This excerpt taken from the C 10-Q filed May 4, 2007.
Impact to retained earnings for certain fair value elections
Effective January 1, 2007, the Company early adopted SFAS 159 for certain eligible financial instruments. Detailed below are the December 31, 2006 carrying values prior to adoption, the transition adjustments booked to opening retained earnings and the fair values (that is, the carrying values at January 1, 2007 after adoption) for those items that were selected for fair value option accounting and that had an impact on retained earnings:
Additional information regarding each of these items follows.
Legg Mason convertible preferred equity securities
The Legg Mason convertible preferred equity securities (Legg shares) were acquired in connection with the sale of Citigroup's Asset Management business in December 2005. We hold these shares as a non-strategic investment for long-term appreciation and, therefore, selected fair value option accounting in anticipation of the January 2008 implementation of the proposed Investment Company Audit Guide Statement of Position, "Clarification of the Scope of Audit and Accounting Guide Audits of Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investment Companies" (SOP).
Under the current investment company accounting model, investments held in investment company vehicles are recorded at full fair value and are not subject to consolidation guidelines. Under the proposed SOP, non-strategic investments not held in investment companies, which are deemed similar to non-strategic investments held in Citigroup's investment companies, must be accounted for at full fair value in order for Citigroup to retain investment company accounting in the Company's Consolidated Financial Statements. If investment company accounting requirements cannot be met (for example, if we failed to account for similar non-strategic investments at fair value with changes in value recorded in earnings), Citigroup would be required to account for each investment in the investment company under other relevant accounting standards, including consolidation of majority-owned or controlled investees. We believe that Citigroup's consolidation of non-strategic investments would not provide meaningful information and would confuse readers of our financial statements. Therefore, we have utilized the fair value option to migrate the Legg shares from available-for-sale (where changes in fair value are recorded in Accumulated other comprehensive income (loss)) to a full fair value model (where changes in value are recorded in earnings). On a prospective basis, as we acquire non-strategic public or private equity investments, we will consider electing fair value accounting for investments that are similar to those held in our investment companies.
Prior to the election of fair value option accounting, these shares were classified as available-for-sale securities with the unrealized loss of $232 million as of December 31, 2006 included in Accumulated other comprehensive income (loss). In connection with the Company's adoption of SFAS 159, this unrealized loss was recorded as a reduction of January 1, 2007 retained earnings as part of the cumulative-effect adjustment. We have no intention of selling the Legg shares prior to our previously estimated recovery period. The Legg shares are now included in Trading account assets on Citigroup's Consolidated Balance Sheet. The decrease in market value for the 2007 first quarter of $7 million pretax was reported with Principal transactions in the Company's Consolidated Statement of Income. Dividends are included in Interest revenue.
Selected portfolios of securities purchased under agreements to resell, securities sold under agreements to repurchase, and certain non-collateralized short-term borrowings
The Company has elected the fair value option for our United States and United Kingdom portfolios of fixed income securities purchased under agreements to resell, and fixed income securities sold under agreements to repurchase (and related non-collateralized short-term borrowings) because these positions are managed on a fair value basis. Specifically, related interest rate risk is managed on a portfolio basis, primarily with derivative instruments that are accounted for at fair value through earnings. Previously, these positions were accounted for on the accrual basis.
The cumulative effect of $58 million pretax ($37 million after-tax) from adopting the fair value option was recorded as an increase in the January 1, 2007 retained earnings balance. $25 million pretax of that cumulative effect related to
securities purchased under agreements to resell, while $40 million pretax related to securities sold under agreements to repurchase, offset by a reduction of $7 million pretax for non-collateralized short-term borrowings. The change in fair value for the first quarter of 2007, a $111 million pretax gain, was recorded in Principal transactions on the Company's Consolidated Statement of Income, $137 million gain related to securities purchased under agreement to resell, offset by a $23 million loss for securities sold under an agreement to repurchase, and a $3 million loss for related non-collateralized short-term borrowings.
The related interest income and interest expense are measured based on the contractual rates specified in the transactions and are reported as interest revenue and expense in the Consolidated Statement of Income.
The March 31, 2007 gross balance of $159 billion for securities purchased under agreements to resell and $262 billion for securities sold under agreements to repurchase are included in their respective accounts in the Consolidated Balance Sheet. Furthermore, uncollateralized short-term borrowings of $4 billion are recorded in that account in the Consolidated Balance Sheet.
Selected letters of credit and revolving loans hedged by credit default swaps or participation notes
The Company has elected fair value option accounting for certain letters of credit that are hedged with derivative instruments or participation notes. Upon electing the fair value option, the related portions of the allowance for loan losses and the allowance for unfunded lending commitments were reversed. Citigroup elected the fair value option for these transactions because the risk is managed on a fair value basis, and to mitigate accounting mismatches
The cumulative effect of $14 million pretax ($9 million after-tax) from adopting fair value option accounting was recorded as an increase in the January 1, 2007 retained earnings balance. The 2007 first quarter change in fair value for these items was a pretax gain of $1.7 million. This change in fair value as well as the receipt of related fees was reported as Principal transactions in the Company's Consolidated Statement of Income
The notional amount of these unfunded letters of credit was $1.9 billion as of March 31, 2007. The amount funded was insignificant and, accordingly, no amounts were 90 days past due or on non-accrual status at March 31, 2007.
These items have been classified in Trading account assets or Trading account liabilities on the Consolidated Balance Sheet.
Various miscellaneous eligible items
Several miscellaneous eligible items currently classified as available-for-sale securities were selected for fair value option accounting. These items were selected in preparation for the adoption of the Investment Company Audit Guide SOP, as discussed above.