New AIG Plan to Leave U.S. With $150B in Exposure

Sunday, November 09, 2008
By Joanna Ossinger
FOXBusiness



The U.S. government on Monday announced a revised bailout package for troubled insurer American International Group (AIG: 2.58, +0.47, +22.27%) that’s now valued at $150 billion.

The announcement comes on the very day AIG reported a $24.47 billion third-quarter loss caused by massive writedowns and investment losses.

These developments show just how dicey the future is for AIG, and even though the government refers to the possibility of eventually making profits off the deal, it’s also possible that taxpayers could end up eating a huge loss. In addition, the amount of money being funneled to a struggling insurer makes it more difficult to avoid bailing out companies in other sectors -- notably the Big Three auto makers General Motors (GM: 3.28, -1.08, -24.77%), Ford Motor (F: 1.96, -0.06, -2.97%) and Chrysler -- which have also been angling for additional government lifelines.

The initial AIG deal of $85 billion had come under fire from all sides -- from lawmakers and citizens upset by what they saw as a bailout of a company that took on too much risk and didn’t deserve the money, and by financial experts who said the plan would have required AIG to sell assets amid a falling market while paying high interest rates on its loans.

That $85 billion deal grew to $123 billion through pieced-together plans, but this new $150 billion plan formalizes a structure designed to deal with one of the main criticisms of the plan, which was that it forced AIG to unload assets quickly during a bear market and credit crunch.

“These new measures establish a more durable capital structure, resolve liquidity issues, facilitate AIG's execution of its plan to sell certain of its businesses in an orderly manner, promote market stability, and protect the interests of the U.S. government and taxpayers,” the Federal Reserve said in its statement.

Under the plan, the Treasury Department will purchase $40 billion in preferred stock through its Troubled Asset Relief Program. Treasury said in a statement that AIG will use the equity to pay down $40 billion of the Federal Reserve's secured lending facility.

Treasury noted that “AIG must continue to maintain and enforce newly adopted restrictions put in place by the new management on corporate expenses and lobbying as well as corporate governance requirements, including formation of a risk management committee under the board of directors.” That’s especially important because AIG has made news for hosting spa retreats, hunting vacations and the like, even after the government bailout occurred.

The details of the plan include a rate reduction and term extension. The Fed’s statement said that “the interest rate on the facility will be reduced to three-month Libor plus 300 basis points from the current rate of three-month Libor plus 850 basis points, and the fee on undrawn funds will be reduced to 75 basis points from the current rate of 850 basis points. The length of the facility will be extended from two years to five years.” Libor, the London Interbank Offered Rate, is a key intrabank lending rate. A basis point is 1/100th of a percentage point.

Also, there are to two lending facilities, one for residential mortgage-backed securities and one for collateralized debt obligations.

In the RMBS facility, the New York Fed will lend up to $22.5 billion to fund the purchase of RMBSs from AIG. AIG will make a $1 billion subordinated loan to the facility and bear the risk for the first $1 billion of any losses on the portfolio.

In the CDO facility, the New York Fed will lend up to $30 billion. AIG will make a $5billion subordinated loan to the LLC and bear the risk for the first $5 billion of any losses on the portfolio. “In connection with the purchase of the CDOs, the CDS counterparties will concurrently unwind the related CDS transactions,” the Fed’s statement said.

For both facilities, the Fed’s statement said that “The New York Fed and AIG will share any residual cash flows after the loans are repaid.”

In addition to the bailout news, AIG reported earnings, swinging to a net loss of $24.47 billion, or $9.05 a share, in the third quarter, compared with net income of $3.09 billion, or $1.19 a share, a year earlier. AIG took $18.31 billion in writedowns in the quarter.