AIG’s European Derivatives May Take Decades to Expire

July 17 (Bloomberg) -- American International Group Inc.’s trading partners may force the insurer to bear the risk of losses on corporate loans and mortgages for years beyond the company’s expectations, complicating U.S. efforts to stabilize the firm, analysts said.

European banks including Societe Generale SA and BNP Paribas SA hold almost $200 billion in guarantees sold by New York-based AIG allowing the lenders to reduce the capital required for loss reserves. The firms may keep the contracts to hedge against declining assets rather than canceling them as AIG said it expects the banks to do, according to David Havens, managing director at investment bank Hexagon Securities LLC.

“For counterparties to voluntarily terminate those contracts makes no sense,” Havens said in an interview. “There’s no question that asset values have soured on a global basis. With the faith and credit of the U.S. government backing those guarantees, why would they give that up?”

The falling value of holdings backed by the swaps may force AIG to post more collateral, pressuring the insurer’s liquidity and credit ratings in a repeat of the cycle that caused the firm’s near collapse in September, Citigroup Inc. analyst Joshua Shanker said last week. The insurer needed a U.S. bailout valued at $182.5 billion after handing over collateral on a different book of swaps backing U.S. subprime mortgages.

The average weighted length of the European swaps protecting residential loans is more than 25 years, while the span tied to corporate loans is about 6 years, AIG said in a regulatory filing. Contracts covering corporate loans in the Netherlands extend almost 45 years, and the swaps on mortgages in Denmark, France and Germany mature in more than 30 years.

‘Theoretical Argument’

The portfolio shrank by about half in 15 months to $192.6 billion on March 31 and AIG’s models show banks will abandon more contracts, said Mark Herr, a spokesman for the insurer. AIG said in a filing last month it expects the banks to cancel “the vast majority” of the contracts in the next year as regulatory changes reduce the benefits of the derivatives for lenders.

“We think we’re right because we’re basing our analysis on actual behavior,” said Herr. “The inarguable fact is that half of the portfolio had been unwound at no cost to us as of March 31.” The contention that the swaps will last beyond a year is a “theoretical argument that is debunked” by banks’ actions, he said.

Last month, AIG said in a regulatory filing that it may be at risk for losses for “significantly longer than anticipated” if the banks don’t terminate their swaps.

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