2014 and $263 million in 2013). Securities gains (losses), other than trading of $1 million for the year ended October 31, 2015 ($5 million in 2014 and $1 million in 2013).
Excluded from the table above are trading securities, net realized and unrealized gains (losses) of $8 million related to our insurance operations for the year ended October 31, 2015 ($379 million in
2014 and $(190) million in 2013).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 4: Loans, Customers’ Liability under Acceptances and Allowance for Credit Losses
Loans are initially measured at fair value plus directly attributable costs, and are subsequently measured at amortized cost using the effective interest method. The effective interest method allocates interest income over the expected term of the loan by applying the effective interest rate to the carrying amount of the loan. The effective interest rate is defined as the rate that exactly discounts estimated future cash receipts through the expected term of the loan to the net carrying amount of the loan. Under the effective interest method, the amount recognized in interest, dividend and fee income, loans, varies over the term of the loan based on the principal outstanding. The treatment of interest income for impaired loans is described below.
Securities Borrowed or Purchased Under Resale Agreements
Securities borrowed or purchased under resale agreements represent the amounts we will receive as a result of our commitment to resell securities that we have purchased, back to the original seller, on a specified date at a specified price. We account for these instruments as if they were loans.
Lending Fees
The accounting treatment for lending fees varies depending on the transaction. Some loan origination, restructuring and renegotiation fees are recorded as interest income over the term of the loan, while other lending fees are taken into income at the time of loan origination. Commitment fees are recorded as interest income over the term of the loan, unless we believe the loan commitment will not be used. In the latter case, commitment fees are recorded as lending fees over the commitment period. Loan syndication fees are included in lending fees at the time the syndication is completed, unless the yield on any loans we retain is less than that of other comparable lenders involved in the financing. In the latter case, an appropriate portion of the syndication fee is recorded as interest income over the term of the loan.
Customers’ Liability under Acceptances
Acceptances represent a form of negotiable short-term debt that is issued by our customers, which we guarantee for a fee. We have offsetting claims, equal to the amount of the acceptances, against our customers in the event of a call on these commitments. The amount due under acceptances is recorded in other liabilities and our corresponding claim is recorded as a loan in our Consolidated Balance Sheet.
Fees earned are recorded in lending fees in our Consolidated Statement of Income over the term of the acceptance.
Impaired Loans
Generally, consumer loans in both Canada and the U.S. are classified as impaired when payment is contractually 90 days past due, or one year past due for residential mortgages if guaranteed by the Government of Canada. Credit card loans are immediately written off when principal or interest payments are 180 days past due, and are not reported as impaired. In Canada, consumer instalment loans, other personal loans and some small business loans are normally written off when they are one year past due. In the U.S., all consumer loans are written off when they are 180 days past due, except for non-real estate term loans, which are written off at 120 days. For the purpose of measuring the amount to be written off, the determination of the recoverable amount includes an estimate of future recoveries.
Corporate and commercial loans are classified as impaired when we determine there is no longer reasonable assurance that principal or interest will be collected in its entirety on a timely basis. Generally, we consider corporate and commercial loans to be impaired when payments are 90 days past due, or for fully secured loans, when payments are 180 days past due. Corporate and commercial loans are written off following a review on an individual loan basis that confirms all recovery attempts have been exhausted.
A loan will be reclassified to performing status when we determine that there is reasonable assurance of full and timely repayment of interest and principal in accordance with the terms and conditions of the loan, and that none of the criteria for classification of the loan as impaired continue to apply.
Our average gross impaired loans and acceptances were $2,115 million for the year ended October 31, 2015 ($2,261 million in 2014). Our average impaired loans, net of the specific allowance, were $1,730 million for the year ended October 31, 2015 ($1,783 million in 2014).
Once a loan is identified as impaired, we continue to recognize interest income based on the original effective interest rate of the loan. In the periods following the recognition of impairment, adjustments to the allowance for these loans reflecting the time value of money are recognized and presented as interest income. Interest income on impaired loans of $91 million was recognized for the year ended October 31, 2015 ($111 million in
2014).
During the year ended October 31, 2015, we recorded a net gain of $72 million before tax ($12 million in 2014) on the sale of impaired and written-off loans.
Allowance for Credit Losses (“ACL”)
Notes
The allowance for credit losses recorded in our Consolidated Balance Sheet is maintained at a level that we consider adequate to absorb credit-related losses on our loans, customers’ liability under acceptances and other credit instruments. The portion related to other credit instruments is recorded in other liabilities in our Consolidated Balance Sheet and amounted to $197 million as at October 31, 2015 ($232 million in 2014).
The allowance is comprised of a specific allowance and a collective allowance.
Specific Allowance
These allowances are recorded for individually identified impaired loans to reduce their carrying value to the expected recoverable amount. 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 (excluding credit card loans, which are classified as impaired and written off when principal or interest payments are
180 days past due, as discussed under Impaired Loans). The review of individually significant problem loans is conducted at least quarterly by the account managers, each of whom assesses the ultimate collectability and estimated recoveries for a specific loan based on all events and conditions that are relevant to the loan. This assessment is then approved by an independent credit officer.
Individually Significant Impaired Loans
To determine the amount we expect to recover from an individually significant impaired loan, we use the value of the estimated future cash flows discounted at the loan’s original effective interest rate. The determination of estimated future cash flows of a collateralized impaired loan reflects the expected realization of the underlying security, net of expected costs and any amounts legally required to be paid to the borrower. Security can vary by type of loan and may include cash, securities, real properties, accounts receivable, guarantees, inventory or other capital assets.
148 BMO Financial Group 198th Annual Report 2015
Individually Insignificant Impaired Loans
Residential mortgages, consumer instalment and other personal loans are individually insignificant and may be individually assessed or collectively assessed for losses at the time of impairment, taking into account historical loss experience.
Collective Allowance
We maintain a collective allowance in order to cover any impairment in the existing portfolio for loans that have not yet been individually identified as impaired. Our approach to establishing and maintaining the collective allowance is based on the requirements of IFRS, considering guidelines issued by OSFI.
The collective allowance methodology incorporates both quantitative and qualitative factors to determine an appropriate level for the collective allowance. For the purpose of calculating the collective allowance, we group loans on the basis of similarities in credit risk characteristics. The loss factors for groups of loans are determined based on a minimum of five years of historical data and a one-year loss emergence period, except for credit cards, where a seven-month loss emergence period is used. The loss factors are back-tested and calibrated on a regular basis to ensure that they continue to reflect our best estimate of losses that have been incurred but not yet identified, on an individual basis, within the pools of loans.
Historical loss experience data is also reviewed in the determination of loss factors. Qualitative factors are based on current observable data, such as current macroeconomic and business conditions, portfolio-specific considerations and model risk factors.
Provision for Credit Losses (“PCL”)
Changes in the value of our loan portfolio due to credit-related losses or recoveries of amounts previously provided for or written off are included in the provision for credit losses in our Consolidated Statement of Income.
Loans, including customers’ liability under acceptances, and allowance for credit losses by category are as follows:
(Canadian $ in millions)
Residential mortgages (1)
2015
Gross loan balances at end of year (3)
Impairment allowances (specific
ACL), beginning of year
Amounts written off
Recoveries of amounts written off in previous years
Charge to income statement
(specific PCL)
Foreign exchange and other movements Credit card, consumer instalment and other personal loans
2014
2013
2015
2014
Business and government loans
2013
2014
2015
Customers’ liability under acceptances
2013
2015
2014
Total
2013
2015
2014
2013
105,918 101,013 96,392 73,578 72,115 71,510 145,076 120,766 104,585 11,307 10,878 8,472 335,879 304,772 280,959
88
(83)
89
(87)
76
(104)
99
(670)
81
(655)
62
(750)
237
(312)
315
(407)
338
(443)
–
–
–
–
–
–
424
485
(1,065) (1,149)
476
(1,297)
72
40
24
190
161
152
194
423
596
–
–
–
456
624
772
11
77
129
497
519
618
104
(35)
(150)
–
–
–
612
561
597
(19)
(31)
(36)
Specific ACL, end of year
69
88
89
Collective ACL, beginning of year
Charge to income statement
(collective PCL)
Foreign exchange and other movements
83
88
19
(8)
(7)
(1)
(13)
(59)
(26)
–
–
–
(35)
(97)
(63)
113
99
81
210
237
315
–
–
–
392
424
485
47
678
622
624
754
756
759
27
19
30
1,542
1,485
1,460
40
7
50
(33)
(50)
(35)
7
8
(11)
–
–
(3)
(4)
(10)
9
3
1
29
6
2
80
48
32
–
–
–
118
57
35
Collective ACL, end of year
111
83
88
714
678
622
801
754
756
34
27
19
1,660
1,542
1,485
Total ACL
180
171
177
827
777
703
1,011
991
1,071
34
27
19
2,052
1,966
1,970
Comprised of: Loans
Other credit instruments (2)
149
144
157
827
777
703
845
786
786
34
27
19
1,855
1,734
1,665
31
27
20
–
–
–
166
205
285
–
–
–
197
232
305
Net loan balances at end of year 105,769 100,869 96,235 72,751 71,338 70,807 144,231 119,980 103,799 11,273 10,851 8,453 334,024 303,038 279,294
(1) Included in the residential mortgages balance are Canadian government and corporate-insured mortgages of $56,579 million as at October 31, 2015 ($58,511 million in 2014).
(2) The total specific and collective allowances related to other credit instruments are included in other liabilities.
(3) Included in loans as at October 31, 2015 are $117,098 million ($95,269 million in 2014 and $81,069 million in 2013) of loans denominated in U.S. dollars and $1,966 million ($1,039 million in 2014 and $947 million in 2013) of loans denominated in other foreign currencies.
Certain comparative figures have been reclassified to conform with the current year’s presentation and changes in accounting policies.
Loans, including customers’ liability under acceptances, and allowance for credit losses by geographic region are as follows:
(Canadian $ in millions)
Gross amount
Specific allowance (2) Collective allowance (3)
Net amount
2014
2015
2014
2015
2014
2015
2014
By geographic region (1):
Canada
United States
Other countries
223,500
101,198
11,181
213,490
80,135
11,147
145
212
–
191
182
1
816
682
–
766 222,539
594 100,304
– 11,181
212,533
79,359
11,146
Total
335,879
304,772
357
374
1,498
1,360 334,024
303,038
(1) Geographic region is based upon the country of ultimate risk.
(2) Excludes specific allowance of $35 million for other credit instruments ($50 million in 2014), which is included in other liabilities.
(3) Excludes collective allowance of $162 million for other credit instruments ($182 million in 2014), which is included in other liabilities.
BMO Financial Group 198th Annual Report 2015 149
Notes
2015
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired loans, including the related allowances, are as follows:
(Canadian $ in millions)
Gross impaired amount
Specific allowance (3)
Net of specific allowance
2015
2014
2015
2014
2015
2014
Residential mortgages
Consumer instalment and other personal loans
Business and government loans
370
546
1,043
532
544
972
38
113
206
61
99
214
332
433
837
471
445
758
Total (1)
1,959
2,048
357
374
1,602
1,674
By geographic region (2):
Canada
United States
Other countries
641
1,314
4
742
1,301
5
145
212
–
191
182
1
496
1,102
4
551
1,119
4
Total
1,959
2,048
357
374
1,602
1,674
(1) Excludes purchased credit impaired loans.
(2) Geographic region is based upon the country of ultimate risk.
(3) Excludes specific allowance of $35 million for other credit instruments ($50 million in 2014), which is included in other liabilities.
Fully secured loans with past due amounts between 90 and 180 days that we have not classified as impaired totalled $83 million and $134 million as at October 31, 2015 and 2014, respectively.
Specific provisions for credit losses by geographic region are as follows:
(Canadian $ in millions)
Residential mortgages
Credit card, consumer instalment and other personal loans
2015
2014
2015
2014
9
2
–
12
65
–
393
104
–
410
109
–
11
77
497
519
By geographic region (1):
Canada
United States
Other countries
Total
Business and government loans (2)
2015
97
8
(1)
104
2014
Total
2015
2014
107
(140)
(2)
499
114
(1)
529
34
(2)
(35)
612
561
(1) Geographic region is based upon the country of ultimate risk.
(2) There were no provisions relating to customers’ liability under acceptances as at October 31, 2015 and 2014.
Foreclosed Assets
Property or other assets that we receive from borrowers to satisfy their loan commitments are classified as either held for use or held for sale according to management’s intention and are recorded at the lower of carrying amount or fair value less costs to sell. Fair value is determined based on market prices where available. Otherwise, fair value is determined using methods such as analysis of discounted cash flows or market prices for similar assets.
During the year ended October 31, 2015, we foreclosed on impaired loans and received $102 million of real estate properties that we classified as held for sale ($145 million in 2014).
As at October 31, 2015, real estate properties held for sale totalled $109 million ($158 million in 2014). These properties are disposed of when considered appropriate. During the year ended October 31, 2015, we recorded an impairment loss of $22 million on real estate properties classified as held for sale ($34 million in 2014).
Renegotiated Loans
From time to time we modify the contractual terms of loans due to the poor financial condition of the borrower. We assess renegotiated loans for impairment consistent with our existing policies for impairment. When renegotiation leads to significant concessions being granted, and the concessions are for economic or legal reasons related to the borrower’s financial difficulty that we would not otherwise consider, the loan is classified as impaired. We consider one or a combination of the following to be significant concessions: (1) a reduction of the stated interest rate, (2) an extension of the maturity date or dates at a stated interest rate lower than the current market rate for a new loan with similar terms, or
(3) forgiveness of principal or accrued interest.
Renegotiated loans are permitted to remain in performing status if the modifications are not considered to be significant, or are returned to performing status when none of the criteria for classification as impaired continue to apply.
The carrying value of our renegotiated loans was $730 million as at October 31, 2015 ($728 million in 2014). Renegotiated loans of $361 million were classified as performing during the year ended October 31, 2015 ($291 million in 2014). Renegotiated loans of $42 million and $25 million were written off in the years ended October 31, 2015 and 2014, respectively.
Notes
Purchased Loans
We record all loans that we purchase at fair value on the day that we acquire the loans. The fair value of the acquired loan portfolio includes an estimate of the interest rate premium or discount on the loans, calculated as the difference between the contractual rate of interest on the loans and prevailing interest rates (the “interest rate mark”). Also included in fair value is an estimate of expected credit losses (the “credit mark”) as of the acquisition date. The credit mark consists of two components: an estimate of the amount of losses that exist in the acquired loan portfolio on the acquisition date but that haven’t been specifically identified on that date (the “incurred credit mark”) and an amount that represents future expected losses (the “future credit mark”). Because we record the loans at fair value, no allowance for credit losses is recorded in our Consolidated Balance
Sheet on the day we acquire the loans. Fair value is determined by estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. We estimate cash flows expected to be collected based on specific loan reviews for commercial loans. For retail loans, we use models that incorporate management’s best estimate of current key assumptions, such as default rates, loss severity and the timing of prepayments, as well as collateral.
Acquired loans are classified into the following categories: those for which on the acquisition date we expect to continue to receive timely principal and interest payments (the “purchased performing loans”) and those for which on the acquisition date the timely collection of interest and
150 BMO Financial Group 198th Annual Report 2015
principal was no longer reasonably assured (the “purchased credit impaired loans” or “PCI loans”). Because PCI loans are recorded at fair value at acquisition based on the amount expected to be collected, none of the PCI loans are considered to be impaired at acquisition.
Subsequent to the acquisition date, we account for each type of loan as follows:
Purchased Performing Loans
For performing loans with fixed terms, the future credit mark is fully amortized into net interest income over the expected life of the loan using the effective interest method. The impact on net interest income for the year ended October 31, 2015 was $26 million ($34 million in 2014 and
$48 million in 2013). The incurred credit losses are remeasured at each reporting period, with any increases recorded as an increase in the collective allowance and the provision for credit losses. Decreases in incurred credit losses are recorded as a decrease in the collective allowance and the provision for credit losses until the accumulated collective allowance related to these loans is exhausted. Any additional decrease is recorded in net interest income.
The impact of the remeasurement of incurred credit losses for performing loans with fixed terms for the year ended October 31, 2015 was a
$1 million recovery in the provision for credit losses and $nil in net interest income ($2 million provision and $6 million, respectively, in 2014 and $nil and $143 million, respectively, in 2013).
For performing loans with revolving terms, the incurred and future credit marks are amortized into net interest income on a straight-line basis over the contractual terms of the loans. The impact on net interest income of such amortization for the year ended October 31, 2015 was $15 million
($35 million in 2014 and $123 million in 2013).
As performing loans are repaid, the related unamortized credit mark remaining is recorded as net interest income during the period in which the payments are received. The impact on net interest income of such repayments for the year ended October 31, 2015 was $62 million ($151 million in
2014 and $241 million in 2013).
Actual specific provisions for credit losses related to these performing loans will be recorded as they arise in a manner that is consistent with our policy for loans we originate. The total specific provision for credit losses for purchased performing loans for the year ended October 31, 2015 was
$5 million ($56 million in 2014 and $240 million in 2013).
As at October 31, 2015, the amount of purchased performing loans remaining on the balance sheet was $4,993 million ($7,755 million in 2014).
As at October 31, 2015, the credit mark remaining on performing term loans, revolving loans and other performing loans was $217 million,
$69 million and $nil, respectively ($279 million, $94 million and $2 million, respectively, in 2014). Of the total credit mark for performing loans of
$286 million, $151 million represents the credit mark that will be amortized over the remaining life of the portfolio. The remaining balance of
$135 million represents the incurred credit mark and will be remeasured each reporting period.
Purchased Credit Impaired Loans
Subsequent to the acquisition date, we regularly re-evaluate the cash flows we expect to collect on the PCI loans. Increases in expected cash flows will result in a recovery in the specific provision for credit losses and either a reduction in any previously recorded allowance for credit losses or, if no allowance exists, an increase in the current carrying value of the PCI loans. Decreases in expected cash flows will result in a charge to the specific provision for credit losses and an increase in the allowance for credit losses. The impact of these evaluations for the year ended October 31, 2015 was a $86 million recovery in the specific provision for credit losses ($252 million recovery in 2014 and $410 million recovery in 2013).
As at October 31, 2015, the amount of PCI loans remaining on the balance sheet was $383 million ($488 million in 2014). There is no remaining credit mark on the PCI loans ($nil in 2014).
FDIC Covered Loans
Certain acquired loans are subject to a loss share agreement with the Federal Deposit Insurance Corporation (“FDIC”). Under this agreement, the FDIC reimburses us for 80% of the net losses we incur on the covered loans.
We recorded net provisions of $36 million for the year ended October 31, 2015 (net recoveries of $8 million in 2014). These amounts are net of the amounts expected to be reimbursed by the FDIC.
Note 5: Risk Management
We have an enterprise-wide approach to the identification, measurement, monitoring and management of risks faced across our organization. The key risks related to our financial instruments are classified as credit and counterparty, market, and liquidity and funding risk.
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. Credit risk arises predominantly with respect to loans, over-the-counter derivatives and other credit instruments. This is the most significant measurable risk that we face. Our risk management practices and key measures are disclosed in the text and tables presented in a blue-tinted font in Management’s Discussion and Analysis on pages 94 to 96 of this report. Additional information on loans and derivative-related credit risk is disclosed in Notes 4 and 8, respectively.
Concentrations of Credit and Counterparty Risk
BMO Financial Group 198th Annual Report 2015 151
Notes
Concentrations of credit risk exist if a number of clients are engaged in similar activities, are located in the same geographic region or have similar economic characteristics such that their ability to meet contractual obligations could be similarly affected by changes in economic, political or other conditions. Concentrations of credit risk indicate a related sensitivity of our performance to developments affecting a particular counterparty, industry or geographic location. At year end, our credit assets consisted of a well-diversified portfolio representing millions of clients, the majority of them consumers and small to medium-sized businesses.
From an industry viewpoint, our most significant exposure as at year end was to individual consumers, captured within the individual sector in the following table, comprising $178,708 million ($169,039 million in 2014). Additional information on the composition of our loans and derivatives exposure is disclosed in Notes 4 and 8, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basel III Framework
We use the Basel III Framework and our economic capital framework for risk management purposes. For regulatory capital, we use the Advanced
Internal Ratings Based (“AIRB”) approach to determine credit risk-weighted assets in our portfolio, except for acquired loans in our M&I and other select portfolios, for which we use the Standardized Approach. The framework uses exposure at default to assess credit and counterparty risk.
Exposures are classified as follows:
‰ Drawn loans include loans, acceptances, deposits with regulated financial institutions, and certain securities. Exposure at default (“EAD”) represents an estimate of the outstanding amount of a credit exposure at the time a default may occur. 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.
‰ Undrawn commitments cover all unutilized authorizations, associated with the drawn loans noted above, including those which are unconditionally cancellable. EAD for undrawn commitments is model generated based on internal empirical data.
‰ Over-the-counter (“OTC”) derivatives are those in our proprietary accounts that attract credit risk in addition to market risk. EAD for OTC derivatives is equal to the positive replacement cost; after considering netting, plus any potential credit exposure amount.
‰ Other off-balance sheet exposures include items such as guarantees, standby letters of credit and documentary credits. EAD for other off-balance sheet items is based on management’s best estimate.
‰ Repo-style transactions include repos, reverse repos and securities lending transactions, which represent both asset and liability exposures. EAD for repo-style transactions is the total amount drawn, adding back any write-offs.
‰ Adjusted EAD represents exposures that have been redistributed to a more favourable probability of default band or a different Basel asset class as a result of applying credit risk mitigation.
Total non-trading exposure at default by industry sector, as at October 31, 2015 and 2014, based on the Basel III classifications is as follows:
(Canadian $ in millions)
Commitments
(undrawn)
Drawn
Other off-balance sheet items
OTC derivatives
Repo-style transactions
Total
2015
2014
2015
2014
2015
2014
2015
2014
2015
2014
2015
2014
Financial institutions
Governments
Manufacturing
Real estate
Retail trade
Service industries
Wholesale trade
Oil and gas
Individual
Agriculture
Others (1)
85,854
42,709
16,133
21,100
14,352
28,311
8,453
6,575
139,885
9,860
51,337
69,174
43,035
13,678
18,408
11,973
21,944
8,260
5,969
132,360
9,016
38,090
19,268
2,069
13,039
5,871
4,614
11,881
5,288
7,847
38,674
1,860
14,218
15,164
1,838
9,499
5,602
4,995
8,873
4,253
6,931
36,627
1,905
12,692
7
–
21
–
–
2
–
–
–
–
1
1
–
40
–
–
6
–
–
26
–
1
3,321
794
1,311
809
539
2,936
372
818
149
27
5,329
2,825
1,010
1,189
1,072
537
2,748
461
612
18
36
4,303
50,393
6,478
–
–
–
–
–
–
–
–
–
40,362
10,266
–
–
–
2
–
–
8
–
397
158,843
52,050
30,504
27,780
19,505
43,130
14,113
15,240
178,708
11,747
70,885
127,526
56,149
24,406
25,082
17,505
33,573
12,974
13,512
169,039
10,957
55,483
Total exposure at default 424,569
371,907
124,629
108,379
31
74
16,405
14,811
56,871
51,035
622,505
546,206
(1) Includes industries having a total exposure of less than 2%.
Additional information about our credit risk exposure by geographic region and product category for loans, including customers’ liability under acceptances, is provided in Note 4.
Credit Quality
We assign risk ratings based on the probability of counterparties defaulting on their financial obligations to us. Our process for assigning risk ratings is disclosed in the text presented in a blue-tinted font in the Enterprise-Wide Risk Management section of Management’s Discussion and Analysis on pages 95 to 96 of this report.
The following tables present our business and government gross loans and acceptances and consumer gross loans outstanding by risk rating as at October 31, 2015 and 2014.
Business and Government Gross Loans and Acceptances by Risk Rating
(Canadian $ in millions)
Business and government loans and acceptances
2015
71,282
56,181
2,881
1,300
156,383
Total
2014
84,059
67,586
3,530
1,208
Acceptable
Investmentgrade
Sub-investment grade
Problem
Default / Impaired
131,644
Consumer Gross Loans by Risk Rating
Notes
(Canadian $ in millions)
Residential mortgages
Credit card and other personal loans
Total
2015
Exceptionally low (≤ 0.05%)
Very low (> 0.05% to 0.20%)
Low (> 0.20% to 0.75%)
Medium (> 0.75% to 7.00%)
High (> 7.00% to 99.99%)
Standardized performing / Not rated
Default / Impaired
Total
152 BMO Financial Group 198th Annual Report 2015
2014
2015
2014
2015
2014
2
69,100
17,233
16,513
408
2,246
416
3
65,704
17,200
8,668
6,385
2,253
800
16,834
18,795
14,933
16,969
1,600
3,878
569
2,691
31,243
13,171
18,285
1,707
4,245
773
16,836
87,895
32,166
33,482
2,008
6,124
985
2,694
96,947
30,371
26,953
8,092
6,498
1,573
105,918
101,013
73,578
72,115
179,496
173,128
Loans Past Due Not Impaired
Loans that are past due but not classified as impaired are loans where our customers have failed to make payments when contractually due, but for which we expect the full amount of principal and interest payments to be collected. The following table presents the loans that are past due but not classified as impaired as at October 31, 2015 and 2014:
(Canadian $ in millions)
1 to 29 days
30 to 89 days
90 days or more
Total
2015
2014
2015
2014
2015
2014
2015
2014
Residential mortgages (1)
Credit card, consumer instalment and other personal loans (2)
Business and government loans
Customers’ liability under acceptances
641
2,474
416
–
647
1,915
414
20
459
494
162
–
488
471
126
4
33
90
92
–
37
104
169
–
1,133
3,058
670
–
1,172
2,490
709
24
Total
3,531
2,996
1,115
1,089
215
310
4,861
4,395
(1) The percentage of loans 90 days or more past due but not impaired that were guaranteed by the Government of Canada is 5% for 2015 and 5% for 2014.
(2) Credit card loans that are past due are not classified as impaired loans and are written off when 180 days past due.
Loan Maturities and Interest Rate Sensitivity
The following table presents gross loans and acceptances by contractual maturity and by country of ultimate risk:
(Canadian $ in millions)
1 year or less
Over 1 year
Over 5 years
Total
2015
Canada
Consumer
Commercial and corporate (excluding real estate)
Commercial real estate
United States
Other countries
Total
2014
2015
2014
2015
2014
2015
2014
50,911
43,329
4,739
30,886
10,136
50,026
41,608
4,506
22,292
10,632
97,482
13,677
6,254
50,647
741
93,486
10,981
5,331
41,084
465
5,272
461
1,375
19,665
304
5,984
141
1,427
16,759
50
153,665
57,467
12,368
101,198
11,181
149,496
52,730
11,264
80,135
11,147
140,001
129,064
168,801
151,347
27,077
24,361
335,879
304,772
The following table presents net loans and acceptances by interest rate sensitivity:
(Canadian $ in millions)
2015
2014
Fixed rate
Floating rate
Non-interest sensitive (1)
160,469
162,248
11,307
150,021
142,139
10,878
Total
334,024
303,038
(1) Non-interest sensitive is comprised of customers’ liability under acceptances.
Market Risk
Market risk is the potential for adverse changes in the value of our assets and liabilities resulting from changes in market variables such as interest rates, foreign exchange rates, equity and commodity prices and their implied volatilities, and credit spreads, as well as the risk of credit migration and default. We incur market risk in our trading and underwriting activities and in the management of structural market risk in our banking and insurance activities. Our market risk management practices and key measures are disclosed in the text and tables presented in a blue-tinted font in the EnterpriseWide Risk Management section of Management’s Discussion and Analysis on pages 100 to 104 of this report.
Liquidity and Funding Risk
Liquidity and funding risk is the potential for loss if we are unable to meet financial commitments in a timely manner at reasonable prices as they fall due. It is our policy to ensure that sufficient liquid assets and funding capacity are available to meet financial commitments, including liabilities to depositors and suppliers, and lending, investment and pledging commitments, even in times of stress. Managing liquidity and funding risk is essential to maintaining both depositor confidence and stability in earnings.
Our liquidity and funding risk management practices and key measures are disclosed in the text presented in a blue-tinted font in the EnterpriseWide Risk Management section of Management’s Discussion and Analysis on pages 105 to 109 of this report.
Note 6: Transfer of Assets
Loan Securitization
BMO Financial Group 198th Annual Report 2015 153
Notes
We sell Canadian mortgage loans to third-party Canadian securitization programs, including the Canadian Mortgage Bond program, and directly to third-party investors under the National Housing Act Mortgage-Backed Securities program. We assess whether substantially all of the risk and rewards of the loans have been transferred to determine if they qualify for derecognition.
Under these programs, we are entitled to the payment over time of the excess of the sum of interest and fees collected from customers, in connection with the loans that were sold, over the yield paid to investors in the third-party securitization programs, less credit losses and other costs.
Since we continue to be exposed to substantially all of the prepayment, interest rate and/or credit risk associated with the securitized loans, they do not qualify for derecognition. We continue to recognize the loans and the related cash proceeds as secured financing in our Consolidated Balance
Sheet. The interest and fees collected, net of the yield paid to investors, is recorded in net interest income using the effective interest method over the term of the securitization. Credit losses associated with the loans are recorded in the provision for credit losses. During the year ended
October 31, 2015, we sold $6,905 million of loans to third-party securitization programs ($5,564 million in 2014).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the carrying amount and fair value of transferred assets that did not qualify for derecognition and the associated liabilities: (Canadian $ in millions)
2015 (1)
Carrying amount of assets
Residential mortgages
Other related assets (2)
7,458
10,181
Total
17,639
Associated liabilities 2014
Carrying amount of assets
Associated liabilities 9,569
8,382
17,199
17,951
17,546
(1) The fair value of the securitized assets is $17,785 million and the fair value of the associated liabilities is $17,666 million, for a net position of $119 million. Securitized assets are those which we have transferred to third parties, including other related assets.
(2) Other related assets represent payments received on account of loans pledged under securitization programs that have not yet been applied against the associated liabilities. The payments received are held on behalf of the investors in the securitization vehicles until principal payments are required to be made on the associated liabilities. In order to compare all assets supporting the associated liabilities, this amount is added to the carrying value of the securitized assets in the table above.
Securities Lent or Sold Under Repurchase Agreements
Securities lent or sold under repurchase agreements represent short-term funding transactions in which we sell securities that we own and simultaneously commit to repurchase the same securities at a specified price on a specified date in the future. We retain substantially all of the risk and rewards associated with the securities and we continue to recognize them in our Consolidated Balance Sheet with the obligation to repurchase these securities recorded as secured borrowing transactions at the amount owing. The interest expense related to these liabilities is recorded on an accrual basis. For further details, refer to Note 14.
Note 7: Structured Entities
We enter into certain transactions in the ordinary course of business which involve the establishment of structured entities (“SEs”) to facilitate or secure customer transactions and to obtain alternative sources of funding. We are required to consolidate an SE if we control the entity. We control an
SE when we have power over the SE, exposure to variable returns as a result of our involvement, and the ability to exercise power to affect the amount of our returns.
In assessing whether we control an SE, we consider the entire arrangement to determine the purpose and design of the SE, the nature of any rights held through contractual arrangements and whether we are acting as a principal or agent.
We perform a re-assessment of consolidation if facts and circumstances indicate that there have been changes to one or more of the elements of control over the SE.
Consolidated Structured Entities
Bank Securitization Vehicles
We use securitization vehicles to securitize our Canadian credit card loans in order to obtain alternate sources of funding. The structure of these vehicles limits the activities they can undertake and the types of assets they can hold, and the vehicles have limited decision-making authority. The vehicles issue term asset-backed securities to fund their activities. We control and consolidate these vehicles, as we have the key decision-making powers necessary to obtain the majority of the benefits of their activities.
U.S. Customer Securitization Vehicle
We sponsor a customer securitization vehicle (also referred to as a bank-sponsored multi-seller conduit) that provides our customers with alternate sources of funding through the securitization of their assets. This vehicle provides clients with access to financing in the asset-backed commercial paper (“ABCP”) markets by allowing them to sell their assets into the vehicle, which then issues ABCP to investors to fund the purchases. We do not sell assets to the customer securitization vehicle. We earn fees for providing services related to the securitizations, including liquidity, distribution and financial arrangement fees for supporting the ongoing operations of the vehicle. We have determined that we control and therefore consolidate this vehicle, as we are exposed to its variable returns and we have the key decision-making powers necessary to affect the amount of those returns in our capacity as liquidity provider and servicing agent.
We provide liquidity facilities to this vehicle which may require that we provide additional financing to the vehicle in the event that certain events occur. The total committed undrawn amount under these facilities at October 31, 2015 was $7,213 million ($5,236 million at October 31,
2014).
Notes
Credit Protection Vehicle
We sponsor a credit protection vehicle which provides credit protection to investors on investments in corporate debt portfolios through credit default swaps. In May 2008, upon the restructuring of the vehicle, we entered into credit default swaps with swap counterparties and offsetting swaps with the vehicle. In 2015, the vehicle redeemed $nil of its outstanding medium-term notes ($1,049 million in 2014, of which $678 million were held by us). We continue to hold $256 million of outstanding medium-term notes which mature in September 2016. As at October 31, 2015 and
2014, we have hedged our exposure to our holdings of notes issued by the vehicle. A third party holds its exposure to the vehicle through a total return swap with us on $108 million of notes. We control and therefore consolidate this vehicle.
Capital and Funding Vehicles
Capital and funding vehicles are created to issue notes or capital trust securities or to guarantee payments due to bondholders on bonds issued by us.
These vehicles may purchase notes issued by us, or we may sell assets to the vehicles in exchange for promissory notes.
For those trusts that purchase assets from us, we have determined that, based on the rights of the arrangements, we have significant exposure to their variable returns as we are exposed to the variability of their underlying assets, and that we control and therefore consolidate these vehicles.
See Note 1 and Note 16 for further information related to capital trusts.
154 BMO Financial Group 198th Annual Report 2015
Unconsolidated Structured Entities
The table below presents amounts related to our interests in unconsolidated SEs:
(Canadian $ in millions)
Capital and funding vehicles
Canadian customer securitization vehicles (1)
Structured finance vehicles
11
2
–
–
39
10
652
–
–
10,414
–
42
2,277
13
701
10,456
1,296
250
732
1,265
–
21
39
–
–
5,853
1,115
3,447
1,286
39
10,415
57
5,876
10,456
1,286
3,783
10,456
Capital and funding vehicles
Structured finance vehicles
11
2
–
–
69
21
573
10
–
2,266
–
11
13
673
1,265
–
20
69
–
–
1,285
69
2,278
57
6,175
2,278
1,285
4,289
2,277
Interests recorded on the balance sheet
Cash and cash equivalents
Trading securities
Available-for-sale securities
Other
Deposits
Derivatives
Other
Exposure to loss (2)
Total assets of the entities
2014
2015
Canadian
customer securitization vehicles (1)
(1) Securities held that are issued by our Canadian customer securitization vehicles are comprised of asset-backed commercial paper and are classified as trading securities and available-for-sale securities. All assets held by these vehicles relate to assets in Canada.
(2) Exposure to loss represents securities held, drawn and undrawn facilities, and derivative assets.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Capital and Funding Vehicles
Certain of our capital and funding vehicles purchase notes issued by us as their underlying assets. In these situations, we are not exposed to significant default or credit risk. Our remaining exposure to variable returns is less than that of the note holders, who are exposed to our default and credit risk. We have determined that we do not consolidate these vehicles. See Note 1 and Note 16 for further information related to capital trusts.
Canadian Customer Securitization Vehicles
We sponsor customer securitization vehicles (also referred to as bank-sponsored multi-seller conduits) that provide our customers with alternate sources of funding through the securitization of their assets. These vehicles provide clients with access to financing in the ABCP markets by allowing them to sell their assets into the vehicles, which then issue ABCP to investors to fund the purchases. We do not sell assets to the customer securitization vehicles. We earn fees for providing services related to the securitizations, including liquidity, distribution and financial arrangement fees for supporting the ongoing operations of the vehicles. We have determined that we do not have control of these entities as their key relevant activity, the servicing of program assets, does not reside with us. We provide liquidity facilities to these vehicles which may require that we provide additional financing to the vehicles in the event that certain events occur. The total committed undrawn amount under these facilities at October 31,
2015 was $5,573 million ($5,214 million at October 31, 2014).
Structured Finance Vehicles
We facilitate development of investment products by third parties, including mutual funds, unit investment trusts and other investment funds that are sold to retail investors. We enter into derivative contracts with these third parties to provide investors with their desired exposure, and we hedge our exposure related to these derivative contracts by investing in other funds through SEs. We are not required to consolidate these vehicles.
Compensation Trusts
We sponsor various share ownership arrangements, certain of which are administered through trusts. Generally these arrangements permit employees to purchase bank common shares.
Employees can direct a portion of their gross salary towards the purchase of our common shares and we match 50% of employees’ contributions up to 6% of their individual gross salary. Our matching contributions are paid into trusts, which purchase our common shares on the open market for distribution to employees once those employees are entitled to the shares under the terms of the plan. We are not required to consolidate our compensation trusts. These trusts are not included in the table above, as we have no interest in the trusts.
Total assets held under our share ownership arrangements amounted to $1,446 million as at October 31, 2015 ($1,532 million in 2014).
BMO Managed Funds
Non-BMO Managed Funds
We purchase and hold units of non-BMO managed funds for investment and other purposes. We are considered to have an interest in these funds through our holding of units, and because we may act as counterparty in certain derivative contracts or other interests. These activities do not constitute control, and as a result our interests in these funds are not consolidated. Our total exposure to non-BMO managed funds was
$3,735 million at October 31, 2015 ($11,647 million in 2014), which is included in securities on our Consolidated Balance Sheet.
BMO Financial Group 198th Annual Report 2015 155
Notes
We have established a number of funds that we also manage. We assess whether or not we control these funds based on the economic interest we have in the funds, including investments in the funds and management fees earned from the funds, and any investors’ rights to remove us as investment manager. Based on our assessment, we have determined that we do not control these funds. Our total exposure to unconsolidated BMO managed funds was $589 million at October 31, 2015 ($513 million in 2014), which is included in securities on our Consolidated Balance Sheet.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Structured Entities
We may be deemed to be the sponsor of an SE if we are involved in the design, legal set-up or marketing of the SE. We may also be deemed to be the sponsor of an SE if market participants would reasonably associate the entity with us. We do not have an interest in certain SEs that we have sponsored. The amounts of revenue earned from such entities are not significant.
Note 8: Derivative Instruments
Derivative instruments are financial contracts that derive their value from underlying changes in interest rates, foreign exchange rates or other financial or commodity prices or indices.
Derivative instruments are either regulated exchange-traded contracts or negotiated over-the-counter contracts. We use these instruments for trading purposes, as well as to manage our exposures, mainly to currency and interest rate fluctuations, as part of our asset/liability management program. Types of Derivatives
Swaps
Swaps are contractual agreements between two parties to exchange a series of cash flows. The various swap agreements that we enter into are as follows: Interest rate swaps – counterparties generally exchange fixed and floating rate interest payments based on a notional value in a single currency.
Cross-currency swaps – fixed rate interest payments and principal amounts are exchanged in different currencies.
Cross-currency interest rate swaps – fixed and/or floating rate interest payments and principal amounts are exchanged in different currencies.
Commodity swaps – counterparties generally exchange fixed and floating rate payments based on a notional value of a single commodity.
Equity swaps – counterparties exchange the return on an equity security or a group of equity securities for the return based on a fixed or floating interest rate or the return on another equity security or group of equity securities.
Credit default swaps – one counterparty pays the other a fee in exchange for that other counterparty agreeing to make a payment if a credit event occurs, such as bankruptcy or failure to pay.
Total return swaps – one counterparty agrees to pay or receive from the other cash amounts based on changes in the value of a reference asset or group of assets, including any returns such as interest earned on these assets, in exchange for amounts that are based on prevailing market funding rates.
The main risks associated with these instruments are related to exposure to movements in interest rates, foreign exchange rates, credit quality, securities values or commodities prices, as applicable, and the possible inability of counterparties to meet the terms of the contracts.
Forwards and Futures
Forwards and futures are contractual agreements to either buy or sell a specified amount of a currency, commodity, interest-rate-sensitive financial instrument or security at a specified price and date in the future.
Forwards are customized contracts transacted in the over-the-counter market. Futures are transacted in standardized amounts on regulated exchanges and are subject to daily cash margining.
The main risks associated with these instruments are related to exposure to movements in interest rates, foreign exchange rates, credit quality, securities values or commodities prices, as applicable, and the possible inability of counterparties to meet the terms of the contracts.
Options
Options are contractual agreements that convey to the purchaser the right but not the obligation to either buy or sell a specified amount of a currency, commodity, interest-rate-sensitive financial instrument or security at a fixed future date or at any time within a fixed future period.
For options written by us, we receive a premium from the purchaser for accepting market risk.
For options purchased by us, we pay a premium for the right to exercise the option. Since we have no obligation to exercise the option, our primary exposure to risk is the potential credit risk if the writer of an over-the-counter contract fails to meet the terms of the contract.
Caps, collars and floors are specialized types of written and purchased options. They are contractual agreements in which the writer agrees to pay the purchaser, based on a specified notional amount, the difference between the market rate and the prescribed rate of the cap, collar or floor.
The writer receives a premium for selling this instrument.
A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap.
A future option is an option contract in which the underlying instrument is a single futures contract.
The main risks associated with these instruments are related to exposure to movements in interest rates, foreign exchange rates, credit quality, value of the underlying financial instrument or commodity, as applicable, and the possible inability of counterparties to meet the terms of the contracts. Notes
Risks Hedged
Interest Rate Risk
We manage interest rate risk through bonds, interest rate futures, interest rate swaps and options, which are linked to and adjust the interest rate sensitivity of a specific asset, liability, forecasted transaction or firm commitment, or a specific pool of transactions with similar risk characteristics.
Foreign Currency Risk
We manage foreign currency risk through currency futures, foreign currency options, cross-currency swaps and forward contracts. These derivatives are marked to market, with realized and unrealized gains and losses recorded in non-interest revenue, consistent with the accounting treatment for gains and losses on the economically hedged item. Changes in fair value on forward contracts that qualify as accounting hedges are recorded in other comprehensive income, with the spot/forward differential (the difference between the foreign currency exchange rate at the inception of the contract and the rate at the end of the contract) being recorded in interest expense over the term of the hedge. Foreign currency translation on investments in foreign operations is managed through deposits. The foreign currency translation on the deposits designated in net investment hedges is recorded in other comprehensive income.
156 BMO Financial Group 198th Annual Report 2015
Trading Derivatives
Trading derivatives include derivatives entered into with customers to accommodate their risk management needs, market-making to facilitate customer-driven demand for derivatives, derivatives transacted on a limited basis to generate trading income from our principal trading positions and certain derivatives that are executed as part of our risk management strategy that do not qualify as hedges for accounting purposes (“economic hedges”). We structure and market derivative products to enable customers to transfer, modify or reduce current or expected risks.
Principal trading activities include market-making and positioning activities. Market-making involves quoting bid and offer prices to other market participants with the intention of generating revenues based on spread and volume. Positioning activities involve managing market risk positions with the expectation of profiting from favourable movements in prices, rates or indices.
Trading derivatives are recorded at fair value. Realized and unrealized gains and losses are recorded in trading revenues in our Consolidated
Statement of Income. Unrealized gains on trading derivatives are recorded as derivative instrument assets and unrealized losses are recorded as derivative instrument liabilities in our Consolidated Balance Sheet.
Hedging Derivatives
In accordance with our risk management strategy, we enter into various derivative contracts to hedge our interest rate and foreign currency exposures. We may also economically hedge a portion of our U.S. dollar earnings through forward foreign exchange contracts to minimize fluctuations in our consolidated net income due to the translation of our U.S. dollar earnings. These contracts are recorded at fair value, with changes in fair value recorded in non-interest revenue in our Consolidated Statement of Income.
Accounting Hedges
In order for a derivative instrument to qualify as an accounting hedge, the hedging relationship must be designated and formally documented at its inception, detailing the particular risk management objective and strategy for the hedge and the specific asset, liability or cash flow being hedged, as well as how its effectiveness is being assessed. Changes in the fair value of the derivative must be highly effective in offsetting changes in the fair value or changes in the amount of future cash flows of the hedged item.
Hedge effectiveness is evaluated at the inception of the hedging relationship and on an ongoing basis, retrospectively and prospectively, primarily using quantitative statistical measures of correlation. Any ineffectiveness in the hedging relationship is recognized in non-interest revenue, other, in our Consolidated Statement of Income as it arises.
Cash Flow Hedges
Cash flow hedges modify exposure to variability in cash flows for variable interest rate bearing instruments, foreign currency denominated assets and liabilities and certain cash-settled share-based payment grants subject to equity price risk. Variable interest rate bearing instruments include floating rate loans and deposits. Our cash flow hedges have a maximum remaining term to maturity of 20 years.
We record interest that we pay or receive on these cash flow hedge derivatives as an adjustment to net interest income in our Consolidated
Statement of Income over the life of the hedge.
To the extent that changes in the fair value of the derivative offset changes in the fair value of the hedged item, they are recorded in other comprehensive income. The excess of the change in fair value of the derivative that does not offset changes in the fair value of the hedged item
(the “ineffectiveness of the hedge”) is recorded directly in non-interest revenue, other, in our Consolidated Statement of Income.
For cash flow hedges that are discontinued before the end of the original hedge term, the cumulative unrealized gain or loss recorded in other comprehensive income is amortized to our Consolidated Statement of Income in net interest income for interest rate swaps and in employee compensation for total return swaps as the hedged item is recorded in earnings. If the hedged item is sold or settled, the entire unrealized gain or loss is recognized immediately in net interest income in our Consolidated Statement of Income.
The amount of unrealized gain that we expect to reclassify to our Consolidated Statement of Income over the next 12 months is $166 million
($122 million after tax). This will adjust the interest income and interest expense recorded on assets and liabilities and employee compensation expense that were hedged.
Notes
BMO Financial Group 198th Annual Report 2015 157
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the impact of cash flow hedges on our financial results.
(Canadian $ in millions)
Pre-tax gains/(losses) recorded in income
Fair value change recorded in other comprehensive income
Contract type
Fair value change recorded in non-interest revenue – other
Reclassification of gains on designated hedges from other comprehensive income to net interest income 2015
Interest rate
Foreign exchange (1)
Share-based payment awards
697
33
(14)
2
1
–
119
Total
716
3
111
2014
Interest rate
Foreign exchange (1)
224
102
3
–
130
Total
326
3
130
2013
Interest rate
Foreign exchange (1)
(86)
49
–
–
195
Total
(37)
–
195
na
(8)
na
na
(1) Amortization of the spot/forward differential on foreign exchange contracts of a loss of $40 million for the year ended October 31, 2015 ($4 million loss in 2014 and $25 million loss in 2013) was transferred from other comprehensive income to interest expense. na – not applicable
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Fair Value Hedges
Fair value hedges modify exposure to changes in a fixed rate instrument’s fair value caused by changes in interest rates. These hedges convert fixed rate assets and liabilities to floating rate. Our fair value hedges include hedges of fixed rate securities, deposits and subordinated debt.
We record interest receivable or payable on these derivatives as an adjustment to net interest income in our Consolidated Statement of Income over the life of the hedge.
For fair value hedges, the hedging derivative is recorded at fair value and any fixed rate assets and liabilities that are part of a hedging relationship are adjusted for the changes in value of the risk being hedged (“fair value hedge adjustment”). To the extent that the change in the fair value of the derivative does not offset changes in the fair value of the hedged item (the “ineffectiveness of the hedge”), the net amount is recorded directly in non-interest revenue, other, in our Consolidated Statement of Income.
For fair value hedges that are discontinued, we cease adjusting the hedged item to fair value. The cumulative fair value adjustment of the hedged item is then amortized to net interest income over its remaining term to maturity. If the hedged item is sold or settled, the cumulative fair value adjustment is included in the determination of the gain or loss on sale or settlement.
The following table presents the impact of fair value hedges on our financial results.
(Canadian $ in millions)
Pre-tax gains/(losses) recorded in income
Amount of gain/(loss) on hedging derivatives (1)
Contract type
Interest rate contracts
2015
2014
2013
225
46
(371)
Fair value hedge adjustment (2)
Hedge ineffectiveness recorded in non-interest revenue – other
(219)
(39)
360
6
7
(11)
(1) Unrealized gains (losses) on hedging derivatives are recorded in other assets – derivative instruments or other liabilities – derivative instruments in the Consolidated Balance Sheet.
(2) Unrealized gains (losses) on hedged items are recorded in securities – available-for-sale, subordinated debt, deposits and other liabilities.
Net Investment Hedges
Net investment hedges mitigate our exposure to foreign currency exchange rate fluctuations related to our net investment in foreign operations.
Deposit liabilities denominated in foreign currencies are designated as hedges for a portion of this exposure. The foreign currency translation of our net investment in foreign operations and the corresponding hedging instrument is recorded in unrealized gains (losses) on translation of net foreign operations in other comprehensive income. To the extent that the hedging instrument is not effective, amounts are included in the Consolidated
Statement of Income in foreign exchange, other than trading. There was no hedge ineffectiveness associated with net investment hedges for the years ended October 31, 2015 and 2014. We use foreign currency deposits with a term to maturity of zero to three months as hedging instruments in net investment hedges, and the fair value of such deposits was $1,485 million as at October 31, 2015 ($2,365 million in 2014).
Notes
Embedded Derivatives
From time to time, we purchase or issue financial instruments containing embedded derivatives. The embedded derivative is separated from the host contract and carried at fair value if the economic characteristics of the derivative are not closely related to those of the host contract, the terms of the embedded derivative are the same as those of a stand-alone derivative, and the combined contract is not held for trading or designated at fair value.
To the extent that we cannot reliably identify and measure the embedded derivative, the entire contract is carried at fair value, with changes in fair value reflected in income. Embedded derivatives in certain of our equity linked notes are accounted for separately from the host instrument.
Contingent Features
Certain over-the-counter derivative instruments contain provisions that link the amount of collateral we are required to post or pay to our credit ratings (as determined by the major credit rating agencies). If our credit ratings were to be downgraded, certain counterparties to these derivative instruments could demand immediate and ongoing collateralization overnight on derivative liability positions or request immediate payment. The aggregate fair value of all derivative instruments with collateral posting requirements that were in a liability position on October 31, 2015 was
158 BMO Financial Group 198th Annual Report 2015
$11,528 million, for which we have posted collateral of $11,122 million. If our credit rating had been downgraded to A and A- on October 31, 2015
(per Standard & Poor’s Ratings Services), we would have been required to post collateral or meet payment demands of an additional $532 million and $800 million, respectively.
Fair Value
Fair value represents point-in-time estimates that may change in subsequent reporting periods due to market conditions or other factors. A discussion of the fair value measurement of derivatives is included in Note 18. Fair values of our derivative instruments are as follows:
(Canadian $ in millions)
Trading
Interest Rate Contracts
Swaps
Forward rate agreements
Futures
Purchased options
Written options
Foreign Exchange Contracts
Cross-currency swaps
Cross-currency interest rate swaps
Forward foreign exchange contracts
Purchased options
Written options
Commodity Contracts
Swaps
Purchased options
Written options
Equity Contracts
Credit Default Swaps
Purchased
Written
2014
2015
Gross
assets
Gross assets Gross liabilities Gross liabilities Net
(16,449)
(6)
–
–
(581)
933
19
1
637
(581)
17,020
4
17
697
–
(15,986)
(6)
(21)
–
(616)
1,034
(2)
(4)
697
(616)
5,128
6,847
3,099
133
–
(4,239)
889
(12,128) (5,281)
(1,306) 1,793
–
133
(178)
(178)
2,153
5,705
3,874
447
–
(1,182)
(6,682)
(2,856)
–
(465)
971
(977)
1,018
447
(465)
993
674
–
969
(1,818)
(825)
–
674
(953)
(953)
(2,201) (1,232)
376
307
–
947
17,382
25
1
637
–
36
–
–
(48)
Net
(922)
(546)
–
307
(412)
(412)
(3,040) (2,093)
36
(48)
80
–
–
(124)
80
(124)
Total fair value – trading derivatives
35,924
(39,907) (3,983)
31,627
(32,312)
(685)
Average fair value (1)
42,027
(44,445) (2,418)
30,304
(31,092)
(788)
Hedging
Interest Rate Contracts
Cash flow hedges – swaps
Fair value hedges – swaps
664
544
(90)
(387)
574
157
196
330
(115)
(272)
81
58
Total swaps
1,208
(477)
731
526
(387)
139
Foreign Exchange Contracts
Cash flow hedges – forward foreign exchange contracts
1,092
(2,255) (1,163)
502
(958)
(456)
Total foreign exchange contracts
1,092
(2,255) (1,163)
502
(958)
(456)
Equity Contracts
Cash flow hedges – equity contracts
14
–
14
–
–
Total equity contracts
14
–
14
–
–
Total fair value – hedging derivatives (2)
Average fair value (1)
Total fair value – trading and hedging derivatives
Less: impact of master netting agreements
Total
2,314
2,329
38,238
(27,415)
10,823
1,028
(2,732)
(418)
(2,404)
(75)
916
(42,639) (4,401)
32,655
27,415
–
(28,885)
(15,224) (4,401)
3,770
–
–
(1,345)
(317)
(1,089)
(173)
(33,657) (1,002)
28,885
–
(4,772) (1,002)
(1) Average fair value amounts are calculated using a five-quarter rolling average.
(2) The fair values of hedging derivatives wholly or partially offset the changes in fair values of the related on-balance sheet financial instruments or future cash flows.
Assets are shown net of liabilities to customers where we have a legally enforceable right to offset amounts and we intend to settle contracts on a net basis.
Notes
BMO Financial Group 198th Annual Report 2015 159
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Notional Amounts
The notional amounts of our derivatives represent the amount to which a rate or price is applied in order to calculate the amount of cash that must be exchanged under the contract. Notional amounts do not represent assets or liabilities and therefore are not recorded in our Consolidated Balance
Sheet.
(Canadian $ in millions)
2014
2015
Hedging
Hedging
Trading
Exchange-traded
Futures
Purchased options
Written options
Fair value Total
Trading
Cash flow Fair value Total
2,853,087
432,744
21,344
24,154
59,021
–
–
–
47,679
–
–
–
2,959,787
432,744
21,344
24,154
2,580,940
361,484
19,267
22,955
45,753
–
–
–
48,984
–
–
–
2,675,677
361,484
19,267
22,955
3,331,329
Interest Rate Contracts
Over-the-counter
Swaps
Forward rate agreements
Purchased options
Written options
Cash flow 59,021
47,679
3,438,029
2,984,646
45,753
48,984
3,079,383
137,583
26,598
25,038
–
–
–
–
–
–
137,583
26,598
25,038
125,272
21,680
21,342
–
–
–
–
–
–
125,272
21,680
21,342
189,219
Foreign Exchange Contracts
Over-the-counter
Cross-currency swaps
Cross-currency interest rate swaps
Forward foreign exchange contracts
Purchased options
Written options
Exchange-traded
Futures
Purchased options
Written options
–
–
189,219
168,294
–
–
168,294
3,520,548
59,021
47,679
3,627,248
3,152,940
45,753
48,984
3,247,677
75,890
339,431
362,544
28,297
28,960
193
36
30,554
–
–
–
–
–
–
–
76,083
339,467
393,098
28,297
28,960
51,374
279,119
283,196
37,245
36,913
242
–
16,284
–
–
–
–
–
–
–
51,616
279,119
299,480
37,245
36,913
835,122
Total interest rate contracts
30,783
–
865,905
687,847
16,526
–
704,373
677
2,562
2,012
–
–
–
–
–
–
677
2,562
2,012
813
3,110
3,044
–
–
–
–
–
–
813
3,110
3,044
5,251
–
–
5,251
6,967
–
–
6,967
840,373
30,783
–
871,156
694,814
16,526
–
711,340
11,929
6,172
4,103
–
–
–
–
–
–
11,929
6,172
4,103
13,559
8,526
4,166
–
–
–
–
–
–
13,559
8,526
4,166
22,204
–
–
22,204
26,251
–
–
26,251
16,803
7,614
9,720
–
–
–
–
–
–
16,803
7,614
9,720
22,586
6,733
8,499
–
–
–
–
–
–
22,586
6,733
8,499
34,137
–
–
34,137
37,818
–
–
37,818
Total commodity contracts
56,341
–
–
56,341
64,069
–
–
64,069
Equity Contracts
Over-the-counter
Exchange-traded
46,942
4,371
172
–
–
–
47,114
4,371
48,702
7,314
–
–
–
–
48,702
7,314
Total equity contracts
51,313
172
–
51,485
56,016
–
–
56,016
6,665
9,385
–
–
–
–
6,665
9,385
8,801
11,983
–
–
–
–
8,801
11,983
Total foreign exchange contracts
Commodity Contracts
Over-the-counter
Swaps
Purchased options
Written options
Exchange-traded
Futures
Purchased options
Written options
Credit Default Swaps
Over-the-counter purchased
Over-the-counter written
Notes
Total credit default swaps
Total
16,050
–
–
16,050
20,784
–
–
20,784
4,484,625
89,976
47,679
4,622,280
3,988,623
62,279
48,984
4,099,886
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Derivative-Related Market Risk
Derivative instruments are subject to market risk. Market risk arises from the potential for a negative impact on the balance sheet and/or income statement due to adverse changes in the value of derivative 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. We strive to limit market risk by employing comprehensive governance and management processes for all market risk-taking activities.
160 BMO Financial Group 198th Annual Report 2015
Derivative-Related Credit Risk
Over-the-counter derivative instruments are subject to credit risk arising from the possibility that counterparties may default on their obligations. The credit risk associated with derivatives is normally a small fraction of the notional amount of the derivative instrument. Derivative contracts generally expose us to potential credit loss if changes in market rates affect a counterparty’s position unfavourably and the counterparty defaults on payment.
The credit risk is represented by the positive fair value of the derivative instrument. We strive to limit credit risk by dealing with counterparties that we believe are creditworthy, and we manage our credit risk for derivatives using the same credit risk process that is applied to loans and other credit assets. We also pursue opportunities to reduce our exposure to credit losses on derivative instruments, including through collateral and by entering into master netting agreements with counterparties. The credit risk associated with favourable contracts is eliminated by legally enforceable master netting agreements to the extent that unfavourable contracts with the same counterparty must be settled concurrently with favourable contracts.
Exchange-traded derivatives have limited potential for credit exposure as they are settled net daily with each exchange.
Terms used in the credit risk table below are as follows:
Replacement cost represents the cost of replacing all contracts that have a positive fair value, determined using current market rates. It represents in effect the unrealized gains on our derivative instruments. Replacement costs disclosed below represent the net of the asset and liability to a specific counterparty where we have a legally enforceable right to offset the amount owed to us with the amount owed by us and we intend either to settle on a net basis or to realize the asset and settle the liability simultaneously.
Credit risk equivalent represents the total replacement cost plus an amount representing the potential future credit exposure, as outlined in OSFI’s
Capital Adequacy Guideline.
Risk-weighted assets represent the credit risk equivalent, weighted on the basis of the creditworthiness of the counterparty, as prescribed by OSFI.
(Canadian $ in millions)
Riskweighted assets Riskweighted assets Replacement cost Credit risk equivalent –
–
–
17,546
4
691
21,371
45
705
–
–
–
22,712
1,461
18,241
22,121
1,393
5,128
6,847
4,191
115
8,602
13,696
7,838
768
–
–
–
–
2,153
5,705
4,376
415
5,039
11,219
6,477
837
–
–
–
–
16,281
30,904
2,034
12,649
23,572
1,656
993
69
2,472
1,043
–
–
376
30
1,902
1,109
–
–
1,062
3,515
496
406
3,011
472
892
3,366
214
896
3,547
208
36
245
34
80
271
42
4,239
3,771
Replacement cost Credit risk equivalent Interest Rate Contracts
Swaps
Forward rate agreements
Purchased options
18,590
25
633
22,037
24
651
Total interest rate contracts
19,248
Foreign Exchange Contracts
Cross-currency swaps
Cross-currency interest rate swaps
Forward foreign exchange contracts
Purchased options
Total foreign exchange contracts
Commodity Contracts
Swaps
Purchased options
Total commodity contracts
Equity Contracts
Credit Default Swaps
Total derivatives
Less: impact of master netting agreements
2014
2015
37,519
60,742
(27,415)
(40,140)
10,104
20,602
Total
–
4,239
32,272
52,522
(28,885)
(35,585)
3,387
16,937
–
3,771
The total derivatives and the impact of master netting agreements for replacement cost do not include exchange-traded derivatives with a fair value of $719 million as at October 31, 2015 ($383 million in 2014).
Transactions are conducted with counterparties in various geographic locations and industry sectors. Set out below is the replacement cost of contracts (before and after the impact of master netting agreements) with customers located in the following countries, based on country of ultimate risk.
(Canadian $ in millions, except as noted)
Before master netting agreements
After master netting agreements
2014
2015
2014
2015
19,492
7,702
3,220
7,105
52
21
9
18
14,395
7,579
3,623
6,675
45
23
11
21
5,832
2,609
398
1,265
58
26
4
12
1,769
875
232
511
52
26
7
15
Total
37,519
100%
32,272
100%
10,104
100%
3,387
100%
(1) No other country represented 15% or more of our replacement cost in 2015 or 2014.
BMO Financial Group 198th Annual Report 2015 161
Notes
Canada
United States
United Kingdom
Other countries (1)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Transactions are conducted with various counterparties. Set out below is the replacement cost of contracts (before the impact of master netting agreements) with customers in the following industries:
As at October 31, 2015 (Canadian $ in millions)
Interest rate contracts
Foreign exchange contracts
Commodity contracts
Equity contracts
Credit default swaps
Total
Financial institutions
Governments
Natural resources
Energy
Other
13,882
2,940
–
250
2,176
10,565
3,343
27
693
1,653
253
85
114
189
421
708
–
–
–
184
35
–
–
–
1
25,443
6,368
141
1,132
4,435
Total
19,248
16,281
1,062
892
36
37,519
Interest rate contracts
Foreign exchange contracts
Commodity contracts
Equity contracts
Credit default swaps
Total
Financial institutions
Governments
Natural resources
Energy
Other
13,997
2,262
33
171
1,778
8,903
2,330
27
255
1,134
157
11
37
36
165
660
–
–
–
236
66
–
–
–
14
23,783
4,603
97
462
3,327
Total
18,241
12,649
406
896
80
32,272
As at October 31, 2014 (Canadian $ in millions)
Term to Maturity
Our derivative contracts have varying maturity dates. The remaining contractual terms to maturity for the notional amounts of our derivative contracts are set out below:
(Canadian $ in millions)
2015
Term to maturity
2014
Total
notional amounts Within 1 year 1 to 3 years 3 to 5 years 5 to 10 years Over 10 years Total notional amounts
Interest Rate Contracts
Swaps
Forward rate agreements, futures and options
1,110,622
592,366
573,718
64,574
846,317
6,334
380,048
4,064
49,082
123
2,959,787
667,461
2,675,677
572,000
Total interest rate contracts
1,702,988
638,292
852,651
384,112
49,205
3,627,248
3,247,677
Foreign Exchange Contracts
Cross-currency swaps
Cross-currency interest rate swaps
Forward foreign exchange contracts, futures and options
19,320
86,626
445,471
16,868
108,857
8,258
22,170
74,121
1,529
15,342
57,722
332
2,383
12,141
16
76,083
339,467
455,606
51,616
279,119
380,605
Total foreign exchange contracts
551,417
133,983
97,820
73,396
14,540
871,156
711,340
Commodity Contracts
Swaps
Futures and options
3,604
15,824
6,626
25,688
817
2,353
861
502
21
45
11,929
44,412
13,559
50,510
Total commodity contracts
19,428
32,314
3,170
1,363
66
56,341
64,069
Equity Contracts
43,296
5,170
1,535
68
1,416
51,485
56,016
Credit Contracts
10,958
2,966
713
1,021
392
16,050
20,784
2,328,087
812,725
955,889
459,960
65,619
4,622,280
4,099,886
Total notional amount
Notes
Certain comparative figures have been reclassified to conform with the current year’s presentation.
162 BMO Financial Group 198th Annual Report 2015
Note 9: Premises and Equipment
We record all premises and equipment at cost less accumulated amortization, except land, which is recorded at cost. Buildings, computer equipment and operating system software, other equipment and leasehold improvements are amortized on a straight-line basis over their estimated useful lives.
When the major components of a building have different useful lives, they are accounted for separately and amortized over each component’s useful life. The maximum estimated useful lives we use to amortize our assets are as follows:
Buildings
Computer equipment and operating system software
Other equipment
Leasehold improvements
10 to 40 years
15 years
10 years
Lease term to a maximum of 10 years
Amortization methods, useful lives and the residual values of premises and equipment are reviewed annually for any change in circumstances and are adjusted if appropriate. At least annually, we review whether there are any indications that premises and equipment need to be tested for impairment. If there is an indication that an asset may be impaired, we test for impairment by comparing the asset’s carrying value to its recoverable amount. The recoverable amount is calculated as the higher of the value in use and the fair value less costs to sell. Value in use is the present value of the future cash flows expected to be derived from the asset. An impairment charge is recorded when the recoverable amount is less than the carrying value. There were no significant write-downs of premises and equipment due to impairment during the years ended October 31, 2015 and 2014. Gains and losses on disposal are included in non-interest expense, premises and equipment in our Consolidated Statement of Income.
Net rent expense for premises and equipment reported in our Consolidated Statement of Income for the years ended October 31, 2015, 2014 and
2013 was $476 million, $431 million and $434 million, respectively.
(Canadian $ in millions)
2014
2015
Land
Buildings
Computer equipment Other equipment Leasehold improvements Total
Land
Cost
Balance at beginning of year
Additions
Disposals (1)
Additions from acquisitions (2)
Foreign exchange and other
300
5
(64)
–
39
1,802
48
(102)
–
160
1,571
228
(243)
–
75
805
73
(24)
–
47
1,182 5,660 297
75
429
(1)
(12) (445) (16)
–
–
–
40
361
20
Balance at end of year
280
1,908
1,631
901
1,285
1,108
(137)
154
21
554
(14)
56
55
743 3,384
(6) (214)
132
378
(22)
172
–
–
–
–
6,005
300
Buildings
Computer equipment Other equipment Leasehold improvements Total
1,680
106
(44)
–
60
1,531
189
(188)
3
36
770
29
(22)
2
26
1,045
106
(7)
4
34
5,323
429
(277)
9
176
1,802
1,571
805
1,182
5,660
900
(28)
34
73
1,104
(175)
149
30
508
(19)
60
5
643
(5)
122
(17)
3,155
(227)
365
91
Accumulated Depreciation and
Impairment
Balance at beginning of year
Disposals (1)
Amortization
Foreign exchange and other
–
–
–
–
Balance at end of year
–
1,076
1,146
651
847
3,720
–
979
1,108
554
743
3,384
280
832
485
250
438
2,285
300
823
463
251
439
2,276
Net carrying value
979
(57)
36
118
(1) Includes fully depreciated assets written off.
(2) Premises and equipment are recorded at their fair values at the date of acquisition.
Note 10: Acquisitions
The cost of an acquisition is measured at the fair value of the consideration transferred, including contingent consideration. Acquisition-related costs are recognized as an expense in the period in which they are incurred. The identifiable assets acquired and liabilities assumed and contingent consideration are measured at their fair values at the date of acquisition. Goodwill is measured as the excess of the aggregate of the consideration transferred over the net of the amounts of identifiable assets acquired and liabilities assumed. The results of operations of acquired businesses are included in our consolidated financial statements beginning on the date of acquisition.
Future Acquisition – GE Capital Corporation Transportation Finance business (“GE Transportation Finance”)
Acquisition – F&C Asset Management plc (“F&C”)
On May 7, 2014, we completed the acquisition of all the issued and outstanding share capital of F&C Asset Management plc, an investment manager based in the United Kingdom, for cash consideration of £712 million.
BMO Financial Group 198th Annual Report 2015 163
Notes
On September 10, 2015, we announced an agreement to purchase the assets of GE Transportation Finance. The aggregate cash purchase price is approximately US$8.9 billion. The GE Transportation Finance portfolio includes approximately $11.9 billion (US$8.9 billion) in net earning assets, subject to closing adjustments. The acquisition is consistent with our commercial banking activities in both Canada and the U.S. and will expand our commercial customer base. We expect the acquisition to close during the first quarter of 2016 and the results of the acquired business will be included in our U.S. P&C and Canadian P&C reporting segments.
The initial accounting for the business combination is not yet complete and we have not determined the final consideration, fair value of assets acquired, or amount of goodwill expected to be recognized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The acquisition was accounted for as a business combination. The results of the acquired business are included in our Wealth Management reporting segment.
As part of the acquisition, we acquired intangible assets comprised primarily of fund management contracts and customer relationships, including
$178 million of intangible assets that have an indefinite life and $313 million that are being amortized over 2 to 10 years, primarily on a straight-line basis. This acquisition strengthens our position as a globally significant money manager, enhances our asset management platform capabilities and provides opportunities to service wealth markets in the United Kingdom and the rest of Europe. Goodwill of $1,268 million related to this acquisition was recorded and is not deductible for tax purposes.
As part of the acquisition of F&C, we acquired a subsidiary of F&C, F&C REIT LLP, that is 30% owned by three other partners. We have recorded the ownership interests of the partners in F&C REIT LLP as non-controlling interest in our Consolidated Balance Sheet based on the non-controlling partners’ proportionate share of the net assets of F&C REIT LLP.
The fair value of the assets acquired and the liabilities assumed at the date of acquisition are as follows:
(Canadian $ in millions)
2014
F&C
Cash resources
Premises and equipment
Goodwill
Intangible assets
Other assets
338
9
1,268
491
293
Total assets
2,399
Other liabilities
1,083
Non-controlling interests
Purchase price
22
1,294
Note 11: Goodwill and Intangible Assets
Goodwill
Notes
When we complete an acquisition, we allocate the purchase price paid to the assets acquired, including identifiable intangible assets, and the liabilities assumed. Any portion of the consideration transferred that is in excess of the fair value of those net assets is considered to be goodwill.
Goodwill is not amortized and is instead tested for impairment annually.
In performing the impairment test, we utilize the fair value less costs to sell for each group of cash-generating units (“CGUs”) based on discounted cash flow projections. Cash flows were projected for the first 10 years based on actual operating results, expected future business performance and past experience. Beyond the first 10 years, cash flows were assumed to grow at perpetual annual rates of up to 3%. The discount rates we applied in determining the recoverable amounts in 2015 ranged from 5.9% to 11.6% (6.9% to 12.8% in 2014), and were based on our estimate of the cost of capital for each CGU. The cost of capital for each CGU was estimated using the Capital Asset Pricing Model, based on the historical betas of publicly traded peer companies that are comparable to the CGU.
There were no write-downs of goodwill due to impairment during the years ended October 31, 2015 and 2014.
The key assumptions described above may change as market and economic conditions change. However, we estimate that reasonably possible changes in these assumptions are not expected to cause recoverable amounts of our CGUs to decline below their carrying amounts.
164 BMO Financial Group 198th Annual Report 2015
A continuity of our goodwill by group of CGUs for the years ended October 31, 2015 and 2014 is as follows:
Personal and
Commercial
Banking
(Canadian $ in millions)
Canadian
P&C
Total
Total
Traditional Wealth
Management
Insurance
Total
Balance – October 31, 2013
Acquisitions during the year
Other (1)
69
–
(1)
2,702
–
220
2,771
–
219
847
1,268
35
2
–
–
849
1,268
35
199
–
12
3,819
1,268
266
Balance – October 31, 2014
68
2,922
2,990
2,150
2
2,152
211
5,353
–
–
–
471
–
471
Disposals during the year
Other (1)
Balance – October 31, 2015
U.S.
P&C
BMO
Capital
Markets
Wealth
Management
68 (2) 3,393 (3)
(21)
245
3,461
–
–
2,374 (4)
2 (5)
(21)
245
–
21
2,376
232 (6)
(21)
737
6,069
(1) Other changes in goodwill included the effects of translating goodwill denominated in foreign currencies into Canadian dollars, purchase accounting adjustments related to prior-year purchases and disposals of businesses during the year.
(2) Relates primarily to bcpbank Canada, Diners Club and Aver Media LP.
(3) Relates primarily to New Lenox State Bank, First National Bank of Joliet, Household Bank branches, Mercantile Bancorp, Inc., Villa Park Trust Savings Bank, First National Bank & Trust, Ozaukee Bank,
Merchants and Manufacturers Bancorporation, Inc., Diners Club, AMCORE and M&I.
(4) Relates to BMO Nesbitt Burns Inc., Guardian Group of Funds Ltd., Pyrford International plc, Integra GRS, Lloyd George Management, M&I, Harris myCFO, Inc., Stoker Ostler Wealth Advisors, Inc.,
CTC Consulting LLC, AWMB and F&C Asset Management plc.
(5) Relates to AIG.
(6) Relates to Gerard Klauer Mattison & Co., Inc., BMO Nesbitt Burns Inc., Paloma Securities L.L.C. and M&I.
Intangible Assets
Intangible assets related to our acquisitions are initially recorded at their fair value at the acquisition date and subsequently at cost less accumulated amortization. Software is recorded at cost less accumulated amortization. Amortization expense is recorded in amortization of intangible assets on the
Consolidated Statement of Income. The following table presents the changes in the balance of these intangible assets:
Developed
software – amortizing Software under development
544
24
–
(28)
1,606
286
17
24
243
69
–
4
29
–
303
(1)
3,719
379
491
139
167
(4)
–
27
540
7
–
15
1,933
345
–
42
316
42
–
11
331
53
–
37
4,728
420
–
341
190
562
2,320
369
421
5,489
Purchased software – amortizing Developed software – amortizing Software under development
Customer relationships Core deposits Branch distribution networks
Cost as at October 31, 2013
Additions/disposals/other
Acquisitions
Foreign exchange
389
–
171
66
754
–
–
61
154
–
–
13
Cost as at October 31, 2014
Additions/disposals/other
Acquisitions
Foreign exchange
626
(23)
–
80
815
–
–
129
Cost as at October 31, 2015
683
944
(Canadian $ in millions)
Purchased software – amortizing Other
Total
The following table presents the accumulated amortization of the intangible assets:
Customer
relationships
Core deposits Branch distribution networks
Other
Total
Accumulated amortization at October 31, 2013
Disposals/other
Amortization
Foreign exchange
124
–
61
44
397
–
69
40
152
–
2
12
489
–
20
(29)
1,018
–
221
11
–
–
–
–
28
–
9
8
2,208
–
382
86
Accumulated amortization at October 31, 2014
Disposals/other
Amortization
Foreign exchange
229
(8)
78
39
506
–
66
83
166
(3)
2
25
480
–
17
8
1,250
–
230
60
–
–
–
–
45
–
18
(10)
2,676
(11)
411
205
Accumulated amortization at October 31, 2015
338
655
190
505
1,540
–
53
3,281
Carrying value at October 31, 2015
345
289
–
57
780
369
368
2,208
Carrying value at October 31, 2014
397
309
1
60
683
316
286
2,052
(Canadian $ in millions)
BMO Financial Group 198th Annual Report 2015 165
Notes
Intangible assets are amortized to income over the period during which we believe the assets will benefit us, on either a straight-line or an accelerated basis, over a period not to exceed 15 years. We have $198 million as at October 31, 2015 ($178 million as at October 31, 2014) in intangible assets with indefinite lives that relate primarily to fund management contracts.
The useful lives of intangible assets are reviewed annually for any changes in circumstances. We test finite life intangible assets for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. Indefinite life intangible assets are tested annually for impairment. If any intangible assets are determined to be impaired, we write them down to their recoverable amount, the higher of value in use and fair value less costs to sell, when this is less than the carrying value.
There were write-downs of intangible assets of $1 million in the year ended October 31, 2015 ($1 million in 2014).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 12: Other Assets
(Canadian $ in millions)
2015
2014
Accounts receivable, prepaid expenses and other items
Accrued interest receivable
Due from clients, dealers and brokers
Insurance-related assets (1)
Pension asset (Note 23)
6,502
882
309
478
502
6,104
879
542
445
261
Total
8,673
8,231
(1) Includes reinsurance assets related to our life insurance business in the amount of $nil as at October 31, 2015 ($215 million in 2014).
Note 13: Deposits
Payable on demand
(Canadian $ in millions)
Interest bearing
Payable after notice
Non-interest bearing
Payable on a fixed date
Total
2015
2014
2015
2014
2015
2014
2015
2014
2015
2014
Deposits by:
Banks
Businesses and governments
Individuals
828
15,262
3,095
997
14,958
2,524
1,222
35,212
15,095
993
28,001
12,900
4,123
57,335
83,081
2,412
57,165
75,529
20,962
155,809
46,145
13,841
139,015
44,753
27,135
263,618
147,416
18,243
239,139
135,706
Total (1) (2)
19,185
18,479
51,529
41,894
144,539
135,106
222,916
197,609
438,169
393,088
Booked in:
Canada
United States
Other countries
17,031
1,517
637
16,753
1,191
535
35,300
16,091
138
28,832
12,972
90
75,470
68,396
673
77,232
57,314
560
120,199
76,980
25,737
111,193
66,664
19,752
248,000
162,984
27,185
234,010
138,141
20,937
Total
19,185
18,479
51,529
41,894
144,539
135,106
222,916
197,609
438,169
393,088
(1) Includes structured notes designated at fair value through profit or loss.
(2) As at October 31, 2015 and 2014, total deposits payable on a fixed date included $26,960 million and $18,183 million, respectively, of federal funds purchased, commercial paper issued and other deposit liabilities. Included in deposits as at October 31, 2015 and 2014 are $221,268 million and $191,155 million, respectively, of deposits denominated in U.S. dollars, and $19,898 million and
$8,204 million, respectively, of deposits denominated in other foreign currencies.
Deposits payable on demand are comprised primarily of our customers’ chequing accounts, some of which we pay interest on. Our customers need not notify us prior to withdrawing money from their chequing accounts.
Deposits payable after notice are comprised primarily of our customers’ savings accounts, on which we pay interest. Deposits payable on a fixed date are comprised of:
‰ Various investment instruments purchased by our customers to earn interest over a fixed period, such as term deposits and guaranteed investment certificates. The terms of these deposits can vary from one day to 10 years.
‰ Federal funds purchased, which are overnight borrowings of other banks’ excess reserve funds at a United States Federal Reserve Bank. As at
October 31, 2015, we had borrowed $263 million of federal funds ($651 million in 2014).
‰ Commercial paper, which totalled $7,134 million as at October 31, 2015 ($4,294 million in 2014).
‰ Covered bonds, which totalled $12,611 million as at October 31, 2015 ($7,683 million in 2014).
During the year, we issued €1,500 million of 0.25% Covered Bonds, Series CBL 2 due January 22, 2020, GBP 325 million of 3MoGBPLibor + 0.19%
Covered Bonds, Series CBL 3 due January 29, 2018, €1,500 million of 0.375% Covered Bonds, Series CBL 4 due August 5, 2020, €1,000 million of
0.75% Covered Bonds, Series CBL5 due September 21, 2022 and €135 million of 1.597% Covered Bonds, Series CBL6 due September 28, 2035 under our Global Registered Covered Bond Program. During 2014, we issued €1.0 billion of 1.0% Covered Bonds, Series CBL1 due May 7, 2019 under our
Global Registered Covered Bond Program. During the years ended October 31, 2015 and 2014, US$2.0 billion of 2.85% Covered Bonds Series CB2 and
US$2.0 billion of 1.3% Covered Bonds, Series 4 matured, respectively.
The following table presents the maturity schedule for our deposits payable on a fixed date:
2015
2014
Within 1 year
1 to 2 years
2 to 3 years
3 to 4 years
4 to 5 years
Over 5 years
Notes
(Canadian $ in millions)
144,609
23,385
23,324
7,753
11,170
12,675
124,782
22,733
23,491
8,379
8,498
9,726
Total (1)
222,916
197,609
(1) Includes $200,907 million of deposits, each greater than one hundred thousand dollars, of which $103,101 million were booked in Canada, $72,073 million were booked in the United States and
$25,733 million were booked in other countries ($174,612 million, $92,668 million, $62,193 million and $19,751 million, respectively, in 2014). Of the $103,101 million of deposits booked in Canada,
$36,434 million mature in less than three months, $4,956 million mature in three to six months, $11,916 million mature in six to twelve months and $49,795 million mature after 12 months
($92,668 million, $27,304 million, $7,465 million, $11,565 million and $46,334 million, respectively, in 2014). We have unencumbered liquid assets of $188,463 million to support these and other deposit liabilities ($170,981 million in 2014).
166 BMO Financial Group 198th Annual Report 2015
The following table presents the average deposit balances and average rates of interest paid during 2015 and 2014:
Average balances
(Canadian $ in millions)
Average rate paid (%)
2015
2014
2015
2014
Deposits Booked in Canada
Demand deposits – interest bearing
Demand deposits – non-interest bearing
Payable after notice
Payable on a fixed date
18,910
31,762
76,458
120,764
16,469
26,702
76,903
118,094
0.36
–
0.57
1.35
0.45
–
0.70
1.44
Total deposits booked in Canada
247,894
238,168
0.86
0.97
Deposits Booked in the United States and Other Countries
Banks located in the United States and other countries
Governments and institutions in the United States and other countries
Other demand deposits
Other deposits payable after notice or on a fixed date
11,183
13,902
16,109
146,380
8,195
12,095
12,744
127,389
0.28
0.39
0.01
0.31
0.28
0.36
0.02
0.38
Total deposits booked in the United States and other countries
187,574
160,423
0.29
0.35
Total average deposits
435,468
398,591
0.62
0.72
As at October 31, 2015 and 2014, deposits by foreign depositors in our Canadian bank offices amounted to $37,477 million and $30,622 million, respectively.
Most of our structured note liabilities have been designated at fair value through profit or loss and are accounted for at fair value, which aligns the accounting result with the way the portfolio is managed. The change in fair value of these structured notes was recorded as an increase of
$196 million in non-interest revenue, trading revenue, and an increase of $143 million before tax was recorded in other comprehensive income related to changes in our own credit spread for the year ended October 31, 2015 (a decrease of $6 million recorded in non-interest revenue, trading revenue, of which $41 million related to changes in our own credit spread for the year ended October 31, 2014). The impact of changes in our own credit spread is measured based on movements in our own credit spread year over year.
The cumulative change in fair value related to changes in our own credit spread that has been recognized since the notes were designated at fair value to October 31, 2015 was an unrealized gain of approximately $67 million. Upon adoption of the own credit provisions of IFRS 9 this year,
$143 million of unrealized gain has been recorded in other comprehensive income. The remainder, an unrealized loss of $76 million was recorded through the Statement of Income in prior periods.
The fair value and notional amount due at contractual maturity of these notes as at October 31, 2015 were $9,429 million and $9,869 million, respectively ($7,639 million and $7,733 million, respectively, in 2014).
Note 14: Other Liabilities
Acceptances
Acceptances represent a form of negotiable short-term debt that is issued by our customers and which we guarantee for a fee. We have an offsetting claim, equal to the amount of the acceptances, against our customers. The amount due under acceptances is recorded as a liability and our corresponding claim is recorded as a loan in our Consolidated Balance Sheet.
Securities Lending and Borrowing
Securities lending and borrowing transactions are generally collateralized by securities or cash. Cash advanced or received as collateral is recorded in other assets or other liabilities, respectively. The transfer of the securities to counterparties is only reflected in our Consolidated Balance Sheet if the risks and rewards of ownership have also been transferred. Securities borrowed are not recognized in our Consolidated Balance Sheet unless they are then sold to third parties, in which case the obligation to return the securities is recorded in Securities sold but not yet purchased.
Securities Sold but not yet Purchased
Securities sold but not yet purchased represent our obligations to deliver securities that we did not own at the time of sale. These obligations are recorded at their fair value. Adjustments to the fair value as at the balance sheet date and gains and losses on the settlement of these obligations are recorded in trading revenues in our Consolidated Statement of Income.
Securities Lent or Sold Under Repurchase Agreements
Securities lent or sold under repurchase agreements represent short-term funding transactions in which we sell securities that we own and simultaneously commit to repurchase the same securities at a specified price on a specified date in the future. The obligation to repurchase these securities is recorded at the amount owing. The interest expense related to these liabilities is recorded on an accrual basis.
Notes
BMO Financial Group 198th Annual Report 2015 167
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Liabilities
The components of the other liabilities balance were as follows:
(Canadian $ in millions)
2015
2014
Securitization and structured entities liabilities
Accounts payable, accrued expenses and other items
Accrued interest payable
Liabilities of subsidiaries, other than deposits
Insurance-related liabilities
Pension liability (Note 23)
Other employee future benefits liability (Note 23)
21,673
8,747
969
3,948
7,060
364
1,192
22,465
7,713
1,050
3,775
6,827
229
1,204
Total
43,953
43,263
Included in securitization and structured entities liabilities are amounts related to the notes issued by our credit protection vehicle have been designated at fair value through profit or loss and are accounted for at fair value. This eliminates a measurement inconsistency that would otherwise arise from measuring these note liabilities and offsetting changes in the fair value of the related investments and derivatives on a different basis. The fair value of these note liabilities as at October 31, 2015 of $139 million ($139 million in 2014) is recorded in other liabilities in our Consolidated
Balance Sheet. The change in fair value of these note liabilities resulted in $nil in non-interest revenue, trading revenues, for the year ended
October 31, 2015 ($nil in 2014).
We designate the obligation related to certain investment contracts at fair value through profit or loss, which eliminates a measurement inconsistency that would otherwise arise from measuring the investment contract liabilities and offsetting changes in the fair value of the investments supporting them on a different basis. The fair value of these investment contract liabilities as at October 31, 2015 of $525 million
($407 million as at October 31, 2014) is recorded in other liabilities in our Consolidated Balance Sheet. The change in fair value of these investment contract liabilities resulted in an increase of $24 million in insurance claims, commissions, and changes in policy benefit liabilities for the year ended
October 31, 2015 (increase of $37 million in 2014). For the year ended October 31, 2015, a gain of $20 million was recorded in other comprehensive income related to changes in our credit spread. Changes in the fair value of investments backing these investment contract liabilities are recorded in non-interest revenue, insurance revenue. The impact of changes in our own credit spread is measured based on movements in our own credit spread over the year.
Insurance-Related Liabilities
We are engaged in insurance businesses related to life and health insurance, annuities and reinsurance.
Insurance claims and policy benefit liabilities represent current claims and estimates of future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method, which incorporates best-estimate assumptions for mortality, morbidity, policy lapses, surrenders, future investment yields, policy dividends, administration costs and margins for adverse deviation. These assumptions are reviewed at least annually and updated to reflect actual experience and market conditions.
A reconciliation of the change in insurance-related liabilities is as follows:
(Canadian $ in millions)
2015
2014
6,827
Insurance-related liabilities, beginning of year
Increase (decrease) in life insurance policy benefit liabilities from:
New business
In-force policies
Changes in actuarial assumptions and methodology
Foreign currency
6,115
235
–
(355)
4
(116)
349
Net increase (decrease) in life insurance policy benefit liabilities
Change in other insurance-related liabilities
Insurance-related liabilities, end of year
476
346
(291)
2
533
179
7,060
6,827
Reinsurance
In the ordinary course of business, our insurance subsidiaries reinsure risks to other insurance and reinsurance companies in order to provide greater diversification, limit loss exposure to large risks and provide additional capacity for future growth. These ceding reinsurance arrangements do not relieve our insurance subsidiaries of their direct obligation to the insureds. We evaluate the financial condition of the reinsurers and monitor their credit ratings to minimize our exposure to losses from reinsurer insolvency.
Reinsurance premiums ceded are net against direct premium income and included in non-interest revenue, insurance revenue, in our
Consolidated Statement of Income for the years ended October 31, 2015, 2014 and 2013, as shown in the table below.
(Canadian $ in millions)
Notes
2014
2013
2,027
(466)
1,850
(450)
1,567
(434)
1,561
Direct premium income
Ceded premiums
2015
1,400
1,133
Note 15: Subordinated Debt
Subordinated debt represents our direct unsecured obligations, in the form of notes and debentures, to our debt holders and forms part of our
Basel III regulatory capital. Subordinated debt is recorded at amortized cost using the effective interest rate method. The rights of the holders of our notes and debentures are subordinate to the claims of depositors and certain other creditors. We require approval from OSFI before we can redeem any part of our subordinated debt. Where appropriate, we enter into fair value hedges to hedge the risks caused by changes in interest rates (see
Note 8).
168 BMO Financial Group 198th Annual Report 2015
During the year ended October 31, 2015, we did not issue any subordinated debt. During the year ended October 31, 2014, we issued $1.0 billion of 3.12% subordinated debt under our Canadian Medium-Term Note Program. The issue, Series H Medium-Term Notes, Tranche 1, is due
September 19, 2024. The notes reset to a floating rate on September 19, 2019.
During the year ended October 31, 2015, we redeemed all of our outstanding $500 million Subordinated Debentures, Series C Medium-Term
Notes Tranche 2, at a redemption price of 100% of the principal amount plus unpaid accrued interest to the redemption date. During the year ended
October 31, 2014, we did not redeem any of our subordinated debt.
The term to maturity and repayments of our subordinated debt required over the next two years and thereafter are as follows:
(Canadian $ in millions, except as noted)
Debentures Series 16
Debentures Series 20
Series C Medium-Term Notes
Tranche 2
Series D Medium-Term Notes
Tranche 1
Series F Medium-Term Notes
Tranche 1
Series G Medium-Term Notes
Tranche 1
Series H Medium-Term Notes
Tranche 1
Face value
Maturity date
Interest rate (%)
10.00
8.25
Redeemable at our option beginning in
2015
Total
2014
Total
February 2012 (1)
Not redeemable
100
150
100
150
–
500
100
150
February 2017
December 2025 to 2040
500
April 2020
4.87
April 2015
700
April 2021
5.10
April 2016 (2)
700
700
900
March 2023
6.17
March 2018 (3)
900
900
1,500
July 2021
3.98
July 2016 (4)
1,500
1,500
1,000
September 2024
3.12
September 2019 (5)
1,000
1,000
4,350
4,850
Total (6)
(1)
(2)
(3)
(4)
Redeemable at the greater of par and the Canada Yield Price after their redemption date of February 20, 2012 until their maturity date of February 20, 2017.
Redeemable at the greater of par and the Canada Yield Price prior to April 21, 2016, and redeemable at par commencing April 21, 2016.
Redeemable at the greater of par and the Canada Yield Price prior to March 28, 2018, and redeemable at par commencing March 28, 2018.
Interest on this issue is payable semi-annually at a fixed rate of 3.979% until July 8, 2016, and at a floating rate equal to the three-month Canadian Dealer Offered Rate (“CDOR”) plus 1.09%, paid quarterly, thereafter to maturity. This issue is redeemable at par commencing July 8, 2016.
(5) Interest on this issue is payable semi-annually at a fixed rate of 3.12% until September 19, 2019, and at a floating rate equal to the three-month CDOR plus 1.08%, paid quarterly, thereafter to maturity. This issue is redeemable at par commencing September 19, 2019.
(6) Certain amounts of subordinated debt were issued at a premium or discount and include fair value hedge adjustments which together increased their carrying value as at October 31, 2015 by
$66 million ($63 million in 2014); see Note 8 for further details. Subordinated debt that we repurchase is excluded from the carrying value.
Please refer to the offering circular related to each of the above issues for further details on Canada Yield Price calculations and the definition of CDOR.
Non-Viability Contingent Capital
The Series H Medium-Term Notes include a non-viability contingent capital provision, which is necessary for the notes issued after a certain date to qualify as regulatory capital under Basel III. As such, the notes are convertible into a variable number of our common shares if OSFI announces that the bank is, or is about to become, non-viable or if a federal or provincial government in Canada publicly announces that the bank has accepted or agreed to accept a capital injection, or equivalent support, to avoid non-viability.
Note 16: Capital Trust Securities
We issue BMO Capital Trust Securities (“BMO BOaTS”) through our subsidiary BMO Capital Trust (the “Trust”). The proceeds of BMO BOaTS are used for general corporate purposes. We consolidate the Trust, and the BMO BOaTS are reported in our Consolidated Balance Sheet as non-controlling interest in subsidiaries. During the years ended October 31, 2015 and 2014, we did not issue any BMO BOaTS.
Holders of the BMO BOaTS are entitled to receive semi-annual non-cumulative fixed cash distributions as long as we declare dividends on our preferred shares or, if no preferred shares are outstanding, on our common shares in accordance with our ordinary dividend practice.
Distribution dates
BMO BOaTS
Series D
Series E
June 30, December 31
June 30, December 31
Distribution per BOaTS (1)
27.37
23.17 (2)
Redemption date
Principal amount
At the option of the Trust
2015
2014
December 31, 2009
December 31, 2010
–
450
600
450
450
(Canadian $ in millions, except Distribution)
1,050
(1) Distribution paid on each trust security that has a par value of $1,000.
(2) After December 31, 2015, the distribution will be at the Bankers’ Acceptance Rate plus 1.5%.
Redemption by the Trust
Conversion by the Holders
BMO BOaTS Series E cannot be converted at the option of the holders.
Automatic Exchange
The BMO BOaTS Series E will each be automatically exchanged for 40 Class B Non-Cumulative Preferred Shares of the bank, Series 12, without the consent of the holders on the occurrence of specific events, such as a wind-up of the bank, a regulatory requirement to increase capital or violations of regulatory capital requirements.
BMO Financial Group 198th Annual Report 2015 169
Notes
On or after the redemption dates indicated above, and subject to the prior approval of OSFI, the Trust may redeem the securities in whole without the consent of the holders.
During the year ended October 31, 2015, we redeemed all of our BMO BOaTS Series D at a redemption amount equal to $1,000 for an aggregate redemption of $600 million, plus unpaid indicated distributions. During the year ended October 31, 2014, there were no redemptions. On
November 27, 2015, we announced our intention to redeem all of our BMO BOaTS Series E on December 31, 2015.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 17: Equity
Share Capital
(Canadian $ in millions, except as noted)
2015
2014
2013
Number of shares
Amount
Dividends declared per share
Number of shares
Amount
Dividends declared per share
14,000,000
10,000,000
10,000,000
6,267,391
5,732,609
–
–
16,000,000
11,600,000
20,000,000
16,000,000
12,000,000
–
–
–
350
250
250
157
143
–
–
400
290
500
400
300
–
–
–
1.13
1.31
1.45
0.85
0.64
0.41
0.81
1.35
0.98
0.59
0.46
0.31
–
–
–
14,000,000
10,000,000
10,000,000
6,267,391
5,732,609
6,000,000
11,000,000
16,000,000
11,600,000
–
–
–
–
–
–
350
250
250
157
143
150
275
400
290
–
–
–
–
–
–
1.13
1.31
1.45
1.19
0.17
1.63
1.63
1.35
0.98
–
–
–
–
–
–
Number of shares
Preferred Shares – Classified as Equity
Class B – Series 13
Class B – Series 14
Class B – Series 15
Class B – Series 16
Class B – Series 17
Class B – Series 18 (1)
Class B – Series 21 (2)
Class B – Series 23
Class B – Series 25
Class B – Series 27
Class B – Series 29
Class B – Series 31
Class B – Series 33
Class B – Series 35
Class B – Series 36
Amount
Dividends declared per share
–
10,000,000
10,000,000
6,267,391
5,732,609
–
–
–
11,600,000
20,000,000
16,000,000
12,000,000
8,000,000
6,000,000
600,000
–
250
250
157
143
–
–
–
290
500
400
300
200
150
600
0.56
1.31
1.45
0.85
0.60
–
–
0.34
0.98
1.00
0.98
0.95
0.45
0.41
–
3,040
3,240
Common Shares
Balance at beginning of year
Issued under the Shareholder Dividend
Reinvestment and Share Purchase Plan
Issued/cancelled under the Stock Option Plan and other stock-based compensation plans
(Note 22)
Repurchased for cancellation
Balance at End of Year
Share Capital
2,265
649,050,049
12,357
644,129,945
12,003
650,729,644
11,957
690,471
58
2,786,997
223
2,069,269
130
51
(153)
2,133,107
–
131
–
2,068,132
(10,737,100)
116
(200)
649,050,049
12,357
842,821
(8,000,000)
642,583,341
12,313
15,553
3.24
15,397
3.08
644,129,945
12,003
2.94
14,268
(1) During the year ended October 31, 2014, we redeemed all of our Class B – Series 18 Preferred Shares. Dividends declared for the year ended October 31, 2014 were $0.41 per share and 6 million shares were outstanding at the time of the dividend declaration.
(2) During the year ended October 31, 2014, we redeemed all of our Class B – Series 21 Preferred Shares. Dividends declared for the year ended October 31, 2014 were $0.81 per share and 11 million shares were outstanding at the time of the dividend declaration.
Notes
Preferred Shares
We are authorized by our shareholders to issue an unlimited number of Class A Preferred Shares and Class B Preferred Shares without par value, in series, for unlimited consideration. Class B Preferred Shares may be issued in a foreign currency.
On October 16, 2015, we issued 600,000 Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 36, at a price of $1,000.00 per share, for gross proceeds of $600 million.
On July 29, 2015, we issued 6 million Non-Cumulative Perpetual Class B Preferred Shares, Series 35, at a price of $25.00 cash per share, for gross proceeds of $150 million.
On June 5, 2015, we issued 8 million Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 33, at a price of $25.00 cash per share, for gross proceeds of $200 million.
On July 30, 2014, we issued 12 million Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 31, at a price of $25.00 cash per share, for gross proceeds of $300 million.
On June 6, 2014, we issued 16 million Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 29, at a price of $25.00 cash per share, for gross proceeds of $400 million.
On April 23, 2014, we issued 20 million Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 27, at a price of $25.00 cash per share, for gross proceeds of $500 million.
During the year ended October 31, 2013, we did not issue any preferred shares.
During the year ended October 31, 2015, we redeemed all of our Non-Cumulative Class B Preferred Shares, Series 13, at a redemption price of
$25.25 per share for a gross redemption of $353 million. Dividends declared for the year ended October 31, 2015 were $0.56 per share and 14 million shares were outstanding at the time of the dividend declaration. On February 25, 2015, we also redeemed all of our Non-Cumulative Class B Preferred
Shares, Series 23, at a redemption price of $25.00 per share plus declared and unpaid dividends up to but excluding the date fixed for redemption.
Dividends declared for the year ended October 31, 2015 were $0.34 per share and 16 million shares were outstanding at the time of the dividend declaration. During the year ended October 31, 2014, we redeemed all of our Non-Cumulative Class B Preferred Shares, Series 18, at a redemption price of
$25.00 per share plus declared and unpaid dividends up to but excluding the date fixed for redemption. Dividends declared for the year ended
October 31, 2014 were $0.41 per share and 6 million shares were outstanding at the time of the dividend declaration. We also redeemed all of our
Non-Cumulative Class B Preferred Shares, Series 21, at a redemption price of $25.00 per share plus declared and unpaid dividends up to but excluding the date fixed for redemption. Dividends declared for the year ended October 31, 2014 were $0.81 per share and 11 million shares were outstanding at the time of the dividend declaration.
170 BMO Financial Group 198th Annual Report 2015
During the year ended October 31, 2013, we redeemed all of our Non-Cumulative Class B Preferred Shares, Series 5, at a redemption price of
$25.00 per share plus declared and unpaid dividends up to but excluding the date fixed for redemption. Dividends declared for the year ended
October 31, 2013 were $0.33 per share and 8 million shares were outstanding at the time of the dividend declaration.
Preferred Share Rights and Privileges
(Canadian $, except as noted)
Redemption
amount
Class B – Series 14
Class B – Series 15
Class B – Series 16
Class B – Series 17
Class B – Series 25
Class B – Series 27
Class B – Series 29
Class B – Series 31
Class B – Series 33
Class B – Series 35
Class B – Series 36
25.00
25.00
25.00
25.00
25.00
25.00
25.00
25.00
25.00
25.00
1,000.00
Quarterly noncumulative dividend (1)
$ 0.328125
$ 0.3625
$ 0.211875 (3)
Floating (8)
$ 0.24375 (3)
$ 0.2500 (3)
$ 0.24375 (3)
$ 0.2375 (3)
$ 0.2375 (3)
$ 0.3125
$14.6250 (3)
Reset premiums
Does not reset
Does not reset
1.65%
1.65%
1.15%
2.33%
2.24%
2.22%
2.71%
Does not reset
4.97%
Date redeemable / convertible
Current (2)
Current (2)
August 25, 2018 (4)(5)(6)
August 25, 2018 (4)(5)(6)
August 25, 2016 (5)(6)
May 25, 2019 (5)(6)
August 25, 2019 (5)(6)
November 25, 2019 (5)(6)
August 25, 2020 (5)(6)
August 25, 2020 (2)(6)
November 25, 2020 (5)(6)
Convertible to
Not convertible
Not convertible
Class B – Series 17 (7)
Class B – Series 16 (7)
Class B – Series 26 (7)
Class B – Series 28 (7)
Class B – Series 30 (7)
Class B – Series 32 (7)
Class B – Series 34 (7)
Not convertible
Class B – Series 37 (7)
(1) Non-cumulative dividends are payable quarterly as and when declared by the Board of Directors.
(2) Subject to a redemption premium if redeemed prior to November 25, 2016 – Series 14; May 25, 2017 – Series 15; and August 25, 2024 – Series 35.
(3) The dividend rate will reset on the date redeemable and every five years thereafter at a rate equal to the 5-year Government of Canada bond yield plus the reset premium noted. If converted to a floating rate series, the rate will be set as and when declared to the 3-month Government of Canada treasury bill yield plus the reset premium noted.
(4) On July 22, 2013, we announced that we did not intend to exercise our right to redeem the Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 16 on the initial redemption date. As a result, subject to certain conditions, the holders of Series 16 Preferred Shares had the right, at their option, to elect to convert all or part of their Series 16 Preferred Shares on a one-for-one basis into
Non-Cumulative Floating Rate Class B Preferred Shares, Series 17, effective August 26, 2013.
(5) Redeemable on the date noted and every five years thereafter.
(6) Convertible on the date noted and every five years thereafter if not redeemed. Series 16, 17, 26, 28, 30, 32, 34 and 37 are floating rate preferred shares.
(7) If converted, the holders have the option to convert back to the original preferred shares on subsequent redemption dates.
(8) Floating rate will be set as and when declared at the 3-month Government of Canada treasury bill yield plus a reset premium of 1.65%.
Non-Viability Contingent Capital
Class B – Series 27, Class B – Series 29, Class B – Series 31, Class B – Series 33, Class B – Series 35 and Class B – Series 36 preferred share issues include a non-viability contingent capital provision, which is necessary for the shares to qualify as regulatory capital under Basel III. As such, the shares are convertible into a variable number of our common shares if OSFI announces that the bank is, or is about to become, non-viable or if a federal or provincial government in Canada publicly announces that the bank has accepted or agreed to accept a capital injection, or equivalent support, to avoid non-viability.
Common Shares
We are authorized by our shareholders to issue an unlimited number of our common shares without par value, for unlimited consideration. Our common shares are not redeemable or convertible. Dividends are declared by our Board of Directors on a quarterly basis and the amount can vary from quarter to quarter.
Normal Course Issuer Bid
On February 1, 2015, we renewed our normal course issuer bid, effective for one year. Under this normal course issuer bid, we may repurchase up to
15 million of our common shares for cancellation. The timing and amount of purchases under the program are subject to management discretion based on factors such as market conditions and capital adequacy. We will periodically consult with OSFI before making purchases under the bid.
Our previous normal course issuer bid, which allowed us to repurchase for cancellation up to 15 million of our common shares, expired on
January 31, 2015. During the year ended October 31, 2015, we repurchased 8 million of our common shares at an average cost of $77.25 per share.
During the year ended October 31, 2014, we did not make any repurchases under the normal course issuer bid.
Share Redemption and Dividend Restrictions
Shareholder Dividend Reinvestment and Share Purchase Plan
We offer a dividend reinvestment and share purchase plan (“DRIP”) for our shareholders. Participation in the plan is optional. Under the terms of the
DRIP, cash dividends on common shares are reinvested to purchase additional common shares. Shareholders also have the opportunity to make optional cash payments to acquire additional common shares.
For the dividend paid in the first quarter of 2015, common shares to supply the DRIP were issued from treasury without a discount. Commencing with the dividend paid in the second quarter of 2015, common shares to supply the DRIP were purchased on the open market. For the dividend paid in the fourth quarter of 2014, common shares to supply the DRIP were issued from treasury with a two percent discount. For the dividend paid in the
BMO Financial Group 198th Annual Report 2015 171
Notes
OSFI must approve any plan to redeem any of our preferred share issues for cash.
We are prohibited from declaring dividends on our preferred or common shares when we would be, as a result of paying such a dividend, in contravention of the capital adequacy, liquidity or any other regulatory directive issued under the Bank Act. In addition, common share dividends cannot be paid unless all dividends declared and payable on our preferred shares have been paid or sufficient funds have been set aside to do so.
In addition, we have agreed that if either BMO Capital Trust, a consolidated structured entity, or BMO Capital Trust II, an unconsolidated structured entity, (collectively, the “Trusts”), fails to pay any required distribution on their capital trust securities, we will not declare dividends of any kind on any of our preferred or common shares for a period of time following such Trusts’ failure to pay the required distribution (as defined in the applicable prospectuses) unless such Trusts first pay such distribution to the holders of their capital trust securities (see Note 16).
Currently, these limitations do not restrict the payment of dividends on common or preferred shares.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
third quarter of 2014, common shares to supply the DRIP were issued from treasury without a discount. Commencing with the dividend paid in the fourth quarter of 2013 and continuing through the dividend paid in the second quarter of 2014, common shares to supply the DRIP were purchased on the open market.
During the year ended October 31, 2015, we issued a total of 690,471 common shares from treasury (2,786,997 in 2014) and purchased
1,998,589 common shares in the open market for delivery to shareholders (1,276,088 in 2014) under the DRIP.
Potential Share Issuances
As at October 31, 2015, we had reserved 5,842,932 common shares (6,533,403 in 2014) for potential issuance in respect of our Shareholder Dividend
Reinvestment and Share Purchase Plan. We have also reserved 12,111,153 common shares (13,337,765 in 2014) for the potential exercise of stock options, as further described in Note 22.
Treasury Shares
When we purchase our common shares as part of our trading business, we record the cost of those shares as a reduction in shareholders’ equity. If those shares are resold at a price higher than their cost, the premium is recorded as an increase in contributed surplus. If those shares are resold at a price below their cost, the discount is recorded as a reduction first to contributed surplus and then to retained earnings for any amount in excess of total contributed surplus related to treasury shares.
Non-Controlling Interest
Included in non-controlling interest in subsidiaries as at October 31, 2015 were capital trust securities, including accrued interest, totalling
$454 million ($1,060 million in 2014) related to non-controlling interest in subsidiaries, which formed part of our Tier 1 regulatory capital, as further described in Note 16. Non-controlling interest in other consolidated entities was $37 million at October 31, 2015 ($31 million in 2014), which included
$27 million for F&C ($22 million in 2014).
Note 18: Fair Value of Financial Instruments
We record trading assets and liabilities, derivatives, available-for-sale securities and securities sold but not yet purchased at fair value, and other nontrading assets and liabilities at amortized cost less allowances or write-downs for impairment. The fair values presented in this note are based upon the amounts estimated for individual assets and liabilities and do not include an estimate of the fair value of any of the legal entities or underlying operations that comprise our business.
Fair value represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. The fair value amounts disclosed represent point-in-time estimates that may change in subsequent reporting periods due to changes in market conditions or other factors. Some financial instruments are not typically exchangeable or exchanged and therefore it is difficult to determine their fair value. Where there is no quoted market price, we determine fair value using management’s best estimates based on a range of valuation techniques and assumptions; since these involve uncertainties, the fair values may not be realized in an actual sale or immediate settlement of the asset or liability.
Governance Over the Determination of Fair Value
Senior executive oversight of our valuation processes is provided through various valuation and risk committees. In order to ensure that all financial instruments carried at fair value are reasonably measured for risk management and financial reporting purposes, we have established governance structures and controls, such as model validation and approval, independent price verification (“IPV”) and profit and loss attribution analysis (“PAA”), consistent with industry practice. These controls are applied independently of the relevant operating groups.
We establish and regularly update valuation methodologies for each financial instrument that is required to be measured at fair value. The application of valuation models for products or portfolios is subject to independent approval to ensure only validated models are used. The impact of known limitations of models and data inputs is also monitored on an ongoing basis. IPV is a process that regularly and independently verifies the accuracy and appropriateness of market prices or model inputs used in the valuation of financial instruments. This process assesses fair values using a variety of different approaches to verify and validate the valuations. PAA is a daily process used by management to identify and explain changes in fair value positions across all operating lines of business within BMO Capital Markets. This process works in concert with other processes to ensure that the fair values being reported are reasonable and appropriate.
Securities
Notes
For traded securities, quoted market value is considered to be fair value. Quoted market value is based on bid prices. Securities for which no active market exists are valued using all reasonably available market information. Our fair value methodologies are described below.
Government Securities
The fair value of government issued or guaranteed debt securities in active markets is determined by reference to recent transaction prices, broker quotes or third-party vendor prices. The fair values of securities that are not traded in an active market are modelled using implied yields derived from the prices of similar actively traded government securities and observable spreads. Market inputs to the model include coupon, maturity and duration. Mortgage-Backed Securities and Collateralized Mortgage Obligations
The fair value of mortgage-backed securities and collateralized mortgage obligations is determined using independent prices obtained from thirdparty vendor prices, broker quotes and relevant market indices, as applicable. If such prices are not available, fair value is determined using cash flow models that make maximum use of observable market inputs or benchmark prices for similar instruments. Valuation assumptions for mortgage-backed securities and collateralized mortgage obligations include discount rates, expected prepayments, credit spreads and recoveries.
172 BMO Financial Group 198th Annual Report 2015
Corporate Debt Securities
The fair value of corporate debt securities is determined using prices observed in the most recent transactions. When observable price quotations are not available, fair value is determined based on discounted cash flow models using discounting curves and spreads obtained from independent dealers, brokers and multi-contributor pricing sources.
Corporate Equity Securities
The fair value of equity securities is based on quoted prices in active markets, where available. Where quoted prices in active markets are not readily available, fair value is determined using quoted market prices for similar securities or through valuation techniques, including discounted cash flow analysis and multiples of earnings.
Privately Issued Securities
Privately issued debt and equity securities are valued using recent prices observed in market transactions, where available. Otherwise, fair value is derived from valuation models using a market or income approach. These models consider various factors, including projected cash flows, earnings, revenue and other third-party evidence, as available. The fair value of limited partnership investments is based upon net asset values published by third-party fund managers.
Prices from brokers and multi-contributor pricing sources are corroborated as part of our independent review process, which may include using valuation techniques or obtaining consensus or composite prices from other pricing services. We validate the estimates of fair value by independently obtaining multiple quotes for external market prices and input values. We review the approach taken by third-party vendors to ensure that the vendor employs a valuation model which maximizes the use of observable inputs such as benchmark yields, bid-ask spreads, underlying collateral, weighted-average terms to maturity and prepayment rate assumptions. Fair value estimates from internal valuation techniques are verified, where possible, by reference to prices obtained from third-party vendors.
Loans
In determining the fair value of our fixed rate and floating rate performing loans, we discount the remaining contractual cash flows, adjusted for estimated prepayment, at market interest rates currently offered for loans with similar terms.
The value of our loan balances determined using this approach is further adjusted by a credit mark that represents an estimate of the expected credit losses in our loan portfolio.
Derivative Instruments
A number of valuation techniques are employed to estimate fair value, including discounted cash flow analysis, the Black-Scholes model, Monte Carlo simulation and other accepted market models. These vetted models incorporate current market measures for interest rates, currency exchange rates, equity and commodity prices and indices, credit spreads, recovery rates, corresponding market volatility levels, spot prices, correlation levels and other market-based pricing factors. Option implied volatilities, an input into many valuation models, are either obtained directly from market sources or calculated from market prices. Multi-contributor pricing sources are used wherever possible.
In determining the fair value of complex and customized derivatives, we consider all reasonably available information, including dealer and broker quotations, multi-contributor pricing sources and any relevant observable market inputs. Our model calculates fair value based on inputs specific to the type of contract, which may include stock prices, correlation for multiple assets, interest rates, foreign exchange rates, yield curves and volatilities. We calculate a credit valuation adjustment (“CVA”) to recognize the risk that any given derivative counterparty may not ultimately be able to fulfill its obligations. The CVA is derived from market-observed credit spreads or proxy credit spreads and our assessment of the net counterparty credit risk exposure, taking into account credit mitigants such as collateral, master netting agreements and settlements through clearing houses. We also calculate a funding valuation adjustment (“FVA”) to recognize the implicit funding costs associated with over-the-counter derivative positions.
The FVA is determined based on reference to market funding spreads.
Deposits
In determining the fair value of our deposits, we incorporate the following assumptions:
‰ For fixed rate, fixed maturity deposits, we discount the remaining contractual cash flows for these deposits, adjusted for expected redemptions, at market interest rates currently offered for deposits with similar terms and risks.
‰ For fixed rate deposits with no defined maturities, we consider fair value to equal carrying value, based on carrying value being equivalent to the amount payable on the reporting date.
‰ For floating rate deposits, changes in interest rates have minimal impact on fair value since deposits reprice to market frequently. On that basis, fair value is assumed to equal carrying value.
Securities Sold But Not Yet Purchased
The fair value of these obligations is based on the fair value of the underlying securities, which can be equity or debt securities. As these obligations are fully collateralized, the method used to determine fair value would be the same as that used for the relevant underlying equity or debt securities.
BMO Financial Group 198th Annual Report 2015 173
Notes
A portion of our structured note liabilities that have coupons or repayment terms linked to the performance of interest rates, foreign currencies, commodities or equity securities have been designated at fair value through profit or loss. The fair value of these structured notes is estimated using internally vetted valuation models and incorporates observable market prices for identical or comparable securities, as well as other inputs such as interest rate yield curves, option volatilities and foreign exchange rates, where appropriate. Where observable prices or inputs are not available, management judgment is required to determine the fair value by assessing other relevant sources of information, such as historical data and proxy information from similar transactions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securities Purchased Under Resale Agreements and Securities Sold Under Repurchase Agreements
The fair value of these agreements is determined using a discounted cash flow model. Inputs to the model include contractual cash flows and collateral funding spreads.
Securitization Liabilities
The determination of the fair value of securitization liabilities, recorded in other liabilities, is based on quoted market prices or quoted market prices for similar financial instruments, where available. Where quoted prices are not available, fair value is determined using valuation techniques, such as discounted cash flows, that maximize the use of observable inputs.
Subordinated Debt and Capital Trust Securities
The fair value of our subordinated debt and capital trust securities is determined by referring to current market prices for the same or similar instruments. Financial Instruments with a Carrying Value Approximating Fair Value
Short-term Financial Instruments
The carrying value of certain financial assets and liabilities, such as interest bearing deposits with banks, securities borrowed, customers’ liability under acceptances, certain other assets, acceptances, securities lent and certain other liabilities, is a reasonable estimate of fair value due to their short-term nature or because they are frequently repriced to current market rates.
Other Financial Instruments
Carrying value is assumed to be a reasonable estimate of fair value for our cash and cash equivalents and certain other securities.
For longer-term financial instruments within other liabilities, fair value is determined as the present value of contractual cash flows using discount rates at which liabilities with similar remaining maturities could be issued as at the balance sheet date.
Certain assets, including premises and equipment, goodwill and intangible assets, as well as shareholders’ equity, are not considered financial instruments and therefore no fair value has been determined for these items.
Fair Value of Financial Instruments Not Carried at Fair Value on the Balance Sheet
Set out in the following tables are the amounts that would be reported if all financial assets and liabilities not currently carried at fair value were reported at their fair values.
(Canadian $ in millions)
2015
Valued using models (with observable inputs)
Valued using models (without observable inputs)
Carrying value Securities purchased under resale agreements (2)
Loans
Residential mortgages
Consumer instalment and other personal
Credit cards
Businesses and governments
Deposits
Securities sold under repurchase agreements (3)
Other liabilities (4)
Subordinated debt
9,432
656
9,534
2,365
856
–
8,678
–
–
2,365
10,088
55,626
11,899
54,979
856
–
8,678
54,979
2,365
–
105,918
65,598
7,980
145,076
106,322
64,668
7,728
143,387
–
–
–
–
–
–
–
–
106,322
64,668
7,728
143,387
324,572
Securities
Held to maturity
Other (1)
Fair value Valued using quoted market prices 322,105
–
–
322,105
438,169
33,576
22,497
4,416
438,461
33,704
23,025
4,590
–
–
–
–
438,461
33,704
23,025
4,590
–
–
–
–
Notes
This table excludes financial instruments with a carrying value approximating fair value, such as cash and cash equivalents, interest bearing deposits with banks, securities borrowed, customers’ liability under acceptances, certain other assets, acceptances, securities lent and certain other liabilities.
(1) Excluded from other securities is $364 million of securities related to our merchant banking business that are carried at fair value on the balance sheet.
(2) Excludes $12,440 million of securities borrowed for which carrying value approximates fair value.
(3) Excludes $6,315 million of securities lent for which carrying value approximates fair value.
(4) Other liabilities include securitization and SE liabilities and certain other liabilities of subsidiaries, other than deposits.
174 BMO Financial Group 198th Annual Report 2015
(Canadian $ in millions)
2014
Valued using models (with observable inputs)
Valued using models (without observable inputs)
Carrying value Securities purchased under resale agreements (2)
Loans
Residential mortgages
Consumer instalment and other personal
Credit cards
Businesses and governments
Deposits
Securities sold under repurchase agreements (3)
Other liabilities (4)
Subordinated debt
10,344
510
10,490
1,829
838
–
9,652
–
–
1,829
10,854
33,141
12,319
33,095
838
–
9,652
33,095
1,829
–
101,013
64,143
7,972
120,766
101,273
63,280
7,706
119,399
–
–
–
–
–
–
–
–
101,273
63,280
7,706
119,399
293,894
Securities
Held to maturity
Other (1)
Fair value Valued using quoted market prices 291,658
–
–
291,658
393,088
25,485
23,546
4,913
393,242
25,505
23,927
5,110
–
–
–
–
393,242
25,505
23,927
5,110
–
–
–
–
This table excludes financial instruments with a carrying value approximating fair value, such as cash and cash equivalents, interest bearing deposits with banks, securities borrowed, customers’ liability under acceptances, certain other assets, acceptances, securities lent and certain other liabilities.
(1) Excluded from other securities is $477 million of securities related to our merchant banking business that are carried at fair value on the balance sheet.
(2) Excludes $20,414 million of securities borrowed for which carrying value approximates fair value.
(3) Excludes $14,210 million of securities lent for which carrying value approximates fair value.
(4) Other liabilities include securitization and SE liabilities and certain other liabilities of subsidiaries, other than deposits.
Fair Value Hierarchy
We use a fair value hierarchy to categorize financial instruments according to the inputs we use in valuation techniques to measure fair value.
Valuation Techniques and Significant Inputs
We determine the fair value of publicly traded fixed maturity debt and equity securities using quoted prices in active markets (Level 1) when these are available. When quoted prices in active markets are not available, we determine the fair value of financial instruments using models such as discounted cash flows, with observable market data for inputs such as yield and prepayment rates or broker quotes and other third-party vendor quotes (Level 2). Fair value may also be determined using models where significant market inputs are not observable due to inactive markets or minimal market activity (Level 3). We maximize the use of observable market inputs to the extent possible.
Our Level 2 trading securities are primarily valued using discounted cash flow models with observable spreads or broker quotes. The fair value of
Level 2 available-for-sale securities is determined using discounted cash flow models with observable spreads or third-party vendor quotes. Level 2 structured note liabilities are valued using models with observable market information. Level 2 derivative assets and liabilities are valued using industry-standard models and observable market information.
Notes
BMO Financial Group 198th Annual Report 2015 175
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The extent of our use of actively quoted market prices (Level 1), internal models using observable market information as inputs (Level 2) and internal models without observable market information as inputs (Level 3) in the valuation of securities, fair value liabilities, derivative assets and derivative liabilities was as follows:
(Canadian $ in millions)
2014
2015
Valued using quoted market prices Valued using models (with observable inputs)
Valued using models (without observable inputs)
–
–
–
98
–
8,737
3,134
5,725
–
124
1,725
4,062
440
626
99
–
–
–
85
–
491
8,717
1,826
–
243
–
–
1,974
37,221
702
9,319
10,511
–
538
–
55,087
17,032
341
56,915
27,484
623
4,988
2,658
1,754
–
2,328
2,982
2,267
–
6,084
3,084
–
–
–
1
–
4,946
1,679
1,093
–
2,136
5,555
2,425
–
5,814
3,996
–
–
–
1
–
–
5,977
358
12,192
1,972
104
–
6
1,251
–
5,687
456
9,949
1,971
146
–
8
1,104
18,063
28,685
1,258
15,997
29,856
1,113
–
–
364
10
–
467
19,499
–
–
1,727
9,577
525
–
–
–
23,615
–
–
3,733
7,785
407
–
–
–
19,499
11,829
–
23,615
11,925
–
5
18
605
91
–
19,248
16,281
1,062
892
35
–
–
–
–
1
23
32
653
51
–
18,241
12,649
30
896
68
–
–
–
–
12
719
37,518
1
759
31,884
12
25
15
380
103
–
17,488
20,091
2,391
2,098
48
–
–
–
–
–
33
33
1,101
38
–
16,983
12,110
233
3,002
116
–
–
–
–
8
523
42,116
–
1,205
32,444
8
Valued using quoted market prices Trading Securities
Issued or guaranteed by:
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Mortgage-backed securities and collateralized mortgage obligations Corporate debt
Corporate equity
Available-for-Sale Securities
Issued or guaranteed by:
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Mortgage-backed securities and collateralized mortgage obligations Corporate debt
Corporate equity
Valued using models (with observable inputs)
Valued using models (without observable inputs)
12,342
3,183
2,937
–
396
1,512
3,568
314
589
15
–
328
35,901
Other Securities
Fair Value Liabilities
Securities sold but not yet purchased
Structured note liabilities and other note liabilities
Annuity liabilities
Derivative Assets
Interest rate contracts
Foreign exchange contracts
Commodity contracts
Equity contracts
Credit default swaps
Derivative Liabilities
Interest rate contracts
Foreign exchange contracts
Commodity contracts
Equity contracts
Credit default swaps
Notes
Certain comparative figures have been reclassified to conform with the current year’s presentation.
176 BMO Financial Group 198th Annual Report 2015
Quantitative Information about Level 3 Fair Value Measurements
The table below presents the fair values of our significant Level 3 financial instruments, the valuation techniques used to determine their fair values and the value ranges of significant unobservable inputs used in the valuations.
Range of input values (1)
As at October 31, 2015
(Canadian $ in millions, except as noted)
Securities
Private equity (2)
Collateralized loan obligations securities (3)
Merchant banking securities
Reporting line in fair value hierarchy table
Fair value of assets
Corporate equity
1,251
Corporate debt
Other
249
364
Valuation techniques
Significant unobservable inputs
Net Asset Value
EV/EBITDA
Discounted Cash Flow Model
Net Asset Value
EV/EBITDA
Net Asset Value
Multiple
Yield/Discount Margin
Net Asset Value
Multiple
Low
High
na
na
5.5x
1.50%
10.1x
1.50%
na
na
4.5x
8.7x
(1) The low and high input values represent the actual highest and lowest level of inputs used to value a group of financial instruments in a particular product category. These input ranges do not reflect the level of input uncertainty, but are affected by the specific underlying instruments within the product category. The input ranges will therefore vary from period to period based on the characteristics of the underlying instruments held at each balance sheet date.
(2) Included in private equity is $627 million of Federal Reserve Bank and U.S. Federal Home Loan Bank shares that we hold to meet regulatory requirements. These shares are carried at cost, which is deemed to approximate fair value since these shares are not traded in the market.
(3) Includes both trading and available-for-sale instruments. na – not applicable
Significant Unobservable Inputs in Level 3 Instrument Valuations
Net Asset Value
Net asset value represents the estimated value of a security based on valuations received from the investment or fund manager. The valuation of certain private equity securities is based on the economic benefit derived from our investment.
EV/EBITDA Multiple
The fair value of private equity and merchant banking investments is derived by calculating an enterprise value (“EV”) using the EV/EBITDA multiple and then proceeding through a waterfall of the company’s capital structure to determine the value of the assets or securities we hold. The EV/EBITDA multiple is determined using judgment in considering factors such as multiples for comparable listed companies, recent transactions and companyspecific factors, as well as liquidity discounts that account for the lack of active trading in these assets and securities.
Yield/Discount Margin
A financial instrument’s yield is the interest rate used to discount future cash flows in a valuation model. An increase in the yield, in isolation, would result in a decrease in the related fair value measurement. The discount margin is the difference between a debt instrument’s yield and a benchmark instrument’s yield. Benchmark instruments have high credit quality ratings and similar maturities and are often government bonds. The discount margin for an instrument forms part of the yield used in a discounted cash flow calculation. Generally, an increase in the discount margin will result in a decrease in fair value.
Sensitivity Analysis of Level 3 Instruments
Sensitivity analysis at October 31, 2015, for securities which represent greater than 10% of Level 3 instruments, is provided below.
Within Level 3 trading securities is corporate debt of $239 million related to securities which are hedged with credit default swaps that are also considered to be Level 3 instruments. As at October 31, 2015, the derivative assets and derivative liabilities were valued at $1 million and $nil, respectively. We determine the valuation of these derivatives and the related securities based on market-standard models we use to model the specific collateral composition and cash flow structure of the related deal. As at October 31, 2015, the impact of assuming a 10 basis point increase or decrease in the discount margin would be a $0.2 million decrease or increase in fair value, respectively.
We have not applied another reasonably possible alternative assumption to the significant Level 3 categories of private equity investments and merchant banking securities, as the net asset values are provided by the investment or fund managers.
Significant Transfers
Our policy is to record transfers of assets and liabilities between fair value hierarchy levels at their fair values as at the end of each reporting period, consistent with the date of the determination of fair value. Transfers between the various fair value hierarchy levels reflect changes in the availability of quoted market prices or observable market inputs that result from changing market conditions. The following is a discussion of the significant transfers between Level 1, Level 2 and Level 3 balances for the year ended October 31, 2015.
During the year ended October 31, 2015, $158 million of trading securities and $122 million of available-for-sale securities were transferred from
Level 1 to Level 2 due to reduced observability of the inputs used to value these securities. During the year ended October 31, 2015, $90 million of trading securities and $180 million of available-for-sale securities were transferred from Level 2 to Level 1 due to increased availability of quoted prices in active markets.
Notes
BMO Financial Group 198th Annual Report 2015 177
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in Level 3 Fair Value Measurements
The table below presents a reconciliation of all changes in Level 3 financial instruments during the year ended October 31, 2015, including realized and unrealized gains (losses) included in earnings and other comprehensive income.
Change in fair value
For the year ended October 31, 2015
(Canadian $ in millions)
Balance
October 31,
2014
Included in earnings Trading Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies
Corporate debt
85
538
–
(13)
Total trading securities
Included in other comprehensive income
Maturities/
Settlement (1)
Transfers into Level 3
Transfers out of
Level 3
Fair value as at October 31,
2015
Change in unrealized gains
(losses)
recorded in income for instruments still held (2)
Purchases
Sales
13
79
–
–
–
–
–
(361)
–
–
–
–
98
243
–
(13)
–
(361)
–
–
341
(13)
623
(13)
92
–
Available-for-Sale Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies
Corporate debt
Corporate equity
1
8
1,104
–
–
(25)
–
–
178
–
–
151
–
(1)
(157)
–
(1)
–
–
–
–
–
–
–
1
6
1,251
na
Total available-for-sale securities
1,113
(25)
178
151
(158)
(1)
–
–
1,258
na
467
(34)
66
80
(215)
–
–
–
364
(26)
12
(11)
–
–
–
–
–
–
1
(11)
8
(8)
–
–
–
–
–
–
–
(8)
Other Securities
Derivative Assets
Credit default swaps
Derivative Liabilities
Credit default swaps
Notes
(1) Includes cash settlement of derivative assets and derivative liabilities.
(2) Change in unrealized gains (losses) on trading securities, derivative assets and derivative liabilities still held on October 31, 2015 are included in earnings for the year. na – not applicable
178 BMO Financial Group 198th Annual Report 2015
na na The table below presents a reconciliation of all changes in Level 3 financial instruments during the year ended October 31, 2014, including realized and unrealized gains (losses) included in earnings and other comprehensive income.
Change in fair value
Included
in other comprehensive income
Transfers into Level 3
Transfers Fair value as out of at October 31,
2014
Level 3
Change in unrealized gains (losses) recorded in income for instruments still held (2)
Balance
October 31,
2013
Included in earnings Trading Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies
Corporate debt
78
822
–
6
7
59
–
–
–
(66)
–
(268)
–
–
–
(15)
85
538
–
6
Total trading securities
900
6
66
–
(66)
(268)
–
(15)
623
6
Available-for-Sale Securities
Issued or guaranteed by:
U.S. states, municipalities and agencies
Corporate debt
Corporate equity
1
30
918
–
(1)
(23)
–
–
92
–
–
192
–
(21)
(67)
–
–
–
–
–
4
–
–
(12)
1
8
1,104
na
Total available-for-sale securities
949
(24)
92
192
(88)
–
4
(12)
1,113
Other Securities
488
(38)
35
80
(98)
–
–
–
467
(23)
Derivative Assets
Credit default swaps
28
(16)
–
–
–
–
–
–
12
(16)
Derivative Liabilities
Credit default swaps
19
(11)
–
–
–
–
–
–
8
(11)
For the year ended October 31, 2014
(Canadian $ in millions)
Purchases
Sales
Maturities /
Settlement (1)
na na na
(1) Includes cash settlement of derivative assets and derivative liabilities.
(2) Change in unrealized gains (losses) on trading securities, derivative assets and derivative liabilities still held on October 31, 2014 are included in earnings for the year. na – not applicable
Notes
BMO Financial Group 198th Annual Report 2015 179
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 19: Offsetting of Financial Assets and Financial Liabilities
Financial assets and financial liabilities are offset and the net amount is reported in the Consolidated Balance Sheet when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or realize the asset and settle the liability simultaneously. The following table presents the amounts that have been offset in our Consolidated Balance Sheet, including securities purchased under resale agreements, securities sold under repurchase agreements and derivative instruments, generally under a market settlement mechanism
(e.g. an exchange or clearing house) where simultaneous net settlement can be achieved to eliminate credit and liquidity risk between counterparties. Also presented are amounts not offset in the Consolidated Balance Sheet related to transactions where a master netting agreement or similar arrangement is in place with a right of set-off only in the event of default, insolvency or bankruptcy, or where the offset criteria are otherwise not met.
(Canadian $ in millions)
2015
Amounts not offset in the balance sheet
Gross amounts Securities received/ pledged as collateral (1) (2)
Cash collateral Net amount 70,073
54,504
2,007
16,266
68,066
38,238
5,313
27,415
61,587
1,290
–
2,087
1,166
7,446
18,273
106,304
32,728
62,877
2,087
8,612
58,905
41,898
16,266
2,007
42,639
39,891
27,415
5,313
7,990
34,104
492
–
6,742
474
100,803
Financial Liabilities
Derivative instruments
Securities lent or sold under repurchase agreements
Impact of master netting agreements 124,577
Financial Assets
Securities borrowed or purchased under resale agreements
Derivative instruments
Amounts offset in the balance sheet Net amounts presented in the balance sheet
18,273
82,530
32,728
42,094
492
7,216
(Canadian $ in millions)
2014
Amounts not offset in the balance sheet
Gross amounts Securities received/ pledged as collateral (1) (2)
Cash collateral Net amount 57,119
38,338
3,564
5,683
53,555
32,655
10,004
24,398
41,042
1,676
–
825
2,509
5,756
9,247
86,210
34,402
42,718
825
8,265
39,340
43,259
5,683
3,564
33,657
39,695
24,398
10,004
3,048
28,868
323
–
5,888
823
82,599
Financial Liabilities
Derivative instruments
Securities lent or sold under repurchase agreements
Impact of master netting agreements 95,457
Financial Assets
Securities borrowed or purchased under resale agreements
Derivative instruments
Amounts offset in the balance sheet Net amounts presented in the balance sheet
9,247
73,352
34,402
31,916
323
6,711
(1) Financial assets received/pledged as collateral are disclosed at fair value and are limited to the net balance sheet exposure (i.e. any over-collateralization is excluded from the table).
(2) Certain amounts of collateral are restricted from being sold or re-pledged except in the event of default or the occurrence of other predetermined events.
Note 20: Interest Rate Risk
We earn interest on interest bearing assets and we pay interest on interest bearing liabilities. We also hold derivative instruments, such as interest rate swaps and interest rate options, with values that are sensitive to changes in interest rates. To the extent that we hold assets, liabilities and derivative instruments maturing or repricing at different points in time, we are exposed to interest rate risk.
Notes
Interest Rate Gap Position
The determination of the interest rate sensitivity or gap position by necessity entails numerous assumptions. It is based on the earlier of the repricing date or maturity date of assets, liabilities and derivatives used to manage interest rate risk.
The gap position presented is as at October 31, 2015 and 2014. It represents the position outstanding at the close of the business day and may change significantly in subsequent periods based on customer behaviour and the application of our asset and liability management strategies.
The assumptions for the years ended October 31, 2015 and 2014 were as follows:
Assets
Fixed rate, fixed term assets, such as residential mortgage loans and consumer loans, are reported based upon the scheduled repayments and estimated prepayments that reflect expected borrower behaviour.
Trading and underwriting (mark-to-market) assets and interest bearing assets on which the customer interest rate changes with the prime rate or other short-term market rates are reported in the zero to three months category.
180 BMO Financial Group 198th Annual Report 2015
Goodwill and intangible and fixed assets are reported as non-interest sensitive. Other fixed rate and non-interest bearing assets with no defined maturity are reported based upon an assumed maturity profile that considers historical and forecasted trends in balances.
Liabilities
Fixed rate, fixed term liabilities, such as investment certificates, are reported at scheduled maturity with estimated redemptions that reflect expected depositor behaviour.
Interest bearing deposits on which the customer interest rate changes with the prime rate or other short-term market rates are reported in the zero to three months category.
Fixed rate and non-interest bearing liabilities with no defined maturity are reported based upon an assumed maturity profile that considers historical and forecasted trends in balances.
Capital
Common shareholders’ equity is reported as non-interest sensitive.
Yields
Yields are based upon the effective interest rates for the assets or liabilities on October 31, 2015 and 2014.
Interest Rate Gap Position
(Canadian $ in millions, except as noted)
As at October 31
0 to 3 months 4 to 6 months 7 to 12 months Total within 1 year
Effective interest rate (%)
1 to 5 years Effective interest rate (%)
Over 5 years Effective interest rate (%)
Assets
Cash and cash equivalents
Interest bearing deposits with banks
Securities
Securities borrowed or purchased under resale agreements
Loans
Other assets
38,934
7,382
88,780
441
–
863
303
–
3,632
39,678
7,382
93,275
0.25
0.17
0.59
1,413
–
22,536
0.12
–
2.28
(44)
–
14,063
–
–
3.21
63,600
192,385
39,199
3,375
13,943
487
1,041
23,254
1,073
68,016
229,582
40,759
0.28
3.25
50
88,412
8,998
0.65
3.69
–
4,723
399
–
4.04
Total assets
430,280
19,109
29,303
478,692
245,333
21,223
18,022
–
23,935
1
287,290
21,224
0.54
1.04
133,225
–
39,588
58,211
66
1,169
121
296
700
–
182
3,245
1,500
290
39,891
61,752
2,266
1,459
0.22
–
14,312
2,000
2,207
365,590
19,139
Liabilities and Equity
Deposits
Securities sold but not yet purchased
Securities lent or sold under repurchase agreements Other liabilities
Subordinated debt
Total equity
Total liabilities and shareholders’ equity
Asset/liability gap position
Notional amounts of derivatives
na
na
121,409
na
4.21 na 17,654
2
–
–
9,970
150
600
na
4.84 na Total
(752)
40,295
–
7,382
1,044 130,918
–
11,307
11,040
68,066
334,024
61,196
22,639
641,881
0.93
–
–
–
438,169
21,226
–
–
12,232
–
35,647
39,891
98,266
4,416
39,913
641,881
na
19,141
0.86
–
Noninterest sensitive na
7.83 na 29,153
413,882
151,744
28,376
47,879
64,690
(30)
150
64,810
(30,335)
(9,235)
(25,240)
(56,851)
(445)
3,092
(54,204)
48,883
5,321
4,690
(1,448)
13,242
(2,636)
6,608
11,940
1,054
(4,968)
(20,904)
(4,336)
–
–
3,242
10,606
18,548
(3,914)
(25,240)
–
–
–
–
Total interest rate gap position – 2015
Canadian dollar
Foreign currency
6,563
1,276
1,989
(2,464)
Total gap
7,839
(475)
Total interest rate gap position – 2014
Canadian dollar
Foreign currency
3,934
2,174
(5,433)
(4,072)
6,672
(580)
5,173
(2,478)
16,048
5,399
2,082
(3,877)
(23,303)
956
–
–
Total gap
6,108
(9,505)
6,092
2,695
21,447
(1,795)
(22,347)
–
na – not applicable
Note 21: Capital Management
BMO Financial Group 198th Annual Report 2015 181
Notes
Our objective is to maintain a strong capital position in a cost-effective structure that: considers 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.
Our approach includes establishing limits, targets and performance measures for the management of balance sheet positions, risk levels and minimum capital amounts, as well as issuing and redeeming capital instruments to obtain a cost-effective capital structure.
Regulatory capital requirements and risk-weighted assets for the consolidated entity are determined on a Basel III basis.
Adjusted common shareholders’ equity, referred to as Common Equity Tier 1 capital under Basel III, is the most permanent form of capital. It is comprised of common shareholders’ equity less deductions for goodwill, intangible assets and certain other items under Basel III. Tier 1 capital is primarily comprised of regulatory common equity, preferred shares and innovative hybrid instruments, net of Tier 1 capital deductions. Tier 2 capital is primarily comprised of subordinated debentures and the eligible portion of the collective allowance for credit losses, net of certain Tier 2 capital deductions. Total capital includes Tier 1 and Tier 2 capital. Details of the components of our capital position are presented in Notes 11, 14, 15, 16 and 17.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our Common Equity Tier 1 Capital Ratio, Tier 1 Capital Ratio, Total Capital Ratio and Leverage Ratio are the primary regulatory capital measures.
‰ The Common Equity Tier 1 Capital Ratio is defined as common shareholders’ equity, net of capital adjustments, divided by Common Equity Tier 1 capital risk-weighted assets.
‰ The Tier 1 Capital Ratio is defined as Tier 1 capital divided by Tier 1 capital risk-weighted assets.
‰ The Total Capital Ratio is defined as Total capital divided by Total capital risk-weighted assets.
‰ The Leverage Ratio is defined as Tier 1 capital divided by the sum of on-balance sheet items and specified off-balance sheet items, net of specified adjustments. We have met OSFI’s stated minimum capital ratio requirements as at October 31, 2015.
Regulatory Capital Measures and Risk-Weighted Assets
Basel III
2015
Common Equity Tier 1 Capital
Tier 1 Capital
Total Capital
Common Equity Tier 1 Capital Risk-Weighted Assets
Tier 1 Capital Risk-Weighted Assets
Total Capital Risk-Weighted Assets
Common Equity Tier 1 Capital Ratio
Tier 1 Capital Ratio
Total Capital Ratio
Leverage Ratio
Basel III
2014
25,628
29,416
34,584
239,185
239,471
239,716
10.7%
12.3%
14.4%
4.2%
(Canadian $ in millions, except as noted)
22,421
26,602
31,927
222,092
222,428
222,931
10.1%
12.0%
14.3% na All 2015 and 2014 balances above are on a Basel III “all-in” basis. na – not applicable
Note 22: Employee Compensation – Share-Based Compensation
Stock Option Plan
We maintain a Stock Option Plan for designated officers and employees. Options are granted at an exercise price equal to the closing price of our common shares on the day before the grant date. Stock options granted on or after December 2013 vest in equal tranches of 50% on the third and fourth anniversaries of their grant date. Options granted prior to December 2013 vest in tranches over a four-year period starting from their grant date. Each tranche (i.e. the portion that vests each year) is treated as a separate award with a different vesting period. Certain options can only be exercised once certain performance targets are met. All options expire 10 years from their grant date.
We determine the fair value of stock options on their grant date and record this amount as compensation expense over the period that the stock options vest, with a corresponding increase to contributed surplus. When these stock options are exercised, we issue shares and record the amount of proceeds, together with the amount recorded in contributed surplus, in share capital. The estimated grant date fair value of stock options granted to employees who are eligible to retire is expensed at the date of grant.
The following table summarizes information about our Stock Option Plan:
2015
2014
2013
Number of stock options
Weightedaverage exercise price
Number of stock options
Weightedaverage exercise price
Number of stock options
Weightedaverage exercise price
Outstanding at beginning of year
Granted
Exercised
Forfeited/cancelled
Expired
13,337,765
641,875
842,821
71,281
954,385
76.21
78.09
54.22
64.49
139.14
14,968,711
1,618,223
2,133,107
88,965
1,027,097
78.17
68.60
53.66
79.77
139.34
15,801,966
2,003,446
2,069,588
5,558
761,555
79.96
60.11
47.95
56.35
150.78
Outstanding at end of year
Exercisable at end of year
Available for grant
Outstanding stock options as a percentage of outstanding shares
Notes
(Canadian $, except as noted)
12,111,153
6,959,569
4,275,858
1.88%
74.08
80.52
13,337,765
6,607,237
4,222,722
2.06%
76.21
90.85
14,968,711
7,283,321
5,201,062
2.32%
78.17
98.79
Employee compensation expense related to this plan for the years ended October 31, 2015, 2014 and 2013 was $6 million, $11 million and
$14 million before tax, respectively ($6 million, $11 million and $13 million after tax, respectively).
The intrinsic value of a stock option grant is the difference between the current market price of our common shares and the strike price of the option. The aggregate intrinsic value of stock options outstanding at October 31, 2015, 2014 and 2013 was $179 million, $279 million and
$215 million, respectively. The aggregate intrinsic value of stock options exercisable at October 31, 2015, 2014 and 2013 was $125 million,
$145 million and $107 million, respectively.
182 BMO Financial Group 198th Annual Report 2015
Options outstanding and exercisable at October 31, 2015 and 2014 by range of exercise price were as follows:
(Canadian $, except as noted)
Number of stock options Range of exercise prices $30.01 to $40.00
$40.01 to $50.00
$50.01 to $60.00
$60.01 to $70.00
$70.01 and over (1)
2014
2015
Options outstanding
Weightedaverage Weightedaverage remaining exercise contractual price life (years)
577,358
187,327
4,218,387
5,458,588
1,669,493
3.1
3.6
5.3
5.2
4.7
Options outstanding
Options exercisable
Number of stock options Weightedaverage remaining contractual life (years)
34.13
577,358
42.46
187,327
56.00 3,624,686
63.94 1,531,760
170.26 1,038,438
3.1
3.6
5.2
4.5
2.0
Weightedaverage exercise price
Number of stock options 34.13
718,299
42.46
208,437
56.00 5,087,750
61.87 5,956,232
226.28 1,367,047
Options exercisable
Weightedaverage Weightedaverage remaining exercise contractual price life (years)
Weightedaverage Weightedaverage remaining exercise contractual price life (years)
4.1
4.6
5.7
6.0
2.6
Number of stock options 34.13
718,299
42.36
208,437
56.05 3,000,262
63.89 1,313,192
232.14 1,367,047
4.1
4.6
6.0
4.1
2.6
34.13
42.36
55.73
62.71
232.14
(1) Issued as part of the acquisition of M&I.
The following table summarizes non-vested stock option activity for the years ended October 31, 2015 and 2014:
(Canadian $, except as noted)
2014
2015
Number of stock options
Weighted-average grant date fair value
Number of stock options
Weighted-average grant date fair value
Non-vested at beginning of year
Granted
Vested
Expired
Forfeited/cancelled
6,730,528
641,875
1,533,402
623,730
63,687
6.74
7.45
6.90
8.55
6.68
7,685,390
1,618,223
1,971,073
559,841
42,171
7.18
6.36
7.56
8.83
6.49
Non-vested at end of year
5,151,584
6.55
6,730,528
6.74
(Canadian $ in millions, except as noted)
2015
2014
2013
Unrecognized compensation cost for non-vested stock option awards
Weighted-average period over which this cost will be recognized (in years)
Total intrinsic value of stock options exercised
Cash proceeds from stock options exercised
Actual tax benefits realized on stock options exercised
Weighted-average share price for stock options exercised (in dollars)
4
2.3
18
46
1
76.1
5
2.7
49
115
1
76.6
6
2.1
35
99
–
64.8
The following table summarizes further information about our Stock Option Plan:
The fair value of options granted was estimated using a binomial option pricing model. The weighted-average fair value of options granted during the years ended October 31, 2015, 2014 and 2013 was $7.45, $6.36 and $5.29, respectively. To determine the fair value of the stock option tranches on the grant date, the following ranges of values were used for each option pricing assumption:
2014
2015
Expected dividend yield
Expected share price volatility
Risk-free rate of return
Expected period until exercise (in years)
4.7% – 4.8%
16.9% – 17.0%
1.9% – 2.0%
6.5 – 7.0
5.0%
16.4%
2.5% – 2.6%
6.5 – 7.0
2013
6.0% – 6.2%
18.1% – 18.6%
1.7% – 1.9%
5.5 – 7.0
Changes to the input assumptions can result in different fair value estimates.
Expected dividend yield is based on market expectations of future dividends on our common shares. Expected share price volatility is determined based on the market consensus implied volatility for traded options on our common shares. The risk-free rate is based on the yields of a Canadian swap curve with maturities similar to the expected period until exercise of the options. The weighted-average exercise price on the grant date for the years ended October 31, 2015, 2014 and 2013 was $78.09, $68.60 and $60.11, respectively.
Other Share-Based Compensation
Mid-Term Incentive Plans
We offer mid-term incentive plans for executives and certain senior employees. Payment amounts are adjusted to reflect reinvested dividends and changes in the market value of our common shares. Depending on the plan, the recipient receives either a single cash payment at the end of the three-year period of the plan, or cash payments over the three years of the plan. As the awards are cash settled, they are recorded as liabilities.
BMO Financial Group 198th Annual Report 2015 183
Notes
Share Purchase Plans
We offer various employee share purchase plans. The largest of these plans provides the employee the option of directing a portion of their gross salary toward the purchase of our common shares. We match 50% of employee contributions up to 6% of their individual gross salary. Our initial contributions vest after two years participation in the plan, with subsequent contributions vesting immediately. The shares held in the employee share purchase plan are purchased on the open market and are considered outstanding for purposes of computing earnings per share. The dividends earned on our common shares held by the plan are used to purchase additional common shares on the open market.
We account for our contribution as employee compensation expense when it is contributed to the plan.
Employee compensation expense related to these plans for the years ended October 31, 2015, 2014 and 2013 was $52 million, $50 million and
$50 million, respectively. There were 19.0 million, 18.7 million and 19.3 million common shares held in these plans for the years ended October 31,
2015, 2014 and 2013, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amounts payable under such awards are recorded as compensation expense over the vesting period. Amounts related to units granted to employees who are eligible to retire are expensed at the time of grant. Subsequent changes in the fair value of the liability are recorded in compensation expense in the period in which they arise.
Prior to 2015, we entered into agreements with third parties to assume our liabilities related to a portion of units granted for a fixed up-front payment. For units subject to such arrangements, we no longer have any obligation for future cash payments and as a result no liability is recorded related to these awards. All cash payments made under such arrangements are deferred on the Consolidated Balance Sheet as other assets and are recognized on a straight-line basis over the vesting period. Subsequent changes in fair value of our common shares do not affect the amount of compensation expense related to these awards.
Mid-term incentive plan units granted during the years ended October 31, 2015, 2014 and 2013 totalled 5.8 million, 5.9 million and 5.8 million, respectively. Of these, we entered into agreements with third parties in 2014 and 2013 for 2.8 million and 4.8 million units, respectively. For agreements entered into in 2014 and 2013, we made cash payments of $214 million and $292 million, respectively. The amount of deferred compensation remaining in other assets relating to these arrangements at October 31, 2015 was $38 million ($131 million in 2014) and is expected to be recognized over a weighted-average period of 1 year (1.7 in 2014). Employee compensation expense related to plans where we entered into agreements with third parties for the years ended October 31, 2015, 2014 and 2013 was $81 million, $239 million and $279 million before tax, respectively ($60 million, $177 million and $206 million after tax, respectively).
Mid-term incentive plan units for which we did not enter into agreements with third parties for the years ended October 31, 2015, 2014 and
2013 totalled 5.8 million, 3.1 million and 1.0 million units, respectively. The weighted-average grant date fair value of these awards as at October 31,
2015, 2014 and 2013 was $475 million, $228 million and $50 million, respectively. We recorded employee compensation expense of $289 million,
$159 million and $63 million before tax, respectively ($214 million, $118 million and $47 million after tax, respectively). Beginning in November
2014, we no longer enter into agreements with third parties; however, we economically hedge the impact of the change in market value of our common shares by entering into total return swaps (equity contracts). Gains (losses) recognized for the years ended October 31, 2015, 2014 and 2013 were $(26) million, $55 million and $32 million, respectively, resulting in net employee compensation expense of $315 million, $104 million and
$31 million, respectively.
A total of 16.1 million, 16.5 million and 15.3 million mid-term incentive plan units were outstanding as at October 31, 2015, 2014 and 2013, respectively, and the intrinsic value of those awards which had vested was $497 million, $288 million and $126 million, respectively. Cash payments made in relation to these liabilities were $173 million, $57 million and $37 million, respectively.
Deferred Incentive Plans
We offer deferred incentive plans for members of our Board of Directors, executives and key employees in BMO Capital Markets and Wealth
Management. Under these plans, fees, annual incentive payments and/or commissions can be deferred as share units of our common shares. These share units are either fully vested on the grant date or vest at the end of three years. The value of these share units is adjusted to reflect reinvested dividends and changes in the market value of our common shares.
Deferred incentive plan payments are paid upon the participant’s departure from the bank.
Employee compensation expense for these plans is recorded in the year the fees, incentive payments and/or commissions are earned. Changes in the amount of the incentive plan payments as a result of dividends and share price movements are recorded as increases or decreases in employee compensation expense in the period of the change.
Deferred incentive plan units granted during the years ended October 31, 2015, 2014 and 2013 totalled 0.3 million, 0.4 million and 0.4 million, respectively, and the weighted-average grant date fair value of these units was $26 million, $26 million and $22 million, respectively.
Liabilities related to these plans are recorded in other liabilities in our Consolidated Balance Sheet and totalled $395 million and $404 million as at October 31, 2015 and 2014, respectively. Payments made under these plans for the years ended October 31, 2015, 2014 and 2013 were
$25 million, $18 million and $16 million, respectively.
Employee compensation expense related to these plans for the years ended October 31, 2015, 2014 and 2013 was $12 million, $76 million and
$85 million before tax, respectively ($9 million, $56 million and $63 million after tax, respectively). We have entered into derivative instruments to hedge our exposure related to these plans. Changes in the fair value of these derivatives are recorded as employee compensation expense in the period in which they arise. Gains (losses) on these derivatives for the years ended October 31, 2015, 2014 and 2013 were $(17) million, $56 million and $75 million before tax, respectively. These gains resulted in net employee compensation expense for the years ended October 31, 2015, 2014 and 2013 of $29 million, $20 million and $10 million before tax, respectively ($21 million, $15 million and $7 million after tax, respectively).
A total of 4.9 million, 4.7 million and 4.3 million deferred incentive plan units were outstanding for the years ended October 31, 2015, 2014 and
2013, respectively.
Note 23: Employee Compensation – Pension and Other Employee Future Benefits
Notes
Pension and Other Employee Future Benefit Plans
We sponsor a number of arrangements in Canada, the United States and the United Kingdom that provide pension and/or other employee future benefits to our retired and current employees. The largest of these arrangements, by defined benefit obligation, are the primary defined benefit pension plans for employees in Canada and the United States and the primary other employee future benefit plan for employees in Canada.
Pension arrangements include defined benefit pension plans, as well as supplementary arrangements that provide pension benefits in excess of statutory limits. Generally, under these plans we provide retirement benefits based on an employee’s years of service and average annual earnings over a period of time prior to retirement. Our pension and other employee future benefit expenses, recorded in employee compensation expense, mainly comprise the current service cost plus or minus the interest on net defined benefit assets or liabilities. In addition, we provide defined contribution pension plans to employees in some of our subsidiaries. The costs of these plans, recorded in employee compensation expense, are equal to our contributions to the plans.
184 BMO Financial Group 198th Annual Report 2015
We also provide other employee future benefits, including health and dental care benefits and life insurance, for current and retired employees.
Short-term employee benefits, such as salaries, paid absences, bonuses and other benefits, are accounted for on an accrual basis over the period in which the employees provide the related services.
Investment Policy
The assets of the defined benefit pension plans are managed in accordance with all applicable laws and regulations. The plans are administered with a well-defined governance structure, with the oversight and decision-making resting with the Board of Directors.
The plans are managed under a framework that considers both assets and liabilities in the development of an investment policy and in managing risk.
The plans invest in asset classes that include equities, fixed income and alternative strategies, under established investment guidelines. Plan assets are diversified across asset classes and by geographic exposure. They are managed by asset management firms that are responsible for the selection of investment securities. Derivative instruments are permitted under policy guidelines and are generally used to hedge foreign currency exposures, manage interest rate exposures or replicate the return of an asset.
Asset Allocations
The asset allocation ranges and weighted-average actual asset allocations of our primary pension plans, based on the fair market values at
October 31, are as follows:
Pension benefit plans
Range
2015
Equities
Fixed income investments
Other
Actual
2015
Actual
2014
25% – 50%
35% – 55%
10% – 25%
42%
45%
13%
42%
45%
13%
Our pension and other employee future benefit plan assets are measured at fair value on a recurring basis.
Risk Management
The plans are exposed to various risks, including market risk (interest rate, equity and foreign currency risks), credit risk, operational risk, surplus risk and longevity risk. We follow a number of approaches to monitor and actively manage these risks, including monitoring surplus-at-risk, which measures a plan’s risk in an asset-liability framework; stress testing and scenario analyses to evaluate the volatility of the plans’ financial positions and any potential impact on the bank; hedging of currency exposures and interest rate risk within policy limits; controls related to asset mix allocations, geographic allocations, portfolio duration, credit quality, sector guidelines, issuer/counterparty limits and others; and ongoing monitoring of exposures, performance and risk levels.
Pension and Other Employee Future Benefit Liabilities
Our actuaries perform valuations of our defined benefit obligations for pension and other employee future benefits as at October 31 of each year using the projected unit credit method based on management’s assumptions about discount rates, rates of compensation increase, retirement age, mortality and health care cost trend rates.
The discount rates for the primary Canadian and U.S. pension and other employee future benefit plans were selected using high-quality AA rated corporate bonds with terms matching the plans’ cash flows.
The fair value of plan assets is deducted from the defined benefit obligation to determine the net defined benefit asset or liability. For defined benefit pension plans that are in a net defined benefit asset position, the recognized asset is limited to the present value of economic benefits available in the form of future refunds from the plan or reductions in future contributions to the plan (the “asset ceiling”). Changes in the asset ceiling are recognized in other comprehensive income. Components of the change in our net defined benefit assets or liabilities and our pension and other employee future benefit expense are as follows:
Benefits earned by employees represent benefits earned in the current year. They are determined with reference to the current workforce and the amount of benefits to which employees will be entitled upon retirement, based on the provisions of our benefit plans.
Interest on net defined benefit asset or liability represents the increase in the net defined benefit asset or liability that results from the passage of time and is determined by applying the discount rate to the net defined benefit asset or liability.
Actuarial gains and losses may arise in two ways. First, each year our actuaries recalculate the defined benefit obligations and compare them to those estimated as at the previous year end. Any differences that result from changes in demographic and economic assumptions or from plan member experience being different from management’s expectations at the previous year end are considered actuarial gains or losses. Second, actuarial gains and losses arise when there are differences between the discount rate and actual returns on plan assets. Actuarial gains and losses are recognized immediately in other comprehensive income as they occur and are not subsequently reclassified to income in future periods.
Plan amendments are changes in our defined benefit obligations that result from changes to provisions of the plans. The effects of plan amendments are recognized immediately in income when a plan is amended.
Settlements occur when defined benefit obligations for plan participants are settled, usually through lump sum cash payments, and as a result we no longer have any obligation to provide such participants with benefit payments in the future.
We fund our defined benefit pension plans in Canada and the United States in accordance with statutory requirements, and the assets in these plans are used to pay benefits to retirees and other employees. Some groups of employees are also eligible to make voluntary contributions in order to receive enhanced benefits. Our supplementary pension plan in Canada is funded, while in the United States the supplementary pension plan is unfunded. BMO Financial Group 198th Annual Report 2015 185
Notes
Funding of Pension and Other Employee Future Benefit Plans
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our other employee future benefit plans in Canada and the United States are either partially funded or unfunded. Benefit payments related to these plans are either paid through the respective plan or paid directly by us.
We measure the fair value of plan assets for our plans in Canada and the United States as at October 31. In addition to actuarial valuations for accounting purposes, we are required to prepare valuations for determining our minimum funding requirements for our pension arrangements in accordance with the relevant statutory framework (our “funding valuation”). An annual funding valuation is performed for our plans in Canada and the United States. The most recent funding valuation for our primary Canadian plan was performed as at October 31, 2015 and the most recent funding valuation for our primary U.S. plan was performed as at January 1, 2015. Benefit payments for fiscal 2016 are estimated to be $402 million.
A summary of plan information for the past three years is as follows:
(Canadian $ in millions)
Pension benefit plans
Other employee future benefit plans
2015
Defined benefit obligation
Fair value of plan assets
2014
2013
2015
2014
2013
7,934
8,072
7,504
7,536
6,181
6,267
1,323
131
1,317
113
1,174
95
138
32
86
(1,192)
(1,204)
(1,079)
362
(224)
197
(165)
192
(106)
(32)
(1,160)
(12)
(1,192)
(9)
(1,070)
138
32
86
(1,192)
(1,204)
(1,079)
Surplus (deficit) and net defined benefit asset (liability)
Surplus (deficit) is comprised of:
Funded or partially funded plans
Unfunded plans
Surplus (deficit) and net defined benefit asset (liability)
Pension and Other Employee Future Benefit Expenses
Pension and other employee future benefit expenses are determined as follows:
(Canadian $ in millions)
Pension benefit plans
Other employee future benefit plans
2015
2014
2013
2015
Annual benefits expense
Benefits earned by employees
Net interest (income) expense on net defined benefit (asset) liability
Gain on settlement
Administrative expenses
Remeasurement of other long-term benefits
2014
2013
286
(5)
(13)
4
–
241
(11)
–
5
–
234
4
–
5
–
29
50
–
–
4
25
50
–
–
(5)
27
48
–
–
(1)
Benefits expense
Canada and Quebec pension plan expense
Defined contribution expense
272
73
86
235
68
66
243
69
57
83
–
–
70
–
–
74
–
–
Total annual pension and other employee future benefit expenses recognized in the Consolidated Statement of Income
431
369
369
83
70
74
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Weighted-average assumptions used to determine benefit expenses
Pension benefit plans
Other employee future benefit plans
2015
Discount rate at beginning of year
Rate of compensation increase
Assumed overall health care cost trend rate
2014
2013
4.1%
2.9%
4.6%
2.9%
4.2%
2.9%
na
na
na
2014
2015
4.7%
2.7%
5.4% (1)
4.2%
2.6%
5.5% (1)
2013
4.4%
3.2%
5.4% (1)
(1) Trending to 4.5% in 2030 and remaining at that level thereafter. na – not applicable
Assumptions regarding future mortality are based on published statistics and mortality tables calibrated to plan experience, when applicable. The current life expectancies underlying the amounts of the defined benefit obligations for our primary plans are as follows:
(Years)
Canada
United States
2015
Notes
Life expectancy for those currently age 65
Males
Females
Life expectancy at age 65 for those currently age 45
Males
Females
186 BMO Financial Group 198th Annual Report 2015
2014
2015
2014
23.5
23.9
23.4
23.8
22.2
23.7
21.3
23.4
24.5
24.9
24.4
24.8
23.3
24.9
23.3
25.2
Changes in the estimated financial positions of our pension benefit plans and other employee future benefit plans are as follows:
(Canadian $ in millions, except as noted)
Pension benefit plans
Other employee future benefit plans
2015
Defined benefit obligation
Defined benefit obligation at beginning of year
Opening adjustment for acquisitions
Benefits earned by employees
Interest cost on accrued benefit obligation
Gain due to settlement
Benefits paid to pensioners and employees
Settlement payments
Voluntary employee contributions
Actuarial gains (losses) due to:
Demographic assumption changes
Financial assumption changes
Plan member experience
Foreign exchange and other
2014
2015
2014
7,504
–
286
311
(13)
(373)
(92)
12
6,181
455
241
289
–
(326)
–
12
1,317
–
29
55
–
(39)
–
4
1,174
–
25
55
–
(36)
–
3
17
(146)
108
320
48
532
(14)
86
(47)
(33)
11
26
(15)
98
(3)
16
Defined benefit obligation at end of year
7,934
7,504
1,323
1,317
Wholly or partially funded defined benefit obligation
Unfunded defined benefit obligation
7,710
224
7,339
165
163
1,160
125
1,192
Total defined benefit obligation
7,934
7,504
1,323
1,317
Weighted-average assumptions used to determine the defined benefit obligation
Discount rate at end of year
Rate of compensation increase
Assumed overall health care cost trend rate
4.2%
2.7%
4.1%
2.9%
na
na
4.4%
2.4%
5.5% (1)
4.2%
2.6%
5.4% (1)
Fair value of plan assets
Fair value of plan assets at beginning of year
Opening adjustment for acquisitions
Interest income on plan assets
Excess (shortfall) of actual returns over interest income
Employer contributions
Voluntary employee contributions
Benefits paid to pensioners and employees
Settlement payments
Administrative expenses
Foreign exchange and other
7,536
–
316
182
231
12
(373)
(92)
(4)
264
6,267
456
300
458
284
12
(326)
–
(5)
90
113
–
5
(5)
35
4
(39)
–
–
18
95
–
4
5
33
3
(36)
–
–
9
Fair value of plan assets at end of year
8,072
7,536
131
113
138
32
(1,192)
(1,204)
502
(364)
261
(229)
–
(1,192)
–
(1,204)
138
32
(1,192)
(1,204)
182
458
(6)
5
(17)
146
(108)
(22)
(48)
(532)
14
–
44
35
(4)
1
14
(95)
(4)
–
181
(108)
70
(80)
Surplus (deficit) and net defined benefit asset (liability) at end of year
Recorded in:
Other assets
Other liabilities
Surplus (deficit) and net defined benefit asset (liability) at end of year
Actuarial gains (losses) recognized in other comprehensive income
Net actuarial gains on plan assets
Actuarial gains (losses) on defined benefit obligation due to:
Demographic assumption changes
Financial assumption changes
Plan member experience
Foreign exchange and other
Actuarial gains (losses) recognized in other comprehensive income for the year
(1) Trending to 4.5% in 2030 and remaining at that level thereafter. na – not applicable
Notes
BMO Financial Group 198th Annual Report 2015 187
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our pension and other employee future benefit plan assets are measured at fair value on a recurring basis. The fair values of plan assets held by our primary plans as at October 31 are as follows:
(Canadian $ in millions)
Canadian plans
U.S. plans (1)
2015
Cash and money market funds (2)
Securities issued or guaranteed by: (3)
Canadian federal government
Canadian provincial and municipal governments
U.S. federal government
U.S. states, municipalities and agencies
Other governments
Pooled funds (4)
Derivative instruments (5)
Corporate debt (6)
Corporate equity (2)
2014
2015
2014
44
55
62
39
–
–
91
14
–
86
–
458
511
–
–
87
18
–
85
–
401
535
1,222
1,165
188
603
–
–
9
3,166
(5)
892
792
151
584
4
2
5
2,780
(17)
966
834
5,689
5,364
(1) All of the U.S. plans’ assets have quoted prices in active markets, except pooled funds, corporate debt and securities issued or guaranteed by U.S. states, municipalities and agencies.
(2) All of the cash and money market funds and corporate equity held by Canadian plans as at October 31, 2015 and 2014 have quoted prices in active markets.
(3) $307 million ($294 million in 2014) of securities issued or guaranteed by governments held by Canadian plans have quoted prices in active markets.
(4) $1,495 million ($1,328 million in 2014) of pooled funds held by Canadian plans have quoted prices in active markets.
(5) $Nil ($1 million in 2014) of derivatives held by Canadian plans have quoted prices in active markets.
(6) $36 million ($69 million in 2014) of corporate debt held by Canadian plans have quoted prices in active markets.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
No plan assets are directly invested in the bank’s or related parties’ securities as at October 31, 2015 and 2014. As at October 31, 2015, our primary
Canadian plan indirectly held, through a BMO managed pooled fund, approximately $9 million ($11 million in 2014) of our common shares. The plans do not hold any property we occupy or other assets we use.
The plans paid $4 million in the year ended October 31, 2015 ($4 million in 2014) to us and certain of our subsidiaries for investment management, record-keeping, custodial and administrative services rendered.
Sensitivity of Assumptions
Key weighted-average assumptions used in measuring the defined benefit obligations for our primary plans are outlined in the following table. The sensitivity analysis provided in the table should be used with caution as it is hypothetical and the impact of changes in each key assumption may not be linear. The sensitivities to changes in each key variable have been calculated independently of the impact of changes in other key variables. Actual experience may result in simultaneous changes in a number of key assumptions. Changes in one factor may result in changes in another, which would amplify or reduce certain sensitivities.
Defined benefit obligation
(Canadian $ in millions, except as noted)
Discount rate (%)
Impact: 1% increase ($)
1% decrease ($)
Rate of compensation increase (%)
Impact: 0.25% increase ($)
0.25% decrease ($)
Mortality
Impact: 1 year shorter life expectancy ($)
1 year longer life expectancy ($)
Assumed overall health care cost trend rate (%)
Impact: 1% increase ($)
1% decrease ($)
Pension benefit plans
Other employee future benefit plans
4.2
(817)
1,033
4.4
(144)
183
2.7
43
(42)
2.4
1
(1)
(119)
116
(26)
26
5.5 (1)
73
(76)
na na na
(1) Trending to 4.5% in 2030 and remaining at that level thereafter. na – not applicable
Disaggregation of Defined Benefit Obligation
Disaggregation of the defined benefit obligation for our primary plans is as follows:
2015
Canadian pension plans
Active members
Inactive and retired members
2014
Notes
68%
32%
62%
38%
100%
43%
57%
45%
55%
100%
188 BMO Financial Group 198th Annual Report 2015
100%
100%
Canadian other employee future benefit plans
Active members
Inactive and retired members
46%
54%
100%
U.S. pension plans
Active members
Inactive and retired members
44%
56%
100%
Maturity Profile
The duration of the defined benefit obligation for our primary plans is as follows:
(Years)
2015
2014
Canadian pension plans
U.S. pension plans
Canadian other employee future benefit plans
13.2
10.6
16.2
13.6
11.2
16.5
Cash Flows
Cash payments we made during the year in connection with our employee future benefit plans are as follows:
(Canadian $ in millions)
Pension benefit plans
Other employee future benefit plans
2015
2013
2015
2014
2013
198
86
33
254
66
30
154
57
24
–
–
35
–
–
33
–
–
30
317
Contributions to defined benefit plans
Contributions to defined contribution plans
Benefits paid directly to pensioners
2014
350
235
35
33
30
Our best estimate of the contributions we expect to make for the year ending October 31, 2016 is approximately $195 million to our pension benefit plans and $42 million to our other employee future benefit plans.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Note 24: Income Taxes
We report our provision for income taxes in our Consolidated Statement of Income based upon transactions recorded in our consolidated financial statements regardless of when they are recognized for income tax purposes, with the exception of repatriation of retained earnings from our foreign subsidiaries, as noted below.
In addition, we record an income tax expense or benefit in other comprehensive income or directly in shareholders’ equity when the taxes relate to amounts recorded in other comprehensive income or shareholders’ equity. For example, income tax expense (recovery) on hedging gains (losses) related to our net investment in foreign operations is recorded in our Consolidated Statement of Comprehensive Income as part of unrealized gains
(losses) on translation of net foreign operations.
Current tax is the amount of income tax recoverable (payable) in respect of the taxable loss (profit) for a period. Deferred income tax assets and liabilities are measured at the tax rates expected to apply when temporary differences reverse. Changes in deferred income tax assets and liabilities related to a change in tax rates are recorded in income in the period the tax rate is substantively enacted, except to the extent that the tax arises from a transaction or event which is recognized either in other comprehensive income or directly in shareholders’ equity. Current and deferred taxes are only offset when they are levied by the same taxation authority, levied on the same entity or group of entities and when there is a legal right to offset. Included in deferred income tax assets is $16 million related to Canadian tax loss carryforwards that will expire in various amounts between
2033 and 2035, $1,302 million related to U.S. tax loss carryforwards that will expire in various amounts in U.S. taxation years from 2028 through 2034 and $6 million related to U.K. tax loss carryforwards that are available for use indefinitely against relevant profits generated in the U.K. On the evidence available, including management projections of income, we believe that there will be sufficient taxable income generated by our business operations to support these deferred tax assets. The amount of tax on temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in our Consolidated Balance Sheet as at October 31, 2015 is $193 million. Deferred tax assets have not been recognized in respect of these items because it is not probable that realization of these assets will occur.
Income that we earn in foreign countries through our branches or subsidiaries is generally subject to tax in those countries. We are also subject to Canadian taxation on the income earned in our foreign branches. Canada allows a credit for certain foreign taxes paid on this income. Upon repatriation of retained earnings from certain foreign subsidiaries, we would be required to pay tax on certain of these earnings. As repatriation of such earnings is not planned in the foreseeable future, we have not recorded the related deferred income tax liability.
The amount of temporary differences associated with investments in subsidiaries, branches, associates and interests in joint ventures for which deferred tax liabilities have not been recognized is $27 billion as at October 31, 2015 ($23 billion in 2014).
Notes
BMO Financial Group 198th Annual Report 2015 189
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Provision for Income Taxes
(Canadian $ in millions)
2015
2014
2013
685
18
547
(1)
1,095
(29)
248
(15)
361
(4)
(10)
(1)
936
903
51
(87)
43
174
(167)
(63)
(15)
–
51
(144)
126
(31)
–
(57)
(146)
950
732
947
(Canadian $ in millions)
2015
2014
2013
Canada: Current income taxes
Federal
Provincial
395
215
292
200
457
300
Consolidated Statement of Income
Current
Provision for income taxes for the current period
Adjustments in respect of current tax for prior periods
Deferred
Origination and reversal of temporary differences
Effect of changes in tax rates
Other Comprehensive Income and Shareholders’ Equity
Income tax expense (recovery) related to:
Gains (losses) on remeasurement of pension and other employee future benefit plans
Unrealized (losses) on available-for-sale securities, net of hedging activities
Gains (losses) on remeasurement of own credit risk on financial liabilities designated at fair value
Gains (losses) on cash flow hedges
Hedging of unrealized (gains) on translation of net foreign operations
Total
1,055
Components of Total Provision for Income Taxes
610
492
757
Canada: Deferred income taxes
Federal
Provincial
131
71
33
29
(109)
(76)
202
62
(185)
Total Canadian
812
554
572
Foreign: Current income taxes
Deferred income taxes
36
102
(58)
236
90
285
Total foreign
138
178
375
Total
950
732
947
Set out below is a reconciliation of our statutory tax rates and income taxes that would be payable at these rates to the effective income tax rates and provision for income taxes that we have recorded in our Consolidated Statement of Income:
(Canadian $ in millions, except as noted)
Combined Canadian federal and provincial income taxes at the statutory tax rate
Increase (decrease) resulting from:
Tax-exempt income from securities
Foreign operations subject to different tax rates
Change in tax rate for deferred income taxes
Income attributable to non-controlling interests
Adjustments in respect of current tax for prior periods
Other
Provision for income taxes and effective tax rate
Notes
Certain comparative figures have been reclassified to conform with the current year’s presentation.
190 BMO Financial Group 198th Annual Report 2015
2014
2015
1,410
26.4%
1,382
26.4%
(378)
(39)
(15)
(29)
18
(31)
(7.1)
(0.7)
(0.3)
(0.5)
0.3
(0.6)
(343)
(69)
(4)
(33)
(1)
(29)
(6.5)
(1.3)
(0.1)
(0.7)
–
(0.6)
936
17.5%
903
17.2%
2013
1,386
(250)
(10)
(1)
(35)
(29)
(6)
1,055
26.4%
(4.7)
(0.2)
–
(0.7)
(0.6)
(0.1)
20.1%
Components of Deferred Income Tax Balances
Other
comprehensive income Allowance for credit losses
Employee future benefits
Deferred compensation benefits
914
329
344
(29)
–
(252)
–
96
8
31
3
3
15
42
–
18
–
–
(3)
25
As at October 31, 2014
758
374
419
(7)
Benefit (expense) to income statement
Benefit (expense) to equity
Translation and other
149
–
112
(Canadian $ in millions)
Deferred Income Tax Assets (1)
As at October 31, 2013
Acquisitions
Benefit (expense) to income statement
Benefit (expense) to equity
Translation and other
Deferred Income Tax Liabilities (2)
As at October 31, 2013
Acquisitions
Benefit (expense) to income statement
Expense to equity
Translation and other
As at October 31, 2014
Benefit (expense) to income statement
Benefit (expense) to equity
Translation and other
As at October 31, 2015
1,019
(16)
–
28
–
(20)
(4)
382
431
(31)
Premises and equipment As at October 31, 2015
(1)
–
9
Pension benefits Goodwill and intangible assets
Tax loss carryforwards Other
Total
1,485
461
3,504
10
(180)
–
103
2
49
–
72
1,418
584
(300)
–
206
14
–
76
35
(310)
–
317
3,546
(154)
(20)
427
1,324
674
3,799
Securities
Other
Total
(320)
(31)
(275)
(35)
77
(584)
5
(10)
–
(24)
–
(35)
60
2
(90)
28
–
(30)
–
32
–
2
–
(62)
–
1
(85)
(47)
60
(49)
(349)
(4)
(367)
(1)
16
(705)
(71)
–
(34)
29
(51)
(7)
92
–
(41)
6
–
4
(135)
–
11
(79)
(51)
(67)
(454)
(33)
(316)
9
(108)
(902)
(1) Deferred tax assets of $3,162 million and $3,019 million as at October 31, 2015 and 2014, respectively, are presented on the balance sheet net by legal jurisdiction.
(2) Deferred tax liabilities of $265 million and $178 million as at October 31, 2015 and 2014, respectively, are presented on the balance sheet net by legal jurisdiction.
Note 25: Earnings Per Share
Basic earnings per share is calculated by dividing net income attributable to our shareholders, after deducting preferred share dividends by the daily average number of fully paid common shares outstanding throughout the year.
Diluted earnings per share is calculated in the same manner, with further adjustments made to reflect the dilutive impact of instruments convertible into our common shares.
The following table presents our basic and diluted earnings per share:
Basic Earnings per Share
(Canadian $ in millions, except as noted)
Net income attributable to bank shareholders
Dividends on preferred shares
Net income available to common shareholders
Average number of common shares outstanding (in thousands)
Basic earnings per share (Canadian $)
Diluted Earnings per Share
Net income available to common shareholders
Stock options potentially exercisable (1)
Common shares potentially repurchased
Average diluted number of common shares outstanding (in thousands)
Diluted earnings per share (Canadian $)
2015
2014
2013
4,370
(117)
4,277
(120)
4,130
(120)
4,253
4,157
4,010
644,916
645,860
648,476
6.59
6.44
6.19
4,253
9,472
(7,226)
4,157
10,832
(8,217)
4,010
10,656
(9,326)
647,162
648,475
649,806
6.57
6.41
6.17
(1) In computing diluted earnings per share, we excluded average stock options outstanding of 1,906,715, 1,734,932 and 2,677,737 with weighted-average exercise prices of $185.22, $235.07 and
$201.93 for the years ended October 31, 2015, 2014 and 2013, respectively, as the average share price for the period did not exceed the exercise price.
Notes
BMO Financial Group 198th Annual Report 2015 191
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 26: Commitments, Guarantees, Pledged Assets, Provisions and Contingent Liabilities
In the normal course of business, we enter into a variety of contracts under which we may be required to make payments to reimburse the counterparty for a loss if a third party does not perform according to the terms of a contract or does not make payments when due under the terms of a debt instrument, and contracts under which we provide indirect guarantees of the indebtedness of another party all of which are considered guarantees. Guarantees that qualify as derivatives are accounted for in accordance with the policy for derivative instruments (see Note 8). For guarantees that do not qualify as derivatives, the liability is initially recorded at fair value, which is generally the fee received. Subsequently, guarantees are recorded at the higher of the initial fair value, less amortization to recognize any fee income earned over the period, and the best estimate of the amount required to settle the obligation. Any change in the liability is reported in our Consolidated Statement of Income.
In addition, we enter into a variety of commitments, including off-balance sheet credit instruments such as backstop liquidity facilities, securities lending, letters of credit, credit default swaps and commitments to extend credit, as a method of meeting the financial needs of our customers. These commitments include contracts where we may be required to make payments to a counterparty, based on changes in the value of an asset, liability or equity security that the counterparty holds, due to changes in an underlying interest rate, foreign exchange rate or other variable. The contractual amount of our commitments represents our maximum undiscounted potential exposure, before possible recoveries under recourse and collateral provisions. Collateral requirements for these instruments are consistent with collateral requirements for loans.
A large majority of these commitments expire without being drawn upon. As a result, the total contractual amounts may not be representative of the funding likely to be required for these commitments.
We strive to limit credit risk by dealing only with counterparties that we believe are creditworthy, and we manage our credit risk for other credit instruments using the same credit risk process that is applied to loans and other credit assets.
The maximum amount payable related to our various commitments is as follows:
(Canadian $ in millions)
Financial Guarantees
Standby letters of credit (1)
Credit default swaps (2) (3)
Other Credit Instruments
Backstop liquidity facilities (4)
Securities lending
Documentary and commercial letters of credit
Commitments to extend credit (5)
Other commitments
Total
2015
2014
15,351
9,385
13,949
11,983
5,528
6,081
1,101
101,173
3,586
5,501
5,269
1,111
78,817
2,261
142,205
118,891
(1) As at October 31, 2015, we recognized $35 million ($50 million in 2014) in other liabilities.
(2) As at October 31, 2015, $8,000 million of the credit default swaps outstanding relates to our credit protection vehicle and will mature within one year.
(3) The fair value of the related derivative liabilities included in our Consolidated Balance Sheet was $48 million as at October 31, 2015 ($124 million in 2014).
(4) As at October 31, 2015, $53 million was outstanding from backstop liquidity facilities ($53 million in 2014) and was recognized in other liabilities.
(5) Commitments to extend credit exclude personal lines of credit and credit cards that are unconditionally cancellable at our discretion.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Financial Guarantees
Standby letters of credit represent our obligation to make payments to third parties on behalf of customers if they are unable to make the required payments or meet other contractual requirements. The majority have a term of one year or less. Collate 