American Express 2004 Annual Report Download - page 101

Note 5 VARIABLE INTEREST ENTITIES
The variable interest entities for which the Company is
considered the primary beneficiary and which were con-
solidated beginning December 31, 2003, primarily relate
to structured investments, including a collateralized debt
obligation (CDO) and three secured loan trusts (SLTs),
which are both managed and partially-owned by AEFA.
The CDO consolidated as a result of FIN 46 contains debt
issued to investors that is non-recourse to the Company
and solely supported by a portfolio of high-yield bonds
and loans. AEFA manages the portfolio of high-yield
bonds and loans for the benefit of CDO debt held by
investors and retains an interest in the residual and rated
debt tranches of the CDO structure. The SLTs consoli-
dated as a result of FIN 46 provide returns to investors pri-
marily based on the performance of an underlying port-
folio of high-yield loans which are managed by AEFA.
One of the SLTs originally consolidated was liquidated in
2004 and the remaining two SLTs are in the process of
being liquidated as of December 31, 2004.
Ongoing valuation adjustments specifically related to
the application of FIN 46 to the CDO are non-cash items
and will be reflected in the Company’s results until its
maturity. These ongoing valuation adjustments are
dependent upon market factors during such time and
result in periodic gains or losses. The Company expects,
in the aggregate, such gains or losses related to the
CDO, including the December 31, 2003 FIN 46 imple-
mentation non-cash charge of $57 million ($88 million
pretax), to reverse themselves over time as the structure
matures, because the debt issued to the investors in the
consolidated CDO is non-recourse to the Company and
further reductions in the value of the related assets will
be absorbed by the third-party investors.
The 2004 results of operations (reported in net invest-
ment income) include a $24 million pretax, non-cash
charge related to the complete liquidation of one SLT,
and a $4 million pretax, non-cash charge related to the
expected impact of liquidating the two remaining SLTs.
However, further adjustments to that amount could
occur based on market movements and execution of the
liquidation process. To the extent further adjustments
are included in the liquidation of the remaining SLT port-
folios, the Company’s maximum cumulative exposure
to losses was $462 million at December 31, 2004.
The following table presents the consolidated assets,
essentially all of which are restricted, and other bal-
ances related to these entities at December 31:
(Millions) 2004 2003
Restricted cash $ 543 $ 844
Below investment grade
securities
(a)
249 244
Derivative financial
instruments
(b)
43 64
Loans and other assets 10 15
Total assets $ 845 $ 1,167
Debt $ 317 $ 325
Deferred tax liability 85
Other liabilities 119 175
Total liabilities $ 444 $ 505
Net unrealized after-tax
appreciation on
securities classified as
Available-for-Sale $14 $9
(a) Securities are classified as Available-for-Sale and include $22 million and
$14 million of unrealized appreciation as of December 31, 2004 and 2003,
respectively.
(b) Represents the estimated fair market value of the total return swap deriva-
tives related to the consolidated SLTs which have a notional amount of $1.8
billion and $3.2 billion as of December 31, 2004 and 2003, respectively.
The Company has other significant variable interests
for which it is not considered the primary beneficiary
and, therefore, does not consolidate. These interests
are represented by carrying values of $27 million of
CDO residual tranches managed by the Company and
$375 million of affordable housing partnerships as the
Company is not the primary beneficiary. For the CDOs
managed by the Company, the Company has evaluated
its variability in losses and returns considering its
investment levels, which are less than 50% of the
residual tranches, and the fee received from managing
the structures and has determined that consolidation is
not required. The Company manages approximately
$4.3 billion of underlying collateral within the CDO
structures it manages. The Company is a limited partner
in affordable housing partnerships in which the Com-
pany has a less than 50% interest and receives the ben-
efits and accepts the risks consistent with other limited
partners. In the limited cases in which the Company has
a greater than 50% interest in affordable housing part-
nerships, it was determined that the relationship with
the general partner is an agent relationship and the
general partner was most closely related to the partner-
ship as it is the key decision maker and controls the
operations. The Company’s maximum exposure to
loss as a result of its investment in these entities is
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Notes to Consolidated Financial Statements