AIG Seeks to Ease Its Bailout Terms

By MATTHEW KARNITSCHNIG, LIAM PLEVEN and SERENA NG American International Group Inc. is seeking an overhaul of its $150 billion government bailout package that would substantially reduce the insurer's financial burden, while further exposing U.S. taxpayers to its fortunes, people familiar with the matter say. Under the plan, the government loan of up to $60 billion at the heart of the bailout would be repaid with a combination of debt, equity, cash and operating businesses, such as stakes in AIG's lucrative Asian life-insurance arms. AIG and the government have been discussing the changes since December and plan to announce them by Monday when the insurer is expected to report fourth-quarter results, the people said. The earnings report is expected to underscore AIG's worsening condition with its total loss for the quarter likely to top $60 billion, these people said. One of the restructuring plan's central goals is to safeguard AIG's credit ratings, which, if cut, would force it to make billions of dollars in payments to its trading partners, further weakening its already precarious financial position. The new plan is being structured in close consultation with major credit-rating agencies. AIG's talks with the government are ongoing and while they are at an advanced stage the deal may still fall apart or change significantly. Government approval would signal a complete turnabout in its approach to the insurer since it first intervened to rescue it: from that of a creditor to one of a potential owner. At the time of the original bailout in September, the government imposed what many considered onerous interest rates and deadlines for AIG to repay its loans by selling off assets. It quickly became clear, however, that the erosion of the value of AIG's assets and worsening financial crisis would make it difficult to meet the goals without jettisoning assets at fire-sale prices. Associated Press AIG's offices in New York. The bank is expected to report a quarterly loss that will likely top $60 billion. "The markets aren't open for asset sales," said one person close to AIG. "There is a trade-off between protecting the value of the assets for the government and just selling them in the short term." Under the new structure, AIG's interest burden on the government money would be reduced. It currently pays 3% plus the London interbank offered rate, or Libor, a common benchmark interest rate, on a loan of up to $60 billion that it gets from the government, and also pays a 10% annual dividend on a separate $40 billion investment by the government in the company. The plan would entail a wholesale restructuring of the company. AIG would continue to try to sell some assets to repay its obligations but other assets would be transferred to the government in lieu of cash repayment. The assets, expected to include some of AIG's Asian holdings, would likely be spun off and may be taken public with the government owning a major stake, according to people familiar with the discussions. AIG's debt to the government would be reduced by an equal amount. One major sticking point is how to value the assets, especially because prices are in rapid decline. Similarly, the government could end up the outright owner of certain businesses, which presents myriad issues, both operational and regulatory. Inside the Fed, officials have been worried about AIG's fourth-quarter loss and about the risk that the insurance giant will have its credit rating downgraded. AIG's share price has fallen nearly 59% since the end of January and ended trading Monday at just 53 cents a share. That AIG would be reporting large investment losses in the fourth quarter is not, in and of itself, a huge surprise given the turmoil in the financial markets late last year and the breadth of the company's portfolio. In a statement Monday, the company said it is continuing to work with the government "to evaluate potential new alternatives for addressing AIG's financial challenges." The company has a week to report fourth-quarter and full 2008 earnings. "We will provide a complete update when we report financial results in the near future," AIG said. News of AIG's expected loss was first reported by CNBC. The government's stake in the parent company already stands at nearly 80% and is unlikely to be substantially changed in the near term, according to a person close to AIG. The new rescue moves are being weighed in part because a new credit-rating downgrade would force AIG to come up with billions of dollars to pay counterparties. It was just such a downgrade in September that nearly pushed AIG into bankruptcy and triggered the initial rescue. "If there were a downgrade, it would be difficult," says a person familiar with the matter. "Nothing's locked down. Everything is under discussion." AIG's results are expected to include large write-downs of its exposures to commercial mortgage debt, which suffered record price declines during the fourth quarter of last year. Delinquencies among real-estate loans, which help finance office buildings, shopping centers and other properties, are also on the rise, a factor that is weighing on their values. A Merrill Lynch index of triple-A commercial real-estate securities indicates prices declined around 13% in the fourth quarter and currently trade at around 75% of their original values. Similar securities with lower ratings fared much worse -- some declining 50% or more during the quarter. Even though the Federal Reserve helped protect AIG from further write-downs on certain swap positions late last year by financing the purchase of troubled securities AIG had insured against losses, the company continued to incur collateral calls and further write-downs on other swap trades that couldn't be unwound easily. Most of the troubled collateralized debt obligations were backed mainly by subprime-mortgage collateral. Prices of those mortgage assets also slumped further during the fourth quarter. The threat of further collateral calls is one major reason why a downgrade in AIG's credit ratings could pose an immediate threat to its liquidity. Standard & Poor's has an A-minus long-term rating on AIG, and Moody's Investors Service has an equivalent rating of A3. Both credit-rating firms said Oct. 3 they were reviewing the ratings for downgrades. Such reviews typically take around 90 days, but have been known to go longer. Rating downgrades from current levels could be devastating to AIG's finances and would trigger billions of dollars more in payments to its policyholders, trading partners and customers. A one-notch rating cut would push AIG's long-term ratings down to BBB-plus at S&P and Baa1 at Moody's. Downgrades may also cause AIG's short-term debt ratings to fall below A-1, which is the minimum rating threshold for borrowings under the Federal Reserve's Commercial Paper Funding Facility. Since that facility went live in late October, some AIG units have been tapping it to the tune of around $15 billion. Any loss of access to these rolling three-month loans -- which have very low interest rates -- may force AIG to draw down more of its credit line from the Fed and incur significantly more in interest costs. In a November filing with the Securities and Exchange Commission, AIG warned that a one-notch downgrade of its long-term rating could cause it to have to pay out around $8 billion to its counterparties, including collateral and "termination payments" on contracts it has written. The filing said the impact of a two-notch downgrade from current levels could be much bigger, giving counterparties the right to terminate transactions that cover nearly $48 billion in debt. AIG has since exited or posted collateral against some of those positions, so its actual cash outflow in such a situation would likely be less than that amount. AIG's rescue package has already been increased twice since September, from $85 billion to nearly $123 billion in October and then to $150 billion in November. The expanded rescue reflects, in part, the pressure on AIG from the same market turmoil that's tripping up many other financial institutions that made soured bets on the housing market. AIG's losses for the first three quarters of 2008 were due largely to write-downs in the value of credit protection it had sold on securities backed in part by subprime mortgages. The latest changes under consideration could require the government to increase its exposure to potential losses, if they lead to the government essentially insulating AIG from some losses on risky assets still in its portfolio, even if it doesn't actually put up any more dollars right away. With Citigroup Inc., for instance, the government has agreed to shoulder most losses on $301 billion of assets. As of Sept. 30, AIG was exposed to commercial mortgage-backed securities originally valued at at least $20 billion, but that sector has been hit hard during the downturn. Yet insuring against losses on troubled assets might be another imperfect solution. Such protection has been used in other cases -- Citigroup and Bank of America Corp. -- and the share prices of both companies have kept falling. —Jon Hilsenrath contributed to this article. Write to Matthew Karnitschnig at matthew.karnitschnig@wsj.com, Liam Pleven at liam.pleven@wsj.com and Serena Ng at serena.ng@wsj.com