NYT : Big Insurer Seeks Cash as Portfolio Plummets

Big Insurer Seeks Cash as Portfolio Plummets

By MICHAEL J. de la MERCED and GRETCHEN MORGENSON | September 15, 2008

The big insurance company, the American International Group, was seeking a $40 billion bridge loan Sunday night from the Federal Reserve, as it faces a potential downgrade from credit ratings agencies that could spell its doom, a person briefed on the matter said.

Ratings agencies threatened to downgrade the insurance giant’s credit rating by Monday morning, allowing counterparties to withdraw capital from their contracts with the company. One person close to the firm said that if such an event occurred, A.I.G. may survive for only 48 hours to 72 hours.

A.I.G.’s sickly financial health emerged late into one of the most tumultuous days in Wall Street history. The investment bank, Lehman Brothers, was expected to file for bankruptcy protection Sunday night, while Bank of America has agreed to buy Merrill Lynch for $50.03 billion.

A.I.G. has already raised $20 billion this year. But even that capital raise may not be enough.

Though this past weekend was convened to focus on Lehman, the Wall Street chieftains who gathered at the Federal Reserve Bank of New York also pondered a solution for A.I.G. The firm had become one of the biggest underwriters of complex debt securities known credit default swaps, used as insurance for a wide range of products, including the mortgage instruments that have been the bane of Wall Street for the past year and a half.

Eric Dinallo, the New York state insurance superintendent, has been deeply involved in discussions about A.I.G.’s survival, this person said.

J. C. Flowers & Company, a buyout firm focused on financial services firms, offered $8 billion for a stake in the business that would have given it an option to buy all of A.I.G. down the road. Kohlberg Kravis Roberts and TPG also said they would buy preferred shares in the insurer.

But J. C. Flowers's bid was rejected, and the other two firms withdrew at the last minute, citing anxiousness over the company's precarious financial health. K.K.R. and TPG had said they would invest only if the Fed provided a backstop to any investment they made.

A.I.G.’s extraordinary move of reaching out to the Fed for help may spur other non-investment banks to try a similar move. Companies ranging from General Electric to GMAC have been hurting badly and would desperately love the liquidity that the Fed would provide.

Yet it is not clear whether the Fed would acquiesce to A.I.G.’s request.

Before seeking a lifeline, the firm had earlier been reported to be interested in selling its aircraft leasing business, the International Lease Finance Corporation. Founded in 1973, the business has nearly 1,000 planes in its fleet. But people briefed on the matter said that unit bore special tax advantages that A.I.G. had decided would be lost on any other owner.

Investors, afraid that A.I.G. would have to absorb further write-downs in its already damaged mortgage securities and collateralized debt obligations, have driven down the company’s shares in recent days. The stock closed Friday at $12.14 a share, a decline of 46 percent for the week.

A.I.G.’s problems are not new. The company lost $13.2 billion in the first six months of 2008, largely owing to declining values in mortgage-related securities held in its investment portfolio and collateralized debt obligations it owns.

But the company’s outlook grew grimmer last week when Standard & Poor’s warned that it was considering downgrading the company’s debt as a result of further write-downs it might have to take.

As the credit storm has raged in recent months, insurance companies like A.I.G. have been better positioned than the nation’s banks and brokerage firms to weather it because accounting rules do not require insurers to mark the investments held in their long-term portfolios to market. Insurance companies like A.I.G. can hold their investments until they mature, riding out the ups and downs in the market for those assets.

But the moment it began trying to raise capital, A.I.G. had to open its books to potential investors who were likely to take a sharp pencil to the company’s portfolio values, analysts said. And with Lehman Brothers last week providing investors with a valuation for the same types of assets held by A.I.G., subprime and Alt-A mortgage securities, the investment bank’s marks can now be applied to the big insurer’s books.

As of the most recent quarter, for example, A.I.G. had $20 billion of subprime mortgages marked at 69 cents on the dollar and $24 billion in Alt-A securities valued at 67 cents on the dollar.

But Lehman officials on a conference call with investors last week said it was valuing similar subprime mortgage securities to those held by A.I.G. at 34 cents on the dollar; its mark on the Alt-A holdings was 39 cents. Those valuations suggest almost a $14 billion decline in A.I.G.’s holdings, after taxes, an amount representing 18 percent of the company’s book value.

Additional write-downs may also be required in A.I.G.’s collateralized debt obligations, which the company does mark to market because they are held in a short-term account known as available for sale. The company valued $42 billion in high-grade holdings at 75 cents on the dollar, while it marked another $16 billion in lower-rated obligations at 70 cents.

A spokesman for A.I.G., Nicholas J. Ashooh, said it was inappropriate to compare the markdowns of Lehman Brothers’ securities with those at A.I.G.

“We don’t think that’s valid, to look at somebody else’s portfolio markdowns and then infer what A.I.G.’s might be, because there’s so many variables,” Mr. Ashooh said, “what kind of risk is in the portfolio, what kind of collateral there is, and how the marks were calculated. We think we use a very thorough and conservative approach that includes third-party input and input from the rating services.”

A.I.G., which is based in New York, has also been under pressure from the derivatives contracts that its London-based financial products unit sold in connection with complex debt securities. Those contracts, called credit default swaps, acted as a type of insurance on the debt securities, making them more attractive to buyers. The swaps also gave speculators an opportunity to bet on the debt securities’ overall creditworthiness, which has declined in response to the turmoil in the housing markets.

When A.I.G.’s financial products unit sold the credit default swaps, it effectively promised to compensate buyers of the debt securities if the mortgages underlying them got into trouble. At the time, the securities were rated AAA, so it seemed at first that A.I.G. was not taking on inordinate risk.

But that picture changed as the housing crisis took hold and homeowners began to default. A.I.G. wrote down the value of its swap portfolio by $25 billion, telling investors that the markdowns did not represent a cash loss of that magnitude. It estimated possible cash payouts on the swaps of between $5 billion and $8 billion.

But because the debt securities covered by the swaps are so complex and opaque, it has been hard for investors to verify A.I.G.’s numbers on their own, and investors have grown impatient as A.I.G. reported big losses they did not expect in the last two quarters.

A.I.G. also said recently that it might have to post collateral to its swap counterparties, heightening concerns that the company would have to raise capital in tight markets. A.I.G. said in a filing with the Securities and Exchange Commission that if its own credit were downgraded one notch by Moody’s and Standard & Poor’s, its swap contracts would require it to post collateral of about $13 billion.

In addition, A.I.G. said some of the contracts gave counterparties the option to terminate their swaps, which would cost A.I.G. between $4 billion and $5 billion. A.I.G. said that it did not expect all of its counterparties to exercise that option, however.

As a result, when S.& P. announced a negative outlook for A.I.G.’s credit on Friday, investors understood the company might soon have to produce up to $18 billion

Mary Williams Walsh contributed reporting.