Citibank 2010 Annual Report Download - page 233

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22. 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 changes to the
accounting for transfers and servicing of financial assets and consolidation
of variable interest entities (VIEs), including the elimination of qualifying
SPEs (QSPEs).
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 all (or a portion) of 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 in 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, a line of
credit, or from a liquidity facility, such as a 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 than unsecured debt.
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. Since QSPEs were eliminated, most of Citigroup’s SPEs
are now VIEs.
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,
and right to receive the expected residual returns of the entity or 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. Since January 1, 2010, the
variable interest holder, if any, that has a controlling financial interest in a VIE
is deemed to be the primary beneficiary and must consolidate the VIE. Citigroup
would be deemed to have a controlling financial interest and be the primary
beneficiary if it has both of the following characteristics:
power to direct activities of a VIE that most significantly impact the •฀
entity’s economic performance; and
obligation to absorb losses of the entity that could potentially be •฀
significant to the VIE or right to receive benefits from the entity that could
potentially be significant to the VIE.
The Company must evaluate its involvement in each VIE and understand
the purpose and design of the entity, the role the Company had in the entity’s
design, and its involvement in its ongoing activities. The Company then
must evaluate which activities most significantly impact the economic
performance of the VIE and who has the power to direct such activities.
For those VIEs where the Company determines that it has the power
to direct the activities that most significantly impact the VIE’s economic
performance, the Company then must evaluate its economic interests, if any,
and determine whether it could absorb losses or receive benefits that could
potentially be significant to the VIE. When evaluating whether the Company
has an obligation to absorb losses that could potentially be significant, it
considers the maximum exposure to such loss without consideration of
probability. Such obligations could be in various forms, including but not
limited to, debt and equity investments, guarantees, liquidity agreements,
and certain derivative contracts.
Prior to January 1, 2010, the variable interest holder, if any, that would
absorb a majority of the entity’s expected losses, receive a majority of the
entity’s residual returns, or both, was deemed to be the primary beneficiary and
consolidated the VIE. Consolidation of the VIE was determined based primarily
on the variability generated in scenarios that are considered most likely to
occur, rather than on scenarios that are considered more remote. In many
cases, a detailed quantitative analysis was required to make this determination.
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 to be variable interests and thus not an indicator of
power or potentially significant benefits or losses.