AIG: Stock Falls 30%, Bonds and Credit Default Swaps Trading at Distressed Levels

Even though all eyes have been on Lehman, the potentially more troubling slow-motion train wreck is AIG. The insurer is a large credit default swaps protection writer and provides a host of financing products. Not only is AIG a larger firm than Lehman and could trigger a systemic event in the CDS market alone, but it isn’t clear how it could be bailed out if it continues to unravel. Insurers are state regulated; the Fed and Treasury have no relevant expertise and no regulatory authority. While insurers are not vulnerable to runs, how can investors who have CDS positions that are hedged by CDS written by AIG manage their exposures? While they are hedged on paper, in practice they might not be, or more relevant, might be perceived by counterparties not to be.

From Bloomberg (hat tip reader Saboor):

American International Group Inc., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. led a rise in the cost of protecting financial-company bonds from default amid concern firms will be hard-pressed to raise needed capital.

Credit-default swaps on New York-based AIG soared to a record and its bonds traded at distressed levels….

Credit-default swaps on AIG, the biggest U.S. insurer, soared on concern that it may be the next big financial firm to run short of capital after $587 billion in contracts guaranteeing home loans, corporate bonds and other investments plunged in value. Standard & Poor’s and Moody’s Investors Service have said AIG’s credit ratings may be cut if its mortgage assets fall further or if potential capital needs aren’t addressed. AIG may have to post more than $13 billion of collateral following a downgrade, it has said in regulatory filings.

Credit-default swap sellers demanded 12.5 percentage points upfront and 5 percentage points a year to protect AIG bonds from default for five years, according to broker Phoenix Partners Group. That means it would cost $1.25 million initially and $500,000 a year to protect $10 million in AIG bonds for five years. Yesterday, it cost $688,000 a year with no upfront payment, according to CMA Datavision.

Yves here. The change to up-front payment is significant. Only credits in serious distress require upfront payment. Back to the story:

AIG’s market value shrank by 46 percent this week on concern its credit ratings will be cut. Chief Executive Officer Robert Willumstad has promised to deliver a turnaround plan on Sept. 25 after the firm posted three straight quarterly losses totaling $18.5 billion…

“As distressed as they are, raising new capital could be extremely hard,” said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California, today in an e-mail.

The article mentioned that the investor presentation might be moved up, and the Wall Street Journal tells us it has been. Given how well that worked for Lehman, I’m not sure that is a great move.

From the Journal:

On Friday, credit-ratings firm Standard & Poor’s threatened to downgrade American International Group Inc., citing the significant decline in the company’s share price and the increase in credit spreads on the company’s debt. Meanwhile, AIG will likely hold an analyst call Monday morning and could announce a series of steps aimed at reassuring investors, including possible asset sales, a person familiar with the matter said.

A rapid plunge during the week in the price of AIG shares — the stock fell more than 30% on Friday alone — coupled with equally worrisome signs for the insurance giant in the debt markets, appeared to increase the heat on management to act….

As for AIG, which has posted $18 billion in losses over the last three quarters, it’s in a chicken-egg game. As it’s stock and debt woes brew, it could face a ratings downgrade that would force it to raise capital. But the lower its stock price, the harder it becomes to raise capital. On the plus side, as an insurer, AIG has advantages that some other financial institutions don’t.

It isn’t vulnerable to a run on the bank for its standard insurance policies — those typically are promises to pay future claims, not accounts subject to withdrawal. And AIG has a number of strong businesses it could sell to raise capital — businesses that aren’t as directly impacted by market conditions as those of investment banks. These include life insurance and property/casualty insurance operations in the U.S. and abroad, in addition to a consumer lending unit, a mortgage insurance unit and an aircraft leasing unit.

Still, investors and analysts weren’t assuaged. Prices of some junior AIG debt fell Friday to distress levels of as little as 35 cents on the dollar, down from 65 Thursday morning. The current price represents a yield of 16%, said Tom Atteberry, a partner at First Pacific Advisors, LLC. AIG’s most recently issued bond, a $3 billion 10-year note issued just a month ago, traded Friday at about 79 cents on the dollar, down from 93 Thursday.

Reader Jon passed along this telling reminder of AIG’s belief that risk taking was virtuous. Conversely, Warren Buffett is of the view that insurance is about taking as little risk as possible, and getting paid handsomely when you do.

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  1. DH

    Remember the good ol days when I used to bitch about chaos and entropy — and The Pension Protection Act? That was only a year ago!

  2. David Merkel

    Yves, on the bright side, there aren’t any worries yet about the operating insurers — only the holding company. This may not have much systemic risk — as an employee at AIG, I know their books were aggressive back in 1992.

  3. Anonymous

    Who could be shotgun partners for AIG?

    Cant they just spin out their operating businesses and then BK the holding company?

    What happens to policy holders? Are they hosed if they have a claim?

  4. a

    “Not only is AIG a larger firm than Lehman and could trigger a systemic event in the CDS market alone…”

    Also, don’t forget why AIG is heading down – it insured 600 B Usd of the toxic waste. The insured will take some or all of the losses if AIG goes down.

  5. Scott Frew

    From the Journal:

    As it’s (sic) stock and debt woes brew, it could face a ratings downgrade that would force it to raise capital. But the lower its stock price, the harder it becomes to raise capital.


    Back in the spring, the Fed/Treasury encouraged, practically demanded, that the GSEs raise capital. Freddie was never able to get that done, but Fannie raised I believe $7 billion of preferred–that’s from memory, and I’m sure the number’s off at least slightly. But given that within six months of doing that, the takeover-nationalization-rescue featured a wiping out of that preferred, I’d say it’s not simply low share prices that inhibit all these firms’ ability to raise new capital, but also and perhaps principally the specter of future action by our activist Treasury-Fed combo–who’s going to inject serious capital when it could get wiped out before the Asian markets open on any given Sunday? Unintended consequences abound here.

    On a related note, the financials in total have–again, from memory, and without checking–between $200 and $300 billion of shorter term debt to roll over by year end. If a solution to Lehman’s woes includes much of a haircut to its debt, that task too will be made significantly more difficult, and possibly prohibitively expensive.

    In that case, asset sales would be the only alternative, and that would of course put considerable downward pressure on those assets, and force all the firms to take marks on similar assets remaining on their balance sheets. An end game, or maybe end days, scenario. Surely the second coming is at hand …

  6. Anonymous

    Is AIG the equivalent to Bear, Lehman, and possibly Merrill (not to mention the GSEs) just without access to the discount window?

  7. Richard Kline

    Re: AIG, everyone’s watching the fire in the shirt factory so they don’t notice the smoke plume coming from the gunpowder warehouse.

    On the issue of ‘sudden death’ for preferred equity, oh please just get off this stone non-issue. FNM, FRE, and all those otheres where preferreds are going to get wiped _have been functionally insolvent for 14 months_. Given their exposures fromt he time the bubble burst, these and many other institutions were dead, _dead_, DEAD. Anyone buying preferreds in these institutions in the last year are total dunces, and deserve having their financial foot being blown off, not to mince words. If they bought preferreds on the bet that the public authorities would come to the rescue and keep them whole, their flesh has been harrowed but dem’s da breaks, so they can stop bitching while the stitches are sewn in ’em. All that is really different regarding the willingness of those in the money to buy preferreds in those out of it, my friend, is that those still solvent have finally wised up. ‘Bout time—’cause we will need their capital and willingness to deploy it when we re-float the banking system after the raging zombies are put down ‘n’ we start to re-build our New Jerusalem.

  8. Anonymous

    Just out of curiosity, did Charlie Gibson by any chance ask Palin about her views on privatizing gains and socializing losses? On bailouts for firms that support free markets so long as those markets do not have any risk? Did he ask her whether, as VP or President, she’d support the Treasury and Fed bailing out Lehman? AIG? Did he ask her whether there are any differences between the LEH versus AIG situations?

    Did he ask her if she were concerned with the growing positions/dominance of foreign central banks? Did he ask what her much balleyhooed ‘instinct’ told her to do in these situations vis a vis foreign central banks? And, if so, did she by any chance say that her instincts were that foreign central banks were either for us or against us – and if they took too much ownership of our capital markets, we’d not hesitate to apply the Bush Doctrine!!

  9. Dean

    One is getting the sense the real party is just beginning.

    One expert was recently asked to compare our market conditions to a baseball game. If so, what inning were we? His reply: We are just finishing the national anthem.

    BTW, I like Ano’s idea above. So, Ms. Palin what are your views on the AIG doctrine?

  10. Matt Dubuque

    Yves, thanks for posting this important piece! This story deserves more attention.

    So it all comes down to Eric Dinallo again, the NY State Insurance commissioner. We are hampered by the ouster of former New York governor Elliot Spitzer, who played a crucial role smashing cretin skulls together during the intermediate phases of the monoline crisis. Dinallo is far less effective without Spitzer in the room. In comparing Dinallo v. Spitzer, think of Bernanke vs. Volcker, but Dinallo is less intelligent than Bernanke. Not good.

    The LACK of federal regulation by institutions posing GLOBAL systemic risks is precisely what the Fed has been SCREAMING about for so long. To deaf ears I might add. Corrigan was complaining about this very thing back in 1985 when he was head of the NY Fed. But nobody would listen to us.

    Now, 22 years later, we will ALL pay the price.

    The Federal Reserve has been thwarted by the stranglehold, in this PARTICULAR instance, that the insurance companies have on this nation.

    And Congressmen from BOTH parties have long enjoyed the fabulous parties hosted by insurance company lobbyists teeming with hordes of gorgeous women so fabulously interested, for no apparent reason, in making the Congressmen and their aides extremely comfortable. This failure of Congress is an important subtext to the story.

    AIG, and the insurance industry that is essentially unregulated, has been a hotbed of free market jihadi “innovation”. And AIG is INDEED the gunpowder factory.

    Yves, our faithful moderator and guide for this historic journey has described this story as a “slow motion” one.

    AIG’s stock was down approximately 30% on Friday and I believe was THE most actively traded stock on the NYSE.

    I would therefore use a different adjective other than “slow motion” to describe that. But I am thankful that she brings it front and center for our undivided attention.

    We are indeed falling off a cliff in slow motion. But the ground is now in sight.

    Inflation bugs, fasten your seat belts!

    Matt Dubuque

  11. Dean

    The big question according to Brian Pretti of Contrary Investor is as follows:

    “As this process plays out and the Federal government is continually forced to expand its balance sheet as an offset to the leverage contraction occurring largely throughout the remainder of the economy and domestic financial markets ahead, THE big question becomes, where will the funding for this balance sheet expansion come from and what will it ultimately cost? A question near and dear to the hearts of US taxpayers everywhere, to say nothing of the investment community. This, we believe, is now and will continue to become one of the most important questions for our investment activities. We cannot take our eye off of this ball as we move ahead. Point blank, and we could not be more serious when we ask this, will the US face a funding problem at some point?”

  12. K Ackermann


    Yes, will the US even bother to monetize? It should have some class and spare us the embarassment.

    How much gold does Saudi Arabia have?

    I never really liked them.

    Missiles are highly inflationary by design.

  13. Anonymous

    Palin’s reply,

    “I think… like, South Africa…

    sometimes… because… they don’t have maps, … and… because…”

  14. Anonymous

    I have several life insurance policies with AIG. Are those in any jeopardy, or is that part of the business somehow firewalled off?

  15. James B

    “it isn’t clear how it could be bailed out if it continues to unravel. Insurers are state regulated; the Fed and Treasury have no relevant expertise and no regulatory authority.”

    I think the Bear deal showed us that the Fed won’t let a lack of authority or expertise stand in the way of their of bailing out a big financial company.

  16. Ryan-Stock Market Prices for American International Group

    There’s nothing fundamentally wrong with the core insurance business units of American International Group Inc. (AIG). Nothing at all. What imploded the venerable insurance giant was an accumulation of misplaced bets on credit default swaps.

    By the best estimates of the International Swaps and Derivatives Association and the Bank for International Settlements (BIS), often referred to as the central banks’ central bank, the notional value of credit default swaps is some $62 trillion, or 35 trillion British Pounds at an exchange rate of $1.78.It share price

    A credit default swap (CDS) is akin to an insurance policy. It’s a financial derivative that a debt holder can use to hedge against the default by a debtor corporation of sovereign. But a CDS can also be used to speculate.

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