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AARON HARRIS/REUTERS

It was shaping up to be a strong year for Bank of Montreal's capital markets arm. Then the fourth quarter happened.

Nine months into fiscal 2014, BMO's capital business was on pace to grow by more than 7 per cent over the year prior. But volatile bond markets and a one-time charge related to derivatives valuations conspired to hurt the bank during the fourth quarter, resulting in respectable, but uninspiring, growth of 3 per cent for the full year.

By looking at the financial statements, it's hard to tell exactly what went down, other than that interest rate trading took a severe hit. Revenues from this business slumped 79 per cent from the same period a year prior.

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Executives elaborated on a conference call Tuesday afternoon. $39-million of the drop can be attributed to a funding valuation adjustment, or FVA – the first time BMO has seen such a charge. For those who follow such things, FVAs can be considered cousins to DVAs and CVAs. For those who aren't derivatives experts, the Financial Times' Alphaville blog has got you covered. In short, an FVA charge accounts for a change in the cost of funding for certain derivatives.

But even after adding back this charge, interest rate trading revenues still fell to $60-million, down 40 per cent from the year prior. Capital markets head Darryl White attributed the rest to "fairly extreme market volatility" that started in the middle of the quarter.

Everyone in the fixed-income world will know what he's referring to. By mid-October, some people on trading desks sounded like they were in shell shock after the yield on the 10-year U.S. Treasury bond fell to 2.14 per cent from 2.62, only to quickly gain back most of the losses. The yield on the five-year Government of Canada bond also dropped to 1.38 per cent from 1.6 per cent, only to quickly regain most of the loss.

Mr. White said the amount of money lost by the trading desk during the quarter wasn't out of the ordinary, but the volatility scared clients and kept them out of the market. "It's almost all reduced client activity," he said, referring to the drop in revenues.

"November certainly feels better than what we experienced in Q4," he added, but it's too early to tell whether trading revenues will jump back to the previous level.

In other business lines, equities trading revenues soared to $626-million, up 25 per cent in 2014; foreign exchange revenues popped to $356-million, up 25 per cent last year and underwriting and advisory fees climbed to $744-million by year-end, up 13 per cent over 2013.

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