SecProbe.io

CORRESP
1
filename1.htm

corresp

    Karen E. Maidment, FCA

Senior Executive Vice President

& Chief Financial Officer

    BMO Financial Group

1 First Canadian Place

100 King Street West, 18th Floor

Toronto, ON M5X 1A1

Tel: (416) 867-6776

Fax: (416) 867-4137

karen.maidment@bmo.com

December 5, 2005

Don Walker

Senior Assistant Chief Accountant

United States

Securities and Exchange Commission

Washington D.C. 20549

Mail Stop 4561

    RE:

    Bank of Montreal

Form 40-F for the Fiscal Year Ended October 31, 2004

Filed December 15, 2004

File No. 1-13354

Dear Mr. Walker:

Thank you for your letter of November 18, 2005 requesting additional information. We are pleased
to provide the following responses to your questions, as well as the additional disclosure we will
be providing in our Form 40-F filing for the year ended October 31, 2005. As discussed with Michael
Volley, we are in the process of finalizing our disclosure for public release on or about December
19, 2005.

Note 9 Derivative Financial Instruments, page 97

    1.

    Refer to prior comment 1 from our letter dated September 20, 2005. We note your response
related to the liquidity reserve in which you disclose that the reserve is evaluated where
factors such as size, among other things, indicate that the instrument is less liquid. Please
tell us the accounting guidance on which you rely to record a liquidity reserve specifically
where the size of the position indicates that the instrument is less liquid. Refer to
paragraph 58 of SFAS 107 and paragraph 315 of SFAS 133.

    A small proportion of our trading derivatives are exchange-traded. All exchange-traded
derivatives are recorded at fair value using quoted market prices (i.e., fair value is
calculated as the quoted market price multiplied by the number of units) and no liquidity
reserve is applied. Paragraph 58 of SFAS 107 indicates that quoted market prices should be used
for instruments recorded at fair value, even if the instrument in question is only thinly
traded. Paragraph 315 further indicates that no premium or discount should be
applied to quoted market prices based on the size of a position relative to trading volumes.
Since we do not apply liquidity reserves against the quoted market values of our exchange-traded
derivatives, our accounting is consistent with the above noted
paragraphs of SFAS 107 and SFAS 133.

    The significant majority of our trading derivatives are over-the-counter derivatives. Since
quoted market prices are not available, we use models incorporating observable market data to
estimate fair value. For some derivatives the over-the-counter market is considered illiquid,
for example due to unusual size of the position or terms of the derivative. In these cases, we
take the model-determined value and apply a liquidity reserve to adjust the derivative to our
best estimate of its fair value. We consider the liquidity reserve to be a necessary element of
our fair value estimate where the market data used in our valuation models is based on more
liquid markets for instruments with more common terms. Without the liquidity reserve our model
would not arrive at our best estimate of fair value for an illiquid derivative.

    Under Canadian GAAP, we rely on EIC 39, “Accounting for the Issue of Certain Derivatives
Instruments,” as prescribed by the Emerging Issues Committee of the Canadian Institute of
Chartered Accountants. EIC 39 states that in calculating the fair value of a derivative
consideration should be given to “the risk that an entity will not be able to quickly acquire or
sell an instrument at an amount close to its fair value due to a lack of liquidity in the
market.” Furthermore, we believe our use of a liquidity reserve is consistent with paragraph 22
of SFAS 107, which indicates that fair value for instruments with no quoted market prices should
be determined using judgment to arrive at our best estimate. Our approach is also supported by
paragraph 7.43 of the AICPA Accounting and Auditing Guide, Brokers and Dealers in Securities,
which states: “In determining a derivative’s value, consideration should be given to recognizing
and providing for credit and liquidity risk...”

    2.

    Refer to prior comment 1 from our letter dated September 20, 2005. Please tell us the
accounting guidance on which you rely to record an administrative reserve.

    Under Canadian GAAP, we rely on EIC 39, as mentioned above. EIC 39 states that “the fair value
of the derivative instruments should provide for any remaining risks and any remaining servicing
costs associated with the instruments.” The need for a reserve for administrative costs is also
discussed in paragraph 7.43 of the AICPA Accounting and Auditing Guide, Brokers and Dealers in
Securities as follows: “In determining a derivative’s value, consideration should be given to
recognizing and providing for...the operational and administrative costs associated with the
management of derivative portfolios. “

    3.

    Refer to prior comment 1 and 2 from our letter dated September 20, 2005. Please revise future
filings to:

    •

    Disclose the methodologies for calculating your fair value reserves;

    •

    Quantify each of your fair value reserves for the periods presented; and

    •

    Discuss any significant change to the methodologies and significant increases or
decreases in the amounts recorded.

    We have included the following disclosure in our discussion of Financial Instruments Measured at
Fair Value, which will appear in the Critical Accounting Estimates section of our MD&A on page
63 of our 2005 Annual Report. The Annual Report for the year ended October 31, 2005 will be
included in our Form 40-F filing that we will be making on or about December 19, 2005.

********

    Valuation models use general assumptions and market data and therefore do not reflect the
specific risks and other factors that would impact on a particular instrument’s fair value. Our
fair value adjustments take into account the estimated impact of credit risk, liquidity risk,
valuation considerations, administrative costs and closeout costs. For example the credit risk
adjustment factors credit risk into our fair values by taking into account factors such as the
counterparty’s credit rating, the duration of the instrument and changes in credit spreads.

    A group independent of the trading lines of business, Valuation Product Control (VPC), verifies
the fair values at which instruments are recorded. For instruments that are valued using models,
VPC identifies situations where adjustments must be made to the model estimates to arrive at
fair value.

    The methodologies used for calculating these adjustments are reviewed at least annually to
ensure that they remain appropriate. Significant changes in methodologies are rare and are made
only when we feel that the change will result in better estimates of fair value.

    Valuation adjustments as at October 31 (in millions of Canadian dollars)

    2005

    2004

    Credit

    63

    39

    Liquidity

    19

    11

    Administrative Costs

    17

    17

    Others

    5

    10

    104

    77

    There were no significant changes in methodologies for calculating the reserves during 2005 and
2004. The increase in the adjustment for credit risk is due to the 26% increase in the fair
value of derivative assets compared to 2004 as well as increased credit spreads. The increase in
the adjustment for liquidity risk is due primarily to some unusually long-dated instruments.

    4.

    Please tell us if you net the fair value of derivative contracts on your balance sheet in
accordance with FIN 39. If so, please tell us your accounting policy specifically indicating
if you net cash collateral against the applicable derivative exposures based upon provisions
contained in legal netting agreements.

    In accordance with FIN 39 paragraph 10, we net the amounts recognized for derivative contracts
with the same counterparty where we have an enforceable right to offset amounts and we intend to
settle contracts on a net basis. This is disclosed in Note 9 of our Consolidated Financial
Statements included in our 2004 Annual Report.

    We also hold cash as collateral from certain derivative counterparties in order to reduce our
credit exposure to these counterparties. We net the obligation to return the cash held as
collateral against the fair value of the derivatives we have with that counterparty as all the
conditions outlined in paragraph 5 of FIN 39 are met.

Should you have any further questions, please contact Cally Hunt, Vice President and Chief
Accountant at (416) 643-1727, or me

at (416) 867-6776.

Sincerely,

/s/ Karen E. Maidment

Karen Maidment

Senior Executive Vice President

& Chief Financial Officer

BMO Financial Group