Citigroup Inc.

Transfers of Financial AssetsFor a transfer of financial assets to be considered a sale: the assets must havebeen isolated from the Company, even in bankruptcy or other receivership;the purchaser must have the right to sell the assets transferred or, if thepurchaser is an entity whose sole purpose is to engage in securitizationand asset-backed financing activities and that entity is constrained frompledging the assets it receives, each beneficial interest holder must have theright to sell the beneficial interests (prior to January 1 2010, the entity hadto be a QSPE); and the Company may not have an option or any obligationto reacquire the assets. If these sale requirements are met, the assets areremoved from the Company’s Consolidated Balance Sheet. If the conditionsfor sale are not met, the transfer is considered to be a secured borrowing, theassets remain on the Consolidated Balance Sheet, and the sale proceeds arerecognized as the Company’s liability. A legal opinion on a sale is generallyobtained for complex transactions or where the Company has continuinginvolvement with assets transferred or with the securitization entity. For atransfer to be eligible for sale accounting, those opinions must state thatthe asset transfer is considered a sale and that the assets transferred wouldnot be consolidated with the Company’s other assets in the event of theCompany’s insolvency.For a transfer of a portion of a financial asset to be considered a sale,the portion transferred must meet the definition of a participating interest.A participating interest must represent a pro rata ownership in an entirefinancial asset; all cash flows must be divided proportionally, with the samepriority of payment; no participating interest in the transferred asset maybe subordinated to the interest of another participating interest holder; andno party may have the right to pledge or exchange the entire financial assetunless all participating interest holders agree. Otherwise, the transfer isaccounted for as a secured borrowing.See Note 22 to the Consolidated Financial Statements for furtherdiscussion.Risk Management Activities—Derivatives Used forHedging PurposesThe Company manages its exposures to market rate movements outside itstrading activities by modifying the asset and liability mix, either directlyor through the use of derivative financial products, including interestrateswaps, futures, forwards, and purchased-option positions, as well asforeign-exchange contracts. These end-user derivatives are carried at fairvalue in Other assets, Other liabilities, Trading account assets and Tradingaccount liabilities.To qualify as a hedge under the hedge accounting rules, a derivativemust be highly effective in offsetting the risk designated as being hedged.The hedge relationship must be formally documented at inception, detailingthe particular risk management objective and strategy for the hedge, whichincludes the item and risk that is being hedged and the derivative that isbeing used, as well as how effectiveness will be assessed and ineffectivenessmeasured. The effectiveness of these hedging relationships is evaluated ona retrospective and prospective basis, typically using quantitative measuresof correlation with hedge ineffectiveness measured and recorded in currentearnings. If a hedge relationship is found to be ineffective, it no longerqualifies as a hedge and hedge accounting would not be applied. Any gainsor losses attributable to the derivatives, as well as subsequent changes in fairvalue, are recognized in Other revenue or Principal transactions with nooffset on the hedged item, similar to trading derivatives.The foregoing criteria are applied on a decentralized basis, consistent withthe level at which market risk is managed, but are subject to various limitsand controls. The underlying asset, liability or forecasted transaction may bean individual item or a portfolio of similar items.For fair value hedges, in which derivatives hedge the fair value of assetsor liabilities, changes in the fair value of derivatives are reflected in Otherrevenue or Principal transactions, together with changes in the fairvalue of the hedged item related to the hedged risk. These are expected to,and generally do, offset each other. Any net amount, representing hedgeineffectiveness, is reflected in current earnings. Citigroup’s fair valuehedges are primarily hedges of fixed-rate long-term debt and available-forsalesecurities.For cash flow hedges, in which derivatives hedge the variability of cashflows related to floating- and fixed-rate assets, liabilities or forecastedtransactions, the accounting treatment depends on the effectiveness ofthe hedge. To the extent these derivatives are effective in offsetting thevariability of the hedged cash flows, the effective portion of the changesin the derivatives’ fair values will not be included in current earnings, butis reported in Accumulated other comprehensive income (loss). Thesechanges in fair value will be included in earnings of future periods whenthe hedged cash flows impact earnings. To the extent these derivatives arenot effective, changes in their fair values are immediately included in Otherrevenue. Citigroup’s cash flow hedges primarily include hedges of floatingratedebt, as well as rollovers of short-term fixed-rate liabilities and floatingrateliabilities and forecasted debt issuances.For net investment hedges in which derivatives hedge the foreigncurrency exposure of a net investment in a foreign operation, the accountingtreatment will similarly depend on the effectiveness of the hedge. The effectiveportion of the change in fair value of the derivative, including any forwardpremium or discount, is reflected in Accumulated other comprehensiveincome (loss) as part of the foreign currency translation adjustment.End-user derivatives that are economic hedges, rather than qualifyingfor hedge accounting, are also carried at fair value, with changes in valueincluded in Principal transactions or Other revenue. Citigroup oftenuses economic hedges when qualifying for hedge accounting would be toocomplex or operationally burdensome; examples are hedges of the creditrisk component of commercial loans and loan commitments. Citigroupperiodically evaluates its hedging strategies in other areas and may designateeither a qualifying hedge or an economic hedge, after considering therelative cost and benefits. Economic hedges are also employed when thehedged item itself is marked to market through current earnings, such ashedges of commitments to originate one-to-four-family mortgage loans to beheld-for-sale and mortgage servicing rights (MSRs).For those hedge relationships that are terminated or when hedgedesignations are removed, the hedge accounting treatment described in theparagraphs above is no longer applied. Instead, the end-user derivative isterminated or transferred to the trading account. For fair value hedges, anychanges in the fair value of the hedged item remain as part of the basis of theasset or liability and are ultimately reflected as an element of the yield. Forcash flow hedges, any changes in fair value of the end-user derivative remain167