Citibank 2013 Annual Report Download - page 291

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Trading account assets and liabilities—derivatives
Exchange-traded derivatives are generally measured at fair value using
quoted฀market฀(i.e.,฀exchange)฀prices฀and฀are฀classified฀as฀Level฀1฀of฀the฀fair฀
value hierarchy.
The majority of derivatives entered into by the Company are executed
over the counter and are valued using internal valuation techniques, as no
quoted market prices exist for such instruments. The valuation techniques
and inputs depend on the type of derivative and the nature of the underlying
instrument. The principal techniques used to value these instruments are
discounted cash flows and internal models, including Black-Scholes and
Monte Carlo simulation. The fair values of derivative contracts reflect cash
the Company has paid or received (for example, option premiums paid
and received).
The key inputs depend upon the type of derivative and the nature
of the underlying instrument and include interest rate yield curves,
foreign-exchange rates, volatilities and correlation. The Company uses
overnight indexed swap (OIS) curves as fair value measurement inputs
for the valuation of certain collateralized derivatives. Citi uses the relevant
benchmark฀curve฀for฀the฀currency฀of฀the฀derivative฀(e.g.,฀the฀London฀
Interbank Offered Rate for U.S. dollar derivatives) as the discount rate
for uncollateralized derivatives. Citi has not recognized any valuation
adjustments to reflect the cost of funding uncollateralized derivative positions
beyond that implied by the relevant benchmark curve. Citi continues
to monitor market practices and activity with respect to discounting in
derivative valuation.
The฀derivative฀instruments฀are฀classified฀as฀either฀Level฀2฀or฀Level฀3฀
depending upon the observability of the significant inputs to the model.
Subprime-related direct exposures in CDOs
The valuation of high-grade and mezzanine asset-backed security (ABS)
CDO positions utilizes prices based on the underlying assets of each high-
grade and mezzanine ABS CDO. The high-grade and mezzanine positions
are largely hedged through the ABS and bond short positions. This results in
closer symmetry in the way these long and short positions are valued by the
Company. Citigroup uses trader marks to value this portion of the portfolio
and will do so as long as it remains largely hedged.
For most of the lending and structured direct subprime exposures, fair
value is determined utilizing observable transactions where available, other
market data for similar assets in markets that are not active and other
internal valuation techniques.
Investments
The investments category includes available-for-sale debt and marketable
equity securities, whose fair value is generally determined by utilizing similar
procedures described for trading securities above or, in some cases, using
consensus pricing as the primary source.
Also included in investments are nonpublic investments in private equity
and real estate entities held by the S&B business. Determining the fair
value of nonpublic securities involves a significant degree of management
resources and judgment, as no quoted prices exist and such securities are
generally very thinly traded. In addition, there may be transfer restrictions
on private equity securities. The Company’s process for determining the fair
value of such securities utilizes commonly accepted valuation techniques,
including comparables analysis. In determining the fair value of nonpublic
securities, the Company also considers events such as a proposed sale of
the investee company, initial public offerings, equity issuances or other
observable transactions. As discussed in Note 14 to the Consolidated Financial
Statements, the Company uses net asset value to value certain of these
investments.
Private฀equity฀securities฀are฀generally฀classified฀as฀Level฀3฀of฀the฀fair฀
value hierarchy.
Short-term borrowings and long-term debt
Where fair value accounting has been elected, the fair value of non-
structured liabilities is determined by utilizing internal models using the
appropriate discount rate for the applicable maturity. Such instruments are
generally฀classified฀as฀Level฀2฀of฀the฀fair฀value฀hierarchy,฀as฀all฀inputs฀are฀
readily observable.
The Company determines the fair value of structured liabilities (where
performance is linked to structured interest rates, inflation or currency risks)
and hybrid financial instruments (where performance is linked to risks
other than interest rates, inflation or currency risks) using the appropriate
derivative valuation methodology (described above in “Trading account
assets and liabilities—derivatives”) given the nature of the embedded risk
profile.฀Such฀instruments฀are฀classified฀as฀Level฀2฀or฀Level฀3฀depending฀on฀the฀
observability of significant inputs to the model.
Alt-A mortgage securities
The Company classifies its Alt-A mortgage securities as held-to-maturity,
available-for-sale and trading investments. The securities classified as trading
and available-for-sale are recorded at fair value with changes in fair value
reported in current earnings and AOCI, respectively. For these purposes, Citi
defines Alt-A mortgage securities as non-agency residential mortgage-backed
securities (RMBS) where (i) the underlying collateral has weighted average
FICO scores between 680 and 720 or (ii) for instances where FICO scores
are greater than 720, RMBS have 30% or less of the underlying collateral
composed of full documentation loans.
Similar to the valuation methodologies used for other trading securities
and trading loans, the Company generally determines the fair values of
Alt-A mortgage securities utilizing internal valuation techniques. Fair value
estimates from internal valuation techniques are verified, where possible, to
prices obtained from independent vendors. Consensus data providers compile
prices from various sources. Where available, the Company may also make
use of quoted prices for recent trading activity in securities with the same or
similar characteristics to the security being valued.
The valuation techniques used for Alt-A mortgage securities, as with other
mortgage exposures, are price-based and yield analysis. The primary market-
derived input is yield. Cash flows are based on current collateral performance
with prepayment rates and loss projections reflective of current economic
conditions of housing price change, unemployment rates, interest rates,
borrower attributes and other market indicators.
Alt-A mortgage securities that are valued using these methods are
generally฀classified฀as฀Level฀2.฀However,฀Alt-A฀mortgage฀securities฀backed฀
by Alt-A mortgages of lower quality or subordinated tranches in the capital
structure฀are฀mostly฀classified฀as฀Level฀3฀due฀to฀the฀reduced฀liquidity฀that฀
exists for such positions, which reduces the reliability of prices available from
independent sources.