AIG 2009 Annual Report Download - page 287

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
structures, AIGFP does not expect that it will be required to make payments pursuant to the contractual terms of
those transactions providing regulatory relief. AIGFP continues to reassess the expected maturity of this portfolio. As
of December 31, 2009, AIGFP estimated that the weighted average expected maturity of the portfolio was 1.35 years.
AIGFP has not been required to make any payments as part of terminations initiated by counterparties. The
regulatory benefit of these transactions for AIGFP’s financial institution counterparties is generally derived from the
terms of Basel I that existed through the end of 2007 and which is in the process of being replaced by Basel II. It was
expected that financial institution counterparties would have transitioned from Basel I to Basel II by the end of the
two-year adoption period on December 31, 2009, after which they would have received little or no additional
regulatory benefit from these CDS transactions, except in a small number of specific instances. However, the Basel
Committee recently announced that it has agreed to keep in place the Basel I capital floors beyond the end of 2009,
although it remains to be seen how this extension will be implemented by the various European Central Banking
districts. Should certain counterparties continue to receive favorable regulatory capital benefits from these
transactions, those counterparties may not exercise their options to terminate the transactions in the expected time
frame.
Arbitrage Portfolio
A total of $30.0 billion and $63.1 billion in net notional amount of AIGFP’s super senior credit default swaps as of
December 31, 2009 and 2008, respectively, are arbitrage-motivated transactions written on multi-sector CDOs or
designated pools of investment grade senior unsecured corporate debt or CLOs.
The outstanding multi-sector CDO CDS portfolio at December 31, 2009 was written on CDO transactions that
generally held a concentration of RMBS, CMBS and inner CDO securities. At December 31, 2009, approximately
$3.8 billion net notional amount (fair value liability of $2.4 billion) of this portfolio was written on super senior multi-
sector CDOs that contain some level of sub-prime RMBS collateral, with a concentration in the 2005 and earlier
vintages of sub-prime RMBS. AIGFP’s portfolio also included both high grade and mezzanine CDOs.
The majority of multi-sector CDO CDS transactions require cash settlement and, other than for collateral posting,
AIGFP is required to make a payment in connection with such transactions only if realized credit losses in respect of
the underlying portfolio exceed AIGFP’s attachment point. In the remainder of the 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.
Included in the multi-sector CDO portfolio are 2a-7 Puts. Holders of securities are required, in certain
circumstances, to tender their securities to the issuer at par. If an issuer’s remarketing agent is unable to resell the
securities so tendered, AIGFP must purchase the securities at par so long as the security has not experienced a
payment default or certain bankruptcy events with respect to the issuer of such security have not occurred.
At January 1, 2008, 2a-7 Puts with a net notional amount of $6.5 billion were outstanding and included as part of
the multi-sector CDO portfolio. During 2008, AIGFP issued new 2a-7 Puts with a net notional amount of $5.4 billion
on the super senior security issued by a CDO of AAA-rated CMBS pursuant to a facility that was entered into in 2005.
At December 31, 2009 and December 31, 2008, there were $1.6 billion and $1.7 billion net notional amount of 2a-7
Puts issued by AIGFP outstanding. AIGFP is not a party to any commitments to issue any additional 2a-7 Puts.
During 2008, AIGFP repurchased multi-sector CDO securities with a principal amount of $9.4 billion in connection
with these obligations, of which $8.0 billion was funded using existing liquidity arrangements. In connection with the
ML III transaction, ML III purchased $8.5 billion of multi-sector CDOs underlying 2a-7 Puts written by AIGFP. A
portion of the net payment made by ML III to the counterparties for the purchase of the multi-sector CDOs
facilitated the resolution of liquidity arrangements, which had funded certain of the multi-sector CDOs in connection
with the 2a-7 Puts.
Among the multi-sector CDOs purchased by ML III are certain CDO securities with a net notional amount of
$1.7 billion for which the related 2a-7 Puts to AIGFP remained outstanding as of December 31, 2008, of which
279 AIG 2009 Form 10-K