16 September 2008

Fed to Make an $85 Billion Bridge Loan to AIG

AIG will receive its bridge loan, will have a limited time in which to sell assets to pay it back, the top management is replaced. Fed Considering Loan Package for AIG

We still don't quite understand the Fed's 79.9% stake in AIG. If AIG pays back the loan, with interest, does the Fed (Treasury?) still own 79.9% of the company? Is this a purchase or does that stake represent a kind of warrant should the terms of the loan not be met? Is this a purchase with an 'option to return' like a repo, or is the stake a form of collateral?

The obvious question is the amount of dilution to the shareholders. The details will like be released and clarified over time.

This may be a solution to the AIG crisis, but with regard to the US credit crisis it is more likely the end of the beginning.

For release at 9:00 p.m. EDT

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Here is the relevant section of the Federal Reserve Act referenced in the press release.
In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions.

And the most important question of all: Is the NY Fed really going to replace AIG in the Dow Jones Industrial Average tomorrow?

Are they going to have options?

Stocks stabilize, but critical insurer teeters
September 16, 8:56 pm ET
By Ellen Simon

NEW YORK (AP) -- The Federal Reserve resisted a cut in interest rates Tuesday and then forged a plan to take over American International Group Inc. and rescue the insurance giant from the brink of bankruptcy with an extraordinary $85 billion loan.

The moves, along with a slight rebound on Wall Street, offered some respite after the chaos that shook the financial system Monday when investment house Lehman Brothers declared bankruptcy and the Dow Jones industrials suffered its biggest point drop since the 2001 terrorist attacks.

Investors worried that a failure by AIG, the world's largest insurer, would set off even more financial turmoil.

AIG is little known off Wall Street but does business with almost every financial institution in the world. It insures $88 billion worth of assets and plays an outsized role insuring mortgages and corporate loans, but even more threatening was its integral role in the murky world of hedge funds and credit derivatives.

People with knowledge of the situation, who asked not to be identified because of the sensitive nature of the negotiations, said bankers and federal officials had decided a government bailout of AIG was the best solution to save it from collapse. An announcement of the takeover was expected late Tuesday.

The plan called for the government to seize up to 80 percent of the company and remove its management, similar to the way it took control of mortgage giants Fannie Mae and Freddie Mac.
All three major credit rating agencies had cut AIG's ratings at least two notches late Monday night, and while the new ratings were still considered investment grade, they added pressure on AIG as it sought tens of billions of dollars to strengthen its balance sheet.

New York Gov. David Paterson said Monday he would support allowing AIG to use $20 billion of assets held by its subsidiaries to pay for its business -- essentially giving it a bridge loan from itself.

A collapse of AIG would force Wall Street to untangle the complex credit derivatives markets and send the market scrambling to figure out who owes what to whom -- or even who owns what.

"Regulators knew that if Lehman went down, the world wouldn't end," money manager Michael Lewitt wrote in an op-ed column Tuesday in The New York Times. "But Wall Street isn't remotely prepared for the inestimable damage the financial system would suffer if AIG collapsed."

The Fed stepped in hours after it decided, in its first unanimous vote this year, to keep the closely watched federal funds rate unchanged at 2 percent. At the same time, however, the Fed noted that strains on the market have "increased significantly" and said it was ready to act if needed.

Stocks slumped immediately after the Fed announcement. The Dow initially dropped about 100 points but rallied to finish the day up 141, and back over 11,000.

As AIG teetered, central bankers around the globe scrambled to revive credit markets. The Fed injected $70 billion into the American financial system. The European Central Bank pumped one-day financing of nearly $100 billion into the 15-nation zone. The Bank of Japan added $24 billion, and England's central bank almost $36 billion.

Cash left world markets Monday like an outgoing tide. The interest rate banks charge each other for overnight loans soared as high as 6 percent -- far above the Fed's target rate of 2 percent and a sign banks didn't trust each other enough to make even 12-hour loans...

New York Times
Fed Readies A.I.G. Loan of $85 Billion for an 80% Stake
Published: September 16, 2008

In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.

All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that would give it an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.

If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad.

The Fed’s action came after Treasury Secretary Henry M. Paulson and Ben S. Bernanke, president of the Federal Reserve, went to Capitol Hill on Tuesday night to meet with House and Senate leaders. Mr. Paulson called the Senate majority leader, Harry Reid, Democrat of Nevada, about 5 p.m. and asked for a meeting in the Senate leader’s office, which began about 6:30 p.m.

The Federal Reserve and Goldman Sachs and JPMorgan Chase had been trying to arrange a $75 billion loan for A.I.G. to stave off the financial crisis caused by complex debt securities and credit default swaps. The Federal Reserve stepped in after it became clear Tuesday afternoon that the banking consortium would not be able to complete the deal.

Without the help, A.I.G. was expected to be forced to file for bankruptcy protection.

The need for the loans became necessary after the major credit ratings agencies downgraded A.I.G. late Monday, a move that likely to have forced the company to turn over billions of dollars in collateral to its derivatives trading partners worsening its financial health.

Until this week, it would have been unthinkable for the Federal Reserve to bail out an insurance company, and A.I.G.’s request for help from the Fed of just a few days ago was rebuffed.

But with the prospect of a giant bankruptcy looming — one with unpredictable consequences for the world financial system — the Fed abandoned precedent and agreed to let the money flow.

AIG Said to Accept Federal Takeover, Replace Managers
By Hugh Son

Sept. 16 (Bloomberg) -- American International Group Inc., the biggest U.S. insurer by assets, has accepted a deal to turn over control in exchange for an $85 billion loan from the Federal Reserve, a person familiar with the situation said.

AIG will replace management as part of the deal, said the person, who declined to be named because no public announcement has been made. AIG spokesman Peter Tulupman had no immediate comment.

The agreement would keep New York-based AIG in business, averting a collapse that could have threatened more financial companies and caused $180 billion in losses, according to RBC Capital Markets. AIG needed the loan to stave off a collapse after its credit ratings were cut and shares plunged 79 percent since Sept. 11.

The federal lifeline will allow AIG to sell assets in an orderly fashion, the person said. Proceeds from the divestments may be used to help pay back the two-year loan, the person said.

``The alternatives are much worse,'' said U.S. Senator Charles Schumer, Democrat of New York, in a statement after lawmakers met with U.S. regulators.