Thursday, October 9, 2008

AIG Increases Borrowings While Racing to Sell Assets

American International Group Inc. drew down another $9 billion in loans from the government to meet massive demands for cash from its trading partners as the company scrambles to sell off its assets.

The insurer has now borrowed $70.3 billion from the government in three weeks and is in a race against time to sell assets to pay off the loan as the financial markets tumble, making it harder for the company to find buyers for its units. The government originally said it would loan the company $85 billion but raised the amount to $122.8 billion on Wednesday.

The lion's share of the Fed's original loan has gone for two things: providing collateral to AIG's trading partners on complex derivatives known as credit default swaps, and covering losses in AIG's securities-lending program. When the threat of losses from the lending program mounted, the Fed had to step in again this week.

... Securities lending involves both lending securities and investing collateral for a return. If the value of the collateral declines, as it has for AIG and other securities lenders, the investor needs to make up the difference when the borrower returns the securities. AIG's program had faced problems for months, but they intensified after AIG was downgraded by credit-rating agencies in September, just before the government rescue. AIG's securities-lender clients flooded the program for their collateral, creating a "mini-run" on the bank, says Doug Slape, chief financial analyst of the Texas Department of Insurance. The company began drawing down on the Fed loan commitment to cover the collateral requests, it told Mr. Slape in recent conversations, he said. By Oct. 3, Moody's Investors Service said AIG's default-insurance and securities-lending program had experienced "substantial losses and write-downs" due to mortgage securities. Securities lending has long been a reliable side business for life insurers, approved by state regulators. But Moody's warned in April about the risks that insurers were taking related to these programs. Hampton Finer, a deputy to New York State Insurance Superintendent Eric Dinallo, said policyholders in AIG's life-insurance subsidiaries weren't at risk due to the securities-lending programs. But, he said, New York will review what types of assets insurers are allowed to invest securities-lending collateral in. Mr. Slape said his team is keeping a close watch on three AIG insurance units because of the securities-lending exposure. Ohio's Department of Insurance said it is investigating the securities-lending activities of at least one life insurer. Darrel Ng, a spokesman for the California Department of Insurance, said the state is "looking at the securities-lending practices of those insurers domiciled in California," along with AIG's. According to AIG's quarterly report for the period ending June 30, the collateral for the securities-lending program shows investments totaling $36.2 billion in mortgage securities and other bundled securities, $12.9 billion in corporate debt, and $10.5 billion in cash or short-term investments, for a portfolio totaling nearly $60 billion.

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