Aug 7, 2008
Executives
Charlene M. Hamrah - VP and Director - IR Robert B.
Willumstad - Chairman and CEO Steven J. Bensinger - EVP and CFO Christopher Swift - VP - Life and Retirement Services Elias Habayeb - CFO AIG Financial Services William V.
Nutt, Jr - President and CEO UGC Kevin B. McGinn - VP and Chief Risk Officer Richard W.
Scott - Sr. VP - Investments David Herzog - Chief Accounting Officer Frank H.
Douglas - VP and Casualty Actuary
Analysts
Jamminder Bhullar - J.P. Morgan Daniel Johnson - Citadel Investments Joshua Shanker - Citigroup Andrew Kligerman - UBS Thomas Cholnoky - Goldman Sachs Thomas Gallagher - Credit Suisse Jay Gelb - Lehman Brothers Alain Karaoglan - Banc of America Securities Jay Cohen - Merrill Lynch Larry Greenberg - Langen McAlenney
Operator
Welcome and thank you for standing by. At this time all participants are in a listen-only mode until the question-and-answer session in today's conference.
[Operator Instructions]. I would also like to remind parties this call is being recorded.
If you have any objections please disconnect at this time. I would now like to turn the call over to Ms.
Charlene Hamrah. Thank you, ma'am you may begin.
Charlene M. Hamrah - Vice President and Director - Investor Relations
Thank you. Good morning and thank you for joining us today for AIG's Second Quarter Earnings Conference Call.
Before we begin, I would just like to remind you that the remarks made today may contain projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management operations, products and services, and assumptions underlying these projections and statements. It is possible that AIG's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these projections and statements.
Factors that could cause AIG's actual results to differ, possibly materially, from those in the specific projections and statements are discussed in Item 1A, Risk Factors, of AIG's Annual Report on Form 10-K for the year ended December 31, 2007 and in the Outlook section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the quarterly report on Form 10-Q for the quarterly period ended June 30, 2008. AIG is not under any obligation and expressly disclaims any such obligation to update or alter its projections and other statements whether as a result of new information, future events or otherwise.
The information provided today may also contain certain non-GAAP financial measures. The reconciliation of these measures to the comparable GAAP figures are included in the first quarter 2008 financial supplements or within the presentation available in the Investor Information section of AIG's corporate website.
And now I would like to turn the call over to Bob Willumstad.
Robert B. Willumstad - Chairman and Chief Executive Officer
Thank you, Charlene, good morning to everybody. I'd like to begin with some observations about the current economic and market environment and how they affected AIG's second quarter results.
And I'll ask Steve Bensinger to provide more details on the quarter. Finally, I'll make some comments on expenses and give you an update on our strategic review process and what you can expect from us when we report on that process in September.
We'll then take your questions. The second quarter results do not reflect the earnings power of AIG's businesses.
The loss we reported for the quarter resulted from some external factors, as well as some company specific operating issues. Three factors in particular had a significant effect on our results.
We reported large investment impairment charges and unrealized losses that were primarily driven by severe conditions in the housing and credit markets. We had a 3.6 billion after tax unrealized market valuation loss on super senior credit default swap in our capital markets business and a $4.4 billion after tax other than temporary impairment charge relating to our investment portfolio.
Let me put these figures in context, regarding the unrealized market valuation loss on the CDS portfolio, clearly, this is a big number. That said, this loss is smaller than the after tax loss of 5.9 billion that we recognized in the first quarter.
Regarding the 4.4 billion of after tax impairment charges in the investment portfolio, approximately two-thirds of the severity component of those charges was already reflected as unrealized depreciation in shareholders equity at March 31st. Steve will go into more detail on these points.
Division [ph] of those charges we also experienced below average investment performance in the quarter. Net investment income in the second quarter was $6.7 billion, lower than the 7.9 billion, we reported last year but above what we reported in the first quarter.
Partnership income was the principle driver of the second quarter results and our focus on liquidity also dampened our returns. We reported an operating loss of $518 million pre-tax at United Guaranty from mortgage insurance business, largely reflecting the same housing and mortgage market conditions that drove the unrealized market valuation loss in our CDS portfolio.
All three of these factors reflect extreme market conditions [indiscernible] to put our second quarter results in context not to minimize operational issues that need and are getting our immediate attention. Our primary focus is on strengthening our balance sheet, maintaining our liquidity, and improving profits.
Now I'll turn it over to Steve for a review of the second quarter and I'll come back after his comments.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Thanks, Bob. Please refer to the PowerPoint presentation posted to our website last night, and titled Conference Call Presentation.
Then if you start on page three, there are four key messages we'd like you to take away. First, and maybe most obvious is that the disruption in the U.S housing market that Bob referenced continues to dominate our reported results.
We reported a net loss for the third consecutive quarter. That said there was a tempering of some of the marks in the quarter as exemplified by the reduction in size of the AIGFP unrealized market valuation loss in the second quarter compared, to the first, and the reduction and the decline of a cumulated other comprehensive income which reflects the change in the unrealized depreciation of our available for sales securities, more on that in the moment.
Second, our capital position is stronger today than it was as of the end of the first quarter. Granted, we raided capital, but that was the prudent action to take in light of the volatile capital markets we continue to face.
Third, you have seen the results of our four segments in last night's release. There are clearly some challenges, nonetheless our franchise continues to show resilience, I'll comment on that in more depth shortly.
And finally, our priorities, Bob has made it clear about our focus in these turbulent times. Protect our capital, and reduce risk, focus on expenses and complete the business review.
Bob will comment more on these in a moment. Let's turn to slide four.
As you can see our total equity on hybrid capital increased in the second quarter to $96.8 billion as a result of our capital raise, that's less than a 5% decline from our year-end position. Our financial debt to total capital ratio has declined to 13.7% indicating increased financial flexibility.
While we can't predict what the future holds, in terms of capital market conditions, and the effects of the ongoing U.S. housing market disruption.
Based on what we know today our capital position is sound. Let's take a look at slide five.
As I said earlier, we reported a net loss for the quarter, which totaled about $5.4 billion. Including that total, as Bob mentioned, are approximately $4.4 billion of after tax other than temporary impairment charges.
Now they are reflected in the caption titled Realized Capital Losses, but in fact represent almost entirely unrealized market valuation losses. Actual sales activity of securities in the quarter resulted in a pre-tax net gain of about $200 million.
Importantly, as Bob mentioned almost two-thirds of the severity component of the other than temporary impairment charge was already reflected as a reduction in ALCI [ph] as of March 31st, this is in stark contrast to what occurred in the first quarter. There continues to be a diversity in practice among companies in terms of taking impairment charges through P&L at AIG we've a rigorous process where we evaluate several dimensions of potential impairments on a security-by-security basis.
Of the $6.8 billion pre-tax other than temporary impairment charge, 4.8 billion relates to severity losses. Almost two-thirds of that severity charge related to securities rated AAA, and nearly 80% related to AA and AAA combined.
The securities continue to perform. Our judgment to take an impairment charges based on the uncertainty of the timeframe for price recovery.
We cannot yet make an assertion as to the recovery period. The $337 million after tax effect of the credit valuation adjustment relates to the effect of credit spreads on AIGFP's assets and liabilities accounted for under the fair value option using the guidance in FAS 159.
While credit spreads in the quarter widened on both AIGFP's invested assets and on AIG's own credit spreads, which affect the fair value of AIGFP's liabilities, the net result was a loss. We've summarized in the box area on the slide the adjusted net income excluding the AIGFP unrealized market valuation loss, and the credit valuation adjustment to highlight some of the key themes for the quarter which I will cover now.
If we would, please turn to slide six. As we stated previously, partnership and mutual fund income is volatile from quarter-to-quarter and the first half of 2007 generated very strong results.
While the second quarter of 2008 results includes $190 million in partnership and mutual fund income, this is still down $1.1 billion year-on-year, and affected most of our segments' results. Looking ahead, the second half of 2007 also generated strong results, so we anticipate that year-on-year comparisons will remain difficult for the remainder of 2008.
In addition, we've been building liquidity within the insurance companies as a prudent response to the market dislocation. However, this does have a negative effect on net investment income which we estimate in the range of 1 to $200 million pre-tax in the quarter.
As everyone on this call is well aware the U.S housing market continues to be very difficult and that's reflected in the substantial increase in losses at UGC. First and second line [ph] losses increased 264 and 107% respectively over the second quarter of 2007 and include the effect of low reported tier rate [ph] probability assumption.
We anticipate UGC's operating losses will continue into 2009. American General Finance net receivables were down 1% sequentially but up 6% year-on-year primarily due to the Equity One portfolio acquisition in February.
Loan loss provisions increased significantly in the quarter, and delinquency rates have increased to 3.56% [ph] which remains within AGF's target band. Let's turn to slide seven.
Commercial insurance is facing an increasingly challenging environment. Nonetheless, our overall view is that rates are still adequate, with the exception of certain lines of business, most notably workers comp and aviation.
We continue to look for ways to shift our product mix to compensate for declining rates and are certainly maintaining our underwriting discipline. Our underwriting results continued to suffer from the drag of adverse development in excess casualty in the 2003 and prior accident years, although the second quarter...
in the second quarter this was substantially offset by positive developments in the 2004 and later accident years. The effect of the Midwest flood was about 1.4 points on the loss ratio in the quarter, in fire and general our results benefited from AIG's broad global footprints and strong franchise up 15% in dollar terms, net premiums written rose 5% in original currency due to growth in Continental Europe, in the Middle East as well as due to high retention levels in major accounts despite declining rates in certain markets.
Underwriting income fell 5.9% due to an increase in severe but non-catastrophic losses and increased loss frequency as well as increased expenses due to the realignment of the legal entities through which fire and gen operates. In personal lines good growth in AIG's private client group was offset by reductions in net premiums written in aigdirect.com and, and agency auto, as a result of planned reduction in these lines as we speak to improve underwriting performance.
Turning to slide eight. Domestic life and retirement services generated 14% growth in premium, reflecting AIG's off season's product portfolio.
Private placement VUL and payout annuity sales were up strongly, while life insurance and home service were up 5%. With continued uncertainty in equity markets consumers favored individual fixed annuities where deposits increased by $450 million and surrender rates fell 300 basis points.
Spreads on key products reflected lower investment income. Foreign life results benefited from AIG's product mix [ph] while growth in life products was muted, accident and health group, fixed annuities and variable annuities, all had strong growth.
So growth was favorably affected by exchange rate movements. Life insurance and retirement services reserves continued to grow in excess of 15% reflecting AIG's success in accumulating assets.
Net investment income fell 5.9% primarily due to losses on investment linked products in the U.K., though reduced partnership and mutual fund income also affected results. Turning to slide nine.
IOSC [ph] had record results in the quarter. Revenues increased 14% while operating income was up 85%, on the back of higher lease rates and strong demand for IOSC's modern fuel efficient aircraft.
New aircraft are 100% leased through 2008 and 2009 and all of the 16 aircrafts returned to IOSC were released as of July 31st. Results in asset management continued to be affected by the run-off of the GIC program.
External assets under management were down sequentially due to market price declines despite attracting new assets of $2 billion in the quarter. Operating income in the core external assets management business was negatively effected by lower carried interest and the timing of real estate related gains.
Comparisons with the second quarter were also unfavorable due to a $398 million gain in the second quarter of '07 related to the poor... the sale of a portion of AIG's holdings in the Black Sound Group's [ph] IPL.
Turning to page ten. I'd like to turn your attention to a role forward of our shareholders equity.
As a framework for some further comments about the effects of the AIGFP unrealized market valuation losses and the effect of the declines in the value of portions of our investment portfolio. Let's turn to slide 11, in the quarter AIGFP recorded a further $5.6 billion pre-tax, unrealized market valuation loss on its super senior credit default swap portfolio, bringing the cumulative valuation loss on this business to $25.9 billion.
The preponderance of that amount toward [ph] $24.8 billion pertains to the credit default swap portfolio covering multi-sector CDO. The primary drivers of the write down were declines in market prices for Alt A and sub-prime RMBS collateral and rating agency actions taken in the quarter.
Based on the cumulative loss to-date, the portfolio is now marked to an average of about $0.69 on the dollar. For those CDOs containing sub-prime collateral the average mark is now $0.60...
$0.66 for high grade deals and $0.56 for mezzanine transactions. The total super senior portfolio declined by a net $28.5 billion in the quarter to $441 billion.
This reduction results from $5.9 billion in amortizations across the portfolio and $22.6 billion in early terminations in the regulatory capital relief book. Included in the net decrease was an increase in exposure due to honoring an existing commitment to conclude a $5.4 billion dollar transaction in the multi-sector CDO portfolio.
With regards to the regulatory capital portfolio, there continues to be no market value adjustments for the vast preponderance of that book. The early terminations of transactions by counter parties at no cost to AIGFP provide the most important information supporting our conclusion that these transactions are motivated by regulatory capital release and not by transferring risk on the underlying portfolios.
We'll continue to monitor counter party behavior to inform our decisions on valuation of this book. I should point out that there was one European RMBS regulatory capital relief transaction with a notional amount of $1.6 billion that was not terminated as expected.
This transaction has specific features not found in the remainder of the regulatory capital book. We took a mark on that transaction in the second quarter of $125 million.
Let's turn to slide 12. Despite, the marks taken the portfolio of CDOs is showing resilience.
We have not yet incurred any realized credit losses in the portfolio. Further the level of defaulted assets in the underlying collateral of CDOs is very low compared, to the weighted average attachment points in those structures.
We continue to refine our analytical methodologies to produce stress test scenario of potential ultimate realized credit losses in the portfolio. In the first quarter we introduced the roll rate analysis to develop estimates of potential ultimate loss.
Applying this methodology last quarter resulted in an estimate of potential credit losses of $2.4 billion. In the second quarter, we've introduced enhancements for the model methodology.
We now include prime RMBS in the portfolio of securities subjected to the roll rate analysis, and have introduced analytics to capture the potential effects, both positive and negative, of the cash flow waterfall. This quarter, we include two stress scenarios of potential realized credit losses.
Each of which incorporate more highly stressed assumptions than used in previous scenarios. The underlying roll rate and severity assumptions used in these scenarios are available for your review in the conference call credit presentation slide posted to our website.
The potential realized credit losses resulting from the two scenarios with produced losses of 5 billion and $8.5 billion respectively. To put the $8.5 billion scenario into perspective, if we look at the assumptions used regarding sub-prime mortgages, which represent a significant component of our collateral, the scenario assumes that currently delinquent mortgages will default at percentages approaching 96%.
And that the net recoveries upon foreclosure will only be $0.28 on the dollar compared to average nationwide recoveries currently of about $0.50 on the dollar. Of course, the collateral pools underlying the CDOs contain other classes of RMBS and other securities of various vintages, which are also incorporated in the model.
However, this example may help to show that these scenarios are conservative. And provide comfort to AIG that the potential ultimate credit losses, which may be incurred from the portfolio, are substantially less than the 24.8 billion of fair valuation losses we recorded to-date.
Turning to slide 13; back to the shareholders equity role forward and the effects of impairment charges and the change in unrealized losses on available for sale investments. I spoke earlier about the impairment charge of over $4 billion and will now focus on the change in the unrealized losses in our equity.
The net decline for the second quarter of $2.6 billion is principally driven by declines in market prices on foreign investments held in Japan, Taiwan, Thailand and other Asian countries due to rising interest rates. Well, such movements in interest rates result in a decline in shareholders equity.
The economic effects are actually quite positive for the fundamental performance of the business. Because we don't mark the liabilities to fair value, rising interest rates are not reflected in the evaluation of the corresponding liabilities under current accounting standards.
Turning to slide 14; within our insurance investment portfolios, our total exposure to RMBS at amortized cost is $77.5 billion and has declined by a net $4.8 billion in the quarter, primarily as a result of payments of principle and charge-off taken rather than temporary impairment charges. The only purchases have been of agency pass-through certificates.
The difference in our holdings of $87.8 billion at par value and the $77.5 billion that amortized costs, represent the other than temporary impairment charges already taken against these securities. Of the OTTI charges taken year-to-date, 87% of them represent severity charges.
The underlying securities have retained their investment grade ratings, and virtually all are paying principle and interest. However, in consideration of the rapid and severe market valuation decline, AIG could not reasonably assert that the recovery period would be temporary.
The entire portfolio, including agency pass-through certificates is marked at approximately $0.77 on the dollar. Let's go the slide 15; and as you can see, despite continued rating agency actions taken in this sector, our holdings are performing, and are still almost 95% rated AAA and AA.
Slide 16 highlights the remaining changes in shareholders equity for the quarter. And I won't go through all of them in detail, but the principal point that you see is the effect of our capital raise in May.
And now, I'll turn the call back over to Bob.
Robert B. Willumstad - Chairman and Chief Executive Officer
Thanks, Steve. As I indicated at the outset, our second quarter results are not indicative of the performance AIG can deliver.
And I know many of you have questions about what we're doing to get the company back on track. There are no quick fixes.
In uncertain times like these, we will continue to make every effort to protect our capital, reduce risk and strengthen our balance sheet. One the way to strengthen our balance sheet is to improve the profitability of our operating businesses.
This company has seen significant growth in operating expenses over the past three years. We are working across all our businesses to reduce expense growth.
There will be some areas where we'll continue to spend heavily such as financial reporting and controls, as well as risk management systems. But we need to improve our expense management across all of our businesses.
I am not in a position today to give you definitive targets for expense reduction. We will, however, identify those opportunities in our September strategic review.
In the meantime, we've curtailed the expansion of capital intensive businesses and would not consider any major acquisitions at this time. Once we complete our review, we will act quickly to implement the necessary and appropriate changes to our businesses.
I have already spent significant time visiting our U.S. operations and will do the same in Asia later this month.
We also met with some of our key regulators and plan to meet with more of them soon. Our goal is straightforward; to define AIG's vision and determine the optimal portfolio of the businesses based on where our true competitive advantages lie.
We will also change AIG's risk profile and sharpen our risk management and capital allocation process in addition to strengthening our accounting and reporting infrastructure. A less complex AIG will be a better competitor.
These actions will result in significant changes with conditions demanded and we are moving forward with focus and a sense of urgency. We've already reached to one conclusion that we should retain ILFC.
This is a strong market leading business and we determined it is best both for ILFC and AIG to say together. I am not prepared to disclose any other strategic conclusions today.
However, we will report to you the results of our review at an investor meeting on September 25th. Details of that meeting will be provided to you.
It's clear from second quarter results; we have a lot of work to do to restore AIG's profitability to where it should be. However, we understand the challenges ahead of us and we are developing a game plan to see AIG through these difficult times and rebuild shareholder value.
Before taking your questions, I'd like to offer general observations after being AIG's Chief Executive Officer for nearly two months. I'm convinced that AIG is a great company.
But as you can see our results, we are facing some serious challenges. I know there is more than a little frustration with our performance.
And that shareholders understandably want a clear picture of our business outlook and whether the worst is over. Well, I cannot provide all those answers for you today.
We are committed to being an open... being as open and candid as we can be.
We will now take your questions. Operator, can we open the line for questions?
Question And Answer
Operator
Thank you. We will now begin the question-and-answer session.
[Operator Instructions]. The first question comes from Jimmy Bhullar, J.P.
Morgan. Your line is opened.
Jamminder Bhullar - J.P. Morgan
Hi, thank you. Good morning.
I have a couple of questions. The first one is on your capital position.
If you could talk about under what scenario do you foresee or do you foresee a scenario on which you would have to raise equity capital again if results don't improve or continue at this pace? And then secondly on...
you have had several, a couple of quarters at least of DAC benefits in your life business because of realized losses and if you believe that we're sort of in a period of a secular decline in investment returns especially if you include the realized losses along with the portfolio yields and the returns don't improve could you have a DAC recoverability issue in the domestic life businesses [indiscernible]?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Thank you. Jimmy, it relates to capital, obviously, it's a question that we focus on a regular basis, as I said before we are doing our best to reserve as much capital as we can.
It's very hard to predict right now when and if we will need more capital. Our current position we think is satisfactory.
Future losses obviously, can change that, that assumption and we are obviously dependent on the condition of the U.S. housing market and how those will affect the securities that we hold.
But I would say right now, we feel comfortable with the amount of capital that we do have, its just no way of predicting the future at the moment. I think on the second question about DAC...
Christopher Swift - Vice President - Life and Retirement Services
Jimmy, its Chris Swift, I can maybe comment from a global life retirement services side, as you know our practices to review our DAC assumptions and do any formal unlockings in the fourth quarter that is on track, to tell you our early thinking right now is in the domestic markets particularly in the variable annuity product line. We are on the high end of our reversions range.
So if the equity markets particularly continued to decline in the third and fourth quarter, that could potentially necessitate our unlocking in conjunction then with our normal fourth quarter we'll reviews... we will look at other global markets and our long term assumptions on our market performance and asset performance.
And Bob has indicated if we need to de-risk in changes we will but right now it's too early to say what that global review will predict in the fourth quarter.
Jamminder Bhullar - J.P. Morgan
Thank you.
Operator
Next question comes from Dan Johnson, Citadel Investments. Your line is open.
Daniel Johnson - Citadel Investments
Great, thank you very much. Would you folks mind giving us a little bit more of a tutorial around the issues referred to as 2a-7 Puts I believe its on page 87, of the Q, just basically trying to understand how many more I guess clients could put this business back to you that would cause you to generate more CDOs as we did in the second quarter?
Elias Habayeb - Chief Financial Officer AIG Financial Services
Dan it's Elias Habayeb. With respect to the 2a-7 at this point we have written all the 2a-7s we're committed to write.
So that's the maximum amount of 2a-7 Puts that we have outstanding. The way those work is that that if there is a failed remarketing then we would have potential obligation to buy the CDO back and/or the underlying security back and on most of them we do have backstop liquidity lines in the event those bonds have been put back to us.
Daniel Johnson - Citadel Investments
And is it that we don't have any more exposure to this because there is been no failed remarketings or even that whole issue is basically there are no more 2a-7 that we would be on, potentially on a risk for?
Elias Habayeb - Chief Financial Officer AIG Financial Services
No, we do have outstanding 2a-7 Puts that continue to be outstanding and given the current state of the market we would be expecting to be buying back those underlying referenced obligations.
Daniel Johnson - Citadel Investments
And if sometime now what that means from capital consumption?
Elias Habayeb - Chief Financial Officer AIG Financial Services
Not at this point.
Daniel Johnson - Citadel Investments
Okay moving over the MI business can we talk a little bit about the captive benefits that we probably are receiving by now and importantly do we have any captive counterparties that have put their captives into run-off?
William V. Nutt, Jr - President and Chief Executive Officer UGC
Dan, this is Billy Nutt, at UGC. We have got approximately 65 captives that were ceding incurred losses to.
So far this year we have ceded through 630, we've ceded $255 million in ceded incurred losses, we expect to cede about $460 million, this full year leakage... potential leakage from captives that would exhaust their trust accounts would be a modest.
Right now we are estimating about $25 million, there have been some captives that have decided to get out of the mortgage guarantee reinsurance business and have notified us as such but of course they are still obligated for any books of business that we currently have on our books at this time.
Daniel Johnson - Citadel Investments
That... the obligation refers to the amount of money that's already in the trust?
William V. Nutt, Jr - President and Chief Executive Officer UGC
That is correct...
Daniel Johnson - Citadel Investments
Okay.
William V. Nutt, Jr - President and Chief Executive Officer UGC
We've got currently right now $1.1 billion of monies in the trust accounts in the 65 captives.
Daniel Johnson - Citadel Investments
Great, and your 25 billion leakage [ph] that was for this year?
William V. Nutt, Jr - President and Chief Executive Officer UGC
That is for this year, that's our estimate for this year.
Daniel Johnson - Citadel Investments
When we think about next year's performance are we going to get most of the benefits from the captives in this year and potentially beyond the outside of the next year or maybe just a little color there?
William V. Nutt, Jr - President and Chief Executive Officer UGC
Well right now we are estimating that most of the benefits will come through this year as losses accelerate due to the dislocation, the increase in dislocation in the housing markets. We will receive benefits next year though it's a little early to estimate that but we think it will be some what less than the benefit that we are estimating for this year of $460 million.
Daniel Johnson - Citadel Investments
Great, and finally Mr. Swift is the market assumption underlying the DAC...
the market growth assumption I guess tell you that unrealized the DAC calculation?
Christopher Swift - Vice President - Life and Retirement Services
Dan, the domestic one is roughly 10%.
Daniel Johnson - Citadel Investments
Inclusive of dividends?
Christopher Swift - Vice President - Life and Retirement Services
Yes.
Daniel Johnson - Citadel Investments
Great, thank you very much for taking the questions.
Operator
Josh Shanker, Citi. Your line is now open.
Joshua Shanker - Citigroup
Thank you. Good morning my two questions, the first I would like to understand in retrospect when you talked one year ago that you...
that one quarter ago that 1.2, 2.4 billion would be the realistic stress case for the portfolio. Obviously, you've increased that to 5 to 8.5 billion, looking back on it, what was wrong with the stress test that you did at that time and what makes you more comfortable with the ones that you are using today?
Robert B. Willumstad - Chairman and Chief Executive Officer
We'll have Kevin McGinn, our Chief Risk Officer, Joshua to address that point.
Kevin B. McGinn - Vice President and Chief Risk Officer
Hi, Josh. Good morning.
The major change that we made was simply because of deteriorating market conditions, we felt we needed to move our loss to vary down real estate values have obviously been declining even more sharply than we thought. And so we took our loss severities in our delinquency pipeline up especially on the '05 vintage which of course because we have so much '05 is a...
has a significant impact on the number. The other significant change this year...
this quarter was we had a much better estimate of what we might experience in leakage in the CDOs themselves in terms of the principle payments that are coming down to the lower rate of traunches, we made strong estimate of that and as you can see in the conference slide that was almost $1 billion difference in the quarter. There were other issues that are explained in one of the conference slides, another significant impact was because we haircut the CDOs using current ratings and because the rating agencies continuing to downgrade CDOs, we've been using current ratings as opposed to original ratings to give ourselves some buffer there.
Joshua Shanker - Citigroup
And is that 5 to 8.5 billion a likely worst case or realistic case given the way you are looking at things right now?
Kevin B. McGinn - Vice President and Chief Risk Officer
We think if you look at our assumptions, especially in our rows and our lost severities we think right now the 5 is probably is a very... very conservative estimate and the 8.5 was, would be even much more stressed.
So we don't think we are going to get to those numbers but they are there to give you some indication of what, of what could happen.
Joshua Shanker - Citigroup
And then... if the deterioration of the marketplace were to freeze right now, things didn't get better but they didn't further deteriorate of the 26 billion that you margin losses, what actual loss for the portfolio take?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
That's a... I mean a very good question.
We haven't really taken any credit losses to-date as we paid nothing out. I would think that it's hard to really give you an accurate answer on that because there are so many moving parts.
But I think it would be something less than the $5 billion number that we've published.
Joshua Shanker - Citigroup
Okay. And then just a quick number's question, Steve something mentioned that two thirds of the OTTI loss were already reflected in book value at unrealized losses from prior quarters.
Is there any way that we can get up, understand the trend, what was the cumulative unrealized credit losses plus OTTI for the last three quarters? Can we see a trend in that?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Well, the trend... I think you have to look at the trend in the total evaluations of the portfolio and not just what's in...
other than temporary impairment charges but also including what comes through in the balance sheet. And if you look, for example, at the change in other comprehensive income for this quarter versus last quarter, you see about a $7 billion improvement in the change, in the AOCI, which is principally driven by unrealized appreciation or depreciation.
So that's 7 billion pre-tax, about $4 billion or so after tax. So we've certainly seen a moderation...
significant moderation in the second quarter of the overall pace of decline in those evaluations.
Joshua Shanker - Citigroup
And then, am I more or less somewhat just find it so many with the first quarter of this year, the fourth quarter of last year, the OTTI losses were not taken from the AOCI calculation, but they are really sort of emergent losses at that time?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Yes. That's the big difference.
This quarter, the OTTI was very significantly offset, effectively a lot of it moved from the balance sheet to the income statement, where certainly in the previous quarter and the fourth quarter, it was more additive.
Joshua Shanker - Citigroup
Okay. Well, thank you very much.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Yes.
Operator
Andrew Kligerman, UBS. Your line is now opened.
Andrew Kligerman - UBS
Thank you. First question comes back to the excess capital issue.
I know you've refrained from providing an excess economic capital number. But you are saying in, at least as I read in the 10-Q that you have 99.95% confidence that your capital is commencering with a AA range rating.
If I go back to your previous metrics for estimating excess economic capital, I come up with a number of 13 to $19 billion. So, the first question is the 13, 19 to 19 even in the ballpark with reality?
And secondly, maybe just a little more clarity on why you are so confident?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Okay, Andrew, Steve. Good morning.
Andrew Kligerman - UBS
Good morning.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
It's a very good question. I am going to refrain from either affirming or denying your quantitative assessment because that's not something we really want to do at this point in time.
I mean you can do you your math and come up with your numbers what you've done. The reason that we have not quantified it as we have in the past, as its pretty clear to us that at this point in time, in this environment the ultimate governors of capital are not solely our point of view, which we've settled along on the economic capital, but the point of view of the rating agencies, the points of view of the regulators and other market participants.
So, while we certainly have a point of view based on what we think is rigorous analysis, that's not a prevailing point of view in this marketplace. And we have to be realistic about what's really driving our capital needs.
And, hence, while we have a point of view and we have a confidence level associated with that and we communicate that, it's not the... its not the driving factor in this environment.
Bob, I don't know if you want to add anything?
Robert B. Willumstad - Chairman and Chief Executive Officer
No. I think obviously, Steve said it correctly.
The rating agencies today are the governor of how much capital we have and how much capital we need.
Andrew Kligerman - UBS
Do you have a... if you had to sort of assess your level of concern that you're going to need to raise capital in the next six months, how would you rank it sort of low, medium or high?
Unidentified Company Representative
Again, similar question as before. The real question is what's the level of future losses and that's going to be dependent on the capital markets and I just don't think that we are prepared to make that forecast right now.
We've shown our stress analysis. But obviously as an issue of timing and so right now our efforts are to protect our capital bases as much as we can and go through with difficult...
Andrew Kligerman - UBS
Okay. Fair enough.
And then just sort shifting over to the Super Senior CDS losses. Steve, talked a bit about the role forward and some of the conservative assumptions going on in that new 5 to 8.5 number.
But now you've got an aggregate loss of $25 billion. Could you give us a sense one or two big data points that drove the $25 billion that, that's in that $25 billion loss, I think out of $80 billion in initial securities or insurance?
What's in that number? What are the assessments there that are driving that and what do you think the likelihood is that we are going to see another 5 or $10 billion hit next quarter?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Maybe I'll just, no comment on our overall basis and if Elias wants to add anything, I'll certainly open the mike to him. I think the principle driver of the fair value marks that we're taking on our GAAP financials, is based upon market pricing.
Market prices were both underlying collateral with any mortgage type exposure or structured securities continues to be very adverse in today's marketplace. You have a market that's, first of all, adverse to these types of risks.
Secondly, illiquid, there is a very little trading going on. And then you also have sales of securities that are done on a for sale or on fire sale type of basis that also dive the entire market now.
There is also the very little distinguishing characteristic in the market today in pricing between different vintages. Our portfolio is principally 2005 and prior as we've highlighted before.
But the pricing and the market of CDOs and underlying collateral is really not distinguishing properly in our view between different performances characteristics of those vintages. Alois, do you have anything further on that.
Elias Habayeb - Chief Financial Officer AIG Financial Services
Yes. Couple of quick points.
That from an accounting perspective the fair value we reflect what's the exit price or liquidation price of the transaction today in the current market and the way we value this portfolio that came to us holding the actual CDO security. So there is a hefty liquidity premium that's going in the evaluation.
On the stress analysis, what that stress analysis is looking at if we hold the position until maturity, how much cash do we expect to loose from today through the maturity of that position. And so that's kind of the highlight the difference between our credit analysis, estimates and the evaluations that we are using from the financial reporting perspective.
Andrew Kligerman - UBS
So, can you give a blunt number around, sort of an average recovery expectation or something like that, to just trying to get a flavor for what you are thinking?
Elias Habayeb - Chief Financial Officer AIG Financial Services
In the evaluations itself?
Andrew Kligerman - UBS
Yes.
Elias Habayeb - Chief Financial Officer AIG Financial Services
The recovery expectation will be the difference between the stress scenarios that we show and the mark that's been taken.
Andrew Kligerman - UBS
Okay.
Elias Habayeb - Chief Financial Officer AIG Financial Services
And again those are not expected losses, those are stress case analysis. So we're not giving expected loss-mark because we really have no way to base that.
We can use scenarios and I would suggest, you take a look in the larger presentation that we posted last night, the credit presentation, pages 14 through 23. I think give you a lot of information about first of all, how the stress test moved from last quarter's number to where they are now.
And secondly, the underlying assumptions around frequency and severity associated with those two different stress analysis. And you'll see, as I noted in my remarks, that they are print some pretty conservative assumptions on those.
Andrew Kligerman - UBS
Okay. I'll check that out.
And then just lastly, Bob with regards to your conversations with Hank Greenberg, has there been any progress on that front?
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, we continue to talk I've just spoken to him as recently as a few days ago. I'm not going to disclose kind of the progress or the nature of the conversations but we continue to talk to each other.
Andrew Kligerman - UBS
Thanks a lot.
Robert B. Willumstad - Chairman and Chief Executive Officer
You are welcome.
Operator
You have a question from Andy Den [ph], RBC. Your line is open.
Unidentified Analyst
Good morning, could you give us some more color on the securities lending losses?
Unidentified Company Representative
yes, maybe we'll give that one to Richard Scott.
Richard W. Scott - Senior Vice President - Investments
The securities involved are primarily direct securitizations of mortgage home of various types. But primarily sub-prime and Alt A they were initially AAA in the mark-to-market which is what's going through the OTTD calculation is just that.
It's taking the market price of those securities as they are currently trading and marking it through our income statement.
Unidentified Analyst
To securities you held that were downgraded? Actually most of them have not been downgraded the bulk of them were AAA floaters.
Richard W. Scott - Senior Vice President - Investments
Its another... it's a function of pricing again, it's the same explanation I just gave to Andrew on the CDOs, its is the same market price phenomena that's driving the price valuation on the RMBS collateral that back the securities lending for.
Unidentified Analyst
Okay, and then was any of it due to a mismatch in the duration of the financing?
Richard W. Scott - Senior Vice President - Investments
No, the duration is primarily... there are floating rate-to-floating rate so no, I would not characterize it is a duration mismatch.
Unidentified Analyst
Okay, thank you very much.
Operator
Tom Cholnoky, Goldman Sachs. Your line is now open.
Thomas Cholnoky - Goldman Sachs
Thanks, good morning, thank you, I've got two questions, Bob if your fact historically at AIG one of the hallmarks of the company was is it's willingness and ability to take risk and generate returns that were clearly in excess so if what other companies were able to do, and given the underlying trends in your core businesses and your focus on what appears to be de-risking the businesses. How would you really access the core earnings power of the company, especially in light of previous management's target of a 15% ROE over the next five years?
And then I have got a follow-up.
Robert B. Willumstad - Chairman and Chief Executive Officer
Okay, I think you know that the hallmark of AIG historically has been its ability and willingness to take risks and I will say prudent risks out in my judgment anyway largely in its core business of property and casualty and life underwriting. I think as you look now you see again in retrospect much of the problems that have come about, have been a concentration of risk in the U.S.
housing market both in the investment portfolio and [indiscernible] but it's default swap, my own view is that lowering the level of risk will be making sure of that we are getting paid adequately for the risk that we take I mean if you look at the impact in financial products area these are relatively small... and narrow margins for what's now turned out to be a much greater amount of risk than I think any body anticipated.
So, I think we will stick to where we have competitive advantages which is essentially in our core insurance business and I think as we go through this review process we need to better understand the amount of risk that we have taken whether we are going to get adequately compensated [indiscernible]. Many of these businesses that have performed quite well in the past have been a byproduct of company that was AAA rated which we don't now have.
So I think the environment's changed and the competitive landscape has changed and obviously the ratings of the company have changed and I think we have to factor that into our judgments.
Thomas Cholnoky - Goldman Sachs
Does that mean that 15% that was earned is no longer something that makes sense in the current environment?
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, certainly in the current environment, it would be hard to say, put your finger on any return. I think as we go through this evaluation and hopefully in September we'll be able to talk about what we think the returns will be as we kind of look at the composition of the portfolio businesses going forward.
But I'd be hesitant to put a number on it right now.
Thomas Cholnoky - Goldman Sachs
And do you think, and how do you think or how do you... what are the rating agencies saying to you currently I haven't seen any of them come out to make any pronouncements but given your most recent results, do you foresee any changes in the way that they are viewing the company?
Robert B. Willumstad - Chairman and Chief Executive Officer
No, we've spent time with the rating agencies that we just haven't heard back from them. They haven't made any public statements.
So we're waiting to hear.
Thomas Cholnoky - Goldman Sachs
Okay. And sorry one last question, if I can on ILFC real quickly.
There's been a lot of speculation in the market if oil tends to trade back up to 140 that the global airline industry will start to have some significant problems in terms of being able to keep airplanes in the air and is there any risk that you could envision where perhaps the residual values of your fleets could be impaired, if somebody could comment on that?
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, I will make one comment, maybe turn it over to Allan [indiscernible]. Our most recent review of that business is that all of those claims [ph] have been put out on lease and well I think every body understands that there is a potential for some risk going forward in the airline business.
I think ILFC really is a premier company with a market leadership position and has proven very adept at dealing with a lot of these problems insuring that these aircrafts are leased but Allan maybe you want to comment?
Unidentified Company Representative
Yes, I think what I would add to that is that we have by far the most fuel efficient fleet that's out there in general and so where there are airlines now that will be trying to get less fuel efficient airplanes out of their fleet and they, and in the current financing environment where they are having problems taking on an incremental airplanes that they would be looking for leasing and we have got the right product for what they need to deal with the higher cost of fuel.
Thomas Cholnoky - Goldman Sachs
Okay, great thank you.
Robert B. Willumstad - Chairman and Chief Executive Officer
Thank you.
Operator
Tom Gallagher, Credit Suisse. Your line is now open.
Thomas Gallagher - Credit Suisse
Hi, few questions, first for Bob, just broadly speaking I know you are not really prepared to go into specifics but broadly speaking when you mention risk reduction as a strategy does that contemplate meaningful reduction of housing related exposure, or do you still think that's too cost prohibitive based on a liquidity? Its question number one.
Related question is your consideration here to reducing the types of assets that you invest in including private equity and hedge funds a potential reduction in allocation to those asset classes. And then why don't stop with those and I have a few follow-ups.
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, your comment about cost prohibitive on housing obviously is the challenge we face... we continue to look at any number of options again given the analysis that we shown around the stress testing, most everything we think that might be available in the marketplace would be cost prohibitive.
But we are going to continue to look at all those of things. Obviously, any effort to de-risk that part of the business would be an important decision for us and obviously we'd have to look at the cost implications of that.
I think on the second question obviously, investment performance and investment income is down considerably against the high watermark of last year much of it driven by private equity and alternative. Again we think that business for the long term has good returns attached to it and I think it's a question of risk, it's a question of timing and obviously it will create more lumpy if you will investment returns but I think over the long term that's a decent asset class first to be in.
Thomas Gallagher - Credit Suisse
Okay. And then just a couple of other questions, one on some disclosure you have on VIEs I believe there is 38 billion of worst case losses at least as indicated in your 10-Q, can you comment a little bit about how much of this should we think about being first loss or subordinated positions versus being more of a carry pursue investor with collateral pulls that you've originated?
So that's the question on the VIE. Another question I had on the regulatory capital CDS on the market took, Steve if I understood you correctly, you said it was $125 million mark related to one contract for 1.6 billion that you had expected to mature that didn't, and that looks to be if I am right about an 8% mark.
How should we think about as that relates to the remaining 307 billion of the notional led west. Should we think about all of that being assumed to run off and that which is does not run off, would have a similar mark or maybe you can help us think through that?
Thanks.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
yes. Let me take that question and then we'll go to VIEs in a second.
This particular trade, and again I'll let Elias amply on it, had different characteristics in terms of the underlying reference pools, than the rest of regulatory capital relief books. So, the reason we separated it out is because we don't see that as being indicative of evaluation or the remainder of that portfolio.
The remainder of the portfolio continues to show terminations, many of them earlier than we expect at either at no cost or some times with a payment to AIG for termination as the regulatory capital relief is no longer provided to the counter-party as they implement Basel II. This particular run had different features and may be Eli, you can just explain that.
Elias Habayeb - Chief Financial Officer AIG Financial Services
Yes. I'd be happy to.
In this one transaction... the difference in this transaction is we run a security that is Vera [ph], a security that was backed by mortgages while in the rest of the regulatory capital portfolio, we entered into a derivative with the bank on loans that they spectate on their balance sheet.
And in this case through our surveillance and monitoring, we understood that their counterparty's motivation has gone beyond capital relief for other purposes. And we continue to monitor as we've said before the portfolio very closely, say very close our counterparty.
And we educate ourselves from the 80 plus billion in transactions that's have already been terminated early during the year, which have told us that for those types of derivatives that are used for capital management purposes, the value propositions that our counterparties are seeing is insensitive to what's happening to spreads in the marketplace. And we continued to believe at this point, based on the data that's available for us if the rest of the portfolio is being used for capital management purposes and once that benefit disappears, the intent of the counterparty is to unwind its transaction.
And therefore, we believe the market we have on those today on the balance sheet as of June 30 is the right mark for that portfolio.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
I would also point out Tom that the... if you have a chance, take a look at page 9 of the credit presentation.
That shows the reference pool losses to-date against the weighted average attachment points on these different pools. And I think you'll see that they are extremely low.
Thomas Gallagher - Credit Suisse
Okay. So just a follow-up on that.
So, is it fair to say, this was more of a one off transaction embedded within the pool, where the risk or the quality of the collateral was not nearly as good as what's left? I guess mine only concern here would be, if we roll forward several quarters and we keep thinking about the embedded assumptions for how fast this runs off and maybe some of it doesn't run off, would we see marks that are somewhat similar, even considering the fact that losses maybe way away from attachments.
I'm just worried more about the marks that we might see on this.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
I'll let Elias or Andy Foster talk but its not... it really wasn't a...
it's not a quality of collateral issue. It's more of the form of the underlying collateral.
Andy do you want to just talk about that on this transaction?
Unidentified Company Representative
yes, sure. I think, the quality of this transaction is indicative of those transaction we have.
There is no change there as Steve mentioned. And going forward, as Eli said, we will continue to monitor the transactions and ensure that the motivations remain consistent with our current beliefs.
Thomas Gallagher - Credit Suisse
Okay, thanks. And then on the VIEs.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Yes. I'll let David Herzog, our Chief Accounting Officer to talk about that one.
David Herzog - Chief Accounting Officer
Hi Tom. It's David.
The best performance [ph] so that exposure we are indeed credit pursue with the equity holders.
Thomas Gallagher - Credit Suisse
And David is there an equity sort of first loss position content there, if we were to say starting with the 38 billion?
David Herzog - Chief Accounting Officer
No. Tom No.
These investments are recorded on our... most of them are consolidated on our balance...
included on our balance sheet, not consolidated but included on the balance sheet and again it's not a first loss.
Thomas Gallagher - Credit Suisse
Got it. So the 438 is prior to sale.
David Herzog - Chief Accounting Officer
That's correct. As performance of its credit pursuit.
Thomas Gallagher - Credit Suisse
Thanks a lot.
Operator
We have a question from Jay Gelb, Lehman Brothers. Your line is now opened.
Jay Gelb - Lehman Brothers
Thank you. I was hoping if you could give us a sense of what your minimum target ratings would be for as with the corporate level for financial strength as well as senior long-term debt?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Jay, its Steve. I think our target is to maintain our current rating levels.
I don't think we have a minimum target level that we are shooting for her. So, that's a tough question to answer beyond that.
Jay Gelb - Lehman Brothers
Okay. That's fair.
And then, as we get closer to the results of the strategic review, should investors be prepared for earnings or balance sheet charges related to that?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
That would be premature to say. I don't think that's necessarily part of any expectation.
Obviously, if we were to decide to the best of assets, I suppose could be some charges for that. But that's not the thought process I think right now.
Jay Gelb - Lehman Brothers
Will there be a reserve review on the property casualty businesses part of the strategic review or might that come later?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Well, I don't know if that's necessarily a strategic issue. I think that goes on a regular basis.
Frank H. Douglas - Vice President and Casualty Actuary
yes. This is Frank Douglas.
We... many different sets of eyes review our reserves every quarter.
We do a fairly complete update of the reserves for each profits and our each quarter. That's what you see in the results.
We have outside eyes also look at the number on a regular basis. So, we're pretty comfortable that many folks has need to, are already reviewing the results.
Jay Gelb - Lehman Brothers
Okay. Thank you very much.
Thank you.
Operator
Next question comes from Alain Karaoglan, Banc of America Securities. Your line is now opened.
Alain Karaoglan - Banc of America Securities
Good morning. I have several questions.
The first one relates to the capital, the $20 billion in capital that was raised already. Where have you allocated the...
to which segments of the business that is found a home and do you have any left or has it been all allocated or you expect to allocate it in the third quarter?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
Alain, its Steve. No.
It has not been all allocated. There is a large sum of it left.
The allocation that's been made so far has been... some of it to the domestic life and retirement clearances companies for capital purposes.
And the most of it I would say has been used to... for AIGFP purposes in terms of collateral.
Alain Karaoglan - Banc of America Securities
Okay. In terms of the de-risking of the company, I assume if you are going to de-risk that means you are going to lower the risk on the investment portfolio.
And the question that I have is in, should you be selling so much and fix annuities outside the U.S. which depend on it...
which is a spread business, or is that going to force you to maintain a riskier portfolio Bob than you would like because you've sold these annuities on the crediting at minimum rates? And related to that, on the partnership income really the issue is not one of volatility and whether you should have any at all.
But isn't that more the size of the partnership investments compared to other companies that is more significant, so while you might still have some, it should going to de-risk, you should have less of it?
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, I mean, in response to the last question, in terms of partnership income, I am not sure again I haven't looked at it from a competitive point of view very closely. But given the size of our balance sheet, the 3, 4% that we have is, seems to me is not unreasonable given again the size of this balance sheet.
I think to try and response your first question, when I think about de-risking, I think about businesses that I'll say are not necessarily core to our overall franchise. And I think there are lot components both to the property and casualty as well as the life business that we need to look at carefully.
But again, I think there is a certain amount of risk one has to take to be in these businesses to be a leading player in the industry. So, again all of those things are certainly going to be the part of the review process.
But we'll look at the investment portfolio as well.
Alain Karaoglan - Banc of America Securities
And could you update us on this CFO search and what your expectations are?
Robert B. Willumstad - Chairman and Chief Executive Officer
Well, the process is ongoing. I've met with the number of the potential candidates, very attractive.
And I expect over the course of the next six to eight weeks to have that resolved, if not sooner.
Alain Karaoglan - Banc of America Securities
Thank you very much.
Robert B. Willumstad - Chairman and Chief Executive Officer
You're welcome.
Operator
We have a question from Jay Cohen, Merrill Lynch. Your line is now opened.
Jay Cohen - Merrill Lynch
Yes. Thank you.
Just some unrelated questions, first is on the domestic retirement, the fixed annuities individual, fixed annuities. It look like on a consecutive quarter bases, not only did the base yield go down, but it look like the cost of funds went up.
So I guess the crediting rate went up. Why would that occur when base yields are coming down?
Unidentified Company Representative
Hi. This is Jay Wintrob.
Good morning. Just a couple of comments other than just back track on...
I'll answer earlier question on, I do not know if you are connecting partnerships with fixed annuity crediting rates. But as...
for our pricing purposes, the returns on partnership investments are not factored into the pricing we use on our credited interest rates as in the side. The reason cost of funds went up is pretty straightforward.
In the quarter you had along the yield curve treasuries, the treasury curve is shifting up at the longer duration by way of example. Two year tier was up a 103 basis points, five year tier was up 89 basis points, 10 year tier was up 56.
So, it's logical that some of that increases would be reflected as we adjust our crediting interest rate on new business, not all of it of course because new business is just a component of the overall block. And the primary reason I think was mentioned earlier on the declining of base yield was directly related to what Steve mentioned, which was the prudent build up of liquidity in those portfolios.
Jay Cohen - Merrill Lynch
That makes sense. Thanks.
Second question, this is probably a quick one. In the other income, the other unallocated expenses were up quite a bit and there were something as charge for settlement of dispute.
I'm wondering if you can quantify that that was a material reason why those expenses went up.
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
That was a $100 million, Jay.
Jay Cohen - Merrill Lynch
Pretty material. Can you talk about the dispute that was settled?
Steven J. Bensinger - Executive Vice President and Chief Financial Officer
It was relating to our buyout of the remaining interest in Ascot in London and you know fully resolved.
Jay Cohen - Merrill Lynch
Okay. That's great.
Thanks Steve. And then last question on UGC, I guess the losses have just been so astronomical.
It's really mind boggling. When did these losses peak?
Can you look out at all and give us any sense of when these losses will at least peak and level off?
William V. Nutt, Jr - President and Chief Executive Officer UGC
Jay, this is Billy Nutt. Good morning.
Obviously, the ongoing disruption... in the deepening disruption in the housing market is placing pressure on our first and second lean losses as well as those of the rest of our industry.
We anticipate that the housing market is not going to stabilize until the middle... or to the second half of next year.
Combined that with weakening in the economy... ongoing weakening in the economic environment that it's going to continue to challenge our domestic businesses.
And therefore, we expect losses to continue at their current levels for the next several quarters. And we think that 2009 is going to be a challenging year as well.
Jay Cohen - Merrill Lynch
Is it fair to say that the loss in 2009 might be smaller than 2008?
William V. Nutt, Jr - President and Chief Executive Officer UGC
It's hard to tell at this point in time. It should not be any worse than 2008.
But again that depends upon how much further this housing market deteriorates. And whether we go into a rather strong economic recession.
Jay Cohen - Merrill Lynch
Billy, have you made any management changes at this... at the company?
William V. Nutt, Jr - President and Chief Executive Officer UGC
I don't anticipate any management changes. Perhaps I should defer that to Bob.
Jay Cohen - Merrill Lynch
So, I'm saying going to say that have you management changes for your rank and file?
William V. Nutt, Jr - President and Chief Executive Officer UGC
Yes. We've done some restructuring within our domestic group and we have made some management changes.
In order to consolidate some businesses as you know, we have significantly contracted our second lean business. We reengineered that business and we've made some management changes and some in-forced reductions as a result of those changes.
Jay Cohen - Merrill Lynch
Alright. Thanks for the answers.
Unidentified Company Representative
Operator, we can take one more question please.
Operator
We have a question from Larry Greenberg, Langen McAlenney. Your line is now opened.
Larry Greenberg - Langen McAlenney
Thank you very much, and good morning. Just back to CDOs for a moment.
I am wondering if you have an opinion and the argument that some people have made that some underlying trends in the collateral backing these instruments have actually improved specifically that the inflow of new problems, sub-prime loans Tess load and there is lower roll rate into lead delinquency buckets.
Kevin B. McGinn - Vice President and Chief Risk Officer
Hi, Larry, good morning. This is Kevin McGinn.
As you know the CDO collateral that the sub-prime and Alt A collateral that backs our CDOs is heavily from the 2005 vintage in fact about 71% of it is from the first half of '05 and before...
Larry Greenberg - Langen McAlenney
Okay.
Kevin B. McGinn - Vice President and Chief Risk Officer
And yes, there is definitely been a slowdown in the... especially in the last three months.
We've seen early indications that the pipeline is definitely slowing down. And that is as we expected because as the adjustable rate mortgages flowed through the pipeline we did expect to see as those things reset the data to improve...
is slightly improving. The rate of growth is definitely slowed dramatically.
The '06 and '07 though continues to not show any appreciable decline. We don't have a lot of that in the CDO pulls as you know it.
So it's only a small component of it, but we are encouraged obviously by the '05 development.
Larry Greenberg - Langen McAlenney
Okay, great and then can you give us an update on the material weakness as it relates to CDS valuation?
Unidentified Company Representative
Yes, we can do that, I think we are continuing to make the necessary investments in people and process and automation around that whole area. So I would say that we are hopefully on track to meet our objectives for remediation by the end of the year, that's our objective.
Larry Greenberg - Langen McAlenney
What part of the conclusion of that... your ability to move away from valuing the portfolio as if you own the underlying CDO and go back to some sort of CDS valuation, negative basis adjustment is that part of the thinking?
Unidentified Company Representative
No, that's really not, it's the market observeability will dictate any changes in methodology as of right now, we don't see any thing that will lead us to believe that the absorbability of negative spreads is any where near on the horizon.
Larry Greenberg - Langen McAlenney
Great, and then just switching gears a little bit. On property cash little lost reserves, I know its been discussed in past quarters but the persistence of problems with the 2001 and prior business, in the face of most of the industry recognizing pretty consistent redundancies in the lost reverses.
I recognized the challenges of excess casualty on some long tail lines but I mean there has to be some urgency to put this issue behind the company and I am just wondering if you could elaborate a little bit more on that.
Frank H. Douglas - Vice President and Casualty Actuary
Yes, this is Frank Douglas I guess just a recap briefly what we generally do to set over there as you probably know, we relay on historical loss emergence pattern. We do the same thing for excess casualty.
When you get reported emergence as we have in the past couple of years that has exceeded that historical norm, you are going to get adverse development. So simplistically that's what been occurring for excess casualty including many kinds of latent [ph] claims, which we described to you in the 10-Q in some detail.
Why are we seeing that more than other companies I think a simple answer is no other company, I think you are probably comparing us to or had anywhere near the market share of excess causality that we did. We had a very large share of the market in the late 1990s, as you know that's turned out to be a very unprofitable time, particularly for excess causality and we're still despite the very adverse results, we've recognized through the years, we're still seeing higher than expected emergence patterns coming from those years.
The good news is that the more recent years even for excess casualty continue to develop favorably. As we're concerned about those older years, the overall active book, certainly the last three or fours accident years, five accident years has developed very favorably and I'd say very comparable to these of the other companies you're comparing us to, who don't have an excess causality book, besides of what we have.
And I'll just add, we have added 3 billion to our reserves, year-to-date and I don't think the competition has increased reserves significantly, at least mush of it. So I think that's partly the result of our quarterly updates where we are telling you what we are seeing and if we are seeing a neat increased reserves that's what we reflect.
Larry Greenberg - Langen McAlenney
Thank you.
Robert B. Willumstad - Chairman and Chief Executive Officer
Okay. Again I want to thank everybody for taking the time and we look forward to seeing you in September.
Thank you.
Operator
That concludes today's conference. Thank you for participating.
You may disconnect at this time.