naked capitalism

This post was modified from its original version due to the New York Times reporting that regulators were involved in discussions for AIG to take urgent measures to prevent a debt downgrade. Note the tone of the story at the Times (by Gretchen Morgenson and Mary Williams Walsh) presents the situation as more dire than a Sunday PM report at the Journal indicates. However, the Journal did not mention that regulators had become involved, so the Times may have better insight here.

Note we reported yesterday that American International Group planned to announce the sale of $20 billion of assets on Monday to shore up its balance sheet and hopefully its stock price, which fell by 30% on Friday. We noted that even that large a set of disposals might not prove sufficient, since rating agencies appear to want the world’s largest insurer to raise $30 to $40 billion to avoid a major downgrade.

From the New York Times (hat tip reader Jim B):

State insurance regulators and executives of the American International Group, the insurance company, rushed on Sunday to arrange a capital infusion to stabilize the company in the face of possible credit downgrades.

It was unclear whether A.I.G. would succeed in its capital search, but a person briefed on the discussions said it was seeking more than $15 billion even as it tried to sell assets to shore up its financial footing…

As the credit storm has raged in recent months, insurance companies like A.I.G. have been better positioned than the nation’s banks and brokerage firms to weather it because accounting rules do not require insurers to mark the investments held in their long-term portfolios to market. Insurance companies like A.I.G. can hold their investments until they mature, riding out the ups and downs in the market for those assets.

But the moment it began trying to raise capital, A.I.G. had to open its books to potential investors who were likely to take a sharp pencil to the company’s portfolio values, analysts said. And with Lehman Brothers last week providing investors with a valuation for the same types of assets held by A.I.G., subprime and Alt-A mortgage securities, the investment bank’s marks can now be applied to the big insurer’s books.

As of the most recent quarter, for example, A.I.G. had $20 billion of subprime mortgages marked at 69 cents on the dollar and $24 billion in Alt-A securities valued at 67 cents on the dollar.

But Lehman officials on a conference call with investors last week said it was valuing similar subprime mortgage securities to those held by A.I.G. at 34 cents on the dollar; its mark on the Alt-A holdings was 39 cents. Those valuations suggest almost a $14 billion decline in A.I.G.’s holdings, after taxes, an amount representing 18 percent of the company’s book value.

Additional write-downs may also be required in A.I.G.’s collateralized debt obligations, which the company does mark to market because they are held in a short-term account known as available for sale. The company valued $42 billion in high-grade holdings at 75 cents on the dollar, while it marked another $16 billion in lower-rated obligations at 70 cents.

A spokesman for A.I.G., Nicholas J. Ashooh, said it was inappropriate to compare the markdowns of Lehman Brothers’ securities with those at A.I.G.

“We don’t think that’s valid, to look at somebody else’s portfolio markdowns and then infer what A.I.G.’s might be, because there’s so many variables,” Mr. Ashooh said, “what kind of risk is in the portfolio, what kind of collateral there is, and how the marks were calculated. We think we use a very thorough and conservative approach that includes third-party input and input from the rating services…..”

This may indeed be correct, or at least true enough to make a difference. But in this environment, the highly levered and opaque get no mercy.

A.I.G. wrote down the value of its [credit default] swap portfolio by $25 billion, telling investors that the markdowns did not represent a cash loss of that magnitude. It estimated possible cash payouts on the swaps of between $5 billion and $8 billion.

But because the debt securities covered by the swaps are so complex and opaque, it has been hard for investors to verify A.I.G.’s numbers…

A.I.G. also said recently that it might have to post collateral to its swap counterparties, heightening concerns that the company would have to raise capital in tight markets. A.I.G. said in a filing with the Securities and Exchange Commission that if its own credit were downgraded one notch by Moody’s and Standard & Poor’s, its swap contracts would require it to post collateral of about $13 billion.

Note that the downgrade in the wings might be as much as three notches.

In addition, A.I.G. said some of the contracts gave counterparties the option to terminate their swaps, which would cost A.I.G. between $4 billion and $5 billion. A.I.G. said that it did not expect all of its counterparties to exercise that option, however.

As a result, when S.& P. announced a negative outlook for A.I.G.’s credit on Friday, investors understood the company might soon have to produce up to $18 billion

Today’s story in the Wall Street Journal is broadly similar to the piece in the UK Times that we discussed yesterday, but troublingly, the dollar amount that these efforts are reported to raise is $10 billion, half from the $20 billion reported yesterday. Is this due to some assets being pulled back from disposition more realistic pricing, or the Times simply getting some bad information? From the Journal:

American International Group Inc. plans to disclose a comprehensive restructuring by early Monday morning that is likely to include the disposal of major assets including its aircraft-leasing business and other holdings, according to people familiar with the matter.

AIG’s management team was scrambling on Sunday afternoon to cobble together the plan and present it to the insurer’s board for approval, the people said. The insurer, which has already raised $20 billion in fresh capital so far this year, was also in discussions with several private equity firms about a capital injection and hoped to raise more than $10 billion, the people said.

AIG considered selling or spinning off the aircraft-leasing arm — International Lease Finance Corp. — earlier this year but decided in June to keep it. …In addition to ILFC, AIG was considering selling other parts of its business, including assets related to property and casualty insurance…

As recently as Thursday, AIG, the U.S.’s largest insurer, said it was sticking to a schedule to unveil its strategic plan on September 25. But the precipitous drop in its shares, which have fallen 79% so far this year, forced the insurer to act quickly.

Late Friday, Standard & Poor’s warned that it could cut AIG’s credit rating by one to three notches amid concerns that AIG will have difficulty accessing capital in the short term.
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Update 11:00 PM. This cheery bit of news, that AIG goes under in 48 to 72 hours if downgraded, which is expected to happen Monday morning, comes from the New York Times’ Dealbook (hat tip reader Saboor).

I am again a bit perplexed. The rating agencies dithered like Hamlet over whether to downgrade the monolines, out of an understandable reluctance to End the World of Finance as We Know It. Yet they have no such compunctions with the more obviously systemically important AIG. What gives.

From the Times:

The American International Group is seeking a $40 billion bridge loan from the Federal Reserve, as it faces a potential downgrade from credit ratings agencies that could spell its doom…

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours….

Though this past weekend was convened to focus on Lehman, the Wall Street chieftains who gathered at the Federal Reserve Bank of New York also pondered a solution for A.I.G….

The firm had planned to move $20 billion from its regulated insurance business to its holding company and to sell assets and a stake in the company to private equity firms. But A.I.G. has ruled out the capital shift because of the time and complexity involved.

J. C. Flowers & Company, a buyout firm focused on financial services firms, offered $8 billion for a stake in the business that would have given it an option to buy all of A.I.G. down the road. Kohlberg Kravis Roberts and TPG also said they would bid.

But all three withdrew at the last minute, citing anxiousness over the company’s precarious financial health.

A.I.G.’s extraordinary move of reaching out to the Fed for help may spur other non-investment banks to try a similar move. Companies ranging from General Electric to GMAC have been hurting badly and would desperately love the liquidity that the Fed would provide.

Yet it isn’t clear whether the Fed would acquiesce to A.I.G.’s request.

The firm had earlier been reported to be interested in selling its aircraft leasing business. But people briefed on the matter said that unit bore special tax advantages that A.I.G. had decided would be lost on any other owner.