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The trades involve a type of credit default swap contract that is not included in the $150 billion federal bailout plan that is designed, in part, to enable AIG (NYSE: AIG | Quote | Chart | News | PowerRating) to greatly reduce its CDS debt exposure by purchasing the underlying collateralized debt obligation securities and canceling the contracts.
?This is a section of the $71.6 billion multisector credit default swap portfolio that provides credit protection on synthetic securities rather than physical, actual CDOs,? said AIG spokesman Joe Norton. ?They are derivatives. There is no underlying security to buy, as with the other CDS contracts. That?s the conundrum.?
However, AIG took issue with an article in the Wall Street Journal, which initially reported about debt, which the company said in a statement ?incorrectly reports that AIG has a previously undisclosed obligation to counterparties of about $10 billion.?
?The $9.8 billion notional amount does not represent a loss to AIG or a debt it owes to counterparties,? the statement said. ?It represents the notional value of the maximum potential cash settlement portion of the multisector portfolio.?
Norton said the $9.8 billion in CDS contracts has been consistently included in the $71.6 billion multisector CDS portfolio. He said it was referenced under ?cash settlements? on page 117 of the third-quarter earnings statement filed with the U.S. Securities and Exchange Commission.
?This is not a new $10 billion loss,? Norton said.
He said the contracts are called cash settlement, or ?pay as you go,? because losses are paid in cash when incurred. AIG pays only on the loss amount, he said, as opposed to ?physical settlement? swap contracts, which require AIG to buy the total underlying CDO tranche in an amount equal to AIG?s full notional exposure.
AIG has canceled more than $46.1 billion of its credit default swap exposures, using the recently established public-private facility funded in part by the Federal Reserve under terms of the insurance giant's recently revised $150 billion federal loan package to keep the company solvent (BestWire, Dec. 3, 2008).
Most insurance subsidiaries of AIG have a current Best's Financial Strength Rating of A (Excellent) with a negative outlook.
Shares of AIG were selling at $1.75 in afternoon trading on Dec. 10, down 9.33% from the previous close.
(By Alyn Ackermann, senior associate editor, BestWeek: Alyn.Ackermann@ambest.com)
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