Citibank 2009 Annual Report Download - page 205

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23. SECURITIZATIONS AND VARIABLE INTEREST
ENTITIES
Overview
Citigroup and its subsidiaries are involved with several types of off-balance-
sheet arrangements, including special purpose entities (SPEs). See Note 1
to the Consolidated Financial Statements for a discussion of impending
accounting changes to the accounting for transfers and servicing of
financial assets and Consolidation of Variable Interest Entities, including the
elimination of Qualifying SPEs.
Uses of SPEs
An SPE is an entity designed to fulfill a specific limited need of the company
that organized it.
The principal uses of SPEs are to obtain liquidity and favorable capital
treatment by securitizing certain of Citigroup’s financial assets, to assist
clients in securitizing their financial assets, and to create investment
products for clients. SPEs may be organized in many legal forms including
trusts, partnerships or corporations. In a securitization, the company
transferring assets to an SPE converts those assets into cash before they
would have been realized in the normal course of business, through the
SPE’s issuance of debt and equity instruments, certificates, commercial
paper and other notes of indebtedness, which are recorded on the balance
sheet of the SPE and not reflected on the transferring company’s balance
sheet, assuming applicable accounting requirements are satisfied. Investors
usually have recourse to the assets in the SPE and often benefit from other
credit enhancements, such as a collateral account or over-collateralization
in the form of excess assets in the SPE, or from a liquidity facility, such as
a line of credit, liquidity put option or asset purchase agreement. The SPE
can typically obtain a more favorable credit rating from rating agencies
than the transferor could obtain for its own debt issuances, resulting in less
expensive financing costs. The SPE may also enter into derivative contracts
in order to convert the yield or currency of the underlying assets to match
the needs of the SPE investors or to limit or change the credit risk of the SPE.
Citigroup may be the provider of certain credit enhancements as well as the
counterparty to any related derivative contracts.
SPEs may be Qualifying SPEs (QSPEs) or Variable Interest Entities (VIEs)
or neither.
Qualifying SPEs
QSPEs are a special class of SPEs that have significant limitations on the
types of assets and derivative instruments they may own or enter into and
the types and extent of activities and decision-making they may engage in.
Generally, QSPEs are passive entities designed to purchase assets and pass
through the cash flows from those assets to the investors in the QSPE. QSPEs
may not actively manage their assets through discretionary sales and are
generally limited to making decisions inherent in servicing activities and
issuance of liabilities. QSPEs are generally exempt from consolidation by the
transferor of assets to the QSPE and any investor or counterparty.
Variable interest entities
VIEs are entities that have either a total equity investment that is insufficient
to permit the entity to finance its activities without additional subordinated
financial support or whose equity investors lack the characteristics of a
controlling financial interest (i.e., ability to make significant decisions
through voting rights, right to receive the expected residual returns of the
entity and obligation to absorb the expected losses of the entity). Investors
that finance the VIE through debt or equity interests or other counterparties
that provide other forms of support, such as guarantees, subordinated fee
arrangements, or certain types of derivative contracts, are variable interest
holders in the entity. The variable interest holder, if any, that will absorb
a majority of the entity’s expected losses, receive a majority of the entity’s
expected residual returns, or both, is deemed to be the primary beneficiary
and must consolidate the VIE. Consolidation of a VIE is determined based
primarily on variability generated in scenarios that are considered most
likely to occur, rather than based on scenarios that are considered more
remote. Certain variable interests may absorb significant amounts of losses
or residual returns contractually, but if those scenarios are considered very
unlikely to occur, they may not lead to consolidation of the VIE.
All of these facts and circumstances are taken into consideration when
determining whether the Company has variable interests that would deem
it the primary beneficiary and, therefore, require consolidation of the
related VIE or otherwise rise to the level where disclosure would provide
useful information to the users of the Company’s financial statements. In
some cases, it is qualitatively clear based on the extent of the Company’s
involvement or the seniority of its investments that the Company is not
the primary beneficiary of the VIE. In other cases, a more detailed and
quantitative analysis is required to make such a determination.
The Company generally considers the following types of involvement to be
significant:
assisting in the structuring of a transaction and retaining any amount •฀
of debt financing (e.g., loans, notes, bonds or other debt instruments)
or an equity investment (e.g., common shares, partnership interests or
warrants);
writing a “liquidity put” or other liquidity facility to support the issuance •฀
of short-term notes;
writing credit protection (e.g., guarantees, letters of credit, credit default •฀
swaps or total return swaps where the Company receives the total return or
risk on the assets held by the VIE); or
certain transactions where the Company is the investment manager and •฀
receives variable fees for services.
In various other transactions, the Company may act as a derivative
counterparty (for example, interest rate swap, cross-currency swap, or
purchaser of credit protection under a credit default swap or total return
swap where the Company pays the total return on certain assets to the SPE);
may act as underwriter or placement agent; may provide administrative,
trustee, or other services; or may make a market in debt securities or
other instruments issued by VIEs. The Company generally considers such
involvement, by itself, “not significant.”