NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 Loans and the Allowance for Credit Losses Loans Allowance for Credit Losses Specific Allowances Loan Fees Impaired Loans General Allowance Country Risk Allowance 74 BMO FINANCIAL GROUP ANNUAL REPORT 2002 Loans are recorded at cost net of unearned interest and unamortized discounts. Interest income is recorded on an accrual basis, except for impaired loans the treatment of which is described below.  From time to time we will restructure a loan due to the poor financial condition of the borrower. Interest on these restructured loans is recorded on an accrual basis.  Securities 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 sellers, on a specified date at a specified price. We account for these instruments as loans. The allowance for credit losses recorded in our Consolidated Balance Sheet is maintained at a level which we consider to be adequate to absorb credit-related losses in our loan portfolio. We also have an allowance for credit loss related to derivative financial instruments which is included in other liabilities. The allowance comprises the following components: These allowances are recorded for specific loans to reduce their book value to  the amount we expect to recover. We review our loans and acceptances, other  than consumer instalment and credit card loans, on an ongoing basis to assess  whether any loans should be classified as impaired and whether an allowance or write-off should be recorded. Our review of problem loans is conducted at least quarterly by our account managers who assess the ultimate collectibility and esti- mated recoveries on a specific loan based on all events and conditions that the manager believes are relevant to the condition of the loan. This assessment is then reviewed and concurred by an independent credit officer. In addition, signif- icant specific allowances are reviewed by officers in the Risk Management Group. To determine the amount we expect to recover from an impaired loan we use the value of the estimated future cash flows discounted at the effective rate inherent in the loan. When the amounts and timing of future cash flows cannot be estimated with reasonable reliability the expected recovery amount is esti- mated using the fair value of any security underlying the loan, net of expected costs of realization and any amounts legally required to be paid to the borrower, or an observable market price for the loan. Security can vary by type of loan  and may include cash, securities, real property, accounts receivable, guarantees, inventory or other capital assets. The accounting treatment for loan fees varies depending on the transaction.  Loan syndication fees are included in lending fees when they are earned. Loan origination, restructuring and renegotiation fees are recorded as interest income over the term of the loan. Commitment fees are also 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. We classify loans, except for credit card loans and consumer instalment loans, as impaired when any of the following criteria are met: We maintain a general allowance in order to cover any impairment in the existing portfolio that cannot yet be associated with specific loans. Our approach to  establishing and maintaining the general allowance is based on the guideline  issued by our regulator, the Superintendent of Financial Institutions Canada, that became effective in 2002. Credit card loans are classified as impaired and immediately written off when principal or interest payments become 180 days past due. Consumer instal- ment loans are immediately classified as impaired when the principal or interest payments are 90 days past due, and are written off when they are past due  by one year. We do not accrue interest when we classify a loan as impaired, and any interest income that is accrued is reversed to interest income. The general allowance is reviewed on a quarterly basis. A number of factors  are considered when determining the appropriate level of the general allowance.  statistical analysis of past performance is undertaken to derive the mean  (Expected Loss) and volatility (Unexpected Loss) of loss experience. This analysis  calculates historical average losses for each homogeneous portfolio segment  (e.g., mortgages), while other models estimate loss for portfolios of corporate  loans and investments that can be referenced to market data. In addition, the  level of allowance already in place and managementGLYPH<213>s professional judgement  r egarding portfolio quality, business mix and economic as well as credit market  conditions are also considered. Payments received on a loan that has been classified as impaired are recorded first to recover collection costs and any previous write-offs or allowances, and then as interest income. Payments received on impaired consumer instalment loans and loans to designated countries are applied first to outstanding interest, and then to the remaining principal. b we are no longer reasonably assured principal or interest will be collected on a timely basis;  b principal or interest payments become 90 days past due (unless we are actively trying to collect the loan and it is fully secured);  b fully secured loans become 180 days past due; or b we consider it prudent to cease accruing interest on the loan. Property or other assets that we receive from borrowers to satisfy their loan commitments are classified as impaired and recorded at the lower of the amount we expect to recover and the outstanding balance of the loan at the time of  the transfer. A loan will be reclassified back to performing status when it is determined  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. This allowance is recorded for loans to and securities of countries designated  by the Superintendent of Financial Institutions Canada that have restructured  or experienced difficulties in servicing all or part of their external debt to com- mer cial banks. Changes in the value of our loan portfolio due to credit-related losses are included in the provision for credit losses in our Consolidated Statement of Income. The following table sets out our loans and allowance for credit losses by l oan category: Gros loans Specific General Net loans amou nt allowance allowance amount 2002 2001 2002 2001 2002 2001 2002 2001 Residential mortgages $ 47,569 $ 41,941 $ 5 $ 6 $ 13 $ 12 $ 47,551 $ 41,923 Credit card, consumer instalment and other personal loans 23,448 20,634 4 8  294 247 23,150 20,379 Business and government loans 57,963 61,249 760 755  873 921 56,330 59,573 Securities purchased under resale agreements 15,664 14,954 — — — — 15,664 14,954 Total $ 144,644 138,778 $ 769 $  769 $ 1,180 $  1,180 $ 142,695 $ 136,829 Restructured loans classified as performing during the year ended October 31, 2002 were $38 (nil in 2001). No restructured loans were written off in the years ended October 31, 2002 and 2001. Included in loans as at October 31, 2002 are $53,981 ($53,929 in 2001) of loans denominated in U.S. dollars and $598 ($558 in 2001) of loans denominated in other foreign currencies.