AIG 2010 Annual Report Download - page 312

American International Group, Inc., and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Given the current performance of the underlying portfolios, the level of subordination and AIGFP’s own
assessment of the credit quality of the underlying portfolio, as well as the risk mitigants inherent in the transaction
structures, AIGFP does not expect that it will be required to make payments pursuant to the contractual terms of
those transactions providing regulatory relief.
Arbitrage Portfolio
The arbitrage portfolio includes 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 portfolio at December 31, 2010 was written on CDO transactions (including
synthetic CDOs) that generally held a concentration of RMBS, CMBS and inner CDO securities. At
December 31, 2010, approximately $3.2 billion net notional amount (fair value liability of $1.9 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. As of December 31, 2010, only one
transaction, with a net notional amount of $389 million, has breached its attachment point. AIGFP has paid a
total of $69 million on this trade all of which was paid in 2010. 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
December 31, 2009, there were $1.6 billion of net notional amount of 2a-7 Puts issued by AIGFP outstanding.
During 2010, AIGFP terminated all 2a-7 Puts in respect of notes held by holders other than AIGFP and its
affiliates. AIGFP is not a party to any commitments to issue any additional 2a-7 Puts.
The corporate arbitrage portfolio consists principally of CDS transactions written on portfolios of senior
unsecured corporate obligations that were generally rated investment grade at inception of the CDS. These CDS
transactions require cash settlement. Also, included in this portfolio are CDS transactions with a net notional
amount of $1.3 billion written on the senior part of the capital structure of CLOs, which require physical
settlement.
Certain of the super senior credit default swaps provide the counterparties with an additional termination right
if AIG’s rating level falls to BBB or Baa2. At that level, counterparties to the CDS transactions with a net
notional amount of $1.6 billion at December 31, 2010 have the right to terminate the transactions early. If
counterparties exercise this right, the contracts provide for the counterparties to be compensated for the cost to
replace the transactions, or an amount reasonably determined in good faith to estimate the losses the
counterparties would incur as a result of the termination of the transactions.
Because of long-term maturities of the CDS in the arbitrage portfolio, AIG is unable to make reasonable
estimates of the periods during which any payments would be made. However, the net notional amount represents
the maximum exposure to loss on the super senior credit default swap portfolio.
296 AIG 2010 Form 10-K