AIG 2008 Annual Report Download - page 140

Given the prospect of Basel II, the CDS transactions were structured with early termination rights for
counterparties following a regulatory event such as the implementation of Basel II. The pace at which the CDS
transactions were and will be terminated early varies among the counterparties based on a number of factors
including their progress in having the internal capital models approved by their national regulator, the effect of the
transitional floor on overall total capital charges, the counterparties’ capital needs and their sensitivity to Basel I
capital measures. AIG expects that the counterparties in the remaining CDS transactions will terminate the vast
majority of transactions with AIGFP during this transition period within the next 15 months.
When a counterparty elects to terminate a transaction early pursuant to the terms of the contracts, the early
termination is at no cost to AIGFP. The counterparty may be required to pay the remaining balance of an
agreed-upon minimum fee to AIGFP. Typically, the minimum guaranteed fee on recent transactions is equal to the
fees due to AIGFP through the first call date (which is the first date on which a counterparty can terminate the
transaction at no cost). During 2008, $99.7 billion in net notional amount was terminated or matured. Through
February 18, 2009, AIGFP has also received formal termination notices for an additional $26.5 billion in net
notional amount with effective termination dates in 2009.
The regulatory capital relief CDS transactions require cash settlement and, other than collateral posting,
AIGFP is required to make a payment in connection with a regulatory capital relief transaction only if realized
credit losses in respect of the underlying portfolio exceed AIGFP’s attachment point (see Triggers and Settlement
Alternatives below).
The super senior tranches of these CDS transactions continue to be supported by high levels of subordination,
which, in most instances, have increased since origination. The weighted average subordination supporting the
European residential mortgage and corporate loan referenced portfolios at December 31, 2008 was 12.7 percent and
18.3 percent, respectively. Delinquencies, defaults and realized losses for both types of referenced portfolios have
been modest to date. Substantially all of the underlying assets are not rated by one of the principal rating agencies.
The highest level of realized losses to date in any single residential mortgage and corporate loan pool was
2.1 percent and 0.42 percent, respectively. The European residential mortgage portfolios are each comprised of
thousands of seasoned, prime, full documentation, mostly first lien, owner-occupied mortgages originated largely at
bank retail branches at modest loan-to-value (LTV) ratios, except for one $1.6 billion high LTV CDS transaction,
which benefits from both subordination and a significant percentage of pool mortgage insurance. The corporate
loan transactions are each comprised of several hundred secured and unsecured loans diversified by industry and, in
some instances, by country, and have tight per-issuer concentration limits. Both types of transactions generally
allow some substitution and replenishment of loans, subject to tightly defined constraints, as older loans mature or
are prepaid. These replenishment rights usually mature within the first few years of the trade, after which the
proceeds of any prepaid or maturing loans are applied first to the super senior tranche (sequentially), thereby
increasing the relative level of subordination supporting the balance of AIGFP’s super senior CDS exposure.
134 AIG 2008 Form 10-K
American International Group, Inc., and Subsidiaries