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Citigroup, Inc. (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 a discussion of Citi's recent announcement featuring Robert E. Rubin, Chairman of the Board; Win Bischoff, Acting Chief Executive Officer; and Gary Crittenden, Chief Financial Officer. Today's call will be hosted by Art Tildesley, Director of Investor Relations.

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

Mr. Tildesley, you may begin.

Art Tildesley

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

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

With that let me hand it over to Bob.

Robert E. Rubin

Thank you, Art. Let me make a few comments, they are really just a gloss on the materials you already received. We had a board meeting yesterday, as you know, and the board reiterated it’s enormous respect for Chuck, both professionally and personally. Chuck said to the board that he felt in light of the loss that has been taken, that the only honorable course was to immediately tender his resignation, which the board the accepted but with, as I said, a tremendous statement of support and respect for Chuck.

I am going to be Chairman of the Board. We have a special committee, a search committee -- Alain Belda, Dick Parsons, Frank Thomas and myself -- and this is going 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 Executive Officer. Win had been the CEO of Schroders, and then Schroders became part of Citi. Win has played a very active role in the senior management 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 the institution. Obviously, in addition to all 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 we discussed this, found we had in common a tremendous sense of commitment to this company and to its people and when Chuck decided to step down, both of us felt that this was what we needed to do in order to help this company through this interim period. We will be working with the senior management of the board and all else to move ourselves forward, to continue our momentum as we also conduct the search process. Win?

Win Bischoff

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

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

As acting CEO, I see my role working together with Bob and the board to hand over a vibrant firm which has learnt from its mistakes and is ready once again to take advantage of its considerable assets and heritage. I believe in the strategy and I believe in its continuity. I look forward to an interesting but relatively short 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 to give you a little bit more background on the likely charges that we will take in the fourth quarter that may not be fully evident in the release that we did last night. As you no doubt have read by now, we expect that we will take very significant additional marks during the course of the fourth quarter that are driven by some events that have happened during the month of October.

It is very difficult right now to say exactly what that amount will be when we get to the end of the fourth quarter. It will obviously be dependent on what happens in the markets between now and then. We estimated if we took a current look at that, that it would be something like $8 billion to $11 billion on a revenue basis, so on a pre-tax basis; and $5 billion to $7 billion on an after-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 affecting those revenue reductions at that 38.5% rate.

Now in the third quarter, as you know, we have been primarily focused on the exposure that we have had to sub-prime securities that had sub-prime collateral that were supporting those securities. As I said on the 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 the second quarter and declined slightly in the third quarter down to a total of $11.7 billion.

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

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

Then on October 17th, S&P followed with similar types of downgrades. Following the downgrades on these mortgage-backed securities, the rating agencies then turned their attention to the CDOs, which of course have mortgage-backed securities as an important part of their collateral. During October alone there were approximately 1,000 negative actions taken against CDOs by S&P’s and Moody’s. Moody’s now has more than $30 billion of CDO securities on negative watch and Fitch also followed by putting on negative watch about $37 billion worth of ABS CDO tranches.

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

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

I am just going to pick up a couple of indices here as an example. If you take the AAA 06-2 index it had declined by an average of about 0.5% per month during the first nine months of 2007, but in October alone, the index declined by 8.5%. Additionally in the month of October the single A 06-2 and the BBB 06-2 indices lost about half of their value during the course of one month.

Now you might rightfully ask the question, why didn’t we hedge after the losses that we had in September? Let me just give you a couple of thoughts on that. We did do hedging where it was possible to do, so we had some residential mortgage-backed security sub-prime portfolio exposure where we were able to get effective hedging. We did that; we have reduced our exposure in that book to a very low level and that partially offset the impact of what I am talking about. But in the overall scope of the expected reductions that we are going to take in revenue, it was not particularly material.

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

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

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

To walk you down through how we have thought about that and the exposures that we have since September 30, given the actions that the rating agencies have taken and the developments that have happened in the market, we have $2.7 billion worth of CDO warehouse inventory and unsold tranches of ABS CDOs. We have currently marked 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 at appropriate prices during the last six months and reflect appropriate discounts. They are performing loans. The asset values already reflected significant discounts when we bought them. These are largely hedged. They are actively managed. We didn't in the third quarter -- nor do we anticipate in the fourth quarter -- that there will be significant markdowns against that $4.2 billion.

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

So let me now turn to the $43 billion worth of super senior exposure. As you no doubt noticed, we have a significant range around the valuation that we anticipate here, something like $3 billion. It's driven by a lot of factors. There is still a lot 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 of the quarter. It obviously could be higher and lower than that.

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

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

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

Now these numbers, as I said, can be better or worse during the course of the quarter. It will depend a lot on market factors. Many of these underlying factors are things that you can see and track and make your own judgments about how you think that will fall.

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

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

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

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

Art Tildesley

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

Operator, we are ready to begin.

Question-and-Answer Session

Operator

Your first question comes from Glenn Schorr - UBS.

Glenn Schorr - UBS

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

How do you feel about where the tangible equity ratio is and that the remaining exposures, you could put them in the two-thirds of tangible equity camp? I know that’s being a little over the top, but it seems like an alarming 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 minute ago. So if you actually think about the financial strength of the company, in large measure it is driven by the cash flow the company has. The company has an enormous cash flow that is obviously not discernible in the profit reporting that has been impacted in the last couple of quarters. There have been large non-cash events that have impacted what we have done.

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

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

This is a very dynamic situation, but I actually feel like we have got a very good beat on what we need to do and I feel very confident that we will have the ability to build back to the targeted area that we want to 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 -- it feels like you are still pretty dependent on rating agency action and the inputs into the models. Is there any thought towards just selling and cutting bait or marking to the bid? Or would that be just a poor economic decision and that we need to trust in the marks at this point?

Gary Crittenden

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

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

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

Operator

Your next question comes from Guy Moszkowski - Merrill Lynch.

Guy Moszkowski - Merrill Lynch

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

Gary Crittenden

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

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

I contrast that with the SIVs which is a completely different situation. The composition of the SIVs, the underlying asset quality there is primarily investment grade assets of different types. If you have a chance, 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 the 10-Q we do a pretty good job now of splitting out the composition of the SIVs and you can see both on the asset side and the liability side what they are composed of, and so it is just a completely different topic.

So, the $25 billion is a 2006 and older liquidity put that has 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 $70 million worth of indirect sub-prime exposure in the SIVs and all the rest of the exposures are of a different type. I think it is a fundamentally different situation.

Guy Moszkowski - Merrill Lynch

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

Gary Crittenden

We haven't quantified what that exposure is. They obviously are important counterparties for us in a number of different instruments. I think you raised an important point which is all that I have talked about today are our direct exposures and there's obviously potentially secondary and tertiary exposures that potentially could exist for the company that are not part of what we have talked about today. This is really the direct exposure that we have. But I would assume virtually everyone else that is a significant financial institution have counterparty exposure 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 - Sandler O'Neil.

Jeff Harte - Sandler O'Neil

Good morning. Can you talk a little bit more about the delta between what you are calling the cash flow or the underlying credit performance of 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 during the first three months of the year, but we didn't see much pain as far as marks from you guys going from say par to $0.40; now we are seeing a lot of pain going from $0.40 to $0.20?

Gary Crittenden

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

If you go into the month of October, after the first seven or eight days -- I don't know exactly when it was -- you see a very significant crack and it drops from 96 down to about 88 and losses 8% of its value in a very short period of time. The other indices had been down. I am talking about the As, the BBBs, had been down during the course of the year; the big movement there was a reduction by about half during the course of October so they have had movements but again you had significant movements in those. But it’s really at the high investment grade end where the values had held up very well during the course of the year but obviously you see that movement now.

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

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

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

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

Jeff Harte - Sandler O’Neill & Partners

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

Gary Crittenden

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

The degree of that is what nobody knows today and obviously right 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 of what we think the value of these are going forward. But I would be surprised if we don’t see some trading eventually in these securities, and obviously as we see trading, that will inform the exact decisions that we make on these securities at the time.

Jeff Harte - Sandler O’Neill & Partners

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

Gary Crittenden

You know, that’s exactly the kind of exercise that our central treasury team is going through right now, working with the business teams, evaluating each of those positions and determining what makes sense for us to do.

I mean obviously, if you have something that has a very low risk rating, even if it had a higher wrapped content associated with it and it had a very attractive return, you wouldn’t necessarily want to exit out of that business. I mean, we want to be thoughtful about how we work through the opportunities that we have on the balance sheet, and we also want to do that frankly with an eye towards what’s going to happen with [inaudible] too, to ensure that we are conforming our balance sheet and thinking about our business in 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 our assets. We look at those things that have both bad return or low returns on risk and low return on regulatory capital and in that context, we try to make decisions about what actions we are going to take.

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

Jeff Harte - Sandler O’Neill & Partners

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

Gary Crittenden

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

Jeffrey Harte - Sandler O’Neill & Partners

Okay. Thank you.

Operator

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

Ron Mandle - GIC

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

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 I just don’t know.

Ron Mandle - GIC

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

Gary Crittenden

Let me just correct that a little bit. So the total exposure that we had in the 11.7 or so was I think 2.7, and what I said was that most of that was -- we anticipate most of that to be written off during the course of the 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 is so taking the high end of the range, that was $8 billion in write-offs for the remaining 43, which I don’t know, strikes me as not exceptionally large, given developments that we’ve seen in the third quarter and then since the end of the third quarter.

Gary Crittenden

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

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

Ron Mandle - GIC

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

Gary Crittenden

You can see the level three disclosures that we have in the back of our 10-Q. It has a fair amount of detail there that splits out the type and nature of the assets that we mark to model. We have I think laid that out in 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 from where it was in the second quarter, but on a percentage basis, it think it’s about 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 Mitchell with Buckingham Research.

James Mitchell - Buckingham Research

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

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

Gary Crittenden

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

I was having a conversation with someone down at the CNB not long ago and talking about the fact that we are the largest player in this business and given that we are the largest player in the business reducing the book by half and then putting on what at the time was three times more hedges than we had ever had, at least in our recent history, seemed to be very aggressive 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 we could have moved and obviously there were others who did that and have benefited from the actions that they took.

That said, once this process started, I think the universal view of our team is that it would simply have been -- first of all, the size was simply not there. The market is simply not there to do it in size in any way, and it would have been uneconomic to do it. And that’s particularly true if you have a view that long-term, these securities have an attractiveness associated with them.

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

James Mitchell - Buckingham Research

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

Gary Crittenden

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

James Mitchell - Buckingham Research

Okay, fair enough. Thanks.

Operator

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

Michael Mayo - Deutsche Bank

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

Gary Crittenden

Well, the -- no, Mike, I obviously can’t give you any assurances. 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 the super seniors and we don’t know exactly how this will trade, when observable trades will happen, what the impact will be.

We’ve tried to be reasonable, as you might guess, in terms of the discount rate, so we’ve tried to look at what the ABX is implying in terms of residential housing price deterioration, what the discount rate is that might 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 how things are going to move.

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

Michael Mayo - Deutsche Bank

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

Gary Crittenden

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

Michael Mayo - Deutsche Bank

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

Gary Crittenden

I’ll answer the question on when was this established and then maybe ask Bob to make a comment or two about the process that the board has been engaged with here. In terms of the -- so the positions, the warehouse positions have obviously been accumulated -- the super senior portfolio positions have been accumulated over time. As I mentioned earlier on the call, the $25 billion that was effectively the liquidity puts really came on during the 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 the board became aware of the problem, the board has been engaged with Gary through the audit committee and with people in CMB with respect to understanding these risks 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 is just presenting it to you.

Michael Mayo - Deutsche Bank

Were you surprised about the $43 billion of CDO exposures or have 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 Gary just described it, which is this is what it is and this is the way to address it. I don’t know if that’s responsive or not but I don’t think any thought that I have, Mike, about that $43 billion is different than Gary just described to you.

Michael Mayo - Deutsche Bank

All right. Thank you.

Operator

Your next question will come from the line of Meredith Whitney 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 the fact that you are comfortable with returning to adequate capital levels by the second quarter of 2008 but during the fourth quarter, capital ratios will worsen. I’ve got tangible capital coming down about 8% and I don’t know what your direction in terms of obtainable assets, where that’s going. Are the rating 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 we estimate to be about 90% for 2007 and about 60% for 2008, how the board is thinking about the sustainability of such a payout ratio?

Gary Crittenden

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

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

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 on the other hand, we have very substantial cash flow, so we’re no way impairing the liquidity of the business by doing something like that. So it just is not a particular issue for us and as I said, we are fully committed to maintaining the 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 payout ratio would compromise your ability to otherwise grow the businesses?

Gary Crittenden

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

Meredith Whitney - CIBC World Markets

Okay, thanks, Gary.

Operator

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

Jason Goldberg - Lehman Brothers

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

Gary Crittenden

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

What we did do obviously is modify what we had said on the third quarter earnings release to reflect the fact that we conformed the discount rates across all the super seniors at the rate that we thought was appropriate. The net impact of that was about $300 million overall, exactly I think $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’s Wall Street Journal there was an article saying the SEC was looking into your accounting on SIVs. I’m not sure if that was mentioned in the Q at all or if you want to address that.

Gary Crittenden

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

Jason Goldberg - Lehman Brothers

Okay. Thanks.

Operator

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

William Tanona - Goldman Sachs

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

Gary Crittenden

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

So obviously part of our thinking here as we go through and try and evaluate what we think the real reduction in revenue will be during the fourth quarter is colored by what the underlying collateral is and so on that basis, as I say, we have a reasonable split between the earlier vintages and the 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 in terms 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 you an exact figure is that if we don’t manage the CDO, it’s difficult for us to see through to the underlying collateral with any specificity in exactly how it’s turned over. But it’s relatively balanced based on the numbers that I have.

William Tanona - Goldman Sachs

Great, and then the follow-up, obviously this is pretty disruptive to, I would imagine, the culture. Who’s out there right now talking to employees and leading them through this challenging time, now that you don’t have a CEO in place?

Robert E. Rubin

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

I’ve lived through, as has Win, lived through situations before in other institutions and other places and I think you got it exactly right. 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 and work with people, particularly the senior leadership of the institution. And I’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 this very well.

Win Bischoff

I would say the same thing for myself. I think these -- what I know is from personal experience that these are difficult times and that the people are the most important thing, and I think you are absolutely right in pointing 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 of David Hilder with Bear Stearns.

David Hilder - Bear Stearns

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

Robert E. Rubin

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

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

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

I think it becomes a -- we’ve all been through these things before, picking leaders for institutions. I think it is a little bit intangible when 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’ve already said, but it has to be somebody who can drive a vision and drive and execute -- A, is very good strategically and then can drive the execution against that vision.

David Hilder - Bear Stearns

Thanks very much.

Art Tildesley

Operator, I think that concludes our question-and-answer session. Please call us in investor relations today if you have any other questions. Thank you.

Operator

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

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Source: Citigroup Business Update Call
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