Tuesday, September 16, 2008
AIG Faces Cash Crisis As Stock Dives 61% - WSJ
American International Group Inc. was facing a severe cash crunch last night as ratings agencies cut the firm's credit ratings, forcing the giant insurer to raise $14.5 billion to cover its obligations. With AIG now tottering, a crisis that began with falling home prices and went on to engulf Wall Street has reached one of the world's largest insurance companies, threatening to intensify the financial storm and greatly complicate the government's efforts to contain it. The company, whose stock fell 61% yesterday, is such a big player in insuring risk for institutions around the world that its failure could shake the global financial system. AIG has been scrambling to raise as much as $75 billion to weather the crisis, and people close to the situation said that if the insurer doesn't secure fresh funding by Wednesday, it may have no choice but to opt for a bankruptcy-court filing. "The situation is dire," a person close to AIG said. Many market participants have been anticipating a government-led rescue. So far, however, the U.S. has been reluctant to step in, preferring instead to broker a private-sector solution. The Federal Reserve hosted a meeting to discuss AIG's prospects at the central bank's offices in New York on Monday with company executives, bankers as well as state and federal officials. With strong encouragement from the Fed, Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. are seeking to raise $70 billion to $75 billion in loans to help prop up AIG, according to people familiar with the situation. Word of AIG's efforts to borrow that much sent the stock market tumbling in the last hour of trading. The company turned to the government in earnest after a weekend where intense efforts failed to produce a plan to raise roughly $40 billion in capital. The worsening crisis has now forced the firm to seek considerably more, underscoring its precarious position. AIG needs the money to sidestep a potentially fatal downgrade by credit-rating firms. The downgrades by Moody's Investors Service and Standard & Poor's mean that AIG's counterparties, or trading partners, can demand that it post an additional $14.5 billion in collateral, according to a filing AIG made with the Securities and Exchange Commission in August. It is not clear how quickly AIG would have to produce those funds. In addition, AIG or its counterparties could demand early termination based on the downgrades, resulting in payments of up to about $5.4 billion, the filing said. One sliver of optimism for AIG last night was that much of its exposure is related to credit default swaps, insurance like contracts tied to corporate defaults. AIG's counterparties on these instruments include Wall Street firms, which may have an incentive not to immediately demand more collateral so as not to trigger a wider panic. Such collateral could come in the form of cash or liquid assets such as government or municipal bonds. Crisis on Wall Street AIG, Lehman Shock Hits World Markets Old-School Banks Emerge on Top Complete Coverage: Wall Street in Crisis But many of AIG's counterparties are based in Europe and Asia and may have less interest in helping to prop up the firm. The market for credit default swaps is immense, trading against about $62 trillion of debt. Some participants in the largely unregulated market worry that the default of a major player such as AIG could trigger chaos. On Monday, many of AIG's bonds traded at levels more reflective of junk bonds that are on the verge of default. Some of the bonds traded at less than 50 cents on the dollar, having fallen from more than 80 cents last week. In the market for derivatives contracts that provide protection against debt defaults, investors were agreeing to pay $2.5 million upfront plus $500,000 annually to hedge against a default of $10 million in AIG's debt over five years, according to data provider CMA DataVision. The cost is so high because sellers of the protection want to be adequately compensated for taking on the risk. Analysts believe that AIG's insurance businesses remain healthy. But losses elsewhere, linked to subprime mortgages, have helped make the major credit-rating agencies skeptical of its ability to raise enough capital to offset the losses. In New York, where AIG is based, Gov. David Paterson announced Monday that state officials are working with the insurer on a plan that would allow the firm to, in effect, loan itself $20 billion, by borrowing against its assets. The state would allow the company to shift assets that are subject to tight regulation in order to give the company better liquidity in the short term. The private loans facilitated by banks, should they become available, would provide a huge measure of relief to AIG. The insurer had sought a bridge loan from the Fed to tide it over until it was able to sell some assets, but Fed officials are not inclined to provide one, especially right after spurning Lehman Brothers. The Fed's failure to come to Lehman's aid forced the firm to file for Chapter 11 bankruptcy protection Monday. At a midday news conference, U.S. Treasury Secretary Henry Paulson said AIG's meetings with federal officials had "nothing to do with any bridge loan from the government" and rather represented a private-sector effort that was important to the "financial system." Indeed, the company's woes could pose problems in many corners -- a concern that has the federal government on watch. AIG's massive assets mean that its millions of traditional insurance customers will likely get claims paid, no matter what happens next. But AIG's shares and debt are widely held, and the firm is used by many companies world-wide to manage a range of risks, including exposure to investments in subprime mortgages. Its demise would potentially make it harder or more expensive for businesses to control their risks. Hammered Stock AIG had hoped to have a comprehensive plan in place before the start of trading on Monday. It was unable to broker a deal in time and made no public pronouncements about its plans. Each day lost can make it harder to craft a solution. On Monday, nervous investors continued to hammer its stock. AIG's share price closed at $4.76 in 4 p.m. composite trading on the New York Stock Exchange, down $7.38, and is down 92% for the year. The lower the stock price, the harder it can be for the firm to raise capital. AIG's businesses include selling life and property-casualty insurance policies. It operates in more than 100 countries around the world. With more than 100,000 employees world-wide, AIG has a sprawling portfolio of companies that also includes units that make consumer loans and lease aircraft. AIG's business selling credit protection against the possibility of default in a variety of assets, including subprime mortgages, set it apart from most other insurers and tied it more closely to the fate of the housing and credit markets. When the housing market began to spiral downwards, the value of those contracts plunged. That issue is at the heart of AIG's massive losses, which have totaled $18 billion over the past three quarters. The losses have put the company over a barrel. To raise money, AIG in recent days has explored selling off valuable units. The company, for instance, is looking into selling AIG Variable Annuity Life Insurance Co., which provides retirement services, according to a person familiar with the matter. An AIG spokesman declined to comment. AIG has also held discussions in recent days with private-equity firms about providing an infusion of cash. But some firms balked at putting in money absent a Fed bridge loan, and at this point, private-equity firms such as TPG and Kohlberg Kravis Roberts & Co. are more interested in buying specific AIG assets rather than contributing money to a capital infusion, according to people familiar with these firms' thinking. The company also talked with Warren Buffett, chairman of Berkshire Hathaway Inc., which has a number of insurance businesses. The talks didn't result in specific plans, and it wasn't clear if they were ongoing. Striking Situation The problems confronting AIG are especially striking because the company is so large. At the end of the second quarter, its assets exceeded its liabilities by $78 billion. But most of those assets are held by its insurance subsidiaries, as guarantees that they will be able to pay claims. As a result, those assets can't be liquidated to meet the company's other obligations, such as those associated with the recent losses. AIG raised $20 billion earlier this year, but it's not clear how much of that it still has on hand. And if ratings agencies downgrade it, the company could have to come up with at least $10 billion, and perhaps as much as $18 billion. That is one way loans from banks or New York state's moves could aid the company -- by giving it short-term cash while it works on longer-term efforts to raise money, such as by selling assets. In New York, Insurance Superintendent Eric Dinallo is working with AIG on efforts to shift around assets that it could use to help raise cash. Insurance companies operate under strict regulations about moving assets among subsidiaries, in order to guarantee that they can meet their obligations to policyholders. New York, though, may allow AIG to move certain assets that are harder to liquidate quickly into its insurance subsidiaries, where they would back up possible future claims, and then shift more easily tradable assets, such as municipal bonds, to the parent company. The parent company could then borrow against those more liquid assets, which could in turn help ease its needs for cash in the short term.