- They write extremely risk-remote super senior or AAA-plus credit protection on highly-diversified pools of assets, some of which include residential mortgages.
- They are cash investors in highly-rated securities where some portion of the underlying collateral, which may include collateral from many sectors, includes residential mortgages. While both of these activities involve significant notional exposure, the risk undertaken is very modest and remote, and has been structured and managed effectively.

AIGFP has been running a successful business of writing super senior credit default swap, or CDS protection, since 1998. As of June 30 this year, they had a total net CDS exposure across all asset classes of $465 billion. The super senior portion is the least likely to incur any losses in these deals, since losses are allocated on a sequential basis from lowest to highest quality. Before AIGFP would be at risk for its first dollar of loss, these structures would have to experience exceptional losses that eroded all of the tranches below the super senior level, including a very significant AAA layer of protection.

AIGFP''s entire super senior book covers many different classes, with the bulk of it in corporate loans totaling $258 billion. It also includes $128 billion of exposure to prime mortgages, none of which represent US residential exposure. The balance of $79 billion relates to multi-sector CDOs that FP helped to structure. These multi-sector CDOs consist of very diverse pools of reference securities, some of which are exposed to US sub-prime RMBS collateral. Of this $79 billion, $15 billion has no US sub-prime RMBS exposure, and $64 billion has some collateral that represents US sub-prime RMBS exposure.

The $64 billion of super senior CDO exposure that has some degree of US sub-prime collateral is split among 103 different deals. 45 of these deals, totaling $45 billion of net exposure, consist of multi-sector collateral defined as high grade and being predominantly AAA and AA by virtue of a subordination embedded in each individual underlying security. The average attachment point in these deals is well in excess of the regular AAA attachment point. On average, it is around 16%, with a large part of the subordination, 44% on average, being itself AAA. The firm’s notional net exposure to all of the highly-rated sub-prime collateral after deductible subordination is $17.5 billion. The remaining $19.4 billion of net super senior exposure is spread across 58 deals where the multi-sector collateral is predominantly mezzanine, such as BBB securities, again by virtue of its subordination in each and every individual obligation. The attachment point on these deals is structured to be significantly out of the money, at an average of 36%.

Given the diligence employed in selecting and structuring these deals, none of the AIGFP deals have experienced any significant collateral deterioration. There are only three deals out of the entire 103 multi-sector CDOs transactions that have experienced any negative rating actions on any tranches subordinate to AIGFP''s position. These three deals are rapidly amortizing and make up less than 0.5% of the CDO exposure, totaling $296 million.

The $3.6 billion of multi-sector cash CDO securities, the second source of US residential mortgage exposure at AIGFP, is virtually all AAA rated. Further, the total exposure to all sub-prime collateral originated in 2006 and 2007 is only $10 million.

Key questions and answers from the second quarter fiscal 2007 earnings call conducted by American International Group Inc. on August 9, 2007.

Josh Shanker (Citigroup): Is there any slowing of business generation in AIG Financial Products, as there might be less buyers for the less subordinated tranches?

Andy Foster: In terms of whether we are going to be slowing down our business, the CDOs and writing protection on those, that basically stopped completely back at the end of 2005, when we stopped taking sub-prime as collateral, given the increasing percentage in all the CDOs, that meant that we were effectively ruled out of that market. Yes, that part of our business is effectively stopped.

Joe Cassano: Obviously with the last four weeks of market volatility here, we are not seeing new portfolios of other assets to write, right now. There has been a bit of a slowdown in the flow within the credit business. The Financial Products platform is fairly diverse, and we still see good flows in our equity business, our commodities business, our currencies and rates businesses.

Josh Shanker: Has AIG corporate been a purchaser of any of the less subordinated tranches from AIG Financial Products?

Joe Cassano: If it did happen, it happened coincidentally and it may have been very small. We don’t work in a coordinated fashion with the parent in terms of the super senior portfolios that we have been writing protection on. If it happened, it has to be a de minimus one-off kind of thing.

Josh Shanker: Given some of the ratios that we have seen for 2Q 2007, which have looked good in American General, should we be concerned about what 3Q 2007''s ratios are going to be looking like?

Rick Geissinger: Our credit quality statistics for the end of the second quarter are strong. We set target ranges back in 1996, and we are well below those for delinquency. The target range was 3% to 4%. Charge-off range was 0.75% to 1.25%. But we are well below those target ranges within which we can operate the business at a 15% after-tax ROE or better.

If you look at historical seasonality, delinquency and charge-offs get a little worse every year in the third and fourth quarter. You can expect to see those numbers be a little bit higher. We do have July results, and the change in delinquency and charge-offs is slightly up, but de minimus.

Andrew Kligerman (UBS): The partnership income was phenomenally strong this quarter. At this point in time, how the performance would be if the quarter stopped right now?

Rick Geissinger: It would be a little difficult to tell you exactly what it would look like if the quarter stopped right now. We have said repeatedly that we expect our partnership portfolio, including our hedge fund portfolio, to yield somewhere between 10% and 15% a quarter on a long-term basis. We have been significantly north of that for the last six quarters. The last five quarters anyway.

Andrew Kligerman: On Japan, could you provide an update on the regulatory environment that was mentioned in the press release and how that might affect the Japan sales going forward?

Bob Clyde: The regulatory environment is still strict. The claims reviews that we have been going through have been public information and that has put a little bit of pressure on sales for the industry. This is an industry wide issue. In first quarter, the FSA undertook an industry wide claims review covering claims for the periods of 2001 to 2005; and required us to submit our results to the FSA on April 13. At the first quarter, we reserved for our best estimate exposure for additional claims resulting from this review and subsequent follow-up with our claimants. We have had charges for additional claims and reserves in the second quarter.

Andrew Kligerman: Are the Japan sales going to tick up again now or do you still think there will still be pressure for a while?