(c) Pledged Assets

(Canadian $ in millions)

In the normal course of our business, we pledge assets as security for various liabilities that we incur. The following tables summarize our pledged assets, to whom they are pledged and in relation to what activity: (Canadian $ in millions)

Cash resources Securities Issued or guaranteed by Canada Issued or guaranteed by a Canadian province, municipality or school corporation Other securities Mortgages, securities borrowed or purchased under resale agreements and other Total assets pledged (1)

2011

2010

2,931

3,048

12,432

14,231

4,477 20,225

3,087 29,547

Assets pledged to: (2) Clearing systems, payment systems and depositories Bank of Canada Foreign governments and central banks Assets pledged in relation to: Obligations related to securities lent or sold under repurchase agreements Securities borrowing Derivatives transactions Mortgages Other

35,336

29,562

Total

75,401

79,475

Excludes restricted cash resources disclosed in Note 2.

2011

2010

1,150 2,436 2,772

1,025 2,305 936

28,839 17,229 7,306 11,663 4,006

38,097 16,911 7,620 9,927 2,654

75,401

79,475

Excludes cash pledged with central banks disclosed as restricted cash in Note 2. Excludes collateral received that has been sold or repledged as disclosed in the collateral section of this note. (1) Excludes rehypothecated assets of $11,847 million ($3,180 million in 2010) pledged in relation to securities borrowing transactions. (2) Includes assets pledged in order to participate in clearing and payment systems and depositories or to have access to the facilities of central banks in foreign jurisdictions.

(d) Other Commitments As a participant in merchant banking activities, we enter into commitments to fund external private equity funds and investments in equity and debt securities at market value at the time the commitments are drawn. In addition, we act as underwriter for certain new issuances under which we alone or together with a syndicate of financial institutions purchase the new issue for resale to investors. In connection with these activities, as at October 31, 2011 our related commitments were $2,074 million ($1,177 million in 2010).

Note 29: 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 non-trading assets and liabilities at amortized cost less allowances or write-downs for impairment. Where there is no quoted market value, fair value is determined using a variety of valuation techniques and assumptions. These fair values are based upon the estimated amounts 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 amounts disclosed represent point-in-time estimates that may change in subsequent reporting periods due to market conditions or other factors. Fair value represents our estimate of the amounts for which we could exchange the financial instruments with willing third parties who were interested in acquiring the instruments. In most cases, however, the financial instruments are not typically exchangeable or exchanged and therefore it is difficult to determine their fair value. In those cases, we have estimated fair value taking into account only changes in interest rates and credit risk that have occurred since we acquired them or entered into the underlying contracts. These calculations represent management’s best estimates based on a range of methodologies and assumptions; since they involve uncertainties, the fair values may not be realized in an actual sale or immediate settlement of the instruments.

Interest rate changes are the main cause of changes in the fair value of our financial instruments.

Financial Instruments Whose Book Value Approximates Fair Value Fair value is assumed to equal book value for acceptance-related liabilities and securities lent or sold under repurchase agreements, due to the short-term nature of these assets and liabilities. Fair value is also assumed to equal book value for our cash resources, certain other assets and certain other liabilities.

Loans In determining the fair value of our loans, we incorporate the following assumption: ‰ For fixed rate and floating rate performing loans and customers’ liability under acceptances, 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 the above assumption is further adjusted by a credit mark that represents an estimate of the expected credit losses in our loan portfolio.

Notes BMO Financial Group 194th Annual Report 2011 171

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Securities

‰ For fixed rate deposits with no defined maturities, we consider fair

The fair value of our securities, both trading and available-for-sale, by instrument type and the methods used to determine fair value are provided in Note 3.

value to equal book value based on book 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 book value.

Derivative Instruments The methods used to determine the fair value of derivative instruments are provided in Note 10.

Subordinated Debt and Capital Trust Securities

Deposits

The fair value of our subordinated debt and capital trust securities is determined by referring to current market prices for similar instruments. Set out in the following table are the amounts that would be reported if all of our financial instrument assets and liabilities were reported at their fair values.

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. (Canadian $ in millions)

2011

2010 Book value

Fair value

Fair value over (under) book value

Book value

Fair value

Fair value over (under) book value

19,626 3,968 131,346 37,970

19,626 3,968 131,480 37,970

– – 134 –

17,368 3,186 123,399 28,102

17,368 3,186 123,433 28,102

– – 34 –

54,350 61,241 83,714

55,131 60,829 82,965

781 (412) (749)

48,641 54,080 66,975

49,425 53,718 66,218

784 (362) (757)

Customers’ liability under acceptances

199,305 7,193

198,925 7,146

(380) (47)

169,696 6,947

169,361 6,864

(335) (83)

Total loans and customers’ liability under acceptances, net of allowance for credit losses Derivative instruments Premises and equipment Goodwill Intangible assets Other assets

206,498 55,677 2,117 3,585 1,562 15,074

206,071 55,677 2,117 3,585 1,562 15,134

(427) – – – – 60

176,643 49,759 1,560 1,619 812 9,192

176,225 49,759 1,560 1,619 812 9,192

(418) – – – – –

477,423

477,190

(233)

411,640

411,256

(384)

302,932 51,400 7,227 21,099 39,163 21,731 5,348 400 28,123

303,176 51,400 7,227 21,099 39,163 21,815 5,507 403 28,123

244 – – – – 84 159 3 –

249,251 47,970 7,001 16,438 47,110 17,414 3,776 800 21,880

249,544 47,970 7,001 16,438 47,110 17,504 3,947 823 21,880

293 – – – – 90 171 23 –

477,423

477,913

490

411,640

412,217

Assets Cash and cash equivalents Interest bearing deposits with banks Securities Securities borrowed or purchased under resale agreements Loans Residential mortgages Credit card, consumer instalment and other personal loans Businesses and governments

Liabilities Deposits Derivative instruments Acceptances Securities sold but not yet purchased Securities lent or sold under repurchase agreements Other liabilities Subordinated debt Capital trust securities Shareholders’ equity

Total fair value adjustment

Notes

Certain comparative figures have been reclassified to conform with the current year’s presentation.

172 BMO Financial Group 194th Annual Report 2011

(723)

577 (961)

Fair Value Hierarchy We use 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 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:

As at October 31 (Canadian $ in millions)

2010

2011 Valued using quoted market prices

Valued using models (with observable inputs)

Valued using models (without observable inputs)

Valued using quoted market prices

Valued using models (with observable inputs)

Valued using models (without observable inputs)

17,590 5,895 5,874 390 1,149

16 119 – 212 –

– – – – –

15,932 3,910 8,060 849 1,365

72 5 – 205 –

– – – – –

562 8,185 23,707

202 3,676 2,733

– 1,269 –

859 7,419 27,267

– 3,595 603

211 1,358 –

63,352

6,958

1,269

65,661

4,480

1,569

16,635 1,189 4,670 552 7,704

– 298 – 3,051 825

– – – 24 –

14,701 1,442 5,658 – 9,455

– 253 – 4,237 587

– – – 20 –

5,087 5,337 192

10,539 173 185

– 1,280 943

688 2,959 139

8,204 133 178

20 1,500 369

41,366

15,071

2,247

35,042

13,592

1,909

21,099 –

– 4,301

– –

16,438 –

– 3,976

– –

21,099

4,301

–

16,438

3,976

–

14 31 1,473 3,869 –

37,907 10,432 138 461 1,112

167 – – 6 67

24 45 2,207 1,028 –

33,862 10,089 382 617 1,120

217 – – 8 160

5,387

50,050

240

3,304

46,070

385

22 23 1,520 141 –

36,372 9,827 320 2,192 877

38 – – 65 3

38 20 2,087 53 –

32,593 9,517 501 2,109 930

48 – – 71 3

1,706

49,588

106

2,198

45,650

122

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

Fair Value Liabilities Securities sold but not yet purchased Structured note 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

Valuation Techniques and Significant Inputs

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. Sensitivity analysis at October 31, 2011 for the most significant Level 3 instruments is provided below. Within Level 3 trading securities is corporate debt of $1,246 million that relates to securities that are hedged with total return swaps and credit default swaps that are also considered Level 3 instruments.

BMO Financial Group 194th Annual Report 2011 173

Notes

We determine the fair value of publicly traded fixed income and equity securities using quoted market 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 inputs for inputs such as yield and prepayment rates or broker quotes and other thirdparty vendor quotes (Level 2). Fair value may also be determined using models where the significant market inputs are unobservable due to inactive or minimal market activity (Level 3). We maximize the use of market inputs to the extent possible. Our Level 2 trading securities are primarily valued using discounted cash flow models with observable spreads or based on broker quotes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

During the year ended October 31, 2011, available-for-sale securities purchased as part of the M&I acquisition that are classified as Level 3 totalled $326 million of which $124 million were sold during the year. In addition, to meet regulatory requirements after the acquisition of M&I we purchased $430 million of additional stock in Federal Reserve Banks and Federal Home Loan Banks. During the year ended October 31, 2011, $139 million of trading corporate debt securities were transferred from Level 3 to Level 2 as values for these securities are now obtained through a third-party vendor and are based on market prices. During the year ended October 31, 2011, $207 million and $20 million of mortgage-backed securities and collateralized mortgage obligations were transferred from Level 3 to Level 2 within trading securities and available-for-sale securities, respectively, as values for these securities are now obtained through a third-party vendor and are based on a larger volume of market prices. During the year ended October 31, 2011, derivative assets of $84 million and derivative liabilities of $13 million were transferred from Level 3 to Level 2 as market information became available for certain over-the-counter equity contracts. During the year ended October 31, 2010, a portion of the assetbacked commercial paper issued by the conduits known as the Montreal Accord were transferred from Level 3 to Level 2 within corporate debt trading securities because we are now valuing the notes based on broker quotes rather than internal models due to increased broker/ dealer trading of these securities, resulting in improved liquidity. In addition, certain available-for-sale corporate debt securities that were previously valued using observable market information were transferred from Level 2 to Level 1 as values for these securities became available in active markets.

The sensitivity analysis for the structured product is performed on an aggregate basis and is described as part of the discussion on derivatives below. Within Level 3 available-for-sale corporate debt securities as at October 31, 2011 was a deferred purchase price amount of $609 million related to our off-balance sheet securitization activities. We have determined the valuation of the deferred purchase price (excess spread) based on expected future cash flows. The significant inputs for the valuation model include interest rate, weighted-average prepayment rate, weighted-average maturity, expected credit losses and weightedaverage discount rate. The determination of interest rates has the most significant impact on the valuation of the deferred purchase price. Sensitivity analysis for the deferred purchase price is included in Note 8. Within Level 3 derivative assets and derivative liabilities as at October 31, 2011 was $234 million and $41 million related to the mark-to-market of credit default swaps and total return swaps, respectively, on structured products. We have determined the valuation of these derivatives and related securities based on estimates of current market spreads for similar structured products. The impact of assuming a 10 basis point increase or decrease in that spread would result in a change in fair value of $(3) million and $3 million, respectively.

Significant Transfers Transfers are made between the various fair value hierarchy levels due to changes in the availability of quoted market prices or observable market inputs due to changing market conditions. The following is a discussion of the significant transfers between Level 1, Level 2 and Level 3 balances for the years ended October 31, 2011 and 2010.

Changes in Level 3 Fair Value Measurements The table below presents a reconciliation of all changes in Level 3 financial instruments for the year ended October 31, 2011, including realized and unrealized gains (losses) included in earnings and other comprehensive income. Change in fair value

Notes

For the year ended October 31, 2011 (Canadian $ in millions)

Balance, October 31, Included in 2010 earnings

Included in other comprehensive income

Purchases

Sales

Maturities (1)

Transfers into Level 3

Transfers out of Level 3

Fair value as at October 31, 2011

Unrealized gains (losses) (2)

Trading Securities Mortgage-backed securities and collateralized mortgage obligations Corporate debt

211 1,358

(4) 15

– –

– 42

– (2)

– (5)

– –

(207) (139)

– 1,269

– (17)

Total trading securities

1,569

11

–

42

(2)

(5)

–

(346)

1,269

(17)

20

5

1

23

(18)

(7)

–

Available-for-Sale Securities Issued or guaranteed by: U.S. states, municipalities and agencies Mortgage-backed securities and collateralized mortgage obligations Corporate debt Corporate equity

20 1,500 369

– (83) (11)

– 26 8

– 263 761

– (161) (184)

– (265) –

– – –

Total available-for-sale securities

(363)

(272)

–

24

1

(20) – –

– 1,280 943

– 31 2

–

(20)

2,247

34

1,909

(89)

35

1,047

Derivative Assets Interest rate contracts Equity contracts Credit default swaps

217 8 160

9 8 (9)

– – –

8 – 3

– – –

(68) (4) (9)

1 – –

– (6) (78)

167 6 67

158 9 67

Total derivative assets

385

8

–

11

–

(81)

1

(84)

240

234

Derivative Liabilities Interest rate contracts Equity contracts Credit default swaps

48 71 3

– 10 –

– – –

4 3 –

– – –

(10) (10) –

– – –

(4) (9) –

38 65 3

(42) (65) (2)

122

10

–

7

–

(20)

–

(13)

106

(109)

Total derivative liabilities

(1) Includes cash settlement of derivative assets and derivative liabilities. (2) Unrealized gains or losses on trading securities, derivative assets and derivative liabilities still held on October 31, 2011 are included in earnings in the year. For available-for-sale

174 BMO Financial Group 194th Annual Report 2011

securities, the unrealized gains or losses on securities still held on October 31, 2011 are included in Accumulated Other Comprehensive Income.

The table below presents a reconciliation of all changes in Level 3 financial instruments for the year ended October 31, 2010, including realized and unrealized gains (losses) included in earnings and other comprehensive income. Change in fair value

For the year ended October 31, 2010 (Canadian $ in millions)

Balance, October 31, 2009

Included in earnings

Included in other comprehensive income

Purchases

Sales

Transfers into Maturities (1) Level 3

Transfers out of Level 3

Fair value as at October 31, 2010

–

–

–

Unrealized gains (losses) (2)

Trading Securities Issued or guaranteed by: U.S. states, municipalities and agencies Mortgage-backed securities and collateralized mortgage obligations Corporate debt

49

(7)

–

–

(42)

204 1,476

34 (17)

– –

8 96

(3) –

(32) (1)

– 14

– (210)

211 1,358

20 10

Total trading securities

1,729

10

–

104

(45)

(33)

14

(210)

1,569

30

86

2

(16)

–

(52)

20

–

–

–

Available-for-Sale Securities Issued or guaranteed by: U.S. states, municipalities and agencies Mortgage-backed securities and collateralized mortgage obligations Corporate debt Corporate equity

39 1,960 311

1 (281) (4)

– 31 (18)

– 244 78

– (156) (2)

(20) (252) (2)

– 13 6

– (59) –

20 1,500 369

1 45 –

Total available-for-sale securities

(210)

(274)

19

(59)

1,909

46

–

–

–

2,396

(282)

(3)

322

Derivative Assets Interest rate contracts Equity contracts Credit default swaps

1 11 567

20 (34) (53)

– – –

196 31 3

– – –

– – (357)

– – –

– – –

217 8 160

217 8 160

Total derivative assets

579

(67)

–

230

–

(357)

–

–

385

385

Derivative Liabilities Interest rate contracts Equity contracts Credit default swaps

73 97 3

– (57) –

– – –

– 31 –

– – –

(25) – –

– – –

– – –

48 71 3

48 71 3

173

(57)

–

31

–

(25)

–

–

122

122

Total derivative liabilities

(1) Includes cash settlement of derivative assets and derivative liabilities. (2) Unrealized gains or losses on trading securities, derivative assets and derivative liabilities still held on October 31, 2010 are included in earnings in the year. For available-for-sale

Other Items Measured at Fair Value Certain assets such as foreclosed assets are measured at fair value at initial recognition but are not required to be measured at fair value on an ongoing basis.

securities, the unrealized gains or losses on securities still held on October 31, 2010 are included in Accumulated Other Comprehensive Income.

As at October 31, 2011, we held $181 million of foreclosed assets measured at fair value at inception, all of which were classified as Level 2. For the year ended October 31, 2011, we recorded write-downs of $36 million on these assets.

Notes BMO Financial Group 194th Annual Report 2011 175