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.
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.
The contagion is spreading, the FIRE economy is burning down! Still a long long way to go burn though.
Lynyrd Skynyrd time:
Mister Su-unday Night Special
He’s got a Lehman that’s blue and cold
It ain’t good for nothin’
Cept’ put the market six-a feet in a HOLE …
* awesome air guitar solo follows *
the potentially scary thing about tonight/Tomorrow is that Korea and Japan are closed…we may see a classic sell-what-you-can reaction across Asia if investors with Japanese/Korean positions want to liquidate/hedge their positions.
It’s going to be a crazy week.
“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…..”
First off, to Mr. Ashooh…i say “Gazoontite.”
Second off, who is this “third-party” that keeps signing off on these obviously ridiculous marks, simultaneously facillitating the total annhilation of our modern financial system while maintaining a smile?
Here’s an idea:
Is there a market for this security?
If the answer is “no,” you mark it zero, and move on to the next frame.
If the answer is “yes,” you sell a piece of it and mark the lot based upon the bid you get.
Now THAT would be competent risk management…in indeed there is such a thing.
That’s the problem in a sell off, you have to open your books for perusal and after one look people runaway like it’s Halloween haunted house.
NY times is reporting Lehman will undergo liquidation.
I’m a little surprised that stock futures are only down 3%.
Seems rather cavalier — “What, we worry?”
Maybe they know something we don’t.
For all the economist types out there, I recommend boning up on your Irving Fisher and Hyman Minsky.
Well, I’m so glad that these catastrophes did not occur on September 11. Wonder if Wall Street will erect a memorial to the fallen free market?
LEH filed. After the deadline for the netting trades session, it appears, so those are dead. Apparently that was a bit of disaster so missing the deadline is kind of a moot point.
Yves, to put the radicalization of the ratings agencies into perspective (you draw a wise contrast between their stance on AIG and their inexcusable snail’s pace on the monolines), a bit of background history helps.
We are going to see much more assertive ratings agencies now. I’m reminded of how accounting firms always used to sign off on corporate statements that they never should have.
Enron changed all that, together with the public dismemberment of Arthur Andersen orchestrated by the fearless Paul Volcker.
Nobody thought Andersen could fail. There was blood everywhere after the public execution of Andersen by Volcker and EVERY accountant who went to a good school knows more than a few of their friends who lost their jobs there.
After the lynching of Arthur Andersen, the large accounting firms changed their tune. Look what their AUDITED statements did to corporate earnings last January. (Remember that only ANNUAL reports are audited.)
Wait to see what happens come January 2009 when they AUDIT all this trash posing as quarterly earnings reports.
Similarly, the ratings agencies, all of them were corrupt and complacent.
Now, armies of brilliant commando plaintiff’s lawyers have descended on Federal courtroooms throughout the country armed with hundreds of reams of smoking guns about the liability of the ratings firms in all of this. Their stock price reflects this.
The ratings agencies have now been ordered by their in-house corporate counsel that competence and diligence are more important than chance encounters with gorgeous women facilitated by unnamed third parties in deciding whether and when to downgrade.
It has been nine months since the rating agencies first began to make it clear how foolish it is to build a business whose existence is dependent on maintaining a given credit rating. Any firm like AIG that did not spend those 9 months de-levering as quickly as possible and doing everything possible to insulate itself from rating-driven collateral calls is run by incompetent managers. Willumstad certainly fits that description. Overrated at Citi, fiddled while Rome burned at AIG.
It is Paulson’s fault that it came to this for AIG, LEH, MER, and others, but the management teams had an opportunity to protect itself from his recklessness and the rating agencies’ foolishness. They chose not to take it.
Meanwhile, the maligned monolines, having learned their lesson the hard way much earlier this year, spent the last 3 or 4 months in a frenzy of activity to wind down the one part of their business (asset management) that still was exposed to rating agency irrationality. Unthinkable as it was several months ago, the monolines seem pretty smart compared to the dopes at LEH, AIG, MER, WM, and lord knows who’s next.