AIG, Fed Work Out New Rescue Plan as 3Q Loss Approaches $25 Billion

NEW YORK, Nov 10, 2008 (A. M. Best via COMTEX) -- AIG | Quote | Chart | News | PowerRating -- American International Group Inc. reached an agreement with the federal government aimed at shoring up its capital structure and resolving liquidity issues related to its credit default swap portfolio.

The new agreement was unveiled as AIG reported a net loss of $24.47 billion, or $9.05 per diluted share, for the third quarter. That compares with net income of $3.09 billion, or $1.19 a share, for the same period a year ago.

The deal, reached with the U.S. Treasury and Federal Reserve, will replace the current $123 billion government loan program with AIG with a roughly $150 billion program that involves the creation of two financing entities capitalized by loans from AIG and the Federal Reserve Bank of New York. The entities will buy assets related to AIG's U.S. securities lending program and multi-sector collateralized debt obligations on which AIG has written credit default swap contracts.

According to AIG, the entities will collect cash flows from the assets and pay interest on the debt. The New York Federal Reserve and AIG will share any recoveries in the market prices of the assets.

AIG had originally entered an $85 billion two-year credit facility with the New York Federal Reserve, along with a separate $37.8 billion securities lending program facility.

Under the new plan, the U.S. Treasury will buy $40 billion of new AIG perpetual preferred shares and warrants, equal to 2% of issued and outstanding shares, through the $700 billion Troubled Asset Relief Program, originally passed by Congress to bail out banks. The proceeds will be used to pay down part of the original credit facility.

The Fed's credit facility will commit an additional $60 billion loan following the issuance of the perpetual preferred shares. This funding involves revised loan terms for AIG. The interest rate charged to AIG on the original loan facility will be reduced to the London Interbank Offered Rate [LIBOR] plus 3% from the original LIBOR plus 8.5% terms. Also, fees on undrawn commitments will be cut to 0.75% from the current 8.5%.

Terms of the loan will be extended to five years from the current two.

With the first of the two new entities created under the plan, AIG will transfer residential mortgage-backed securities to the entity capitalized with $1 billion in subordinated funding from AIG, along with senior funding of up to $22.5 billion from the New York Federal Reserve. Once those amounts are repaid, AIG and the Fed will share in any further returns on such securities.

The insurer's remaining exposure to losses from its U.S. securities lending program will be limited to declines in market value prior to closing and its $1 billion share of the funding.

The second new entity will buy up to about $70 billion of multi-sector collateralized debt obligations exposure on which AIG has written credit default swap contracts. AIG will provide up to $5 billion in subordinated funding and the New York Federal Reserve will contribute up to $30 billion in senior funding the finance the entity. Through this entity, the CDS contracts will be terminated.

Under the new plan, U.S. taxpayers would own 77.9% of equity in AIG and will hold warrants to buy another 2% equity interest.

AIG's third-quarter result reflected net realized capital losses of $15.1 billion, compared with net losses of $600 million a year ago.

AIG's losses included a pretax charge of $7.05 billion for net unrealized market valuation losses related to AIG Financial Products Corp., the entity largely responsible for AIG's credit default swap problems. The unit also took a $1.09 billion charge for a credit valuation adjustment on assets and liabilities.

The group also took a charge of $18.31 billion mainly from other-than-temporary impairment charges on its investment portfolio. Those charges included $11.7 billion against AIG's securities lending program and $3.9 billion from the "severe, rapid decline in fair value of securities outside the securities lending program, for which AIG concluded it could not reasonably assert that the impairment period would be temporary."

AIG also recorded $1.39 billion in pretax catastrophe losses for the quarter, compared with $904 million in catastrophe losses for the same period a year earlier. Those catastrophe losses contributed to an $899 million third-quarter operating loss for the general insurance segment, before net realized capital gains or losses.

The general insurance segment also saw a $901 million increase in operating losses from United Guarantee Corp. and a $659 million drop in net investment income.

General insurance net premiums earned fell slightly in the quarter. Commercial insurance net premiums written fell 6.9% to $5.6 billion. The foreign general and private client group said an 11.5% rise in net premiums written. The commercial and foreign general segments are considered core operations for AIG.

Operating income for the life insurance and retirement services segment fell to $1.01 billion from $2.49 billion on losses from partnership and mutual fund investments which AIG attributed to the "poor performance" of equity markets, along with trading account losses related to certain investment-linked products in the United Kingdom.

Life segment premiums and other considerations rose 12.7% to $9.35 billion, partly due to favorable foreign exchange movements.

The financial services group, including AIG Financial Products, reported an $8.35 billion operating loss before net realized capital gains or losses, compared with a $307 million profit a year ago.

(By David Pilla, international editor, BestWeek: David.Pilla@ambest.com)

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