Citibank 2013 Annual Report Download - page 155

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CVA/DVA Methodology
ASC 820-10 requires that Citi’s own credit risk be considered in determining
the market value of any Citi liability carried at fair value. These liabilities
include derivative instruments as well as debt and other liabilities for which
the fair value option has been elected. The credit valuation adjustment
(CVA) also incorporates the market view of the counterparty credit risk in
the valuation of derivative assets. The CVA is recognized on the Consolidated
Balance Sheet as a reduction or increase in the associated derivative asset or
liability to arrive at the fair value (carrying value) of the derivative asset or
liability. The debt valuation adjustment (DVA) is recognized on the balance
sheet as a reduction or increase in the associated fair value option debt
liability to arrive at the fair value of the liability. For additional information,
see “Fair Value Adjustments for Derivatives and FVO Liabilities” above.
Allowance for Credit Losses
Allowance for Funded Lending Commitments
Management provides reserves for an estimate of probable losses inherent
in the funded loan portfolio on the Consolidated Balance Sheet in the
form of an allowance for loan losses. These reserves are established in
accordance with Citigroup’s credit reserve policies, as approved by the
Audit Committee of the Board of Directors. Citi’s Chief Risk Officer and
Chief Financial Officer review the adequacy of the credit loss reserves each
quarter with representatives from the risk management and finance staffs
for each applicable business area. Applicable business areas include those
having classifiably managed portfolios, where internal credit-risk ratings
are assigned (primarily Institutional Clients Group and Global Consumer
Banking), or modified Consumer loans, where concessions were granted due
to the borrowers’ financial difficulties.
The above-mentioned representatives covering these respective business
areas present recommended reserve balances for their funded and unfunded
lending portfolios along with supporting quantitative and qualitative data.
The quantitative data include:
Estimated Probable Losses for Non-Performing, Non-Homogeneous
Exposures Within a Business Line’s Classifiably Managed Portfolio and
Impaired Smaller-Balance Homogeneous Loans Whose Terms Have
Been Modified Due to the Borrowers’ Financial Difficulties, Where It Was
Determined That a Concession Was Granted to the Borrower.
Consideration may be given to the following, as appropriate, when
determining this estimate: (i) the present value of expected future cash flows
discounted at the loan’s original effective rate; (ii) the borrower’s overall
financial condition, resources and payment record; and (iii) the prospects
for support from financially responsible guarantors or the realizable value of
any collateral. When impairment is measured based on the present value of
expected future cash flows, the entire change in present value is recorded in
the Provision for loan losses.
Statistically Calculated Losses Inherent in the Classifiably Managed
Portfolio for Performing and De Minimus Non-Performing Exposures.
The calculation is based upon: (i) Citigroup’s internal system of credit-
risk ratings, which are analogous to the risk ratings of the major credit
rating agencies; and (ii) historical default and loss data, including rating
agency information regarding default rates from 1983 to 2012, and
internal data dating to the early 1970s on severity of losses in the event of
default. Adjustments may be made to this data. Such adjustments include:
(i) statistically calculated estimates to cover the historical fluctuation
of the default rates over the credit cycle, the historical variability of loss
severity among defaulted loans, and the degree to which there are large
obligor concentrations in the global portfolio; and (ii) adjustments made
for specifically known items, such as current environmental factors and
credit trends.
In addition, representatives from both the risk management and finance
staffs that cover business areas with delinquency-managed portfolios
containing smaller homogeneous loans present their recommended reserve
balances based upon leading credit indicators, including loan delinquencies
and changes in portfolio size, as well as economic trends, including housing
prices, unemployment and GDP. This methodology is applied separately for
each individual product within each different geographic region in which
these portfolios exist.
This evaluation process is subject to numerous estimates and judgments.
The frequency of default, risk ratings, loss recovery rates, the size and
diversity of individual large credits, and the ability of borrowers with foreign
currency obligations to obtain the foreign currency necessary for orderly debt
servicing, among other things, are all taken into account during this review.
Changes in these estimates could have a direct impact on Citi’s credit costs
in any period and could result in a change in the allowance. Changes to the
allowance are recorded in the Provision for loan losses.
Allowance for Unfunded Lending Commitments
A similar approach to the allowance for loan losses is used for calculating
a reserve for the expected losses related to unfunded loan commitments
and standby letters of credit. This reserve is classified on the Consolidated
Balance Sheet in Other liabilities. Changes to the allowance for unfunded
lending commitments are recorded in the Provision for unfunded
lending commitments.
For a further description of the loan loss reserve and related accounts, see
Notes 1 and 16 to the Consolidated Financial Statements.