AIG 2005 Annual Report Download - page 105

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
period relative to those entered into during the prior period. borrowings through its derivatives portfolio. The requirements
Generally, the realization of trading revenues as measured by under FAS 133 hedge accounting were not met for these hedge
the receipt of funds is not a significant reporting event as the transactions for the years ending December 31, 2005, 2004 and
gain or loss on AIGFP’s trading transactions is currently 2003. Thus, these hedges are marked to fair value with the
reflected in operating income as the fair values change from unrealized gains or losses reported in income.
period to period.
Derivative transactions are entered into in the ordinary Consumer Finance
course of Capital Markets operations. Therefore, income on Domestically, AIG’s Consumer Finance operations are princi-
interest rate, currency, equity, commodity, energy and credit pally conducted through AGF. AGF derives a substantial
derivatives is recorded at fair value, determined by reference to portion of its revenues from finance charges assessed on
the mark to market value of the derivative or their estimated outstanding mortgages, home equity loans, secured and un-
fair value where market prices are not readily available. The secured consumer loans and retail merchant financing. The real
resulting aggregate unrealized gains or losses from the deriva- estate loans include first or second mortgages on residential
tive are reflected in the income statement in the current year. real estate generally having a maximum term of 360 months,
Where Capital Markets cannot verify significant model inputs and are considered non-conforming. These loans may be
to observable market data and verify the model value to closed-end accounts or open-end home equity lines of credit
market transactions, Capital Markets values the contract at the and may be fixed-rate or adjustable rate products. The secured
transaction price at inception and, consequently, records no consumer loans are secured by consumer goods, automobiles, or
initial gain or loss in accordance with Emerging Issues Task other personal property. Both secured and unsecured consumer
Force Issue No. 02-03, ‘‘Issues Involved in Accounting for loans generally have a maximum term of 60 months. The core
Derivative Contracts Held for Trading Purposes and Contracts of AGF’s originations are sourced through its branches.
Involved in Energy Trading and Risk Management Activities’’ However, a significant volume of real estate loans are also
(EITF 02-03). Such initial gain or loss is recognized over the originated through broker relationships, and to lesser extents,
life of the transaction. Capital Markets periodically reevaluates through correspondent relationships and direct mail
its revenue recognition under EITF 02-03 based on the solicitations.
observability of market parameters. The mark to fair value of Many of AGF’s borrowers are non-conforming, non-prime
derivative transactions is reflected in the balance sheet in the or sub-prime. Current economic conditions, such as interest
captions ‘‘Unrealized gain on swaps, options and forward rate and employment, have a direct effect on the borrowers’
transactions,’’ ‘‘Unrealized loss on swaps, options and forward ability to repay these loans. AGF manages the credit risk
transactions,’’ ‘‘Trading assets’’ and ‘‘Trading liabilities.’’ Un- inherent in its portfolio by using credit scoring models at the
realized gains represent the present value of the aggregate of time of credit applications, established underwriting criteria,
each net receivable by counterparty, and the unrealized losses and in certain cases, individual loan reviews. AGF’s Credit
represent the present value of the aggregate of each net Strategy and Policy Committee monitors the quality of the
payable by counterparty as of December 31, 2005. These finance receivables portfolio on a monthly basis when deter-
amounts will change from one period to the next due to mining the appropriate level of the allowance for finance
changes in interest rates, currency rates, equity and commodity receivable losses. The Credit Strategy and Policy Committee
prices and other market variables, as well as cash movements, bases its conclusions on quantitative analyses, qualitative
execution of new transactions and the maturing of existing factors, current economic conditions and trends, and each
transactions. See also the discussion under ‘‘Derivatives’’ herein committee member’s experience in the consumer finance
and Note 20 of Notes to Consolidated Financial Statements. industry. Through 2005, the credit quality of AGF’s finance
Spread income on investments and borrowings is recorded receivables continues to be strong.
on an accrual basis over the life of the transaction. Invest- Overseas operations, particularly those in emerging markets,
ments are classified as securities available for sale and are provide credit cards, personal and auto loans, term deposits,
marked to market with the resulting unrealized gains or losses savings accounts, sales finance and mortgages.
reflected in accumulated other comprehensive income. Consumer Finance operations are exposed to loss when
U.S. dollar denominated borrowings are carried at cost, while contractual payments are not received. Credit loss exposure is
borrowings in any currency other than the U.S. dollar result in managed through tight underwriting controls, mix of loans,
unrealized foreign exchange gains or losses reported in income. collateral, and collection efficiency.
AIGFP hedges the economic exposure on its investments and
AIG m Form 10-K 53