Citibank 2013 Annual Report Download - page 258

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22. SECURITIZATIONS AND VARIABLE INTEREST
ENTITIES
Uses of Special Purpose Entities
A special purpose entity (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 various 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.
These issuances are recorded on the balance sheet of the SPE, which may
or may not be consolidated onto the balance sheet of the company that
organized the SPE.
Investors usually have recourse only 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 a
liquidity facility, such as a liquidity put option or asset purchase agreement.
Because of these enhancements, the SPE issuances can typically obtain a
more favorable credit rating from rating agencies than the transferor could
obtain for its own debt issuances. This results 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.
Most of Citigroup’s SPEs are variable interest entities (VIEs), as
described below.
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
providing 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 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 the VIE’s 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.
In various other transactions, the Company may: (i) 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);
(ii) act as underwriter or placement agent; (iii) provide administrative,
trustee or other services; or (iv) 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.