Citigroup Inc.

22. SECURITIZATIONS AND VARIABLE INTERESTENTITIESOverviewCitigroup and its subsidiaries are involved with several types of off-balancesheetarrangements, including special purpose entities (SPEs). See Note 1to the Consolidated Financial Statements for a discussion of changes to theaccounting for transfers and servicing of financial assets and consolidationof variable interest entities (VIEs), including the elimination of qualifyingSPEs (QSPEs).Uses of SPEsAn SPE is an entity designed to fulfill a specific limited need of the companythat organized it. The principal uses of SPEs are to obtain liquidity andfavorable capital treatment by securitizing certain of Citigroup’s financialassets, to assist clients in securitizing their financial assets, and to createinvestment products for clients. SPEs may be organized in many legalforms including trusts, partnerships or corporations. In a securitization, thecompany transferring assets to an SPE converts all (or a portion) of thoseassets into cash before they would have been realized in the normal courseof business, through the SPE’s issuance of debt and equity instruments,certificates, commercial paper and other notes of indebtedness, which arerecorded on the balance sheet of the SPE and not reflected in the transferringcompany’s balance sheet, assuming applicable accounting requirementsare satisfied. Investors usually have recourse to the assets in the SPE andoften benefit from other credit enhancements, such as a collateral accountor over-collateralization in the form of excess assets in the SPE, a line ofcredit, or from a liquidity facility, such as a liquidity put option or assetpurchase agreement. The SPE can typically obtain a more favorable creditrating from rating agencies than the transferor could obtain for its own debtissuances, resulting in less expensive financing costs than unsecured debt.The SPE may also enter into derivative contracts in order to convert the yieldor currency of the underlying assets to match the needs of the SPE investorsor to limit or change the credit risk of the SPE. Citigroup may be the providerof certain credit enhancements as well as the counterparty to any relatedderivative contracts. Since QSPEs were eliminated, most of Citigroup’s SPEsare now VIEs.Variable Interest EntitiesVIEs are entities that have either a total equity investment that is insufficient topermit the entity to finance its activities without additional subordinated financialsupport, or whose equity investors lack the characteristics of a controllingfinancial interest (i.e., ability to make significant decisions through voting rights,and right to receive the expected residual returns of the entity or obligation toabsorb the expected losses of the entity). Investors that finance the VIE throughdebt or equity interests or other counterparties that provide other forms of support,such as guarantees, subordinated fee arrangements, or certain types of derivativecontracts, are variable interest holders in the entity. Since January 1, 2010, thevariable interest holder, if any, that has a controlling financial interest in a VIEis deemed to be the primary beneficiary and must consolidate the VIE. Citigroupwould be deemed to have a controlling financial interest and be the primarybeneficiary if it has both of the following characteristics:• power to direct activities of a VIE that most significantly impact theentity’s economic performance; and• obligation to absorb losses of the entity that could potentially besignificant to the VIE or right to receive benefits from the entity that couldpotentially be significant to the VIE.The Company must evaluate its involvement in each VIE and understandthe purpose and design of the entity, the role the Company had in the entity’sdesign, and its involvement in its ongoing activities. The Company thenmust evaluate which activities most significantly impact the economicperformance of the VIE and who has the power to direct such activities.For those VIEs where the Company determines that it has the powerto direct the activities that most significantly impact the VIE’s economicperformance, the Company then must evaluate its economic interests, if any,and determine whether it could absorb losses or receive benefits that couldpotentially be significant to the VIE. When evaluating whether the Companyhas an obligation to absorb losses that could potentially be significant, itconsiders the maximum exposure to such loss without consideration ofprobability. Such obligations could be in various forms, including but notlimited to, debt and equity investments, guarantees, liquidity agreements,and certain derivative contracts.Prior to January 1, 2010, the variable interest holder, if any, that wouldabsorb a majority of the entity’s expected losses, receive a majority of theentity’s residual returns, or both, was deemed to be the primary beneficiary andconsolidated the VIE. Consolidation of the VIE was determined based primarilyon the variability generated in scenarios that are considered most likely tooccur, rather than on scenarios that are considered more remote. In manycases, a detailed quantitative analysis was required to make this determination.In various other transactions, the Company may act as a derivativecounterparty (for example, interest rate swap, cross-currency swap, orpurchaser of credit protection under a credit default swap or total returnswap where the Company pays the total return on certain assets to the SPE);may act as underwriter or placement agent; may provide administrative,trustee, or other services; or may make a market in debt securities orother instruments issued by VIEs. The Company generally considers suchinvolvement, by itself, not to be variable interests and thus not an indicator ofpower or potentially significant benefits or losses.231