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Citigroup, Inc. (NYSE:C)

Business Update Call

November 5, 2007 8:30 am ET

Executives

Robert E. Rubin - Chairman of the Board

Win Bischoff - Acting Chief Executive Officer

Gary Crittenden - Chief Financial Officer

Art Tildesley - Director of Investor Relations

Analysts

Glenn Schorr - UBS

Guy Moszkowski - Merrill Lynch

Jeff Harte - Sandler O'Neil

Ron Mandle - GIC

James Mitchell - Buckingham Research

Michael Mayo - Deutsche Bank

Meredith Whitney - CIBC World Markets

Jason Goldberg - Lehman Brothers

William Tanona - Goldman Sachs

David Hilder - Bear Stearns

Operator

Good morning, ladies and gentlemen and welcome to adiscussion of Citi's recent announcement featuring Robert E. Rubin, Chairman ofthe Board; Win Bischoff, Acting Chief Executive Officer; and Gary Crittenden,Chief Financial Officer. Today's callwill be hosted by Art Tildesley, Director of Investor Relations.

We ask that you hold all questions until the completion ofthe formal remarks at which time you will be given instructions for thequestion-and-answer session. Also as areminder, this conference is being recorded today. If you have any objections, please disconnectat this time.

Mr. Tildesley, you may begin.

Art Tildesley

Thank you, operator and thank you all for joining us todayfor a discussion of the announcements that we made last night. Bob and Win will begin the call with somebrief comments on the management changes and then Garywill comment on our sub-prime related exposures in securities and banking, andthen we would be happy to answer any questions. This call will run until 9:00 amthis morning.

Before we get started, I'd like to remind you that today'sdiscussion may contain forward-looking statements. Citigroup's financial results may differmaterially from those statements, so please refer to our SEC filings for adescription of the factors that could cause our actual results to differ fromexpectations.

With that let me hand it over to Bob.

Robert E. Rubin

Thank you, Art. Letme make a few comments, they are really just a gloss on the materials you alreadyreceived. We had a board meetingyesterday, as you know, and the board reiterated it’s enormous respect forChuck, both professionally and personally. Chuck said to the board that he felt in light of the loss that has beentaken, that the only honorable course was to immediately tender hisresignation, which the board the accepted but with, as I said, a tremendousstatement of support and respect for Chuck.

I am going to be Chairman of the Board. We have a special committee, a searchcommittee -- Alain Belda, Dick Parsons, Frank Thomas and myself -- and this isgoing to be done as expeditiously as possible. Win Bischoff, some of you know him, probably most of you don’t. Win will be the Acting Chief ExecutiveOfficer. Win had been the CEO ofSchroders, and then Schroders became part of Citi. Win has played a very active role in the seniormanagement of Citi in all sorts of ways including serving on the business head,which is the most senior body of the executive management. He is enormously respected throughout theinstitution. Obviously, in addition toall else, has a very strong international focus. That sets the framework as we go forward.

I think it is fair to say that Win and I both, as wediscussed this, found we had in common a tremendous sense of commitment to thiscompany and to its people and when Chuck decided to step down, both of us feltthat this was what we needed to do in order to help this company through thisinterim period. We will be working with the senior management of the board andall else to move ourselves forward, to continue our momentum as we also conductthe search process. Win?

Win Bischoff

Thanks, Bob. Goodmorning, everyone. I know very few ofyou in person, but I have read a lot of your stuff, of course, over the yearsso I feel I know some of you, at least by your writing. As far as I amconcerned, Citi has an extraordinary franchise, both in the United States and outside of the United States, so to somebody viewing this firmfrom outside of the United States;this is obviously even more apparent.

In addition, it has talented people and that’s a verypowerful combination which even the events of the last few months have not beenable to tarnish that, there has not been everlastingly an ability to diminishthat powerful combination.

As acting CEO, I see my role working together with Bob andthe board to hand over a vibrant firm which has learnt from its mistakes and isready once again to take advantage of its considerable assets andheritage. I believe in the strategy andI believe in its continuity. I look forward to an interesting but relativelyshort period of months before handing over to the next CEO. Thank you.

Gary Crittenden

Thanks. I thought I would just take a few minutes here togive you a little bit more background on the likely charges that we will takein the fourth quarter that may not be fully evident in the release that we didlast night. As you no doubt have read bynow, we expect that we will take very significant additional marks during thecourse of the fourth quarter that are driven by some events that have happenedduring the month of October.

It is very difficult right now to say exactly what that amountwill be when we get to the end of the fourth quarter. It will obviously be dependent on whathappens in the markets between now and then. We estimated if we took a current look at that, that it would besomething like $8 billion to $11 billionon a revenue basis, so on a pre-tax basis; and $5 billion to $7 billion on anafter-tax basis. That’s assuming a 38.5%tax rate. Most of these reductions in revenue are taking place in the United States, we have a higher tax rate in the United States broadly and so this reflects tax affectingthose revenue reductions at that 38.5% rate.

Now in the third quarter, as you know, we have beenprimarily focused on the exposure that we have had to sub-prime securities thathad sub-prime collateral that were supporting those securities. As I said onthe third quarter earnings call, our exposure to these positions had gone from$24 billion at the beginning of the year down to $13 billion by the end of thesecond quarter and declined slightly in the third quarter down to a total of$11.7 billion.

Our exposure to high end investment grade securities, whichwe believed had very little risk associated with them, have historically heldup in value and hence they were termed super senior and we did not considerthis to be a significant risk for markdowns. The $43 billion that we disclosed yesterday falls into this super seniorcategory.

So let me give you a little bit of background on the eventsthat happened as we moved through the month of October that has influenced ourthinking about the valuation on the securities that we’re likely to record inthe fourth quarter. On October 11th,Moody’s downgraded a little more than $33 billion worth of residentialmortgage-backed securities that were backed by sub-prime bonds and puts. These were mostly senior tranches and $23.8billion was put on negative watch.

Then on October 17th, S&P followed withsimilar types of downgrades. Following thedowngrades on these mortgage-backed securities, the rating agencies then turnedtheir attention to the CDOs, which of course have mortgage-backed securities asan important part of their collateral. DuringOctober alone there were approximately 1,000 negative actions taken againstCDOs by S&P’s and Moody’s. Moody’snow has more than $30 billion of CDO securities on negative watch and Fitchalso followed by putting on negative watch about $37 billion worth of ABS CDOtranches.

Now once the October downgrade occurred the value of thejunior tranches were driven down to very low levels and as you all know, thisincreased the likelihood or the riskiness of the senior tranches as thesubordination below them eroded and this drove down the value then of the supersenior tranches as well, something that had not occurred during the course ofthe first nine months of the year.

Now the best way to get an outside perspective on this is tolook at the ABX indices, which have dropped dramatically since the end ofSeptember. I know you all follow thisvery closely, but these are reflecting the fundamentals of what we see in therating agency actions.

I am just going to pick up a couple of indices here as anexample. If you take the AAA 06-2 index it had declined by an average of about0.5% per month during the first nine months of 2007, but in October alone, theindex declined by 8.5%. Additionally in the month of October the single A 06-2and the BBB 06-2 indices lost about half of their value during the course of onemonth.

Now you might rightfully ask the question, why didn’t wehedge after the losses that we had in September? Let me just give you a coupleof thoughts on that. We did do hedgingwhere it was possible to do, so we had some residential mortgage-backedsecurity sub-prime portfolio exposure where we were able to get effectivehedging. We did that; we have reducedour exposure in that book to a very low level and that partially offset theimpact of what I am talking about. Butin the overall scope of the expected reductions that we are going to take inrevenue, it was not particularly material.

On the ABS CDO portfolio, we held numerous conversationswith potential counterparties. The totalamounts that were available to us were relatively small in size, certainly notanything that would have offset the expected losses that we will take and thepricing associated with those were uneconomic; in fact, the only place wheretrue hedging was available was at the most senior part of the most seniorsecurities and so it simply was not a viable or economic strategy for us.

We could have obviously shorted an index, but obviouslythere was basis risk associated with that. Those indices were essentially out of the money from a hedgingperspective and would not necessarily have been an effective hedge in any case,because the underlying securities that we would be hedging would not havematched up necessarily with the indices and may not have tracked and been aneffective hedge.

So let me focus now on the writedowns, give you just a littlebit more background on each of those. Soas I mentioned, we had slightly less than $13 billion in the sub-primeportfolio that was supported by sub-prime collateral as of September 30. Thatnumber was actually $11.7 billion.

To walk you down through how we have thought about that andthe exposures that we have since September 30, given the actions that therating agencies have taken and the developments that have happened in themarket, we have $2.7 billion worth of CDO warehouse inventory and unsoldtranches of ABS CDOs. We have currentlymarked that so that the value on our books is close to zero.

There is also $4.2 billion of sub-prime loans. These are loans that were purchased atappropriate prices during the last six months and reflect appropriatediscounts. They are performingloans. The asset values alreadyreflected significant discounts when we bought them. These are largely hedged. They are actively managed. We didn't in the third quarter -- nor do weanticipate in the fourth quarter -- that there will be significant markdownsagainst that $4.2 billion.

Finally in the $11.7 billion is $4.8 billion of financingtransactions that we have with customers that are secured by sub-primecollateral. The collateral valuesalready reflect haircuts; appropriate haircuts. The collateral is topped off by the user of the financing if thecollateral value drops. We did not haveany significant markdowns here in the third quarter, nor would we anticipatesignificant markdowns in the fourth quarter in this class of securities.

So let me now turn to the $43 billion worth of super seniorexposure. As you no doubt noticed, wehave a significant range around the valuation that we anticipate here,something like $3 billion. It's drivenby a lot of factors. There is still alot of uncertainty about what is going to happen in the market and I reiterate,this is just our current view of the way things may look during the course ofthe quarter. It obviously could behigher and lower than that.

But as we evaluated these positions, we took into account awide range of discount rates as well as different collateral values that mightimpact their valuation and that's really what is driving the breadth of thedifference between the $8 billion and the $11 billion.

The total marks that we reported on super seniors on ourOctober 15 conference call were approximately $200 million. Since October 15, we believe that anadditional $300 million worth of writedowns on super seniors in the third quarteris appropriate, and so we have revised our third quarter results to reflectthat. You saw that in the 8-K and if you had a chance to see the 10-Q thismorning, it was also in the 10Q this morning.

What we essentially did is ensure that we had consistentdiscount rates across the various elements of the super senior portfolio andthen recalculated our marks. That resulted in an additional $300 mark which werecorded in the third quarter.

Now these numbers, as I said, can be better or worse duringthe course of the quarter. It will dependa lot on market factors. Many of theseunderlying factors are things that you can see and track and make your ownjudgments about how you think that will fall.

Based on our current assumptions, we do expect that we’ll bemaintaining our current dividend level. We have no reason to think that is anything other than absolutely thecase and we anticipate that we’ll return to the range of our targeted capitalratios by the end of the second quarter of 2008.

Looking forward, the team down at the CMB has a group thatis focused very heavily on the super senior exposures that we have and isensuring that we’re doing everything we can to minimize losses that we wouldtake in this portfolio.

Before I open up to Q&A for Bob and Win and myself, Iwould just say that the $8 billion to $11 billion obviously doesn’t representthe economic cash flows on these exposures. This is the accounting impact that we may take during the course of thequarter. The cash implications of this areobviously different and that we’ll work out over time, depending on what theunderlying performance of the collateral is.

The company’s cash flow is very strong and to reiterate wehave no intention to cut the dividend. Withthat, let me turn the time back to Art.

Art Tildesley

Thanks Gary. Operator, we are ready to begin thequestion-and-answer session. Before wedo, if I may ask the participants on the call to limit their questions to onequestion and one follow-up, we would appreciate that.

Operator, we are ready to begin.

Question-and-AnswerSession

Operator

Your first question comes from Glenn Schorr - UBS.

Glenn Schorr - UBS

How are you thinking about the cap ratios? In other words, Ilook at the disclosure and I understand where your targets and how you canrebuild through the middle of June; in reality, as big as the charge is, youcan re-earn it back in 110 days.

How do you feel about where the tangible equity ratio is andthat the remaining exposures, you could put them in the two-thirds of tangibleequity camp? I know that’s being a little over the top, but it seems like analarming number. How should we be thinking about the tangible side of things?

Gary Crittenden

The way I would think about it is just as I said a minuteago. So if you actually think about the financial strength of the company, in largemeasure it is driven by the cash flow the company has. The company has an enormous cash flow that isobviously not discernible in the profit reporting that has been impacted in thelast couple of quarters. There have beenlarge non-cash events that have impacted what we have done.

We also have very strong capital generation capability as aresult of the normal ongoing profitability of the company. We have the Nikkotransaction which is going to take place likely in the first quarter of thisyear, which will be a capital offering for the remaining shares of Nikko.

As you know, we formed a Central Treasury Group, which has nowput in place for a month or so that is energetically working on assetmanagement across the company and you have seen some of the first instances ofthat as we have sold out of our mortgage book or essentially sold out of theresidential mortgage book that we have maintained for a year or so.

This is a very dynamic situation, but I actually feel likewe have got a very good beat on what we need to do and I feel very confidentthat we will have the ability to build back to the targeted area that we wantto be at by the end of June.

Glenn Schorr - UBS

The follow up I have is, it feels like we all -- I don’t put Citi alone here, but -- itfeels like you are still pretty dependent on rating agency action and theinputs into the models. Is there anythought towards just selling and cutting bait or marking to the bid? Or wouldthat be just a poor economic decision and that we need to trust in the marks atthis point?

Gary Crittenden

I don’t believe it’s a good economic decision. So as I mentioned at the end of the day, it isabout cash and we have had an accounting hit associated with these securities,which I think we have done the appropriate thing from accountingperspective.

But you know, a year from now, two years from now, threeyears from now the real question is going to be how much cash do we receivefrom these securities? The securitiesthat we actually hold have not yet been downgraded, the cash flows actuallyhave not yet been impaired; now that’s likely or possibly will change over thenext little while, but at this point that’s not the case.

To think about selling these at distressed value justwouldn’t make any sense for us whatsoever. I think at the end of the day, we have got to find that the cash flowhere represents the fact that that these are higher quality securities. Theyare in fact, and were -- up until very recently -- thought of as super seniorssecurities; above AAA in terms of their quality

Operator

Your next question comes from Guy Moszkowski - MerrillLynch.

Guy Moszkowski -Merrill Lynch

I have a question for Gary.You refer in the release to $25 billion within the $43 billion that you talkedabout this morning; $25 billion of it is commercial paper exposure withunderlying sub-prime exposures. Maybeyou can talk about how that came on, how it relates to your sponsorship of structuredinvestment vehicles, especially in the context that you said I think that youhave around $80 billion in remaining sponsored SIVs out there, and how shouldwe think about the potential for more commercial paper like this coming on?

Gary Crittenden

So this was essentially a funding mechanism that was used aswe structured CDOs up until I believe the end of 2005. So we would sell astructured CDO to a customer. We wouldprovide a liquidity put, essentially, to that customer during the course of thesummer and this was all backed by sub-prime collateral, I might add, as youknow.

But essentially, it looks like a super senior CDO for allintents and purposes. We decided actually to buy the commercial paper associatedwith that during the course of the summer and as result that came back on ourbooks and obviously we had the exposure to the underlying security there and sothat’s what the $25 billion is made up of. Once it’s back on our books, forall intents and purposes, it operates and looks like a super senior CDOposition; that’s what it is, because in essence this was a financingmechanism.

I contrast that with the SIVs which is a completelydifferent situation. The composition ofthe SIVs, the underlying asset quality there is primarily investment gradeassets of different types. If you have achance, in the 10-Q that we just filed -- I don't know of the top of my head exactly what page it is but -- in the10-Q we do a pretty good job now of splitting out the composition of the SIVsand you can see both on the asset side and the liability side what they arecomposed of, and so it is just a completely different topic.

So, the $25 billion is a 2006 and older liquidity put thathas come back to us, that has all the characteristics of a super senior CDO.The SIVs are high quality investment grade. There are virtually no sub-prime securities there. I think we disclosed that there are $70million worth of indirect sub-prime exposure in the SIVs and all the rest ofthe exposures are of a different type. Ithink it is a fundamentally different situation.

Guy Moszkowski -Merrill Lynch

Thanks for that, and certainly, I will be taking a look atthat queue. Maybe you can comment for usas a follow up on the dependence or lack thereof in any of the vehicles thatyou have exposure to on guarantees or credit support from the mono lineinsurers like MBIA or AMBAC that have obviously had some pretty significantcredit spread blow outs?

Gary Crittenden

We haven't quantified what that exposure is. They obviously are important counterpartiesfor us in a number of different instruments. I think you raised an importantpoint which is all that I have talked about today are our direct exposures andthere's obviously potentially secondary and tertiary exposures that potentiallycould exist for the company that are not part of what we have talked abouttoday. This is really the direct exposure that we have. But I would assumevirtually everyone else that is a significant financial institution have counterpartyexposure to the monoline.

Guy Moszkowski -Merrill Lynch

You can't give us a sense for how much that might be?

Gary Crittenden

No, we haven't disclosed it.

Operator

Your next question will come from the line of Jeff Harte - SandlerO'Neil.

Jeff Harte - SandlerO'Neil

Good morning. Can you talk a little bit more about the deltabetween what you are calling the cash flow or the underlying credit performanceof the assets behind some of these things relative to the accounting? I may be coming at it from the perspective of,we've seen a lot of deterioration in some of the credit derivative indices duringthe first three months of the year, but we didn't see much pain as far as marksfrom you guys going from say par to $0.40; now we are seeing a lot of paingoing from $0.40 to $0.20?

Gary Crittenden

The way I would think about that is these were super seniorsecurities, right? So they were intheory better than investment grade securities. If you track that index, at least the numbers that I have, just as anexample, the AAA ABX, just to pick one, the O-62, had very, very littledeterioration during the course of the first nine months of this year. I think in total it was off about 4%, so itdropped about 0.5% a month.

If you go into the month of October, after the first sevenor eight days -- I don't know exactly when it was -- you see a very significantcrack and it drops from 96 down to about 88 and losses 8% of its value in avery short period of time. The otherindices had been down. I am talkingabout the As, the BBBs, had been down during the course of the year; the bigmovement there was a reduction by about half during the course of October sothey have had movements but again you had significant movements in those. Butit’s really at the high investment grade end where the values had held up verywell during the course of the year but obviously you see that movementnow.

Now, when we had thought about taking these marks, we haveobviously if you look at what the ABX would imply in terms of real estate pricereduction, it starts to imply very, very high numbers of price reduction inreal estate. I guess our view is thatit’s unlikely that those very high levels of price reduction in real estatewill take place. So what’s actually happening is implicitly the market issaying that the cash flows associated with those securities have become morerisky and so as we have thought about valuing those cash flows, we have putdifferent discount rates on those cash flows and that’s reflecting the rangethat you see in the estimate here.

We’ll see, obviously, how that actually plays out overtime. With that higher discount rate,looking at those cash flows in essentially or actually exactly the same way wedid in the third quarter, you come up with a much larger reduction in revenuethan we saw during the course of the third quarter.

The actual real realized cash flow will work out overtime. I mean it depends on how theunderlying mortgages actually get paid, how that cash actually flows. As you know, as a result of the rating agencydowngrades the cash flow gets redirected from the subordinate tranches to themore senior tranches in the structure. We’ll see how that all get realized overtime and the valuation I suspect of the super senior tranches will go up anddown and we may liquidate some of these if market prices come back. We justsimply don’t know.

We wanted to give you a sense of what we thought the impactwould be during the course of the fourth quarter, but it really is verydependent on how the market evolves here now over the next eight weeks or so.

Jeff Harte - SandlerO’Neill & Partners

Would I be incorrectly paraphrasing to say then that yourexpertise within the underlying asset classes suggest that current marks in themarket have gone too far, but that doesn’t really matter, you are forced totake mark-to-market anyway?

Gary Crittenden

I guess the way I would say it is we have not seen areduction in cash flow yet on the super senior portfolios. That’s true, but Ithink everyone on our team believes that that is going to happen, that we aregoing to see that happen very likely, and so although these securities arestill performing just fine and there has not been rating reductions on thesesecurities, we’re anticipating that there will be rating reductions on thesesecurities and we’ll see some cash flow impairment.

The degree of that is what nobody knows today and obviouslyright now, there have been virtually no trades in this super senior category,so these securities are all mark to model, making our very best judgment ofwhat we think the value of these are going forward. But I would be surprised ifwe don’t see some trading eventually in these securities, and obviously as wesee trading, that will inform the exact decisions that we make on thesesecurities at the time.

Jeff Harte - SandlerO’Neill & Partners

Can you talk a little bit about the risk weighting ofassets? I suppose getting from tangible equity to tangible assets to a tier oneimplies there’s some very low risk weighted assets on the balance sheet. Imean, can you give us some idea how big the match book is in the investmentbank, or kind of some other very low risk weighted assets that couldpotentially be liquidated or turned around without losses fairly quickly andimprove that tangible equity ratio, if that’s what you wanted to do?

Gary Crittenden

You know, that’s exactly the kind of exercise that ourcentral treasury team is going through right now, working with the businessteams, evaluating each of those positions and determining what makes sense forus to do.

I mean obviously, if you have something that has a very lowrisk rating, even if it had a higher wrapped content associated with it and ithad a very attractive return, you wouldn’t necessarily want to exit out of thatbusiness. I mean, we want to be thoughtful about how we work through theopportunities that we have on the balance sheet, and we also want to do thatfrankly with an eye towards what’s going to happen with [inaudible] too, toensure that we are conforming our balance sheet and thinking about our businessin the context of how we’ll eventually be managing that.

So we look at both the risk weighting on all of our assets.We look at the wrap weighting or the regulatory capital weighting on ourassets. We look at those things that have both bad return or low returns onrisk and low return on regulatory capital and in that context, we try to makedecisions about what actions we are going to take.

All of that added together are the kinds of things that leadus to the conclusion that we’ll be in the range of our targeted ratios by theend of the second quarter.

Jeff Harte - SandlerO’Neill & Partners

But you won’t comment to specifically how big say the matchbook is within the investment bank?

Gary Crittenden

You know, it’s just nothing that we’ve ever talked aboutspecifically.

Jeffrey Harte -Sandler O’Neill & Partners

Okay. Thank you.

Operator

Your next question will come from the line of Ron Mandlewith GIC.

Ron Mandle - GIC

Hi, Gary. I appreciate your doing this. My questionprimarily relates to your reference to the ABX and regarding CDOs, I thoughtthe TABX index was more indicative, which was down about 30% or 40% in thethird quarter, and then down another 30% or 40% just in October, and I’mlooking at the super senior tranches of that. I guess my question is primarilyis why the TABX isn’t more representative than the ABX of the super seniortranches.

Gary Crittenden

The honest answer is I don’t know -- I don’t know that.We’ll be more than happy to follow-up on it and give you our thoughts, but Ijust don’t know.

Ron Mandle - GIC

I guess the related question is that -- you know, using thefigures that you gave, so you did a little under $3 billion of write-downs onthe U.S. sub-prime mortgage related to the $11.7 billion, so at the max, thatwould leave about $8 billion for the remaining $43 billion, which is --

Gary Crittenden

Let me just correct that a little bit. So the total exposurethat we had in the 11.7 or so was I think 2.7, and what I said was that most ofthat was -- we anticipate most of that to be written off during the course ofthe quarter. It’s a little less than the 2.7.

Ron Mandle - GIC

Right, okay, I’m sorry, but where I was going with this isso taking the high end of the range, that was $8 billion in write-offs for theremaining 43, which I don’t know, strikes me as not exceptionally large, givendevelopments that we’ve seen in the third quarter and then since the end of thethird quarter.

Gary Crittenden

Well, you know, that’s the -- it’s a judgment call. I thinkI underlined that we don’t know if these will be the actual reductions thatwe’ll take in revenue as we go during the course of the quarter. That will bedriven by the facts and circumstances that happen. There are no observabletrades today against this book that would establish a value. There may verywell be trades that will happen during the course of the quarter that willprovide more insight into how they can be marked.

We’ve taken what we believe is a reasonable stab at doingthis but I would encourage you to do the same. I mean, we don’t think that whatwe have done is any more indicative necessarily of where we are going to comeout at the end of the quarter than where we would be two weeks from now or fourweeks from now. I mean, these things are going to move around and change and weare just trying to make an assessment at this point in time about how we wouldthink about it, given that there is no observable trades at the super seniorend of the market.

Ron Mandle - GIC

Okay, thanks. So then my other question, last question, isare there significant amounts of other assets that might fall into the samecategory, where there have been not many trades and so you are really lookingto mark-to-model with significant changes in inputs since the end of thequarter?

Gary Crittenden

You can see the level three disclosures that we have in theback of our 10-Q. It has a fair amount of detail there that splits out the typeand nature of the assets that we mark to model. We have I think laid that outin real detail for you and you can see what we are doing now. It is up,obviously, as it has been I think for virtually all other companies. It’s up fromwhere it was in the second quarter, but on a percentage basis, it think it’sabout in the same range of the other major firms.

Ron Mandle - GIC

Thanks very much.

Operator

Your next question will come from the line of James Mitchellwith Buckingham Research.

James Mitchell -Buckingham Research

Could you speak to your decision not to hedge? It is a bitunusual when you think about the issue around CDOs backed by sub-prime, eventhough Triple A rated, you know has been a question mark since June when itstarted coming out that Bear Stearns was struggling with their hedge funds.

Even though obviously there is always basis risk in anyhedge where it’s not a one-for-one hedge, why still though, given thatpressure, why wouldn’t you have thought to hedge it, given the -- maybe not theeconomic risk but the price risk? Thanks.

Gary Crittenden

I think it’s a very fair question. It is probably somethingthat could have or should have been addressed earlier in the year. If we weretalking back in the January/February time period, there were probablyopportunities to take actions that would have been effective to mitigate thisand in fact, the team actually did take significant actions.

I was having a conversation with someone down at the CNB notlong ago and talking about the fact that we are the largest player in thisbusiness and given that we are the largest player in the business reducing thebook by half and then putting on what at the time was three times more hedgesthan we had ever had, at least in our recent history, seemed to be veryaggressive actions given that we were a major manufacturer of this product.

However, in hindsight, you could always go back and say gee,there were opportunities that we had back at that earlier time period where wecould have moved and obviously there were others who did that and havebenefited from the actions that they took.

That said, once this process started, I think the universalview of our team is that it would simply have been -- first of all, the sizewas simply not there. The market is simply not there to do it in size in anyway, and it would have been uneconomic to do it. And that’s particularly trueif you have a view that long-term, these securities have an attractivenessassociated with them.

There’s no excuses here. It is what it is and I think that’show we thought about it as we went through the course of the year. But at leastin the course of this quarter, there just was really no material opportunity todo something that would have made sense.

James Mitchell -Buckingham Research

When you say this quarter, you mean third quarter or fourthquarter?

Gary Crittenden

Actually, there was little opportunity in the third quarterand then in particular, I was referring to the fourth quarter, something thatcould have offset these very significant reductions that we expect in thefourth quarter.

James Mitchell -Buckingham Research

Okay, fair enough. Thanks.

Operator

Your next question will come from the line of Mike Mayo withDeutsche Bank.

Michael Mayo -Deutsche Bank

In terms of the charges, can you give us any assurances thatthere’s not another shoe to drop? I guess what I’m asking is, did you factor inpotential future rating agency downgrades on that $55 billion? And how much ofthat $55 billion, or just the $43 billion of CDOs, how much has that alreadybeen written down?

Gary Crittenden

Well, the -- no, Mike, I obviously can’t give you anyassurances. I mean, by the very nature of what I’ve said all through this call,we’re making an estimate right now based on marking to model primarily on thesuper seniors and we don’t know exactly how this will trade, when observabletrades will happen, what the impact will be.

We’ve tried to be reasonable, as you might guess, in terms ofthe discount rate, so we’ve tried to look at what the ABX is implying in termsof residential housing price deterioration, what the discount rate is thatmight be attached to that, and to be thoughtful about what we’re doing. But we-- there’s no way that I think anyone can give you an assurance about howthings are going to move.

Obviously this reflects a decision on our part to take asizable reduction in these securities, so the $45 billion is the currentexposure that we have on the super senior side and -- I’m sorry, $43 billion isthe current exposure that we have on the super senior side. That is our nextexposure that we have in total and we’ll take appropriate actions on that as wego through the quarter and it will be reflected in the financial results thatwe have at the end of the year.

Michael Mayo -Deutsche Bank

What’s the difference between the net exposure and the grossexposure? And how much has the $43 billion been written down?

Gary Crittenden

Well, the $43 billion is our exposure as of the end of thethird quarter and it was written down by $500 million during the course of thethird quarter. I don’t have off the top of my head exactly what the grossexposure is but there are hedges against that exposure that would add up to a largernumber than the $43 billion. And implicit in what we’re saying today, if youtake out a big portion of the 2.7 that was taken in the other part of theexposures that we have, there is approximately somewhere in the range of $8billion worth of discussion here against that 43, as part of this announcementthat we made today.

Michael Mayo -Deutsche Bank

And then one follow-up, was the board informed of theserisks? And on $43 billion of CDOs, when were these structures established? Anddid the people on the board step in and asked questions and become moreaggressive in evaluating this risk? Thank you.

Gary Crittenden

I’ll answer the question on when was this established andthen maybe ask Bob to make a comment or two about the process that the boardhas been engaged with here. In terms of the -- so the positions, the warehousepositions have obviously been accumulated -- the super senior portfoliopositions have been accumulated over time. As I mentioned earlier on the call,the $25 billion that was effectively the liquidity puts really came on duringthe course of the summer, so it really happens in two different time periods.Bob.

Robert E. Rubin

Mike, in a broad sense, I would say that ever since theboard became aware of the problem, the board has been engaged with Gary throughthe audit committee and with people in CMB with respect to understanding theserisks and evaluating them and relating to the posting that -- or the analysis,rather, that Gary and others have presented them in much the same way he isjust presenting it to you.

Michael Mayo -Deutsche Bank

Were you surprised about the $43 billion of CDO exposures orhave you known about that for a while? How do you think about that?

Robert E. Rubin

I think about that in the same way that Garyjust described it, which is this is what it is and this is the way to addressit. I don’t know if that’s responsive or not but I don’t think any thought thatI have, Mike, about that $43 billion is different than Garyjust described to you.

Michael Mayo -Deutsche Bank

All right. Thank you.

Operator

Your next question will come from the line of MeredithWhitney with CIBC World Markets.

Meredith Whitney -CIBC World Markets

Good morning, Gary.I had a question, just so I’m clear here -- I appreciate your language on thefact that you are comfortable with returning to adequate capital levels by thesecond quarter of 2008 but during the fourth quarter, capital ratios willworsen. I’ve got tangible capital coming down about 8% and I don’t know whatyour direction in terms of obtainable assets, where that’s going. Are therating agencies on board to give you an understanding past the fourth quarter?Can you comment or not?

And then also, with respect to your payout ratio, which weestimate to be about 90% for 2007 and about 60% for 2008, how the board isthinking about the sustainability of such a payout ratio?

Gary Crittenden

We’ve obviously met with the rating agencies and I think therating agencies will probably have announcements today or tomorrow, so you’llhear from them what their view is on this.

As I mentioned, I think the board thinks about -- first ofall, the long-term strength of the institution and how diversified it is andthe strong source of profitability that we typically have had. That’s kind ofthe fundamental way I think the board thinks about these things, butimportantly cash is something that has to be considered and these are, for themost part, non-cash events, as the cash -- if you actually back through to whatthe cash flow of the company is, the cash flow of the company is very, verylarge.

So because you have a quarter or two where you have a high,implied payout ratio, it’s not certainly something we strive to have. But onthe other hand, we have very substantial cash flow, so we’re no way impairingthe liquidity of the business by doing something like that. So it just is not aparticular issue for us and as I said, we are fully committed to maintainingthe dividend at its current level.

Meredith Whitney -CIBC World Markets

Okay, so Gary,you don’t feel as if one is compromising the other in terms of the high payoutratio would compromise your ability to otherwise grow the businesses?

Gary Crittenden

You know, Meredith, I’m pretty confident in our ability tomanage the balance sheet. I really believe that we are starting to get theright processes in place to focus on the highest return elements of ourbusiness and to ensure that we are growing the balance sheet in ways that makea lot of economic sense and that will enable us over time to produce the kindof cash flow that will be very attractive for doing the things that we want todo, which include obviously maintaining a very strong dividend. So I’moptimistic about our ability to do this. I don’t view this as a -- I view thisas a -- that we are at a place in time where we have a real opportunity to makesignificant progress on balance sheet management.

Meredith Whitney -CIBC World Markets

Okay, thanks, Gary.

Operator

Your next question will come from the line of Jason Goldbergwith Lehman Brothers.

Jason Goldberg -Lehman Brothers

Thank you. I haven’t gotten to the Q yet, but it looks likethere was a restatement in the third quarter. Could you just maybe touch onthat?

Gary Crittenden

Yeah, there’s not -- I mentioned it a couple of times. It’snot a restatement until you actually publish your financial results. We haven’tpublished our financial results until the Q comes out.

What we did do obviously is modify what we had said on thethird quarter earnings release to reflect the fact that we conformed thediscount rates across all the super seniors at the rate that we thought wasappropriate. The net impact of that was about $300 million overall, exactly Ithink $270 million. And you can see right under the headline item on page four,it gives you all the detail associated with it.

Jason Goldberg -Lehman Brothers

Okay, thank you. And then, separately I guess, in Saturday’sWall Street Journal there was an article saying the SEC was looking into youraccounting on SIVs. I’m not sure if that was mentioned in the Q at all or ifyou want to address that.

Gary Crittenden

You know, we never comment on any regulatory inquiries thatwe have at the company.

Jason Goldberg -Lehman Brothers

Okay. Thanks.

Operator

Your next question will come from the line of William Tanonawith Goldman Sachs.

William Tanona -Goldman Sachs

Good morning. Obviously we know you guys are pretty big inthe CDO business but I guess I’m curious as to was there any kind of onevintage that you guys had been stuck with, whether it was ’07, ’06, or ’05? OrI guess, as differently as well, was there any particular vintage that sawsignificant deterioration with this existing write-down?

Gary Crittenden

I think the general trends that are true for the industryare true for us, so that is the more recent vintages are more impacted thanthose that are older. We don’t have perfect information on this because thecollateral in older CDOs tends to get replenished over time and so we don’thave -- like I said, we don’t have perfect information here. But as you justlook at the split of what is 2005 vintages and earlier and 2006 vintages andlater, we actually have a pretty good portion, and I wish I could provide moredetail than that, but a pretty significant portion of what we have done is 2005vintages and earlier.

So obviously part of our thinking here as we go through andtry and evaluate what we think the real reduction in revenue will be during thefourth quarter is colored by what the underlying collateral is and so on thatbasis, as I say, we have a reasonable split between the earlier vintages andthe older vintages based on the information that’s available to us.

William Tanona -Goldman Sachs

That’s helpful. Can you give us a little bit more clarity interms of what that split might be? Is it 60-40, 75 --

Gary Crittenden

I’d say it’s pretty balance. The reason why I can’t give youan exact figure is that if we don’t manage the CDO, it’s difficult for us tosee through to the underlying collateral with any specificity in exactly howit’s turned over. But it’s relatively balanced based on the numbers that Ihave.

William Tanona -Goldman Sachs

Great, and then the follow-up, obviously this is prettydisruptive to, I would imagine, the culture. Who’s out there right now talkingto employees and leading them through this challenging time, now that you don’thave a CEO in place?

Robert E. Rubin

Well, I think we do. We have an acting CEO and we have a newchairman and both of us are going to be very actively involved in working withthe people and talking with people.

I’ve lived through, as has Win, lived through situationsbefore in other institutions and other places and I think you got it exactlyright. You need to, at least figuratively, walk the floor. Obviously the place[this far] you can’t walk on the floors, but figuratively walk the floor andwork with people, particularly the senior leadership of the institution. AndI’d say this, having had a lot of phone calls yesterday at home, phone calls,e-mails, [one thing or other], I think people are pulling together around thisvery well.

Win Bischoff

I would say the same thing for myself. I think these -- whatI know is from personal experience that these are difficult times and that thepeople are the most important thing, and I think you are absolutely right inpointing it out. We’re very much aware of it and Bob and I are going to be --that is going to be -- Bob mentioned it as priority number one, two, three,four, five, six, seven, eight, nine, and ten and you’re absolutely right.

William Tanona -Goldman Sachs

Great. Thank you.

Operator

This morning’s final question will come from the line ofDavid Hilder with Bear Stearns.

David Hilder - BearStearns

Good morning. Gary,I’ll give you a break here with a question for Secretary Rubin. Could you justtalk about the kinds of experience or characteristics that would be yourhighest priorities in searching for a permanent CEO?

Robert E. Rubin

I can give you a personal view and a rather broad sense. Wehave -- we set up the committee yesterday so we haven’t met yet, obviously. Infact, what I’m going to do when I get back to the office is give Dick Parsons aring and start talking about this a little bit more.

I think basically what you are looking for is somebody whocan relate intellectually and in all other respects to the multiplicity ofbusinesses that this institution has. I think you are looking for somebody whocan effectively lead very large numbers of extremely capable people, becausethis business has extremely large -- very large numbers of extremely capablepeople and as you know, that takes a very special kind of leadership.

I think that it is very important that whoever we have has astrong international focus, not necessarily enormous international experiencebut can relate to the globalization of this institution and Chuck’s strategy ofhaving to ever increase that involvement.

I think it becomes a -- we’ve all been through these thingsbefore, picking leaders for institutions. I think it is a little bit intangiblewhen you actually get into the process and start making judgments about people.It has to be somebody who -- and maybe this in a sense repeats what I’vealready said, but it has to be somebody who can drive a vision and drive andexecute -- A, is very good strategically and then can drive the executionagainst that vision.

David Hilder - BearStearns

Thanks very much.

Art Tildesley

Operator, I think that concludes our question-and-answersession. Please call us in investor relations today if you have any otherquestions. Thank you.

Operator

Ladies and gentlemen, this does conclude this morning’srecent announcement discussion. You may now disconnect.

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