Citigroup Inc.

Mortgage Servicing RightsIn connection with the securitization of mortgage loans, the Company’sU.S. Consumer mortgage business retains the servicing rights, which entitlethe Company to a future stream of cash flows based on the outstandingprincipal balances of the loans and the contractual servicing fee. Failure toservice the loans in accordance with contractual requirements may lead to atermination of the servicing rights and the loss of future servicing fees.The fair value of capitalized mortgage servicing rights (MSRs) was$4.6 billion and $6.5 billion at December 31, 2010 and 2009, respectively.The MSRs correspond to principal loan balances of $455 billion and$555 billion as of December 31, 2010 and 2009, respectively. The followingtable summarizes the changes in capitalized MSRs for the years endedDecember 31, 2010 and 2009:In millions of dollars 2010 2009Balance, beginning of year $ 6,530 $ 5,657Originations 658 1,035Changes in fair value of MSRs due to changesin inputs and assumptions (1,067) 1,546Other changes (1) (1,567) (1,708)Balance, end of year $ 4,554 $ 6,530(1) Represents changes due to customer payments and passage of time.The market for MSRs is not sufficiently liquid to provide participantswith quoted market prices. Therefore, the Company uses an option-adjustedspread valuation approach to determine the fair value of MSRs. Thisapproach consists of projecting servicing cash flows under multiple interestrate scenarios and discounting these cash flows using risk-adjusted discountrates. The key assumptions used in the valuation of MSRs include mortgageprepayment speeds and discount rates. The model assumptions and theMSRs’ fair value estimates are compared to observable trades of similar MSRportfolios and interest-only security portfolios, as available, as well as to MSRbroker valuations and industry surveys. The cash flow model and underlyingprepayment and interest rate models used to value these MSRs are subject tovalidation in accordance with the Company’s model validation policies.The fair value of the MSRs is primarily affected by changes inprepayments that result from shifts in mortgage interest rates. In managingthis risk, the Company economically hedges a significant portion of thevalue of its MSRs through the use of interest rate derivative contracts, forwardpurchase commitments of mortgage-backed securities and purchasedsecurities classified as trading.The Company receives fees during the course of servicing previouslysecuritized mortgages. The amounts of these fees for the years endedDecember 31, 2010, 2009 and 2008 were as follows:In millions of dollars 2010 2009 2008Servicing fees $1,356 $1,635 $2,121Late fees 87 93 123Ancillary fees 214 77 81Total MSR fees $1,657 $1,805 $2,325These fees are classified in the Consolidated Statement of Income asOther revenue.Re-securitizationsThe Company engages in re-securitization transactions in which debtsecurities are transferred to a VIE in exchange for new beneficial interests.During the year ended December 31, 2010, Citi transferred non-agency(private-label) securities with original loan proceeds of approximately$4,868 million to re-securitization entities. These securities are backed byeither residential or commercial mortgages and are often structured onbehalf of clients. For the year ended December 31, 2010, Citi recognizedlosses on the sale of securities to private-label re-securitization entities ofapproximately $119 million. As of December 31, 2010, the market valueof Citi-owned interests in re-securitization transactions structured by Cititotaled approximately $435 million and are recorded in trading assets. Of thisamount, approximately $104 million and $331 million relate to senior andsubordinated beneficial interests, respectively.The Company also re-securitizes U.S. government-agency guaranteedmortgage-backed (Agency) securities. For the year ended December 31,2010, Citi transferred agency securities with principal of approximately$28,295 million to re-securitization entities. As of December 31, 2010, themarket value of Citi-owned interests in agency re-securitization transactionsstructured by Citi totaled approximately $351 million and are recorded intrading assets.As of December 31, 2010, the Company did not consolidate any privatelabelor agency re-securitization entities.Citi-Administered Asset-Backed Commercial Paper ConduitsThe Company is active in the asset-backed commercial paper conduitbusiness as administrator of several multi-seller commercial paper conduits,and also as a service provider to single-seller and other commercial paperconduits sponsored by third parties.The multi-seller commercial paper conduits are designed to providethe Company’s clients access to low-cost funding in the commercial papermarkets. The conduits purchase assets from or provide financing facilities toclients and are funded by issuing commercial paper to third-party investors.The conduits generally do not purchase assets originated by the Company.The funding of the conduits is facilitated by the liquidity support and creditenhancements provided by the Company.243