AIG 2009 Annual Report Download - page 289

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Collateral
Most of AIGFP’s super senior credit default swaps are subject to collateral posting provisions, which typically are
governed by International Swaps and Derivatives Association, Inc. (ISDA) Master Agreements (Master Agreements)
and related Credit Support Annexes (CSA). These provisions differ among counterparties and asset classes. AIGFP
has received collateral calls from counterparties in respect of certain super senior credit default swaps, of which a
large majority relate to multi-sector CDOs. To a lesser extent, AIGFP has also received collateral calls in respect of
certain super senior credit default swaps entered into by counterparties for regulatory capital relief purposes and in
respect of corporate arbitrage.
The amount of future collateral posting requirements is a function of AIG’s credit ratings, the rating of the
reference obligations and the market value of the relevant reference obligations, with the latter being the most
significant factor. While a high level of correlation exists between the amount of collateral posted and the valuation of
these contracts in respect of the arbitrage portfolio, a similar relationship does not exist with respect to the regulatory
capital portfolio given the nature of how the amount of collateral for these transactions is determined. Given the
severe market disruption, lack of observable data and the uncertainty of future market price movements, AIGFP is
unable to reasonably estimate the amounts of collateral that it may be required to post in the future.
At December 31, 2009 and December 31, 2008, the amount of collateral postings with respect to AIGFP’s super
senior credit default swap portfolio (prior to offsets for other transactions) was $4.6 billion and $8.8 billion,
respectively.
AIGFP Written Single Name Credit Default Swaps
AIGFP has also entered into credit default swap contracts referencing single-name exposures written on corporate,
index, and asset-backed credits, with the intention of earning spread income on credit exposure. Some of these
transactions were entered into as part of a long short strategy allowing AIGFP to earn the net spread between CDS
they wrote and ones they purchased. At December 31, 2009, the net notional amount of these written CDS contracts
was $2.1 billion. AIGFP has hedged these exposures by purchasing offsetting CDS contracts of $526 million in net
notional amount. The net unhedged position of approximately $1.6 billion represents the maximum exposure to loss
on these CDS contracts. The average maturity of the written CDS contracts is 6.5 years. At December 31, 2009, the
fair value of derivative liability (which represents the carrying value) of the portfolio of CDS was $291 million.
Upon a triggering event (e.g., a default) with respect to the underlying credit, AIGFP would normally have the
option to settle the position through an auction process (cash settle) or pay the notional amount of the contract to the
counterparty in exchange for a bond issued by the underlying credit obligor (physical settle).
AIGFP wrote these written CDS contracts under Master Agreements. The majority of these Master Agreements
include CSA, which provide for collateral postings at various ratings and threshold levels. At December 31, 2009,
AIGFP had posted $354 million of collateral under these contracts.
Non-AIGFP Derivatives
AIG and its subsidiaries (other than AIGFP) also use derivatives and other instruments as part of their financial
risk management programs. Interest rate derivatives (such as interest rate swaps) are used to manage interest rate risk
associated with investments in fixed income securities, outstanding medium- and long-term notes, and other interest
rate sensitive assets and liabilities. In addition, foreign exchange derivatives (principally foreign exchange forwards
and options) are used to economically mitigate risk associated with non-U.S. dollar denominated debt, net capital
exposures and foreign exchange transactions. The derivatives are effective economic hedges of the exposures they are
meant to offset.
In addition to hedging activities, AIG also uses derivative instruments with respect to investment operations, which
include, among other things, credit default swaps, and purchasing investments with embedded derivatives, such as
equity linked notes and convertible bonds.
281 AIG 2009 Form 10-K