Citibank 2014 Annual Report Download - page 278

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As referenced above, during the third quarter of 2014, Citi incorporated
FVA฀into฀the฀fair฀value฀measurements฀due฀to฀what฀it฀believes฀to฀be฀an฀
industry migration toward incorporating the market’s view of funding risk
premium฀in฀OTC฀derivatives.฀In฀connection฀with฀its฀implementation฀of฀FVA฀
in 2014, Citigroup incurred a pretax charge of $499 million, which was
reflected in Principal transactions as a change in accounting estimate.
Citi’s฀FVA฀methodology฀leverages฀the฀existing฀CVA฀methodology฀to฀estimate฀a฀
funding exposure profile. The calculation of this exposure profile considers
collateral agreements where the terms do not permit the firm to reuse
the collateral received, including where counterparties post collateral to
third-party custodians.
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.
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
vendor pricing as the primary source.
Also included in investments are nonpublic investments in private equity
and real estate entities. 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฀when฀all฀significant฀
inputs are readily observable.
The Company determines the fair value of hybrid financial instruments,
including structured liabilities, 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 or 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.