This excerpt taken from the C 10-Q filed Nov 5, 2007.
Highly-Leveraged Financing Commitments
Included in the line item "Commercial and other consumer loan commitments" in the table above are highly-leveraged financing commitments which are agreements that provide funding to a borrower with higher levels of debt (measured by the ratio of debt capital to equity capital of the borrower) than is generally considered normal for other companies. Highly-leveraged financing is commonly employed in corporate acquisitions, management buy-outs and similar transactions.
As a result, debt service (that is, principal and interest payments) absorbs a significant portion of the cash flows generated by the borrower's business. Consequently, the risk that the borrower may not be able to service its debt obligations is greater. However, to compensate for this risk, the interest rate and fees charged for this type of financing is generally higher.
Citigroup manages the risk associated with highly-leveraged financings it has entered into by selling a majority of its exposures to the market prior to or shortly after funding. In certain cases, all or a portion of a highly-leveraged financing to be retained is hedged with credit derivatives or other hedging instruments. Thus, when a highly-leveraged financing is funded, Citigroup records the resulting loan as follows:
Prior to funding, highly-leveraged financing commitments are assessed for impairment in accordance with SFAS 5 and losses are recorded when they are probable and reasonably estimable. For the portion of loan commitments that relate to loans that will be held-for-investment, loss estimates are made based on the borrower's ability to repay the facility according to its contractual terms. For the portion of loan commitments that relate to loans that will be held-for-sale, loss estimates are made in reference to current conditions in the resale market (both interest rate risk and credit risk are considered in the estimate). Loan origination, commitment, underwriting, other fees have been netted against the impairment losses.
Due to the dislocation of the credit markets during the quarter, liquidity in the market for highly-leveraged financings has declined significantly. Consequently, Citigroup has been unable to sell a number of highly-leveraged financings that it entered into during the quarter, resulting in total exposure of $57 billion as of September 30, 2007 ($19 billion for funded and $38 billion for unfunded commitments). The reduction in liquidity has resulted in Citigroup's recognizing total losses on such products during the quarter of $1.4 billion pre-tax of which $552 million is on funded highly-leveraged loans and $800 million on unfunded highly-leveraged financing commitments.