Citibank 2015 Annual Report Download - page 211

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The sections below describe the Company’s process for identifying
credit-related impairments for security types that have the most significant
unrealized losses as of December 31, 2015.
Mortgage-Backed Securities
For U.S. mortgage-backed securities (and in particular for Alt-A and other
mortgage-backed securities that have significant unrealized losses as a
percentage of amortized cost), credit impairment is assessed using a cash
flow model that estimates the principal and interest cash flows on the
underlying mortgages using the security-specific collateral and transaction
structure. The model distributes the estimated cash flows to the various
tranches of securities, considering the transaction structure and any
subordination and credit enhancements that exist in that structure. The cash
flow model incorporates actual cash flows on the mortgage-backed securities
through the current period and then estimates the remaining cash flows
using a number of assumptions, including default rates, prepayment rates,
recovery rates (on foreclosed properties) and loss severity rates (on non-
agency mortgage-backed securities).
Management develops specific assumptions using market data, internal
estimates and estimates published by rating agencies and other third-party
sources. Default rates are projected by considering current underlying
mortgage loan performance, generally assuming the default of (i) 10%
of current loans, (ii) 25% of 30–59 day delinquent loans, (iii) 70% of
60–90 day delinquent loans and (iv) 100% of 91+ day delinquent loans.
These estimates are extrapolated along a default timing curve to estimate the
total lifetime pool default rate. Other assumptions contemplate the actual
collateral attributes, including geographic concentrations, rating actions and
current market prices.
Cash flow projections are developed using different stress test scenarios.
Management evaluates the results of those stress tests (including the
severity of any cash shortfall indicated and the likelihood of the stress
scenarios actually occurring based on the underlying pool’s characteristics
and performance) to assess whether management expects to recover the
amortized cost basis of the security. If cash flow projections indicate that the
Company does not expect to recover its amortized cost basis, the Company
recognizes the estimated credit loss in earnings.
State and Municipal Securities
The process for identifying credit impairments in Citigroup’s AFS and HTM
state and municipal bonds is primarily based on a credit analysis that
incorporates third-party credit ratings. Citigroup monitors the bond issuers
and any insurers providing default protection in the form of financial
guarantee insurance. The average external credit rating, ignoring any
insurance, is Aa3/AA-. In the event of an external rating downgrade or
other indicator of credit impairment (i.e., based on instrument-specific
estimates of cash flows or probability of issuer default), the subject bond is
specifically reviewed for adverse changes in the amount or timing of expected
contractual principal and interest payments.
For state and municipal bonds with unrealized losses that Citigroup plans
to sell (for AFS only), would be more-likely-than-not required to sell (for AFS
only) or will be subject to an issuer call deemed probable of exercise prior to
the expected recovery of its amortized cost basis (for AFS and HTM), the full
impairment is recognized in earnings.