AiG Issues Press Release -- No Headlines

AIG did a pretty good job of explaining the situation, but it already seems like a year ago, and there are more exciting items to blog. Now it is how AIG get zillions while the UAW gets shafted. A quickie to try to explain the AIG Bailout.  This is from an AIG slide as part of the Nov 20 presentation on the revised "deal."  

What is really going on is that AIG had already taken writedowns in the $30 billion range on these CDS's. They had also posted collateral in the $30's. The way it was designed to work is that the $70 billion in blue is the nominal amount (par) of the CDS's.  About 1/2 of that had already been booked as losses.  A similar amount had already been posted as collateral.  The problem is that every quarter, there was a lot of hand wringing about how much more should be written down to "market" that, of course, wasn't functioning.  A theoretical solution would be to write them down to zero, but AIG doesn't $30-$40 billion to take an immediate hit.  So each quarter, another 5%, 10%, or 15% would be written down.  AIG might have wanted to just settle up or buy their way out of this exposure, but there was no one with the capital, regardless of value.  AIG insisted things weren't that bad, but had and have little credibility on this issue.

The  credit facility I keep referring to as a SIV is known by the name Maiden Lane III.  Per the National Underwriter:

Maiden Lane III L.L.C., New York, a Delaware limited liability company controlled by the Federal Reserve Bank of New York, has started to buy “multi-sector collateralized debt obligations” that AIG’s AIG Financial Products Corp unit guaranteed with CDS arrangements back when the economy was stronger, according to AIG, New York.
The New York Fed and AIG announced the creation of the $35 billion Maiden Lane III CDS program shutdown entity in November, in connection with New York Fed efforts to replace a 2-year, $85 billion New York Fed credit facility.

Here is a table of the multi sector CDO's from the 3Q 10K:
Since there is no way you can read it as is, you can click on it to view it in full size. This lays out the numbers in a much more understandable way. However, column 3 shows the Net Notional Amount of $71,644,000,000. Column 4 is the "fair value" of the derivative of $30,207,000,000 as of September, 2008 financial statements. That means that AIG had already booked losses of $30.207 billion as of September -- that is, written that portion off.

Per AIG:

Included within that $71.6 billion portfolio (notional amount as of September 30) is approximately $9.8 billion of swaps that were sold as credit protection on "synthetic" securities. The swaps on these synthetic securities are also referred to as "cash settlement" or "Pay As You Go" (PAUG) swaps because they are settled in cash as and when losses are taken.

Here is what AIG says about it in September:

"Cash Settlement. Transactions requiring cash settlement (also known as “pay as you go”) are in respect of protected baskets of reference credits (which may also include single name CDSs in addition to securities and loans) rather than a single reference obligation as in the case of the physically-settled transactions described above. Under these credit default swaps:

• Each time a “triggering event” occurs a “loss amount” is calculated. A triggering event is generally a failure by the relevant obligor to pay principal of or, in some cases, interest on one of the reference credits in the underlying protected basket. Triggering events may also include bankruptcy of reference credits, write-downs or postponements with respect to interest or to the principal amount of a reference credit payable at maturity. The determination of the loss amount is specific to each triggering event. It can represent the amount of a shortfall in ordinary course interest payments on the reference credit, a write-down in the interest on or principal of such reference credit or any amount postponed in respect thereof. It can also represent the difference between the notional or par amount of such reference credit and its market value, as determined by reference to market quotations.

• Triggering events can occur multiple times, either as a result of continuing shortfalls in interest or write-downs or postponements on a single reference credit, or as a result of triggering events in respect of different reference credits included in a protected basket. In connection with each triggering event, AIGFP is required to make a cash payment to the buyer of protection under the related CDS only if the aggregate loss amounts calculated in respect of such triggering event and all prior triggering events exceed a specified threshold amount (reflecting AIGFP’s attachment point). In addition, AIGFP is typically entitled to receive amounts recovered, or deemed recovered, in respect of loss amounts resulting from triggering events caused by interest shortfalls, postponements or write-downs on reference credits."

They disclosed it.  However, I will say that I didn't see the $9.8 billion of PAUG CDS's specifically addressed.  This is inherently confusing because AIG has chosen to isolate $71.6 billion net notional CDS's on multi sector CDO's as the problem.  There are other CDS's that weren't considered a problem, and it wasn't always clear to me which set of CDS's were being referred to in this section of the 10-K.  However, the diagram below, from the 10-K, lays out how the credit facility or SIV works.  The AIG-FP obligation is for the "Super Senior" tranche - the box on the right.  For Multi Sector CDO's, thats the layer that AIG wrote the CDS on.  There is $38 billion in subordination -- relating to the dark section on the bottom that is someone else's problem.    

For the CDS's on the Super Senior, Multi Sector CDO's, the "Gross Notional" is $108.5 billion.  The result of the credit facility is that when it is completed, AIG will have no net exposure.  They will have written off the entire amount, sold the remaining assets to the credit facility.  Here is my diagram (typo: change the $25 to $30):

The take away from this. First, that Super Senior meant about 1/3 subordination. Secondly, AIG has been writing this stuff off for 4 quarters, and a big chunk of it is gone. Thirdly, the NYFRB has about 75% subordination from the original CDO's, which doesn't sound that bad. Sounds like they have a decent chance to fully recover their money. After all, some people pay off their mortgages, and if not, some of the assets are recoverable. Settling a PAUG CDS on a synthetic CDO may be difficult, but someone needs to drive a good bargain and with the FRBNY, I don't see why it couldn't happen Fifth, this stuff is too complex for normal people. Given the low level of confidence and trust -- people are going to assume the worst. However, one would hope that the WSJ would put a little more effort into it.