Citibank 2011 Annual Report Download - page 258

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For asset/liability management hedging, the fixed-rate long-term debt
would be recorded at amortized cost under current U.S. GAAP. However, by
electing to use ASC 815 (SFAS 133) fair value hedge accounting, the carrying
value of the debt is adjusted for changes in the benchmark interest rate,
with any such changes in value recorded in current earnings. The related
interest-rate swap is also recorded on the balance sheet at fair value, with any
changes in fair value reflected in earnings. Thus, any ineffectiveness resulting
from the hedging relationship is recorded in current earnings. Alternatively,
a management hedge, which does not meet the ASC 815 hedging criteria,
would involve recording only the derivative at fair value on the balance sheet,
with its associated changes in fair value recorded in earnings. The debt would
continue to be carried at amortized cost and, therefore, current earnings
would be impacted only by the interest rate shifts and other factors that cause
the change in the swap’s value and may change the underlying yield of the
debt. This type of hedge is undertaken when hedging requirements cannot
be achieved or management decides not to apply ASC 815 hedge accounting.
Another alternative for the Company would be to elect to carry the debt at
fair value under the fair value option. Once the irrevocable election is made
upon issuance of the debt, the full change in fair value of the debt would
be reported in earnings. The related interest rate swap, with changes in fair
value, would also be reflected in earnings, and provides a natural offset to the
debt’s fair value change. To the extent the two offsets are not exactly equal,
the difference would be reflected in current earnings.
Key aspects of achieving ASC 815 hedge accounting are documentation
of hedging strategy and hedge effectiveness at the hedge inception and
substantiating hedge effectiveness on an ongoing basis. A derivative must
be highly effective in accomplishing the hedge objective of offsetting either
changes in the fair value or cash flows of the hedged item for the risk
being hedged. Any ineffectiveness in the hedge relationship is recognized
in current earnings. The assessment of effectiveness excludes changes in
the value of the hedged item that are unrelated to the risks being hedged.
Similarly, the assessment of effectiveness may exclude changes in the fair
value of a derivative related to time value that, if excluded, are recognized in
current earnings.
Fair Value Hedges
Hedging of benchmark interest rate risk
Citigroup hedges exposure to changes in the fair value of outstanding fixed-
rate issued debt and certificates of deposit. The fixed cash flows from those
financing transactions are converted to benchmark variable-rate cash flows
by entering into receive-fixed, pay-variable interest rate swaps. Some of these
fair value hedge relationships use dollar-offset ratio analysis to determine
whether the hedging relationships are highly effective at inception and on an
ongoing basis, while others use regression.
Citigroup also hedges exposure to changes in the fair value of fixed-rate
assets, including available-for-sale debt securities and loans. The hedging
instruments used are receive-variable, pay-fixed interest rate swaps. Some
of these fair value hedging relationships use dollar-offset ratio analysis to
determine whether the hedging relationships are highly effective at inception
and on an ongoing basis, while others use regression analysis.
Hedging of foreign exchange risk
Citigroup hedges the change in fair value attributable to foreign-exchange
rate movements in available-for-sale securities that are denominated in
currencies other than the functional currency of the entity holding the
securities, which may be within or outside the U.S. The hedging instrument
employed is a forward foreign-exchange contract. In this type of hedge, the
change in fair value of the hedged available-for-sale security attributable
to the portion of foreign exchange risk hedged is reported in earnings and
not Accumulated other comprehensive income—a process that serves
to offset substantially the change in fair value of the forward contract that
is also reflected in earnings. Citigroup considers the premium associated
with forward contracts (differential between spot and contractual forward
rates) as the cost of hedging; this is excluded from the assessment of hedge
effectiveness and reflected directly in earnings. The dollar-offset method is
used to assess hedge effectiveness. Since that assessment is based on changes
in fair value attributable to changes in spot rates on both the available-for-
sale securities and the forward contracts for the portion of the relationship
hedged, the amount of hedge ineffectiveness is not significant.