AIG 2010 Annual Report Download - page 311

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The expected weighted average maturity of AIGFP’s super senior credit derivative portfolios as of
December 31, 2010 was 1.2 years for the regulatory capital corporate loan portfolio, 3.5 years for the regulatory
capital prime residential mortgage portfolio, 4.8 years for the regulatory capital other portfolio, 6.2 years for the
multi-sector CDO arbitrage portfolio and 5.0 years for the corporate debt/CLO portfolio.
Regulatory Capital Portfolio
The regulatory capital portfolio represents 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 certain changes to regulatory capital standards. During 2010, $84.1 billion in net
notional amount was terminated or matured at no cost to AIGFP. Through February 16, 2011, AIGFP had also
received termination notices for an additional $1.4 billion in net notional amount with effective termination dates
in 2011.
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, 2010 was 14.31 percent and
27.70 percent, respectively. The highest realized losses to date in any single residential mortgage and corporate
loan pool were 2.61 percent and 0.52 percent, respectively. Each of the corporate loan transactions consists 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
expire 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.
The regulatory benefit of these transactions for AIGFP’s financial institution counterparties are generally
derived from the capital regulations promulgated by the Basel Committee on Banking Supervision known as Basel
I. In December 2010, the Basel Committee on Banking Supervision finalized a new framework for international
capital and liquidity standards known as Basel III, which, when fully implemented, may reduce or eliminate the
regulatory benefits to certain counterparties from these transactions and thus may impact 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 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. 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.
AIG 2010 Form 10-K 295