AIG 2008 Annual Report Download - page 123

and increases in the provision for finance receivable losses. In 2007, AGF’s mortgage banking operations also
recorded a pre-tax charge of $178 million, representing the estimated cost of implementing the Supervisory
Agreement entered into with the OTS.
ILFC generated strong operating income growth in 2007 compared to 2006, driven to a large extent by a larger
aircraft fleet, higher lease rates and higher utilization.
In 2007, AIGFP began applying hedge accounting under FAS 133 to certain of its interest rate swaps and
foreign currency forward contracts that hedge its investments and borrowings and AGF and ILFC began applying
hedge accounting to most of their derivatives that hedge floating rate and foreign currency denominated borrowings.
Prior to 2007, hedge accounting was not applied to any of AIG’s derivatives and related assets and liabilities.
Accordingly, revenues and operating income were exposed to volatility resulting from differences in the timing of
revenue recognition between the derivatives and the hedged assets and liabilities.
Capital Markets Results
2008 and 2007 Comparison
AIGFP’s operating loss increased in 2008 compared to 2007 primarily related to its super senior multi-sector
CDO credit default swap portfolio and the effect of credit spreads on the valuation of its assets and liabilities. The
2008 net operating loss was driven by the extreme market conditions experienced during the year and the effects of
downgrades of AIG’s credit ratings by the rating agencies. The net operating results were also affected by internal
efforts during the first half of 2008 intended to preserve liquidity. As a result of AIG’s intention to refocus on its core
business, AIGFP began unwinding its businesses and portfolios. For a further discussion, see Overview —
Outlook — Financial Services.
AIG recognized an unrealized market valuation loss of $28.6 billion in 2008 compared to $11.5 billion in 2007,
representing the change in fair value of its super senior credit default swap portfolio. The principal components of
the loss recognized in 2008 were as follows:
• Approximately $25.7 billion relates to derivatives written on the super senior tranches of multi-sector CDOs.
The material decline in the fair value of these derivatives was caused by significant deterioration in the
pricing and credit quality of RMBS, CMBS and CDO securities. Included in this amount is a loss of
$4.3 billion with respect to the change in fair value of transactions outstanding at December 31, 2008 having
a net notional amount of $12.6 billion. Also included in the unrealized market valuation losses on AIGFP’s
super senior credit default swap portfolio are losses of approximately $995 million that were subsequently
realized through payments to counterparties to acquire at par value the underlying CDO securities with fair
values that were less than par. Specifically, during the second quarter of 2008, AIGFP issued new maturity-
shortening puts that allow the holders of the securities issued by certain CDOs to treat the securities as short-
term eligible 2a-7 investments under the Investment Company Act of 1940 (2a-7 Puts), with a net notional
amount of $5.4 billion on the super senior security issued by a CDO of AAA-rated commercial mortgage-
backed securities (CMBS) pursuant to a facility that was entered into in 2005. All of these 2a-7 Puts and
other 2a-7 Puts in AIGFP’s multi-sector CDO super senior credit default swap portfolio with a combined net
notional amount of $9.4 billion were exercised by the counterparties during 2008. In addition, AIGFP
extinguished its obligations with respect to one other credit default swap by purchasing the protected CDO
security at its principal amount outstanding of $162 million. These transactions represent all of the payments
that have been made to counterparties through December 31, 2008 on the super senior credit default swap
portfolio of AIGFP under the settlement provisions of these contracts. AIGFP has not committed to enter
into any new 2a-7 Puts.
Further, included in the unrealized market valuation losses on AIGFP’s super senior credit default swap
portfolio are losses of approximately $21.1 billion that were subsequently realized through the termination
of contracts through the ML III transaction. See Note 5 to the Consolidated Financial Statements.
• Approximately $2.3 billion relates to derivatives written as part of the corporate arbitrage portfolio. The
decline in the fair value of these derivatives was caused by the continued significant widening in corporate
credit spreads.
AIG 2008 Form 10-K 117
American International Group, Inc., and Subsidiaries