AIG shares dropped nearly 40% on Tuesday as the international credit rating agency Fitch joined Moody’s Investor Services and Standard & Poor’s in downgrading the co’s rating. The triple-reduction throws more doubts on the health of AIG’s book of credit-default swaps (CDS), and forces the firm to immediately come up with $14.5 billion of capital – which is the amount the insurer’s credit-default swaps counterparties can now demand as collateral. Based on these latest developments the consensus in the Street is that bankruptcy chances have increased significantly for the world’s largest insurer – which only a few months ago was considered as one of the main pillars of the insurance industry and its financial system.
On Monday, Moody’s Investor Services cut AIG’s senior unsecured debt rating to A2 from Aa3, while S&P reduced AIG’s long-term counterparty rating from AA- to A- citing “reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses.” S&P went on to warn further cuts, possibly to the lower BBB rating, unless the firm is able to raise extra liquidity and sell some of its assets in order to remain solvent. Fitch also reduced its ratings to A from AA-minus, a two notch cut.
At this point AIG also needs an injection of up to $75 bln to satisfy the terms of complex derivative contracts. The co. has been in emergency talks with the The Federal Reserve which is trying to broker a large loan facility of $70 – $75 billion from Goldman Sachs (GS) and JP Morgan (JPM) to keep the firm liquid. However, it seems neither Goldman nor Morgan seem to have that kind of money. Subsequently raising the question of whether a government bailout is the only option left on the table. Treasury Secretary Henry Paulson so far has opposed that idea stressing that a rescue of the world’s largest insurance firm should come through the private sector.
As AIG finds itself fighting for survival – if the firm goes away particularly, after Lehman’s demise, it would create a much tighter credit market where banks may start hoarding liquidity. We are already seeing signs of it. Overnight dollar Libor rates were fixed at 6.4375% compared with 3.10625% on Monday, posting the biggest jump in at least seven years.
“It’s in our national interest that AIG survive,” said Maurice “Hank” Greenberg who still controls the largest stake in the company. The value of which has plummeted by more than $3 bln in the past week alone, as AIG became the worst performing component on the Dow.
Greenberg also added that if the company doesn’t get a bridge loan, new capital or relief from rating agencies, then there would be no alternative, but to file for bankruptcy.
AIG has posted $18 billion of losses in the past nine months, largely due to guarantees it wrote on mortgage-linked derivatives. The firm that generated $110 billion in revenues last year, ended June with $1.05 trillion of assets. Its failure will likely be larger than that of Lehman Brothers, which closed its doors after 158 years in business with $600 billion of assets.
It is unclear how much capital AIG will need to get itself out of this mess and survive as a global insurance powerhouse. The insurer, according to New York Times, has hired the law firm Weil, Gotshal & Manges LLP, which is also handling Lehman’s bankruptcy.
Update 1: Bloomberg is reporting the Fed is reversing its prior stance and is now likely to support a $75 billion loan for AIG, the giant insurer believed to be on the verge of bankruptcy.
Update 2: The NY Times reports the Federal Reserve agreed Tuesday night to take a nearly 80% stake in AIG in exchange for an $85 billion loan. The decision, notes NYT “is the most radical intervention in private business in the central bank’s history”.