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Feds Restructure AIG Aid

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The federal government today relaxed the terms of the American International Group Inc. rescue package as the company posted a $24 billion loss on $898 million in revenue.

Total domestic life sales and deposits increased during the third quarter at AIG, New York, despite the effects of the financial crisis.

But AIG notes in a quarterly report filed with the U.S. Securities and Exchange Commission that further downgrades could result in about $12 billion in collateral calls and termination payments, along with early terminations of some multi-sector super senior credit default swap arrangements, or CDS arrangements, with a net notional value of about $48 billion.


The U.S. Treasury Department says it will try to help AIG recover from lingering problems with its shuttered financial products unit and related problems by changing the company’s rescue package.

In exchange for accepting strict limits on compensation for the top 5 senior executive officers at AIG, limits on golden parachutes, and a freeze on the size of the annual bonus pool for the top 70 company executives, AIG has received a sharp reduction in the cost of the government financing.

The new, $150 billion package will replace a 2-year, $85 billion Federal Reserve Bank of New York credit facility with a 5-year, $60 billion term.

The interest rate will drop to 3 percentage points plus the 3-month U.S. London Interbank Offered Rate, from 8.5 percentage points plus LIBOR.

The fee for undrawn credit facility capacity will drop to 0.75% of the total amount, from 8.5%.

AIG also will sell get $40 billion by selling the government’s Troubled Asset Relief Program preferred shares paying a 10% interest rate.

The government plans to contribute a total of about $52 billion and AIG about $6 billion to 2 entities that would buy and manage assets from AIG’s credit derivatives and securities lending operations.

AIG Chairman Edward Liddy said today during the company’s third-quarter earnings teleconference that AIG now owes the government $61 billion on the credit facility and about $20 billion for money borrowed through a separate secured lending facility.

AIG has been using most of the financing to handle the financial products unit’s obligations.

In the past, when AIG had AAA ratings, the unit used AIG’s financial strength to sell CDS arrangements. The CDS arrangements guaranteed that other large borrowers would keep up payments on their notes and bonds.

When the mortgage-backed securities market began to collapse and the ratings of debt issuers that once seemed secure deteriorated, AIG’s own debt ratings began to fall.

Parties that bought AIG CDS arrangements demanded that AIG back the arrangements with tens of billions of dollars in additional collateral.

One of the new Fed-AIG entities will focus on buying the multi-sector collateralized debt obligations, or CDOs, underlying credit defaults swaps that AIG has written.

Analysts have concluded that AIG and government officials that AIG will be paying about 50 cents on the dollar for the CDOs, then “terminating” the CDS arrangements linked to those CDOs.

The Fed-AIG entity will try to renegotiate the terms of the CDOs underlying the AIG-written CDS arrangements, according to Liddy.

“The Federal Reserve, and its rather substantial influence will be the driver of the negotiations with the counterparties, and we would expect that they will have substantially more success with those discussion than we had,” Liddy said during the earnings conference.

Liddy said the Dutch government has been providing support for ING Groep N.V., Amsterdam, and AEGON N.V., The Hague, Netherlands, to help them cope with the same systemic issues that AIG has been facing.

The new government aid package restructuring “may be a way to stave off or limit the impact of downgrades,” securities analysts at Sandler O’Neill & Partners L.P., New York, write in a comment on the restructuring.

Because of the restructuring, “it looks like AIG might actually survive,” the Sandler O’Neill analysts write. “It puts off the 2-year deadline for selling AIG’s properties. It lowers the debt cost to AIG. It provides long-term equity capital, which is what it really needed.”

Another implication is that other insurers may end up in TARP, the analysts write.

Some publicly traded life insurers seem to like the idea of getting into TARP and hastening the arrival of federal regulation of insurers, but other insurers seem to be leery of TARP and the prospect of federal regulation, the analysts write.

AIG is a bailout fund.

It’s a slightly more sophisticated Tarp. Which is why nobody should really be surprised by this morning’s news.

The US government is to extend its existing credit line to AIG to a staggering $150bn. Not, though, to save the ailing insurer.

As is typical of bailout funds, the money will be put towards supporting asset prices and keeping bank balance sheets stable. Also paying AIG staff bonuses, hunting trips, etc.

Taxpayers capital will continue to go towards meeting collateral calls on CDS contracts: these calls will be direct liquidity-like cash infusions into the banking system. Meeting such calls will also allow the CDS contracts to remain in place, which will allow banks to pretend they don’t own any risky assets, as far as regulatory risk-weighting and capital requirements are concerned.


As AIG was reporting the revised federal aid package, it also was reporting a $24 billion net loss for the third quarter on $898 million in revenue, compared with $3.1 billion in net income on $30 billion in revenue for the third quarter of 2007.

AIG capital losses and market valuation losses on the AIG Financial Products unit’s super credit default swap portfolio cut revenue and net income by about $25 billion.

Revenue from premiums, fees and other considerations increased to $21 billion, from $20 billion.

Excluding the effects of net realized capitalized gains, the domestic life and retirement services operations are reporting $1 billion in operating income for the latest quarter on $23 billion in premiums, deposits and other considerations, compared with $2.5 billion in operating income on $24 billion in premiums, deposits and other considerations for the third quarter of 2007.

Capital losses hit the domestic and global life operations as well as the company as a whole, but AIG says sales and deposits for many domestic life products actually increased during the third quarter and began to decrease only in mid-September.

Universal life and variable universal life sales and deposits fell to $51 million, from $61 million, but term life sales and deposits increased to $58 million, from $53 million, and home service life and annuity sales and deposits increased to $86 million, from $54 million.

Payout annuity sales and deposits increased to $867 million, from $711 million.

Sales of group retirement product premiums revenue and revenue from other considerations fell to $102 million, from $114 million, but individual fixed annuity considerations increased to $26 million, from $24 million.

Individual fixed annuity surrenders held steady at $2.1 billion, and individual variable annuity surrenders increased to $1.3 billion, from $1 billion.

THE 10-Q

AIG has included extra discussions of its operations and turn-around efforts in a Form 10-Q filed with the SEC.

AIG starts a discussion of questions about its ability to continue as a going concern on page 8.

If management’s plans do not work out, “AIG would need to find additional financing and, if such additional financing were to be unavailable, there could exist substantial doubt about AIG’s ability to continue as a going concern,” the company says.

The latest consolidated financial statements do not include the adjustments that would be necessary if the company were unable to continue as a going concern, the company says.

AIG has started a section describing the new federal bailout package on page 24, and a section describing the last-minute efforts to find a private-sector source of liquidity financing – “Liquidity Events Leading Up to September 22, 2008″ — on page 49.

AIG writes about its darkest hour in this passage, on page 50:

The Private Sector Solution Fails

By Tuesday morning, September 16, 2008, it had become apparent that Goldman, Sachs & Co. and J.P. Morgan were unable to syndicate a lending facility. Moreover, the downgrades combined with a steep drop in AIG’s common stock price to $4.76 on September 15, 2008, had resulted in counterparties withholding payments from AIG and refusing to transact with AIG even on a secured short-term basis. As a result, AIG was unable to borrow in the short-term lending markets. To provide liquidity on Tuesday, September 16, 2008, both [AIG's International Lease Finance Corp.] and [AIG's American General Finance] drew down on their revolving credit facilities, resulting in borrowings of approximately $6.5 billion and $4.6 billion, respectively.

Also, on September 16, 2008, AIG was notified by its insurance regulators that it would no longer be permitted to borrow funds from its insurance company subsidiaries under a revolving credit facility that AIG had maintained with certain of its insurance subsidiaries acting as lenders. Subsequently, the insurance regulators required AIG to repay any outstanding loans under that facility and to terminate it. The intercompany facility was terminated effective September 22, 2008.

AIG describes the effects of possible future ratings downgrades on the remnants of AIG Financial Products on page 57:

In the event of a further downgrade of AIG’s long-term senior debt ratings, AIG would be required to post additional collateral and AIG or its counterparties would be permitted to elect early termination of contracts.

It is estimated that as of the close of business on October 27, 2008, based on AIGFP’s outstanding municipal [guaranteed investment agreements]. As and financial derivative transactions at that date, a downgrade of AIG’s long-term senior debt ratings to Baa1 by Moody’s and BBB plus by S&P would permit counterparties to make additional calls and permit either AIG or the counterparties to elect early termination of contracts, resulting in up to approximately $5.2 billion of collateral and termination payments, while a downgrade to Baa2 by Moody’s and BBB by S&P would result in approximately $0.3 billion in additional collateral and termination payments.

For the multi-sector super senior credit default swap portfolio, it is estimated based on the October 24, 2008 notional values a downgrade of AIG’s long-term senior debt ratings to Baa1 by Moody’s and BBB plus by S&P, would increase the amount of collateral posted by approximately $2.7 billion due to the adjustment of threshold and independent amount percentages. A downgrade to Baa2 by Moody’s and BBB by S&P would allow the counterparties to certain 2a7 puts to elect early termination, resulting in a cash outflow of approximately $3.7 billion. In addition, at that rating level, counterparties to transactions representing approximately $47.8 billion in net notional amount have the right to elect early termination. In the event a counterparty elects to terminate a transaction early, such transaction will be terminated at its replacement value, less any previously posted collateral. Due to current market conditions, it is not possible to reliably estimate the replacement cost of these transactions.

During the earnings teleconference this morning, Liddy said the revised government rescue package should help address AIG’s exposure to securities lending and multi-sector CDO challenges.


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