2007 Annual Report - AIG.com
2007 Annual Report - AIG.com
2007 Annual Report - AIG.com
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American International Group, Inc. and Subsidiaries<br />
Management’s Discussion and Analysis of<br />
Financial Condition and Results of Operations Continued<br />
by <strong>AIG</strong>FP for each transaction to provide that the likelihood of any not required to make any payments as part of these terminations<br />
payment obligation by <strong>AIG</strong>FP under each transaction is remote, and in certain cases was paid a fee upon termination. In light of<br />
even in severe recessionary market scenarios. The underwriting this experience to date and after other <strong>com</strong>prehensive analyses,<br />
process for these derivatives included assumptions of severely <strong>AIG</strong> did not recognize an unrealized market valuation adjustment<br />
stressed recessionary market scenarios to minimize the likelihood for this regulatory capital relief portfolio for the year ended<br />
of realized losses under these obligations.<br />
December 31, <strong>2007</strong>. <strong>AIG</strong> will continue to assess the valuation of<br />
In certain cases, the credit risk associated with a designated this portfolio and monitor developments in the marketplace. There<br />
portfolio is tranched into different layers of risk, which are then can be no assurance that <strong>AIG</strong> will not recognize unrealized market<br />
analyzed and rated by the credit rating agencies. Typically, there valuation losses from this portfolio in future periods. In addition<br />
will be an equity layer covering the first credit losses in respect of to writing credit protection on the super senior risk layer on<br />
the portfolio up to a specified percentage of the total portfolio, designated portfolios of loans or debt securities, <strong>AIG</strong>FP also wrote<br />
and then successive layers ranging from generally a BBB-rated protection on tranches below the super senior risk layer. At<br />
layer to one or more AAA-rated layers. In transactions that are December 31, <strong>2007</strong> the notional amount of the credit default<br />
rated with respect to the risk layer or tranche that is immediately swaps in the regulatory capital relief portfolio written on tranches<br />
junior to the threshold level above which <strong>AIG</strong>FP’s payment<br />
below the super senior risk layer was $5.8 billion, with an<br />
obligation would generally arise, a significant majority are rated estimated fair value of $(25) million.<br />
AAA by the rating agencies. In transactions that are not rated,<br />
<strong>AIG</strong>FP has also written credit protection on the super senior<br />
<strong>AIG</strong>FP applies the same risk criteria for setting the threshold level risk layer of diversified portfolios of investment grade corporate<br />
for its payment obligations. Therefore, the risk layer assumed by debt, collateralized loan obligations (CLOs) and multi-sector CDOs.<br />
<strong>AIG</strong>FP with respect to the designated portfolio in these transac- <strong>AIG</strong>FP is at risk only on the super senior portion related to a<br />
tions is often called the ‘‘super senior’’ risk layer, defined as the diversified portfolio referenced to loans or debt securities. The<br />
layer of credit risk senior to a risk layer that has been rated AAA super senior risk portion is the last tranche to suffer losses after<br />
by the credit rating agencies, or if the transaction is not rated, significant subordination. Credit losses would have to erode all<br />
equivalent thereto.<br />
tranches junior to the super senior tranche before <strong>AIG</strong>FP would<br />
suffer any realized losses. The subordination level required for<br />
At December 31, <strong>2007</strong> the notional amounts and unrealized market<br />
each transaction is determined based on internal modeling and<br />
valuation loss of the super senior credit default swap portfolio by<br />
analysis of the pool of underlying assets and is not dependent on<br />
asset classes were as follows:<br />
ratings determined by the rating agencies. While the credit default<br />
Notional Unrealized Market swaps written on corporate debt obligations are cash settled, the<br />
Amount Valuation Loss majority of the credit default swaps written on CDOs and CLOs<br />
(in billions)<br />
(in millions)<br />
require physical settlement. Under a physical settlement arrange-<br />
Corporate loans (a) $230 $ — ment, <strong>AIG</strong>FP would be required to purchase the referenced super<br />
Prime residential mortgages (a) 149 — senior security at par in the event of a non-payment on that<br />
Corporate Debt/CLOs 70 226<br />
security.<br />
Multi-sector CDO (b) 78 11,246<br />
Certain of these credit derivatives are subject to collateral<br />
Total $527 $11,472 posting provisions. These provisions differ among counterparties<br />
(a) Predominantly represent transactions written to facilitate regulatory and asset classes. In the case of most of the multi-sector CDO<br />
capital relief.<br />
transactions, the amount of collateral required is determined<br />
(b) Approximately $61.4 billion in notional amount of the multi-sector CDO<br />
based on the change in value of the underlying cash security that<br />
pools include some exposure to U.S. subprime mortgages.<br />
represents the super senior risk layer subject to credit protection,<br />
Approximately $379 billion (consisting of the corporate loans<br />
and not the change in value of the super senior credit derivative.<br />
and prime residential mortgages) of the $527 billion in notional<br />
<strong>AIG</strong>FP is indirectly exposed to U.S. residential mortgage<br />
exposure of <strong>AIG</strong>FP’s super senior credit default swap portfolio as<br />
subprime collateral in the CDO portfolios, the majority of which is<br />
of December 31, <strong>2007</strong> represents derivatives written for financial<br />
from 2004 and 2005 vintages. However, certain of the CDOs on<br />
institutions, principally in Europe, for the purpose of providing<br />
which <strong>AIG</strong>FP provided credit protection permit the collateral<br />
them with regulatory capital relief rather than risk mitigation. In<br />
manager to substitute collateral during the reinvestment period,<br />
exchange for a minimum guaranteed fee, the counterparties<br />
subject to certain restrictions. As a result, in certain transactions,<br />
receive credit protection in respect of diversified loan portfolios<br />
U.S. residential mortgage subprime collateral of 2006 and <strong>2007</strong><br />
they own, thus improving their regulatory capital position. These<br />
vintages has been added to the collateral pools. At December 31,<br />
derivatives are generally expected to terminate at no additional<br />
<strong>2007</strong>, U.S. residential mortgage subprime collateral of 2006 and<br />
cost to the counterparty upon the counterparty’s adoption of<br />
<strong>2007</strong> vintages <strong>com</strong>prised approximately 4.9 percent of the total<br />
models <strong>com</strong>pliant with the Basel II Accord. <strong>AIG</strong> expects that the<br />
collateral pools underlying the entire portfolio of CDOs with credit<br />
majority of these transactions will be terminated within the next<br />
protection.<br />
12 to 18 months by <strong>AIG</strong>FP’s counterparties as they implement<br />
<strong>AIG</strong>FP has written 2a-7 Puts in connection with certain multimodels<br />
<strong>com</strong>pliant with the new Basel II Accord. As of Februsector<br />
CDOs that allow the holders of the securities to treat the<br />
ary 26, 2008, $54 billion in notional exposures have either been<br />
securities as eligible short-term 2a-7 investments under the<br />
terminated or are in the process of being terminated. <strong>AIG</strong>FP was<br />
122 <strong>AIG</strong> <strong>2007</strong> Form 10-K