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Report Pursuant to Section 129 of the
Emergency Economic Stabilization Act of 2008:
Restructuring of the Government's Financial Support to
the American International Group, Inc.
on November 10, 2008
Overview
On November 10, 2008, the Board of Governors of the Federal Reserve
System (the "Board"), based on the unanimous vote of its five members,
announced its approval under section 13(3) of the Federal Reserve Act
(12 U.S.C. § 343) for the Federal Reserve Bank of New York (the "Reserve
Bank") to restructure the Federal Reserve's existing credit facilities for American
International Group, Inc. ("AIG") and establish two new credit facilities for AIG.
As discussed further below, these actions were taken in conjunction with the
Department of the Treasury (the "Treasury Department") as part of the
restructuring of the government's financial support to AIG. These new measures
establish a more durable capital structure, resolve liquidity issues, facilitate AIG's
execution of its plan to sell certain of its businesses in an orderly manner, promote
market stability, and protect the interests of the U.S. government and taxpayers.
Background
AIG is a large, diversified financial services company that, as of
September 30, 2008, reported consolidated total assets of slightly more than
$1 trillion and stockholders' equity of approximately $71 billion. AIG operates in
four general business lines through a number of subsidiaries: (i) general insurance,
(ii) life insurance and retirement services, (iii) financial services, and (iv) asset
management. In 2007, AIG's U.S. life and health insurance businesses ranked first
in the United States in terms of net premiums written ($51.3 billion) and third in
terms of total assets at year-end ($364 billion). For the same period, AIG's U.S.
property and casualty insurance businesses ranked second in the United States in
terms of net premiums written ($35.2 billion) and third in terms of total assets at
year-end ($124.5 billion). Certain of AIG's regulated insurance subsidiaries also
operate a securities lending program under which the subsidiaries, with the
approval of their appropriate state insurance authority, pool together and lend out
high-quality, fixed-income securities owned by the insurance companies to third
parties in exchange for cash collateral. As of November 5, 2008, the total value of
securities lending payables was $34.2 billion.
Through a wholly-owned subsidiary, United Guaranty Corporation (UGC),
AIG also provides private mortgage insurance for high loan-to-value first- and
second-lien residential mortgages. For the nine months ended September 30, 2008,
AIG's mortgage guaranty business had $872 million in net premiums written.
In addition to its on balance sheet positions, AIG is a major participant in a
wide range of derivatives markets through its Financial Services division, and
particularly through its AIG Financial Products business unit (AIGFP), and is a
significant counterparty to a number of major national and international financial
institutions. For example, as of September 30, 2008, AIGFP had sold credit
default swaps (CDS) with a notional amount of $372 billion on super-senior
tranches of collateralized debt obligations (CDOs). Approximately $250 billion of
that notional amount represented transactions between AIG and banking
organizations that are designed to provide the financial institutions with regulatory
capital relief. These data represent declines of approximately $70 billion and
$57 billion, respectively, from the comparable exposures as of June 30, 2008. As
of September 30, 2008, AIGFP had $39 billion in borrowings outstanding,
including $13.6 billion through guaranteed investment agreements. A significant
portion of the guaranteed investment agreements and financial derivative
transactions entered into by AIGFP include provisions that require AIGFP, upon a
downgrade of AIG's long-term debt ratings, to post additional collateral or, with
the consent of the counterparties, assign or repay its positions or arrange a
substitute guarantee of its obligations by an obligor with higher debt ratings.
For the reasons discussed in the reports previously filed under section 129 of
the Emergency Economic Stabilization Act, the Board on September 16, 2008,
with the full support of the Treasury Department, authorized the Reserve Bank,
pursuant to section 13(3) of the Federal Reserve Act, to establish a revolving credit
facility for AIG under which the Reserve Bank could lend up to an aggregate
amount of $85 billion outstanding at any time ("September Facility"). As
described in the report filed under section 129 on November 3, 2008, in light of the
facts and circumstances at the time, the Board determined that the potential
disorderly failure of AIG could add to already significant levels of financial market
fragility and lead to, among other things, substantially higher borrowing costs,
reduced household wealth, and materially weaker economic performance. The
September Facility was intended to assist AIG in meeting its obligations as they
came due and facilitate a process under which AIG would sell certain of its
businesses in an orderly manner, with the least possible disruption to the overall
economy.
On October 6, 2008, the Board also authorized the Reserve Bank to engage
in securities borrowing transactions withAIG(footnote1Certain
of AIG's regulated insurance subsidiaries operate a securities lending program under
which the subsidiaries, with the approval of their appropriate state insurance authority, pool
together and lend out high-quality, fixed-income securities owned by the insurance companies to
third parties in exchange for cash. The Board authorized the Reserve Bank to engage in
securities borrowing transactions with these regulated insurance companies, either directly or
through the pool established by such companies to conduct their securities lending program end footnote)
through which the Reserve Bank
could lend up to $37.8 billion in cash to AIG in exchange for collateral in the form
of investment grade debt obligations (the "Securities Borrowing Facility"). The
Securities Borrowing Facility addressed the liquidity strains placed on AIG due to
the ongoing withdrawal of counterparties from securities borrowing transactions
and permitted AIG to use the remaining amounts of the September Facility for
other uses. The Secured Borrowing Facility also was designed to help alleviate the
pressure on AIG to liquidate immediately the portfolio of residential
mortgage-backed securities (RMBS) that was purchased with the proceeds of the
securities lending transactions. As of November 5, 2008, $19.9 billion in advances
were outstanding under the Securities BorrowingFacility.(footnote2
On October 7, 2008, the Board announced the creation of a Commercial Paper Funding
Facility (the "CPFF") to complement the Federal Reserve's existing credit facilities to help
provide liquidity to term funding markets. The CPFF involves the purchase, through a special
purpose vehicle with financing from the Federal Reserve, of three-month unsecured and
asset-backed commercial paper directly from eligible issuers. On October 27, 2008, four AIG
affiliates applied for participation in the CPFF, on the same terms and conditions as other
non-AIG participants. AIG has stated that, as of November 5, 2008, these entities had borrowed
a total of approximately $15.2 billion under the CPFF. The proceeds of participation in the
CPFF allowed AIG to make voluntary prepayments of credit extended under the September
Facility
end
footnote)
The reasons for and
the terms of this facility were described in the report filed under section 129 on
October 14, 2008.
The actions taken by the Federal Reserve in September and October 2008
helped address the immediate liquidity needs of AIG. These actions provided AIG
access to credit to meet its obligations as they came due and, thus, helped prevent a
disorderly failure of AIG, which would have posed substantial risks to both
financial stability and the broader economy.
Markets continue to be fragile and stressed, and liquidity pressures are very
high. Many asset classes continue to be illiquid or trade at severe discounts to their
intrinsic value. Since the various Federal Reserve facilities were authorized, AIG
continued to be negatively affected by the decline in value of mortgage-related
assets, particularly the RMBS acquired in connection with the securities borrowing
program operated by its insurance subsidiaries and the CDS protection that AIGFP
has written on multi-sector CDOs. These exposures together accounted for
approximately $19 billion of the $24.5 billion in losses recently announced by the
company for the third quarter of 2008.
In addition, the size and terms of the emergency credit provided under the
September Facility increased the company's leverage and lowered the company's
interest coverage ratio, two key metrics used by the credit rating agencies in
assessing the financial strength of an issuer. As of November 5, 2008, AIG had
approximately $61 billion outstanding under the September Facility, and
$19.9 billion in advances outstanding under the Securities Borrowing Facility.
The continued market turbulence has made it difficult for the company to
quickly realize the value of its operating assets through sales within the time frame
contemplated by the September Facility. Moreover, illiquidity in the markets for
various assets, as well as the continuing decline in the valuation of many financial
assets, including CDOs and RMBS, increased the strain on AIG from investments
and derivatives transactions based on these asset types.
In light of these and all other facts, the Board on November 10, 2008, acting
in conjunction with the Treasury Department, announced the restructuring of the
Federal Reserve's credit facilities for AIG in order to keep the company strong and
facilitate its ability to complete its restructuring process successfully. As noted
above, these new measures establish a more durable capital structure, resolve
liquidity issues, facilitate AIG's execution of its plan to sell certain of its businesses
in an orderly manner, promote market stability, and protect the interests of the U.S.
government and taxpayers.
In authorizing the September Facility, the Board found that the disorderly
potential failure of AIG posed significant systemic consequences in light of fragile
market conditions at that time. Subsequently, market conditions worsened steadily,
which has led to heightened systemic risk concerns throughout the financial
system. While some of the risks that would be posed by a failure of AIG have
decreased somewhat over that timeperiod,(footnote3
For example, money market mutual funds no longer have material exposures to AIG's
unsecured commercial paper, and AIG's counterparties on guaranteed investment agreements
and financial derivatives have smaller exposures as a result of additional collateral posted by
AIG
end
footnote)
counterparties around the world
continue to have significant exposure to AIG and market conditions continue to be
fragile and sensitive to the potential disorderly failure of AIG.
Capital Investment by the Treasury Department
In conjunction with the actions authorized by the Board, the Treasury
Department announced that it will acquire $40 billion in newly-issued Senior
Preferred Stock of AIG, using funding from the Troubled Asset Relief Program
("TARP") established by the Emergency Economic Stabilization Act of 2008.
This investment constitutes an important part of the restructuring actions by
providing new equity capital to AIG, a tool that was not available to the U.S.
government at the time the Federal Reserve established the September Facility and
the Securities BorrowingFacility(footnote4Additionalinformationconcerning
the terms of the Treasury Department's investment is
available in the Treasury Department's "TARP AIG SSFI Investment Summary of Senior
Preferred Terms," http://www.treasury.g0v/press/releases/rep0rts/l 11008aigtermsheet.pdf. end footnote)
Board's Authorizations
In conjunction with the Treasury Department's investment authorization, the
Board announced that it had authorized the Reserve Bank, pursuant to
section 13(3) of the Federal Reserve Act, to take the following actions with respect
to AIG:
1. Restructure the September Facility;
2. Extend up to $22.5 billion in secured credit to a newly formed limited
liability company for the purpose of partially funding the acquisition by the
vehicle from AIG of approximately $23.5 billion (market value) in RMBS
purchased by AIG with the cash collateral received through the securities
lending operations of AIG's regulated insurance subsidiaries; and
3. Extend up to $30 billion in secured credit to a separate, newly formed
limited liability company for the purpose of partially funding the acquisition
by the vehicle from the current counterparties of AIGFP of up to $35 billion
(market value) in multi-sector CDOs protected by CDS written by AIGFP.
Additional details concerning each of these authorizations are provided below.
The foregoing restructuring removes from AIG's balance sheet certain assets
and exposures that have caused substantial liquidity drains on the company and
generated significant losses that have eroded AIG's capital base. In addition, the
modifications of the September Facility are more consistent with the stabilized
condition and prospects of AIG following completion of the restructuring package
of actions. Furthermore, the foregoing modifications and especially the extension
of the September Facility's term should improve the ability of AIG to repay
advances under the September Facility by providing AIG additional time to
execute its large and global divestiture program—the primary source of funding for
repayment of Federal Reserve lending.
Terms of the Restructuring
1. September Facility Restructuring
The September Facility is restructured in various ways to enhance AIG's
ability to repay the credit extended in full while having adequate time to effect its
asset disposition plan in a manner most likely to achieve favorable returns for the
sale of its various businesses. First, the maturity of the loan under the September
Facility was increased from two years to five years (i.e., until September 22, 2013).
Second, the interest rates applicable to drawn and undrawn amounts of funding
under the September Facility were reduced. The interest rate payable on
outstanding advances under the September Facility was reduced from 3-month
LIBOR plus 850 basis points to 3-month LIBOR plus 300 basis points. The
interest rate payable on available but undrawn amounts of funding under the
September Facility was reduced from 850 basis points to 75 basis points. Third,
the maximum amount of credit permitted to be outstanding under the September
Facility was reduced from $85 billion to $60 billion. This reduction will be
effected upon the completion of the Treasury Department's investment of
$40 billion from the TARP, the proceeds of which will pay down the September
Facility.
Other important terms of the September Facility, however, remain
unchanged. AIG remains unconditionally obligated to repay the unpaid principal
amount of all advances, together with accrued and unpaid interest thereon and any
unpaid fees on the maturity date. Also, all outstanding balances under the
September Facility are secured by the pledge of a substantial portion of the assets
of AIG and its primary non-regulated subsidiaries, including AIG's ownership
interest in its regulated U.S. and foreignsubsidiaries(footnote5Inthe
case of foreign subsidiaries, the equity interest the Reserve Bank will accept as
collateral is limited to 66 percent ownership in order to avoid adverse tax consequences for AIG
or
its
subsidiaries
end
footnote)
In addition, upon the
receipt of shareholder approval, additional collateral will be pledged by AIG to
secure the September Facility. Furthermore, AIG's obligations to the Reserve
Bank continue to be guaranteed by each of AIG's domestic, nonregulated
subsidiaries that have more than $50 million inassets(footnote6
Regulated subsidiaries, such as insurance companies, typically are not permitted to provide
such
guarantees
end
footnote)
These guarantees
themselves are separately secured by assets pledged to the Reserve Bank by the
relevant guarantor. Additional subsidiaries of AIG may be added as guarantors
over time by signing a short supplemental agreement.
Finally, the Reserve Bank's agreement to provide advances under the
September Facility continue to be specifically conditioned on the Reserve Bank
being satisfied in its sole discretion with the nature and value of the collateral
securing AIG's obligations at the time of the advance, and on the Reserve Bank
being reasonably satisfied in all respects with the corporate governance of AIG.
Reserve Bank representatives are in regular contact with AIG's senior management
and attend all AIG board of directors meetings, including committee meetings, as
an observer. The Reserve Bank also has staff on-site at AIG to monitor the
company's funding, cash flows, use of proceeds and progress in pursuing its global
divestiture plan. Control and management of the daily business and operations of
AIG and its subsidiaries continue to be vested in the new chairman and chief
executive officer of AIG and his management team. These and other provisions
protect the interests of the Federal Reserve, the Treasury Department, and
taxpayers in having full repayment by AIG of all of its Federal Reserve borrowing
without incurring any losses.
2. RMBS LLC
On October 8, 2008, the Board announced that it had authorized the creation
of the Securities Borrowing Facility for AIG to address the immediate liquidity
needs caused by the ongoing withdrawal of AIG's securities lending
counterparties. AIG remained, however, exposed to further declines in the value of
the RMBS portfolio (par value approximately $40 billion) purchased with the
proceeds of these securities lending transactions. AIG has already experienced
approximately $16.5 billion in mark-to-market losses on these RMBS as of
September 30, 2008, and the market for these securities is illiquid.
In order to reduce the stress and need for continued collateral calls
associated with the securities lending program, the Board authorized the
establishment of a new facility under which certain AIG insurance subsidiaries will
transfer RMBS with a par value of approximately $40 billion and a fair market
value as of September 30, 2008, of up to $23.5 billion to a newly-formed limited
liability company (the "RMBS LLC"). The RMBS LLC will be financed by AIG
with a $1 billion subordinated AIG note, and by the Reserve Bank through a senior
Reserve Bank note of approximately $22.5 billion. The aggregate proceeds of the
subordinated and senior notes will be used to purchase the RMBS portfolio from
AIG, at market value as of October 31, 2008. Proceeds to the insurance company
subsidiaries, together with other AIG funds, will be used to return all cash
collateral posted by securities borrowers, including approximately $19.9 billion to
be returned to the Reserve Bank. After all collateral is returned, AIG will repay in
full all of its obligations under the Securities Borrowing Facility. The Securities
Borrowing Facility will then be terminated, because it will no longer be necessary
once the RMBS LLC is established and functional.
The Reserve Bank senior loan will have a maturity of six years (subject to
extension by the Reserve Bank) and will accrue interest at a rate of 1-month
LIBOR plus 100 basis points. The Reserve Bank's senior note will be fully
secured by the entire portfolio of RMBS acquired by the RMBS LLC, which
RMBS are in turn secured primarily by interests in sub prime and Alt-A residential
mortgages. The RMBS LLC is to be managed by a financial advisor, hired by the
Reserve Bank, so that the RMBS LLC's assets can be managed with a view toward
maximizing repayment of its obligations with minimum disruption to financial
markets.
AIG's subordinated note is to accrue interest at a rate of 1-month LIBOR
plus 300 basis points. AIG will receive no payments until the principal and interest
on the Reserve Bank's senior note is fully repaid. After both the senior debt and
the subordinated debt positions are fully repaid, any residual returns will be
apportioned between the Reserve Bank and AIG in the approximate ratios of 5/6
and 1/6, respectively.
3. CDO LLC
AIGFP has written CDS in favor of third-party counterparties related to
super-senior multi-sector cash CDOs (the "reference obligations"). These CDS
required AIGFP to post collateral with the counterparties to secure its obligations
based on fair value deterioration and ratings downgrades of the reference
obligations and downgrades of AIG's ratings. As of November 5, AIGFP had
posted or agreed to post collateral on all of its super-senior CDS in an aggregate
net amount of approximately $37.3 billion. Further declines in the mark-to-market
values would require AIG to post further collateral, creating significant potential
liquidity drains on AIG.
To address these issues, the Board authorized the Reserve Bank to lend to a
new special purpose vehicle (the "CDO LLC") that will offer to purchase the
reference obligations from the CDS counterparties, who will concurrently with
such purchase terminate the related CDS. The CDO LLC will be funded by a
subordinated AIG note in an amount of up to $5 billion, and by a senior Reserve
Bank note that will not exceed the remaining amount needed to fund the
acquisition of the CDOs, but in any event no more than $30 billion. To the extent
that the market value of the CDOs is less than $35 billion, the senior Reserve Bank
note will be in a lower amount. Separately, AIG will pay the costs associated with
the unwind of the related CDS and bear the risk of declines in market value of the
CDOs through October 31, 2008. After the closing date, AIGFP will not be
subject to any further collateral calls related to the terminated CDS.
Under the CDO LLC, the Reserve Bank's senior note will be fully secured
by the CDOs, the value of which will not exceed $35 billion. The CDOs
themselves are secured by sub prime and Alt-A residential RMBS and other
asset-backed securities. The Reserve Bank's senior note will have a maturity of
six years (subject to extension by the Reserve Bank) and is to accrue interest at a
rate of 1-month LIBOR plus 100 basis points. AIG's subordinated note is to
accrue interest at a rate of 1 month LIBOR plus 300 basis points. AIG will receive
no payments until the principal and interest on the Reserve Bank's senior note is
fully repaid. After both the senior debt and the subordinated debt positions are
fully repaid, any residual returns will be apportioned between the Reserve Bank
and AIG in the approximate ratios of 2/3 and 1/3, respectively. Like the
RMBS LLC, the CDO LLC is to be managed by a financial advisor, hired by the
Reserve Bank, so that the CDO LLC's assets can be managed with a view toward
maximizing repayment of its obligations with minimum disruption to financial
markets.
@FedFRASER