7.3 billion - Citigroup

Sensitivity to Unobservable Inputs and Interrelationshipsbetween Unobservable InputsThe impact of key unobservable inputs on the Level 3 fairvalue measurements may not be independent of one another.For certain instruments, the pricing, hedging, and riskmanagement is sensitive to the correlation between variousinputs rather than on the analysis and aggregation of theindividual inputs.The following section describes the sensitivities andinterrelationships of the most significant unobservable inputsused by the Company in Level 3 fair value measurements.CorrelationFor these instruments, price risk is nonseparable, i.e. a changein one input will affect the sensitivity of valuation to anotherinput. A variety of correlation-related assumptions arerequired for a wide range of instruments including, equitybaskets, foreign-exchange options, CDOs backed by loans,mortgages, subprime mortgages, credit default swaps andmany other instruments. Estimating correlation can beespecially difficult where it may vary over time. Extractingcorrelation information from market data requires significantassumptions regarding the informational efficiency of themarket (for example, swaption markets). Changes incorrelation levels can have a major impact, favorable orunfavorable, on the value of an instrument.VolatilityRepresents the speed and severity of market price changes andis a key factor in pricing derivatives. Typically, instrumentscan become more expensive if volatility increases. Forexample, as an index becomes more volatile, the cost to Citi ofmaintaining a given level of exposure increases because morefrequent rebalancing of the portfolio is required. Volatilitygenerally depends on the tenor of the underlying instrumentand the strike price or level defined in the contract. Volatilitiesfor certain combinations of tenor and strike are not observable.Some instruments benefit from an increase in volatility, othersbenefit from a decrease. The general relationship betweenchanges in the value of a portfolio to changes in volatility alsodepends on changes in interest rates and the level of theunderlying index.PrepaymentPrepayment is generally negatively correlated withdelinquency and interest rate. A combination of lowprepayment and high delinquencies amplify each input‘snegative impact on mortgage securities‘ valuation. Asprepayment speeds change, the weighted average life of thesecurity changes, which impacts the valuation either positivelyor negatively, depending upon the nature of the security andthe direction of the change.RecoveryFor many credit securities, there is no directly observablemarket input for recovery, but indications of recovery levelsare available from pricing services. The assumed recoveries ofa security may differ from its true recoveries that will beobservable in the future. An increase in the recovery ratetypically results in an increased market value from theperspective of a protection seller. Recovery rate impacts thevaluation of credit securities, including mortgage securities.Generally, an increase in the recovery rate assumptionincreases the fair value of the security. An increase in lossseverity, the inverse of the recovery rate, reduces the amountof principal available for distribution and as a result, decreasesthe fair value from the perspective of a protection seller.Credit SpreadChanges in credit spread affect the fair value of securitiesdifferently depending on the characteristics and maturityprofile of the security. Credit spread reflects the marketperception of changes in prepayment, delinquency, andrecovery rates, therefore capturing the impact of othervariables on the fair value.YieldSometimes, a yield of a similar instrument is available in themarket. However, this yield may need to be adjusted tocapture the characteristics of the security being valued. Whenthe amount of the adjustment is significant to the value of thesecurity, the fair value measurement is classified as Level 3.Adjusted yield is generally used to discount the projectedfuture principal and interest cash flows. Adjusted yield isimpacted by changes in the interest rate environment andrelevant credit spreads.In other situations, the yield of a similar security may notrepresent sufficient market liquidity, and therefore, the fairvalue measurement is classified as Level 3.173CITIGROUP – 2012 FIRST QUARTER 10-Q