Operating income in the core external assets management business was negatively effected by lower carried interest and the timing of real estate related gains. Comparisons with the second quarter were also unfavorable due to a $398 million gain in the second quarter of ''07 related to the sale of a portion of AIG''s holdings in the Black Sound Group''s IPL.
AIGFP recorded a further $5.6 billion pre-tax, unrealized market valuation loss on its super senior credit default swap portfolio, bringing the cumulative valuation loss on this business to $25.9 billion. The preponderance of that amount toward $24.8 billion pertains to the credit default swap portfolio covering multi-sector CDO. The primary drivers of the write down were declines in market prices for Alt A and sub-prime RMBS collateral and rating agency actions taken in the quarter. Based on the cumulative loss to-date, the portfolio is now marked to an average of about $0.69 on the dollar. For those CDOs containing sub-prime collateral the average mark is now $0.66 for high grade deals and $0.56 for mezzanine transactions.
The total super senior portfolio declined by a net $28.5 billion in the quarter to $441 billion.
This reduction results from $5.9 billion in amortizations across the portfolio and $22.6 billion in early terminations in the regulatory capital relief book. Included in the net decrease was an increase in exposure due to honoring an existing commitment to conclude a $5.4 billion dollar transaction in the multi-sector CDO portfolio. With regards to the regulatory capital portfolio, there continues to be no market value adjustments for the vast preponderance of that book.
The early terminations of transactions by counter parties at no cost to AIGFP provide the most important information supporting the company’s conclusion that these transactions are motivated by regulatory capital release and not by transferring risk on the underlying portfolios.
There was one European RMBS regulatory capital relief transaction with a notional amount of $1.6 billion that was not terminated as expected. This transaction has specific features not found in the remainder of the regulatory capital book. The company took a mark on that transaction in the second quarter of $125 million.
The company has not yet incurred any realized credit losses in the portfolio.
Further the level of defaulted assets in the underlying collateral of CDOs is very low compared, to the weighted average attachment points in those structures. AIG continues to refine its analytical methodologies to produce stress test scenario of potential ultimate realized credit losses in the portfolio. In the first quarter the company introduced the roll rate analysis to develop estimates of potential ultimate loss. Applying this methodology last quarter resulted in an estimate of potential credit losses of $2.4 billion.
In the second quarter, AIG has introduced enhancements for the model methodology.
The company now includes prime RMBS in the portfolio of securities subjected to the roll rate analysis, and has introduced analytics to capture the potential effects, both positive and negative, of the cash flow waterfall.
The potential realized credit losses resulting from the two scenarios with produced losses of $5 billion and $8.5 billion, respectively.
To put the $8.5 billion scenario into perspective, if the company looks at the assumptions used regarding sub-prime mortgages, which represent a significant component of the collateral, the scenario assumes that currently delinquent mortgages will default at percentages approaching 96%. The net recoveries upon foreclosure will only be $0.28 on the dollar compared to average nationwide recoveries currently of about $0.50 on the dollar.
The collateral pools underlying the CDOs contain other classes of RMBS and other securities of various vintages, which are also incorporated in the model.
The potential ultimate credit losses, which may be incurred from the portfolio, are substantially less than the 24.8 billion of fair valuation losses AIG recorded to-date.
The net decline for the second quarter of $2.6 billion is principally driven by declines in market prices on foreign investments held in Japan, Taiwan, Thailand and other Asian countries due to rising interest rates. Such movements in interest rates result in a decline in shareholders equity.
The economic effects are quite positive for the fundamental performance of the business.
Because AIG doesn''t mark the liabilities to fair value, rising interest rates are not reflected in the evaluation of the corresponding liabilities under current accounting standards.
Within the insurance investment portfolios, the total exposure to RMBS at amortized cost is $77.5 billion and has declined by a net $4.8 billion in the quarter, primarily as a result of payments of principle and charge-off taken rather than temporary impairment charges. The only purchases have been of agency pass-through certificates.
The difference in the company’s holdings of $87.8 billion at par value and the $77.5 billion that amortized costs, represent the other than temporary impairment charges already taken against these securities. Of the OTTI charges taken year-to-date, 87% of them represent severity charges.
The underlying securities have retained their investment grade ratings, and virtually all are paying principle and interest.
|
