Amandeep HundalAndrie LesmanaJoshua PeligalPatrick Tong

Citigroup & Derivatives

The Citi Story

1. Key Stats and Businesses2. Financial Crisis

1. TARP and LSA2. Derivatives

3. Key Statements4. Capital Requirements5. Derivatives Overview

Key Stats for 5 Years

Troubled Asset Relief Program (TARP) and Loss Sharing Agreement (LSA)• Oct/Dec 2008: raised $25 billion, and $20 billion through sales or pref.

stock and warrants to the US Treasury

• Jan 2009: issued $7.1 billion of pref. Stock to the US Treasury and FDIC; issued warrants to the US Treasury

• July 2009: exchanges $25b pref. for $7.7b of common

• July 2009: exchanges $20b pref. And $7.1b pref. for trust preferred securities

• Citigroup has paid $2.2 billion in dividends to the US gov’t on the preferred stock held

• Citigroup has paid $800 million in interest on the trust preferred securities

Exit from TARP and LSA• Dec 2009: repaid $20 billion of the trust preferred

securities, exiting the LSA (also, $1.8b of the $7.1b were cancelled)

• Dec 2009: repaid TARP funds by raising money through common stock issuances, tangible equity units (T-DECs)

• Outstanding Issues– US Treasury holds 27% of common shares (7.7b)

• US Treasury intends to sell in 2010 after Mar 16– US Treasury holds $5.3 billion of trust preferred securities– 3 warrants on Citigroup stock issued to the US Treasury as part

of TARP and loss-sharing are still outstanding

TARP and Derivatives

US Treasury US Treasury US Treasury (LSA)

Issued October 2008 December 2008 January 2009

Term 10 years 10 years 10 years

Exercise Price $17.85 $10.61 $10.61

Amount (Shares) 210,100,000 188,500,000 66,500,000

Valuation (B&S) $4.03 $4.07 $4.07

Total $846,703,000 $767,195,000 $270,655,000

Probability (ITM%) 0.5% 0.7% 0.6%*Based on closing price of $4.18 on March 29th, 2010 using Black and Scholes to

estimate value of warrants

CitiGroup Income Statement

CitiGroup Income Statement II

Securities and Banking (p28)

Special Asset Pool (p36)

Items Impacting SAP Revenue (p37)

• The 1.283 million net gain in derivatives positions held in SAP during 2009 was due to the narrowing of spreads of Citi’s counterparties on its derivatives assets

Trading Account Assets and Liabilities

Cash Flow Statement

Cash Flow Statement Con’t

Historic Capital & Requirements

Current Capital & Requirements

Capital (millions USD)

Derivatives: Obligor Credit Rating

Derivatives: Obligor Industry

Derivatives: Credit Valuation

• in the fourth quarter of 2008, Citigroup’s credit spreads generally narrowed and counterparty credit spreads widened, each of which negatively affected revenues in 2008.

• During 2009, both Citigroup’s and counterparty credit spreads narrowed.

Credit Derivative Portfolio

Principal Transactions

Hedging• Hedging: Citigroup uses derivatives in connection with its risk

management activities to hedge certain risks or reposition the risk profile of the Company. For example, Citigroup may issue fixed-rate long-term debt and then enter into a receive-fixed, pay-variable-rate interest rate swap with the same tenor and notional amount to convert the interest payments to a net variable-rate basis. This strategy is the most common form of an interest rate hedge, as it minimizes interest cost in certain yield curve environments. Derivatives are also used to manage risks inherent in specific groups of on-balance-sheet assets and liabilities, including investments, corporate and consumer loans, deposit liabilities, as well as other interest-sensitive assets and liabilities. In addition, foreign-exchange contracts are used to hedge non-U.S.-dollar-denominated debt, foreign currency-denominated available-for-sale securities, net capital exposures and foreign-exchange transactions.

Hedging• The Company manages its exposures to market rate

movements outside its trading activities by modifying the asset and liability mix, either directly or through the use of derivative financial products, including interest-rate swaps, futures, forwards, and purchased-option positions, as well as foreign exchange contracts.

• The hedge relationship must be formally documented at inception, detailing the particular risk management objective and strategy for the hedge, which includes the item and risk that is being hedged and the derivative that is being used, as well as how effectiveness will be assessed and ineffectiveness measured.

Hedging• The Company issues both fixed and variable rate debt in a

range of currencies. It uses derivative contracts, primarily interest rate swaps, to effectively convert a portion of its fixed rate debt to variable rate debt and variable rate debt to fixed rate debt. The maturity structure of the derivatives generally corresponds to the maturity structure of the debt being hedged. In addition, the Company uses other derivative contracts to manage the foreign exchange impact of certain debt issuances.

• At December 31, 2009, the Company’s overall weighted average interest rate for long-term debt was 3.51% on a contractual basis and 3.91% including the effects of derivative contracts.

Citi, Risk, and Derivatives

1. Risk Management Policy and Team2. Price Risk3. Value at Risk (VAR)4. Foreign Exchange Risk5. Interest Rate Risk

Risk Management

Risk Management• Chief Risk Officer:

– Establishing core standards for management, measurement and reporting of risk

– Identify, assessing, communicating and monitoring risk on company-wide basis

– Engaging with senior management and on a frequent basis on material matters with respect to risk-taking activities in businesses and related risk management processes

– Ensuring that risk function has adequate independence, authority, expertise, staffing, technology and resources

Risk Management• Business Chief Risk Officer: focal point for risk decisions

in company’s major business groups

• Regional Chief Risk Officers: Accountable for risks in their geographic areas

• Product Chief Risk Officers: Accountable for risks within their speciality (real estate, structured products, etc)

Risk Management• Product Chief Risk Officers:

– Accountable for risks within their specialty

– Focus on problem areas across businesses and regions

– Serve as a resource to Chief Risk Officer, Business and Regional Chief Risk officers

Business Management Team– Risk capital group: Enhance risk capital model, ensure it is

consistent across all business activities

– Risk architecture group: Ensures company has integrated systems and common metrics, thereby allows Citi to aggregate and stress-test exposures across the institution

– Infrastructure risk group: Focuses on improving operational processes across businesses and regions

Price Risk• Price risk is the earnings risk from changes in

interest rates, foreign exchange rates, and equity and commodity prices, and in their implied volatilities

• Price risk arises in non-trading portfolios, as well as in trading portfolios

• Focus on interest rate risk and foreign exchange risk

Trading RevenueTotal revenues of the trading business consist of:• customer revenue, which includes spreads from customer flow and positions taken to facilitate customer orders;• proprietary trading activities in both cash and derivative transactions; and• net interest revenue.

Price Risk Measurement• Price risk in trading portfolios are measured by

the following series of measures:– Factor sensitivities– Value at Risk (VAR)– Stress testing

Price Risk Measurement• Factor sensitivities are expressed as the change in the value

of a position for a defined change in a market risk factor, such as a change in the value of a Treasury bill for a one-basis-point change in interest rates.

• Stress testing is regularly performed on trading portfolios on a regular basis to estimate the impact of extreme market movements.

• VAR estimates the potential decline in the value of a position or a portfolio under normal market conditions. The VAR method incorporates the factor sensitivities of the trading portfolio with the volatilities and correlations of those factors and is expressed as the risk to Citigroup over a one-day holding period, at a 99% confidence level.

Value at Risk

Summary of Citigroup’s VAR in trading portfolios as of Dec 31, 2009 and 2008

VAR

VAR2009 Spread 2008 Spread Change % Change

Interest Rate 135 112 23 20.54%

Foreign Exchange 122 107 15 14.02%

Equity 121 177 (56) (31.64%)

Commodity 38 48 (10) (20.83%)

Interest Rate Risk• Citigroup measure risk to Net Interest Revenue (NIR) by Interest Rate

Exposure (IRE)• IRE measures the change in expected NIR in each currency resulting from

unanticipated changes in forward interest rates

• Mitigation and Hedging of Risk• Citigroup may modify pricing on new customer loans and deposits, enter

into transactions with other institutions or enter into off-balance-sheet derivative transactions that have the opposite risk exposures

• Regularly assesses the viability of strategies to reduce unacceptable risks to earnings and implements such strategies when it believes those actions are prudent

• Do stress testing- of the impact of non-linear interest rate movements on the value of the balance sheet- analysis of portfolio duration and volatility, particularly as they relate to mortgage loans and MBS

Interest Rate Risk

Interest Rate Risk

Interest Rate Risk

Interest Rate Risk

Interest Rate Risk

Non-Trading Portfolios• The exposures in the following table represent the annualized risk to NIR assuming unanticipated parallel instantaneous 100bps change as well as a gradual (25 bps per quarter) parallel change in rates compared with the market forward interest rates in the selected currencies

Interest Rate Risk

• The following table shows the risk to NIR from six different changes in the implied forward rates

• Each scenario assumes that the rate change will occur on a gradual basis every three months over the course of the year

Interest Rate Risk

Derivatives

Derivatives

Derivatives

Derivatives

• Other Income in F/S related to derivatives but not designated in a qualified hedging relationship and not recorded in Trading Account assets or Trading Account liabilities are shown below:

Derivatives

Country and Cross-Border RiskCountry Risk• Is the risk than an event in a foreign country will impair the value of

Citigroup assets or will affect the ability of obligors in that country to honour their obligations

• May include sovereign defaults, banking and currency crises, social instability, and changes in government policies, credit risk, market risk, operational risk, and cross-border risk

• Risk management processes- rating models, scenario planning, and stress testing

Cross-Border Risk• Is the risk that actions taken by a non-U.S. Government may prevent the

conversion of local currency into non-local currency and/or the transfer of funds outside the country

• Impacts the ability of Citigroup and its customers to transact business across borders

Country and Cross-Border Risk

Credit Risk

1. Loan Mix2. Exposures3. Derivatives4. Securitization

Credit Risk• Credit risk: Losses result from borrower’s or

counterparty’s inability to meet its obligation• Citi’s business activities that could arise credit risk:

– Lending– Sales and trading– Derivatives– Securities transactions– Settlement– Act as an intermediary

Loan Mix

Loan Mix

Loan Amount

Allowance for Loan Losses

Allowance for Loan Losses

Non-Accrual Assets• Non-Accrual Loans:– Borrower fallen behind in interest payments

– Citi determined payment of interest or principal is doubtful

Non-Accrual Assets

Non-Accrual Assets

U.S. Consumer Lending• Mortgage Lending

– 1st lien mortgage: $118 billion– 2nd lien mortgage: $54 billion

• North America Cards– Citi-branded cards: $83 billion– Retail partner cards $58 billion

Consumer Mortgage• Credit risks and liquidity risk

– Sells most of mortgage loans it originates, retains servicing rights• Mortgage servicing rights (MSR) (intangible assets)

– Still affected by changes in interest rate

• Interest rate risks– Hedge MSR with:

• Interest rate derivative contracts• Forward purchase commitments• Primarily mortgage-backed securities

– Non-perfect hedge basis risk• Reviewing mix of hedging instruments daily

North America Card• Eliminate riskier accounts and sales to mitigate losses:

– Removed higher-risk customers from portfolio:• Reducing available line of credit• Closing accounts

– Improve tools used to identify and manage exposure in each of portfolios by targeting unique customer attributes

• Open accounts down 11%

Credit Derivatives• Makes markets in and trades credit derivatives

– On behalf of clients– Own account

• Uses credit derivatives to mitigate credit risk• Require seller make payments to buyer upon occurrence

of predefined events (settlement triggers)

Credit Derivatives• Settlement triggers

– Market standard of failure to pay on indebtedness

– Bankruptcy of reference credit

– Debt restructuring

Credit Derivatives

Credit Derivatives

Credit Derivative• Citi actively participates in trading variety of credit

derivatives as – Two-way market-maker for clients– To manage credit risk

• Majority was transacted with other financial intermediaries:– Banks– Broker-dealers

• Generally mismatch between total notional amounts of protection purchased and sold

Credit Derivative• Open risk exposures from credit derivative are matched

after– Certain cash positions in reference assets are considered– Notional amounts are adjusted to a

• Duration-based equivalent basis or• Reflect the level of subordination in tranched structures

• Citi actively monitors its counterparty credit risk in credit derivative contracts

Securitizations• Securitizes different asset classes to:

– Strengthen balance sheet– Obtain more favorable credit rating– Accessing competitive financing rates in market

• Assets transferred into a trust and used as collateral by trust to obtain financing

• Cash flows from assets in trust service the corresponding trust securities

Securitizations• Structure of trust meets accounting guidelines?

– Yes: no longer reflected as assets– No: Assets continue recorded as assets, financing activity as

liabilities

• Special Purpose Entities (SPEs):– Entity designed to fulfill specific limited need of company that

organized it– Organized as trusts, partnerships or corporations

Securitizations• SPEs used to:

– Obtain liquidity and favorable capital treatment by securitizing certain Citi’s assets

– Assist clients in securitizing their assets– Create investment products for clients

– Entity designed to fulfill specific limited need of company that organized it

Securitizations• 2 types of SPEs:

1. Qualifying SPEs (QSPEs):• Significant limitations on:– Types of assets or derivatives instruments may own or enter into– Types and extent of activities and decision-making may engage in

• Passive entities designed to– Purchase assets– Pass through cash flows from those assets to investors in QSPE

• Generally exempt from consolidation

Securitizations• 2 types of SPEs:

2. Variable Interest Entities (VIEs):• Entities that have either:– Total equity investment that is insufficient to permit entity to finance its

activities without additional subordinated financial support– Equity investors lack characteristics of controlling financial interest

• Consolidation of VIE based on variability generated in scenarios that are considered most likely to occur

Securitizations

Securitizations (Credit Card)• Securitizes credit card through trusts

• Sells receivables into QSPE trusts on non-resource basis

• After securitization, continues to– Maintain customer account relationships– Provides servicing for receivables transferred to trusts

Securitizations (Credit Card)

Securitizations (Mortgage)• Retains service rights which entitles Citi to:

– Future stream of cash flows based on outstanding principal balances of loans

– Contractual servicing fees

• Primarily non-resources, effectively transfer risk of future credit losses to purchasers

Securitizations (Mortgage)

Loss Mitigation Efforts• Tighten credit standards:

– Stricter underwriting standards for new accounts– Decreasing higher-risk credit lines– Closing high-risk accounts– Re-pricing

• Improvements in collections effectiveness

• Various forbearance programs

Consumer Loan Modification • Assist borrowers with financial difficulties

• Programs include:– Modifying original loan terms

• Credit card – below 10%– Reducing interest rates– Extending remaining loan duration– Waving portion of remaining principal balances

Compensation

1. Stock Options2. Executive Compensation3. Compensation Risks

Stock Options

Outstanding stock options:

Stock option activity:

Stock Options

Reload options can be granted to employees if they use previously owned shares to pay for the exercise price and surrender shares otherwise to be received. The reload option will cover the same number of shares used, but only if the market price on the exercise date is 20% greater than option exercise price.

Reload options are intended to encourage employees to exercise options at an earlier date and to retain the shares acquired, which results in employees generally exercising options as soon as they are able and, therefore, these options have shorter expected lives (thereby resulting in lower valuations).

Executive Compensation

Citi created the executive compensation program to attract and retain the best talent, motivate and reward executives to perform by linking incentive compensation to demonstrable performance-based criteria, align the long-term interests of management with those of stockholders and other stakeholders, and deliver compensation at levels that are competitive within the financial services market.

The compensation programs are designed to:•Facilitate competitiveness•Reward performance over an appropriate period•Promote meritocracy by recognizing employee contributions•Enhance Citi franchise value•Discourage unnecessary or excessive risk-taking

Executive Compensation

Executive Compensation

Executive Compensation

Executive Compensation

Risks Associated with Compensation Programs

Risks Compensation element affected

Mitigation method

Unsustainable level of expenses

Base salary, health and insurance benefits, pension and retirement, severance plans, perks

Management focus on expense controls, limits on eligibility of benefit programs

Retention issues if compensation not at market level

Base salary, health and insurance benefits

HR market surveys

Imprudent risk-taking for short-term gains (resulting from inadequate monitoring and failure of standard risk controls)

Discretionary & fixed incentive and performance compensation programs (such as equity and cash-deferred awards)

Senior management and HR scrutiny of awards; limit framework, independent risk management, clawback provisions; review structure of incentive awards

Risks Associated with Compensation Programs

Risks Compensation element affected

Mitigation method

Legal and compliance risks Pension and retirement benefits

Hire external advisors for counsel

Payout for termination = rewarding poor performance

Severance plans Limits on ‘golden parachute’ clause

Reputational risks Perquisites Limits on perks and luxury expenditure policies