AIG 2009 Annual Report Download - page 122

American International Group, Inc., and Subsidiaries
the first half of 2008 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 Executive Overview — 2010 Business Outlook —
Financial Services — Capital Markets.
AIGFP recognized an unrealized market valuation gain of $1.4 billion in 2009 compared to an unrealized market
valuation loss of $28.6 billion in 2008, representing the change in fair value of its super senior credit default swap
portfolio. The principal components of the valuation gains and losses recognized were as follows:
• AIGFP recognized an unrealized market valuation gain of $1.9 billion in 2009 with respect to CDS transactions
in the corporate arbitrage portfolio, compared to an unrealized market valuation loss of $2.3 billion in 2008.
During 2009, the valuation of these contracts benefited from the narrowing of corporate credit spreads, while
these spreads widened dramatically during 2008.
• AIGFP recognized an unrealized market valuation loss of $669 million in 2009 with respect to CDS transactions
written on multi-sector CDOs, compared to unrealized market valuation losses of $25.7 billion in 2008. The
decrease in the unrealized market valuation loss on this portfolio was largely due to the substantial decline in
outstanding net notional amount resulting from the termination of CDS contracts in the fourth quarter of 2008
in connection with the ML III transaction.
• During the fourth quarter of 2009, one counterparty notified AIG that it will not terminate early two of its prime
residential mortgage transactions. With respect to these two transactions, the counterparty no longer has any
rights to terminate the transactions early and is required to pay AIG fees on the original notional amounts
reduced only by realized losses through the final maturity. Because these two transactions have weighted
average lives that are considerably less than their final legal maturities, there is value to AIG due to the
counterparty paying its contractual fees beyond the date at which the net notional amounts have fully amortized
through the final legal maturity date. As a result, an unrealized market valuation gain of $137 million was
recorded in 2009. This gain was partially offset by losses on the mezzanine tranches of those same transactions.
See Critical Accounting Estimates — Level 3 Assets and Liabilities — Valuation of Level 3 Assets and Liabilities
for a discussion of AIGFP’s super senior credit default swap portfolio.
During 2009, AIGFP:
• recognized a gain of $240 million on credit default swap contracts referencing single-name exposures written on
corporate, index and asset backed credits which are not included in the super senior credit default swap
portfolio, compared to a net loss of $888 million in 2008;
• incurred an additional charge of $198 million related to a transaction entered into in 2002 whereby AIGFP
guaranteed obligations under leases of office space from a counterparty; and
• incurred interest charges of $2.7 billion compared to $1.4 billion in 2008 relating to intercompany borrowings
with AIG that are eliminated in consolidation.
Historically, the most significant component of Capital Markets operating expenses was compensation. For 2009,
compensation expense was approximately $98 million, or 19 percent of operating expenses. In addition, AIGFP
recognized $153 million in expenses related to pre-existing retention plans and related asset impairment and other
expenses. Due to the significant losses recognized by AIGFP during 2008, the entire amount of $563 million accrued
under AIGFP’s various deferred compensation plans and special incentive plan was reversed in 2008. Total
compensation expense in 2008 was $426 million including retention awards.
2008 and 2007 Comparison
AIGFP’s pre-tax loss increased significantly 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 pre-tax loss was driven by the extreme market conditions experienced during 2008 and the effects of
downgrades of AIG’s credit ratings by the rating agencies.
AIG 2009 Form 10-K 114