AIG deemed too big to fail

The United States Federal Reserve Board came to AIG’s rescue late Tuesday evening by authorizing the Federal Reserve Bank of New York to lend up to $85 billion US to the insurance company.

“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,” says a Fed statement.

On Tuesday, AIG was downgraded by America’s four main ratings agencies. As its credit rating fell, the insurer was suddenly on the hook to creditors for an additional $14 billion in collateral.

The purpose of the two-year loan is to help AIG in meeting its obligations as they come due. The 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 U.S. economy.

The loan carries a hefty interest rate of 850 basis points above LIBOR (London Interbank Offer Rate), which itself rose 19 basis points this morning to 3.06%, according to Bloomberg The loan is collateralized by all of 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.

Related Stories

Analysts see little spillover from Wall St. woes Two giants fall on Wall Street Market volatility: Links and other resources

“AIG is a solid company with over $1 trillion in assets and substantial equity, but it has been recently experiencing serious liquidity issues,” says a company statement. “We believe the loan, which is backed by profitable, well-capitalized operating subsidiaries with substantial value, will protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis.”

At first, the move had the desired effect, as markets in Asia and Europe traded moderately higher. But by noon, North American indices were firmly in the red.

Meanwhile, in Britain, all eyes are on Halifax Bank of Scotland (HBOS), which is teetering on the brink of insolvency. The company is said to be in takeover talks with the venerable Lloyds.

Another British bank appears interested in some of the assets of Lehman Brothers. Barclays is said to be interested in Lehman’s European and Asian operations. Barclays has already bought Lehman’s head office in New York, as well as a pair of properties in New Jersey.

In Canada, Manulife Financial has issued a statement outlining its exposure to AIG. Canada’s largest insurer holds fixed income investments issued by the parent company with a par value of $38 million, with an additional $202 million issued by subsidiaries.

Manulife also holds $40 million in “other exposures” to the parent and subsidiaries, as well as $84 million in derivatives exposure, net of collateral.

“These amounts, in aggregate, represent approximately one-half of one per cent of our $164 billion [Cdn.] in assets,” said Donald Guloien, senior executive vice-president and chief investment officer. “In avoiding the perils of many other parts of the capital market, we made the decision to invest in what were deemed to be highly rated, sophisticated and regulated financial institutions. While these developments are extremely disappointing, to date we have avoided the worst problems in the credit markets and our track record remains exemplary.”

Sun Life Financial also disclosed its exposure to AIG, listing $88 million (par value) worth of bonds issued by the parents company, and $227 million (par value) issued by subsidiaries.

“The aggregate exposures discussed above represent less than one half of one percent of Sun Life’s invested assets,” the company said in its statement. “Sun Life Financial continues to have a strong balance sheet, is well capitalized and is very well positioned to fulfill all of its obligations.”

Filed by Craig Sebastiano, Benefits Canada, craig.sebastiano@rci.rogers.com

(09/17/08)