Insurance-like guarantees that American International Group
The guarantees sold by AIG Financial Products, the insurer's controversial derivatives division, enabled banks in Europe to reduce the amount of capital they needed to set aside in cover potential losses on portfolios of residential mortgages and corporate loans.
These so-called regulatory capital relief swaps permitted European banks such as SocGen
Last fall AIG said it expected the majority of the these derivative deals with European banks to terminate within six months. But in a recent regulatory filing, AIG dropped the six month prediction and said the banks may not exercise their options to terminate the transactions in the expected time frame.
AIG said a decision by European policymakers to give financial institutions more time to switch to a new bank regulatory system may mean more of these derivatives will stay active longer.
At the end of last year, the total dollar value of regulatory capital relief swaps written by AIG Financial Products was $150 billion.
In the company's 2009 annual report, AIG said that as of February 17 it had received a formal termination notice from banks to cancel out an additional $25.6 billion of these swaps. AIG said those derivatives should end sometime in 2010.
Mark Herr, an AIG spokesman, said despite the decision by European regulators to give banks more time to adopt a new series of banking rules, the company still expects transactions to be terminated and mature through 2010.
The regulatory capital relief swaps represent about 16 percent of the value of AIG Financial Product's $940 billion derivatives portfolio.
AIG officials have said they intend to shutter the division by year's end, but expect to retain some of the derivatives on the insurer's books.
The deals with European banks to provide regulatory capital relief never have been as controversial as the derivatives that AIG Financial Products wrote on complex securities backed by subprime mortgages. It was the potential of AIG having to pay out tens of billions of dollars on those other derivatives that ultimately forced the federal government to bail out the insurer in fall 2008.
But in February 2009, AIG cited those regulatory capital relief swaps as one of the reasons the federal government should continue to support the insurer. The company said a collapse of its AIG Financial Products division could force some of the banks that purchased those derivatives to immediately raise an additional $10 billion in capital.
So far, maintaining the regulatory capital relief swaps has not put much of a strain on AIG's balance sheet. As of the end of 2009, AIG had posted just $310 million in collateral on the regulatory capital relief swaps.
Herr said the company does not expect that it will be required to make payments pursuant to the contractual terms of those transactions, given that most of the underlying corporate loans and mortgages are performing well.
But an industry analyst said the longer the swaps remain on AIG's books, the greater the chance that some of those underlying loans may sour -- especially if the economy in Europe weakens further.
It seems AIG is being very optimistic, said David Merkel, chief economist with Finacorp Securities, a small brokerage firm. But the option to terminate these contracts doesn't rest with AIG.
(Reported by Matthew Goldstein; Editing by Tim Dobbyn)