AIG 2009 Annual Report Download - page 286

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(j) Includes $1.4 billion and $1.5 billion in net notional amount of credit default swaps written on the super senior tranches of CLOs as of
December 31, 2009 and 2008, respectively.
(k) Net of offsetting purchased CDS of $1.5 billion and $2.0 billion in net notional amount at December 31, 2009 and 2008, respectively.
All outstanding CDS transactions for regulatory capital purposes and the majority of the arbitrage portfolio have
cash-settled structures in respect of a basket of reference obligations, where AIGFP’s payment obligations, other than
for posting collateral, may be triggered by payment shortfalls, bankruptcy and certain other events such as write-downs
of the value of underlying assets. For the remainder of the CDS transactions in respect of the arbitrage portfolio,
AIGFP’s payment obligations are triggered by the occurrence of a credit event under a single reference security, and
performance is limited to a single payment by AIGFP in return for physical delivery by the counterparty of the
reference security.
The expected weighted average maturity of AIGFP’s super senior credit derivative portfolios as of December 31,
2009 was 0.6 years for the regulatory capital corporate loan portfolio, 1.8 years for the regulatory capital prime
residential mortgage portfolio, 5.8 years for the regulatory capital other portfolio, 5.5 years for the multi-sector CDO
arbitrage portfolio and 4.2 years for the corporate debt/CLO portfolio.
Regulatory Capital Portfolio
A total of $150.0 billion in net notional amount of AIGFP’s super senior credit default swap portfolio as of
December 31, 2009 represented derivatives written for financial institutions in Europe, for the purpose of providing
regulatory capital relief rather than for arbitrage purposes. In exchange for a periodic fee, the counterparties receive
credit protection with respect to a portfolio of diversified loans they own, thus reducing their minimum capital
requirements. These CDS transactions were structured with early termination rights for counterparties allowing them
to terminate these transactions at no cost to AIGFP at a certain period of time or upon a regulatory event such as the
implementation of Basel II. During 2009, $62.9 billion in net notional amount was terminated or matured at no cost to
AIGFP. Through February 17, 2010, AIGFP had also received a formal termination notice for an additional
$25.6 billion in net notional amount with an effective termination date in 2010.
The regulatory capital relief CDS transactions require cash settlement and, other than for 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.
All of the regulatory capital transactions directly or indirectly reference tranched pools of large numbers of whole
loans that were originated by the financial institution (or its affiliates) receiving the credit protection, rather than
structured securities containing loans originated by other third parties. In the vast majority of transactions, the loans
are intended to be retained by the originating financial institution and in all cases the originating financial institution
is the purchaser of the CDS, either directly or through an intermediary.
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 prime
residential mortgage and corporate loan referenced portfolios at December 31, 2009 was 13.23 percent and
22.76 percent, respectively. The highest level of realized losses to date in any single residential mortgage and
corporate loan pool was 2.40 percent and 0.52 percent, respectively. 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 per-issuer concentration limits. Both types of transactions generally allow some substitution and
replenishment of loans, subject to defined constraints, as older loans mature or are prepaid. These replenishment
rights generally 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.
Given the current performance of the underlying portfolios, the level of subordination and AIGFP’s own
assessment of the credit quality of the underlying portfolio, as well as the risk mitigants inherent in the transaction
AIG 2009 Form 10-K 278