AIG 2010 Annual Report Download - page 190

19FEB201106485929
American International Group, Inc., and Subsidiaries
General Contractual Terms
AIGFP entered into CDS transactions in the ordinary course of its business. In the majority of AIGFP’s credit
derivative transactions, AIGFP sold credit protection on a designated portfolio of loans or debt securities.
Generally, AIGFP provides such credit protection on a ‘‘second loss’’ basis, meaning that AIGFP will incur credit
losses only after a shortfall of principal and/or interest, or other credit events, in respect of the protected loans
and debt securities, exceeds a specified threshold amount or level of ‘‘first loss.’’
Typically, the credit risk associated with a designated portfolio of loans or debt securities has been tranched into
different layers of risk, which are then analyzed and rated by the credit rating agencies. At origination, there is
usually an equity layer covering the first credit losses in respect of the portfolio up to a specified percentage of
the total portfolio, and then successive layers ranging generally from a BBB-rated layer to one or more
AAA-rated layers. A significant majority of transactions that are rated by rating agencies have risk layers or
tranches that were rated AAA at origination and are immediately junior to the threshold level at which AIGFP’s
payment obligation would generally arise. In transactions that were not rated, AIGFP applied equivalent risk
criteria for setting the threshold level for its payment obligations. Therefore, the risk layer assumed by AIGFP
with respect to the designated portfolio of loans or debt securities in these transactions is often called the ‘‘super
senior’’ risk layer, defined as a layer of credit risk senior to one or more risk layers that have been rated AAA by
the credit rating agencies, or if the transaction is not rated, structured as the equivalent thereto.
The following graphic represents a typical structure of a transaction including the super senior risk layer:
Underlying Asset
Types SPE or Bank CDS Trade
Regulatory Capital
Gross
Transaction
Notional
Net
Notional
Subordination
AIGFP
Attachment
Point
“Super
Senior”
Risk
Layer or
Reference
Obligation
AIG
FP
AAA
AA
A
BBB
Equity
Multi-sector CDOs
Corporate Arbitrage
Prime Residental
Mortgages
Corporate Loans
RMBS Security
CMBS Security
CDO Security
Other Security
Corporate Debt
CLOs
Regulatory Capital Portfolio
During 2010, $84.1 billion in net notional amount of regulatory capital CDSs were terminated or matured at no
cost to AIGFP. Through February 16, 2011, AIGFP had also received termination notices with respect to an
additional $1.4 billion in net notional amount with an effective termination date in 2011. AIGFP continues to
reassess the expected maturity of this portfolio. As of December 31, 2010, AIGFP estimated that the weighted
average expected maturity of the portfolio was 3.16 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 was generally derived from Basel I. In December 2010, the Basel Committee on Banking
Supervision finalized Basel III, which, when fully implemented, may reduce or eliminate the regulatory benefits to
certain counterparties for these transactions, and this may reduce the period of time that such counterparties are
expected to hold the positions. In prior years, it had been expected that financial institution counterparties would
174 AIG 2010 Form 10-K