AIG Plunges as Downgrades Threaten Quest for Capital

S&P lowered AIG's long-term counterparty rating three grades to A- because of losses tied to home loans and concerns whether the insurer can raise enough money to meet obligations to investors who purchased credit-default swaps from the company.

The downgrade of AIG is the latest tremor to shake the global financial industry, less than a day after Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection and Merrill Lynch & Co. sold itself to Bank of America Corp. for about $50 billion. Stock markets from Tokyo to London tumbled as investors weighed the impact of a potential collapse of the largest U.S. insurer by assets.

``There's a systemic risk if AIG isn't saved,'' Benoit de Broissia, an equity analyst at Richelieu Finance in Paris, said in a Bloomberg Television interview. Richelieu has about $6.2 billion under management.

The rating cuts may trigger more than $13 billion in collateral calls from debt investors who bought swaps, according to an Aug. 6 filing from New York-based AIG, intensifying pressure on Chief Executive Officer Robert Willumstad to raise cash.

`Much Bigger Problem'

Wall Street's largest firms will meet at the New York Federal Reserve for a fifth day today, discussing AIG, said a spokesman for the New York Fed. AIG sold the banks and other investors protection on $441 billion of fixed-income assets, including $57.8 billion in securities tied to subprime mortgages.

``I don't know of a major bank that doesn't have some significant exposure to AIG,'' said Kenneth Lewis, chief executive officer of Bank of America, in a CNBC interview. An AIG collapse would ``be a much bigger problem than most that we've looked at,'' he said.

AIG fell $2.10 to $2.66 at 11:24 a.m. in New York Stock Exchange composite trading, after plunging 61 percent yesterday. AIG's market value has shrunk more than 90 percent since peaking at almost $190 billion at the end of 2006, when it ranked among the world's five biggest financial companies.

Housing `Deterioration'

S&P also lowered AIG's short-term counterparty credit rating by two grades to A-2 from the top A-1+ rating, and cut its counterparty credit and financial strength ratings on most of AIG's insurance operating subsidiaries by three grades to A+ from AA+. The ratings remain on watch for a possible further downgrade, S&P said.

Moody's cut AIG's senior unsecured debt two grades to A2. Fitch Ratings lowered its assessment to A from AA-.

Moody's said in a statement that its decision was made ``in light of the continuing deterioration in the U.S. housing market and the consequent impact on the group's liquidity and capital position due to its related investment and derivative exposures.'' Moody's placed AIG's long-term and Prime-1 short- term ratings on review for possible downgrades.

AIG piled up net losses totaling $18.5 billion in the past three quarters on writedowns tied to the collapse of the U.S. subprime mortgage market. The insurer has units that originate, guarantee and invest in home loans.

``AIG poses a systemic risk because it's a large counterparty in the financial system,'' said Prasad Patkar, who helps manage the equivalent of $1.8 billion at Platypus Asset Management in Sydney. ``It's too big to be allowed to fail.''

Call for Collateral

In an Aug. 6 filing, AIG outlined the implications of credit rating downgrades. A cut in its long-term senior debt ratings to A1 by Moody's and A+ by S&P would permit counterparties to make additional calls for as much as $13.3 billion of collateral, while a downgrade to A2 by Moody's, and to A by S&P would permit counterparties to call for approximately $1.2 billion of additional collateral, the company said in the filing.

AIG has already posted $16.5 billion in collateral through July 31. A downgrade could also set off early termination of swaps with $4.6 billion in payments, AIG had said.

The round of credit-rating cuts ``further accentuates the immediate need for AIG to secure short-term funding and quickly execute sales of several of its subsidiaries,'' said Morgan Stanley analyst Nigel Dally in a note to investors today. ``Whether this is possible in a short time frame remains questionable.''

Goldman, JPMorgan

The Fed yesterday urged AIG to seek private capital, according to two people with knowledge of the discussions. Goldman Sachs Group Inc. and JPMorgan Chase & Co. were working with AIG to determine how much the New York-based insurer needs, said two more people, all of whom declined to be identified because negotiations are private.

The loan would involve temporary financing, a so-called bridge loan, through a syndicate of banks, and there's no assurance a deal will be worked out, one of the people said.

The insurer has issued no official statements on its capital-raising plans this week, frustrating investors.

``We expected the company to make a statement yesterday and they didn't,'' said Cliff Gallant, an insurance analyst at KBW Inc., in an interview with Bloomberg Television. ``They are waiting to have something concrete to say.'' Willumstad had previously said he'd present a turnaround plan Sept. 25.

Waiting for Information

AIG spokesman Nicholas Ashooh had no comment today on the credit downgrades.

``We're still working on a number of alternatives,'' Ashooh said yesterday. JPMorgan's Brian Marchiony and Goldman's Lucas van Praag declined to comment.

AIG was given special permission to access $20 billion of capital in its subsidiaries to free liquidity, New York Governor David Paterson said yesterday. The insurer has one day to raise $75 billion to $80 billion, Paterson told CNBC today. The insurer may file bankruptcy tomorrow, the network said, citing unnamed people close to the company.

When an insurance company stumbles or fails, its operations including obligations to policyholders are handled by state regulators. The holding company that owes money to stockholders and lenders may go through bankruptcy court procedures. That was the route followed by the units of Conseco Inc. after it filed for bankruptcy in 2002.

`A Broader Deal'

AIG hadn't gotten access to the New York lifeline as of about 10:30 a.m., said David Neustadt, a spokesman for state Insurance Superintendent Eric Dinallo.

``It would be part of a broader deal,'' Neustadt said. ``If there's no broader deal, then it doesn't happen.'' The regulators didn't say yesterday that access to the cash would require such conditions.

``We have seen some of the companies that serve as the bedrock of our financial system unraveling before our eyes,'' Paterson said in a news conference yesterday.

Hedge Funds

The $1 trillion-asset company has about $48.7 billion in hard-to-value holdings, and had 116,000 employees as of Dec. 31, compared with 97,000 two years earlier. In addition to selling life insurance and protecting property, AIG owns or manages about $25.7 billion of real estate including residential, industrial and retail properties. The company had private equity and hedge fund holdings of about $30 billion as of June 30.

AIG's $2.5 billion of 5.85 percent notes due in 2018 plunged 19.5 cents to 33 cents on the dollar as of 9:55 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The debt yields 24.3 percent, or about 21 percentage points more than similar-maturity Treasuries, Trace data show.

The Fed has hired Morgan Stanley to examine alternatives for AIG, a person familiar with the situation said. Morgan Stanley will review what role, if any, the government should play in helping the insurer, said the person, who declined to be identified because the talks are confidential.

`The Bigger Problem'

``The bigger problem here is that AIG is a bigger balance sheet, the tentacles go further and we don't have the same relationship between the Fed and an insurance company as we do with some of the others,'' said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in a Bloomberg Television interview.

AIG may report writedowns of $30 billion for the period ending Sept. 30, resulting in its ``worst quarter yet,'' if Lehman's bankruptcy leads to distressed sales of mortgage assets, Citigroup Inc. analyst Joshua Shanker said yesterday in a note. He downgraded AIG to ``hold'' from ``buy.''

The company may consider selling assets, including American General Finance, AIG's consumer lender, which could fetch more than $6 billion if the unit sold for twice its book value. AIG Investments could sell for more than $3 billion if it sold for 2.5 percent of clients' assets under management. The company's stake in reinsurer Transatlantic Holdings Inc. is worth about $2.25 billion, based on yesterday's share price.

Aircraft Leasing

Bank of America analyst Alain Karaoglan said Willumstad, 63, should reconsider the decision to keep its aircraft-leasing unit, International Lease Finance Corp., which could sell for $7 billion to $14 billion. The unit was downgraded today by S&P, which may increase its cost of borrowing.

AIG rejected investments from buyout firms KKR & Co., TPG Inc. and J.C. Flowers & Co., people familiar with the talks said. Billionaire Warren Buffett's Berkshire Hathaway Inc. is no longer talking with AIG about an investment in the insurer, CNBC reported, citing people familiar with the situation it didn't identify.

The insurer raised $20.3 billion in May by selling debt and equity, diluting the holdings of long-time investors. It's ``very hard to predict'' if AIG will need more capital, Willumstad said on Aug. 7. ``We're obviously dependant on the condition of the U.S. housing market.''

Last week, the U.S. Treasury seized Fannie Mae and Freddie Mac, the biggest sources of funding for U.S. mortgages, and nearly wiped out the value of their shares. AIG had $550 million to $600 million of preferred shares in the companies, said a person who declined to be identified because the insurer hadn't made a formal announcement.

Republican presidential nominee John McCain told CNBC today that there is a ``moral hazard'' in forcing taxpayers to be responsible for the poor performance of companies.

Asked whether regulators should allow AIG to fail, McCain said, ``I think you have to.''

AIG former CEO and Chairman Maurice ``Hank'' Greenberg, who controls the largest stake in the insurer, has ``repeatedly offered'' to assist the firm, his spokesman Glen Rochkind said.

Greenberg, 83, saw his holdings decline by $3.1 billion last week. He controls 11 percent of AIG shares through two investment firms and personal holdings.