American International Group (AIG)

 

AIG’s securities lending program historically operated as centrally managed by AIG Investments for the benefit of certain of AIG’s insurance companies. Under this program, securities were loaned to various financial institutions, primarily major banks and brokerage firms. Cash collateral was received and was invested in fixed maturity securities to earn a net spread. The amount of cash advanced by borrowers declined in 2008 due in part to the availability of alternative transactions requiring less collateral. During the fourth quarter of 2008, in connection with certain securities lending transactions, AIG met the requirements of sale accounting as prescribed by FAS 140 because collateral received was insufficient to fund substantially all of the cost of purchasing replacement assets. Accordingly, AIG recognized $2.4 billion of net realized capital losses on deemed sales of the securities it had lent. Also, net realized capital losses in 2008 included a loss of $2.3 billion, incurred in the fourth quarter of 2008, on RMBS prior to their purchase by ML II. Also see Note 5 to the Consolidated Financial Statements.

 

A significant portion of the collateral received was invested in RMBS with cash flows having tenors longer than the liabilities to the counterparties. The value of those collateral securities declined during the latter part of 2007 and throughout 2008 and trading in such securities was extremely limited. Given these events, AIG began increasing liquidity in the securities lending pool by increasing the amount of cash and overnight investments that in the third quarter of 2007 comprised the securities lending invested collateral.

 

Due to AIG-specific credit concerns and systemic issues in the financial markets in the third quarter of 2008, counterparties began curtailing their participation in the program. As a result, liquidity in the collateral pools became constrained. At September 30, 2008, AIG had borrowed approximately $11.5 billion under the Fed Facility to provide liquidity to the securities lending program.

 

On October 8, 2008, AIG announced that certain of its domestic life insurance subsidiaries had entered into a securities lending agreement with the NY Fed pursuant to which the NY Fed agreed to borrow, on an overnight basis, up to $37.8 billion in investment grade fixed income securities from these AIG subsidiaries in return for cash collateral. The Securities Lending Agreement assisted AIG in meeting its obligations to borrowers requesting the return of their cash collateral.

 

On December 12, 2008, AIG, certain of AIG’s wholly owned U.S. life insurance subsidiaries, and AIG Securities Lending Corp. (the AIG Agent), another AIG subsidiary, entered into the ML II Agreement with ML II.

 

Pursuant to the ML II Agreement, the life insurance subsidiaries sold to ML II all of their undivided interests in a pool of $39.3 billion face amount of RMBS held by the AIG Agent as agent of the life insurance subsidiaries in connection with AIG’s U.S. securities lending program. In exchange for the RMBS, the life insurance subsidiaries received an initial purchase price of $19.8 billion plus the right to receive deferred contingent portions of the total purchase price of $1 billion plus participation in the residual, each of which is subordinated to the repayment of the NY Fed loan to ML II. These life insurance subsidiaries applied the net cash proceeds of sale of the RMBS toward the amounts due by such life insurance subsidiaries in terminating both the U.S. securities lending program and the

 

 

166    AIG 2008 Form 10-K

 

AIG’s securities lending program historically operated as centrally managed by AIG Investments for the benefit of certain of AIG’s insurance companies. Under this program, securities are loaned to various financial institutions, primarily major banks and brokerage firms. Cash collateral is received and is invested in fixed maturity securities to earn a net spread. Historically, AIG had received cash collateral from borrowers between 100-102 percent of the value of the loaned securities. The amount of cash advanced by borrowers has been declining, in light of the availability of alternative transactions requiring less collateral. If amounts received are insufficient to fund substantially all of the cost of purchasing identical replacements for the loaned securities, these transactions will cease to be accounted for as secured borrowings and will instead be accounted for as sales and forward purchases.

 

AIG’s liability to the borrowers for collateral received was $42.8 billion and the fair value of the collateral reinvested was $41.5 billion as of September 30, 2008. In addition to the invested collateral, the securities on loan as well as all of the assets of the lending companies are generally available to satisfy the liability for collateral received.

 

A significant portion of the collateral received was invested in RMBS with cash flows with tenors longer than the liabilities to the counterparties. The value of those collateral securities declined over the last 12 months and trading in such securities has been extremely limited. Given these events, AIG began increasing liquidity in the collateral accounts by increasing the amount of cash and overnight investments that comprise the securities lending invested collateral in the third quarter of 2007.