Citigroup (C)

Interest Rate Risk Associated with Consumer Mortgage Lending Activity

Citigroup originates and funds mortgage loans. As with all other lending activity, this exposes Citigroup to several risks, including credit, liquidity and interest rate risks. To manage credit and liquidity risk, Citigroup sells most of the mortgage loans it originates, but retains the servicing rights. These sale transactions create an intangible asset referred to as mortgage servicing rights (MSRs). The fair value of this asset is primarily affected by changes in prepayments that result from shifts in mortgage interest rates. Thus, by retaining the servicing rights of sold mortgage loans, Citigroup is still exposed to interest rate risk.

In managing this risk, Citigroup hedges a significant portion of the value of its MSRs through the use of interest rate derivative contracts, forward purchase commitments of mortgage-backed securities, and purchased securities classified as trading (primarily mortgage-backed securities including principal-only strips).

Since the change in the value of these hedging instruments does not perfectly match the change in the value of the MSRs, Citigroup is still exposed to what is commonly referred to as “basis risk.” Citigroup manages this risk by reviewing the mix of the various hedging instruments referred to above on a daily basis.

Citigroup’s MSRs totaled $5.567 billion and $8.380 billion at December 31, 2008 and 2007, respectively. For additional information about the Company’s MSRs, see Note 19 to the Consolidated Financial Statements on page 165.

As part of the mortgage lending activity, Citigroup commonly enters into purchase commitments to fund residential mortgage loans at specific interest rates within a given period of time, generally up to 60 days after the rate has been set. If the resulting loans from these commitments will be classified as loans held-for-sale, Citigroup accounts for the commitments as derivatives under SFAS 133. Accordingly, changes in the fair value of these commitments, which are driven by changes in mortgage interest rates, are recognized in current earnings after taking into consideration the likelihood that the commitment will be funded. However, a value is not assigned to the MSRs until after the loans have been funded and sold.

Citigroup hedges its exposure to the change in the value of these commitments by utilizing hedging instruments similar to those referred to above.

The Company has risk-sharing agreements with various Mortgage Insurance (MI) companies through company-owned captive reinsurance entities. Under these arrangements, the Company shares in MI premium revenue and participates in losses above a predetermined level (floor), limited by a predetermined loss amount (ceiling), at which time additional losses revert back to the MI companies. The agreements currently support a total of $28.1 billion of loans with $7.1 billion of MI coverage, principally on loans sold to government agencies. During 2008, projections by the MI companies indicated that losses for some books of business were likely to exceed the floor and the Company recorded $67 million in reserves. Total maximum exposure under these captive reinsurance agreements is $1.3 billion.

Interest Rate Risk Associated with Consumer Mortgage Lending Activity

Citigroup originates and funds mortgage loans. As with all other lending activity, this exposes Citigroup to several risks, including credit, liquidity and interest rate risks. To manage credit and liquidity risk, Citigroup sells most of the mortgage loans it originates, but retains the servicing rights. These sale transactions create an intangible asset referred to as mortgage servicing rights (MSRs). The fair value of this asset is primarily affected by changes in prepayments that result from shifts in mortgage interest rates. Thus, by retaining the servicing rights of sold mortgage loans, Citigroup is still exposed to interest rate risk.

In managing this risk, Citigroup hedges a significant portion of the value of its MSRs through the use of interest rate derivative contracts, forward purchase commitments of mortgage-backed securities, and purchased securities classified as trading (primarily mortgage-backed securities including principal-only strips).

Since the change in the value of these hedging instruments does not perfectly match the change in the value of the MSRs, Citigroup is still exposed to what is commonly referred to as “basis risk.” Citigroup manages this risk by reviewing the mix of the various hedging instruments referred to above on a daily basis.

Citigroup’s MSRs totaled $5.567 billion and $8.380 billion at December 31, 2008 and 2007, respectively. For additional information about the Company’s MSRs, see Note 19 to the Consolidated Financial Statements on page 165.

As part of the mortgage lending activity, Citigroup commonly enters into purchase commitments to fund residential mortgage loans at specific interest rates within a given period of time, generally up to 60 days after the rate has been set. If the resulting loans from these commitments will be classified as loans held-for-sale, Citigroup accounts for the commitments as derivatives under SFAS 133. Accordingly, changes in the fair value of these commitments, which are driven by changes in mortgage interest rates, are recognized in current earnings after taking into consideration the likelihood that the commitment will be funded. However, a value is not assigned to the MSRs until after the loans have been funded and sold.

Citigroup hedges its exposure to the change in the value of these commitments by utilizing hedging instruments similar to those referred to above.

The Company has risk-sharing agreements with various Mortgage Insurance (MI) companies through company-owned captive reinsurance entities. Under these arrangements, the Company shares in MI premium revenue and participates in losses above a predetermined level (floor), limited by a predetermined loss amount (ceiling), at which time additional losses revert back to the MI companies. The agreements currently support a total of $28.1 billion of loans with $7.1 billion of MI coverage, principally on loans sold to government agencies. During 2008, projections by the MI companies indicated that losses for some books of business were likely to exceed the floor and the Company recorded $67 million in reserves. Total maximum exposure under these captive reinsurance agreements is $1.3 billion.

Interest Rate Risk Associated with Consumer Mortgage Lending Activity

Citigroup originates and funds mortgage loans. As with all other lending activity, this exposes Citigroup to several risks, including credit, liquidity and interest rate risks. To manage credit and liquidity risk, Citigroup sells most of the mortgage loans it originates, but retains the servicing rights. These sale transactions create an intangible asset referred to as mortgage servicing rights (MSRs). The fair value of this asset is primarily affected by changes in prepayments that result from shifts in mortgage interest rates. Thus, by retaining the servicing rights of sold mortgage loans, Citigroup is still exposed to interest rate risk.

In managing this risk, Citigroup hedges a significant portion of the value of its MSRs through the use of interest rate derivative contracts, forward purchase commitments of mortgage-backed securities, and purchased securities classified as available-for-sale or trading (primarily fixed income debt, such as U.S. government and agencies obligations, and mortgage-backed securities including principal-only strips).

Since the change in the value of these hedging instruments does not perfectly match the change in the value of the MSRs, Citigroup is still exposed to what is commonly referred to as “basis risk.” Citigroup manages this risk by reviewing the mix of the various hedging instruments referred to above on a daily basis.

Prior to January 1, 2006, the portion of the MSRs that was hedged with instruments qualifying for hedge accounting under SFAS 133 was recorded at