USA To Acquire AIG (With Updates)

The Federal Reserve Board says the U.S. government will be getting a 79.9% stake in American International Group Inc. in exchange for the Federal Reserve Bank of New York providing up to $85 billion in financing.

The Fed says it has authority under Section 13(3) of the Federal Reserve Act to approve the deal and is proceeding with the full support of the Treasury Department.

The government is intervening in part because of a concern that a failure of the AIG operations that act as counterparties in derivatives transactions and other complex transactions could trigger failures throughout the financial services industry.

AIG noted in May, in a prospectus filed with the U.S. Securities and Exchange Commission, that the AIG Financial Products Corp.’s super senior credit default swap portfolio has a total of about $469 billion in “notional exposure” to defaults.

“The [Federal Reserve] board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance,” the Fed says in a statement.

“The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due,” the Fed says. “This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.”

The Fed’s Authority

Section 13(3) of the Federal Reserve Act states the following:

3. Discounts for Individuals, Partnerships, and Corporations

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank:

Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.

AIG’s Views

The AIG board has issued a statement welcoming the the move by the Fed and the New York Fed to set up the $85 billion revolving credit facility.

The board “has approved this transaction based on its determination that this is the best alternative for all of AIG’s constituencies, including policyholders, customers, creditors, counterparties, employees and shareholders,” the board says.

“AIG is a solid company with over $1 trillion in assets and substantial equity, but it has been recently experiencing serious liquidity issues,” the board says. “We believe the loan, which is backed by profitable, well-capitalized operating subsidiaries with substantial value, will protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis.”

AIG investors have been expressing confusion about whether the Fed really will be taking ownership of 79.9% of AIG or simply treating that percentage of AIG as collateral and getting the 79.9% stake if AIG misses payments.

The AIG board says in its statement that, “American taxpayers will receive a substantial majority ownership interest in AIG.”

The proceeds of the sales should be enough for AIG to repay the loan in full, the board says.

“Policyholders of AIG companies around the world can rest assured that AIG’s commitments will continue to be honored,” the board says.

In the statement, the AIG board thanks New York Gov. David Paterson, D; New York State Insurance Superintendent Eric Dinallo; Pennsylvania Insurance Commissioner Joel Ario; other state insurance commissioners; officials at the Fed and Treasury Department; and officials at the Office of Thrift Supervision.

The Deal

The New York Fed credit facility “has terms and conditions designed to protect the interests of the U.S. government and taxpayers,” the Fed says.

The New York Fed’s AIG credit facility has:

- A 24-month term.

- An $85 billion maximum.

- A variable interest rate that will equal the London Interbank Offered Rate plus 8.5 percentage points.

The initial interest rate would be over 11%, but AIG apparently would have to pay interest only on the amounts that it draws from the facility.

“The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries,” the Fed says. “These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets.”

In addition to getting a 79.9% equity interest in AIG, the government will have the right to veto the payment of dividends to common and preferred shareholders, the Fed says.

The Fed also will get veto power over “important management decisions,” such as sales of subsidiaries, a Fed official said.

Insurance subsidiaries and affiliates will remain subject to state regulation.

Management

The government has not yet decided whether the Fed or the Treasury Department will be in charge of appointing new management at the holding company level, the Fed official said.

For the moment, the official said, the AIG board will remain the same, but New York Insurance Superintendent Eric Dinallo has confirmed that Edward Liddy, the former chief executive officer of Allstate Corp., Northbrook, Il.., is being recruited to run AIG’s day-to-day operations.