AIG 2010 Annual Report Download - page 191

American International Group, Inc., and Subsidiaries
complete a transition from Basel I to an intermediate standard known as ‘‘Basel II,’’ which could have had similar
effects on the benefits of these transactions, at the end of 2009. Basel III has now superseded Basel II, but the
details of its implementation by the various European Central Banking districts have not been finalized. 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.
The weighted average expected maturity of the Regulatory Capital Portfolio increased as of December 31, 2010
by approximately 1.8 years from December 31, 2009 due to certain counterparties not terminating transactions
with a combined net notional amount of $6.0 billion. Where these counterparties continue to have a right to
terminate the transaction early, AIGFP has extended the expected maturity dates by one year, which is based on
how long AIGFP believes the relevant rules under Basel I will remain effective. Where the counterparties no
longer have the right to terminate early, AIGFP has used the weighted average life of those transactions as their
expected maturity. These counterparties in the Corporate Loan and Prime Residential Mortgage portfolios
continue to receive favorable regulatory capital benefits under Basel I rules and, thus, AIG continues to categorize
them as Regulatory Capital transactions.
Included in the Regulatory Capital portfolio are transactions with one counterparty that notified AIG that it
would not terminate early two of its Prime Residential Mortgage transactions and a related mezzanine transaction
with a combined net notional amount of $24.3 billion that were expected to be terminated in the first quarter of
2010. With respect to these 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 contractual maturity. Since the two transactions have weighted average lives that are considerably less
than their final contractual maturities, there is value to AIGFP representing counterparty contractual fees to be
received beyond the date at which the net notional amounts have fully amortized through to the final contractual
maturity date. The fair value of these two super senior transactions as of December 31, 2010 was a derivative asset
of $190 million. With respect to these two transactions, AIGFP has also written CDS transactions on the
mezzanine tranches of these portfolios; however, the majority of the transactions on the mezzanine tranches were
hedged by AIGFP with other third-party CDS transactions. In October 2008, following a credit ratings agency
downgrade of AIG, AIGFP entered into a CSA to the agreements governing the transactions with this
counterparty that requires AIGFP to post collateral. The CSA provides that one of two methodologies will be
used for determining the amount of collateral to be posted. The same methodology has been used throughout the
term of the CSA, and, at December 31, 2010, AIGFP had posted approximately $217 million of collateral. The
counterparty has provided quotations from two dealers that it contends support using the second methodology,
and contends that a total amount of Euro 1.4 billion (approximately $1.9 billion) should be posted by AIGFP or,
in the alternative, that the parties approach market participants jointly to obtain qualifying quotations. AIGFP
continues to believe that the methodology currently being used is the correct one for computing collateral, that it
has posted the amount of collateral required under the CSA, that the counterparty has not provided qualifying
quotations and that the methodology the counterparty has used for calculating the amount of collateral to be
posted is not valid.
In light of early termination experience to date and after analyses of other market data, to the extent deemed
relevant and available, AIG determined that there was no unrealized market valuation adjustment for any of the
transactions in this regulatory capital relief portfolio for 2010 other than (1) for transactions where AIGFP
believes the counterparty is no longer using the transaction to obtain regulatory capital relief as discussed above
and (2) for transactions where the counterparty has failed to terminate the transaction early as expected and no
longer has any rights to terminate early in the future. Although AIGFP believes the value of contractual fees
receivable on these transactions through maturity exceeds the economic benefits of any potential payments to the
counterparties, the counterparties’ early termination rights, and AIGFP’s expectation that such rights will be
exercised, preclude the recognition of a derivative asset for these transactions.
AIG 2010 Form 10-K 175