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Saturday, 19 April 2014

Sailing troubled waters

AIG has been rocked by losses in structured credit and significant subprime exposure, and despite a year of weighty borrowing there are concerns it may still find itself strapped for cash. Yet in the longer term its diversified business model stands it in good stead. Solomon Teague reports.

In early May 2008, American International Group (AIG) raised the equivalent of nearly US$20.3bn – well above its initial target of US$12.5bn. But not everyone is convinced even this sizeable injection is sufficient for its needs. In the first quarter of the year AIG reported a US$16.1bn fall in its book value, equivalent to 17%. Since the end of the third quarter of 2007 it has lost US$24.4bn, or some 23% of its book value.

With a range of subsidiaries ready to suck money out of the parent, rating agencies could be ready to suggest an increased capital cushion requirement, according to Joshua Shanker, an analyst at Citi in New York. With accumulated pre-tax mark-to-model losses of US$20bn related to AIG Financial Products’ CDS portfolio, US$9.7bn of realised capital losses, another US$18.6bn in unrealised losses and general malaise in the economy, “AIG’s largest challenge is to manage its credit and mortgage related assets and liabilities,” said Shanker.

In what was perhaps the defining moment of the year for the insurer – notwithstanding the defenestration in June 2008 of CEO Martin Sullivan in favour of chairman Bob Willumstad – February saw AIG forced to reveal miscalculations in its losses related to its CDO portfolio.

Soon after, it made a second announcement, admitting that its October and November write-downs would be closer to US$5bn than the US$1bn it had previously suggested.

AIG remains bullish on its RMBS portfolio. “There is a lot of credit enhancement in this portfolio, and it takes a very, very severe decline in the markets before we have significant ultimate realised losses,” said Win Neuger, AIG’s CIO.

The equity and equity-linked portions of AIG’s May capital raising programme had raised a combined US$13.4bn, the success of which then propelled hybrid debt deals denominated in sterling, euros and dollars – all three led by Citi and JPMorgan. The dollar portion totalled US$4bn, rated Aa3/A/A+ and priced with an 8.175% coupon, or 354bp over Treasuries.

The euro and sterling hybrids came in a 60/30 non-call 10 structure. The euro issue came to €750m, priced at a yield of 10-year mid-swaps plus 345bp, or an 8.00% coupon, which was about 25bp behind the outstanding 4.875% hybrid. The £900m tranche printed at 385bp over Gilts for a 8.625% coupon, or about 35bp behind the existing 5.75% hybrid. Both the euro and sterling trades were said to be 2.5 times covered.

In June 2007 AIG had raised €500m in a 10-year deal that was subsequently tapped for a further €100m on the back of attractive absolute yield levels on offer. The 5% June 2017s were priced at mid-swaps plus 23bp and were driven partially by reverse enquiry.

Led by Barclays Capital, BNP Paribas and HSBC, the deal was rated Aa2/AA/AA and priced at plus 23bp – an ample new issue premium, considering its outstanding April 2016 deal bid at plus 19bp. In August it completed a US$1bn two-year floater, priced at par with a coupon of Fed Funds plus 50bp – reoffered at a discount of 99.943.

“The convertible and debt offering will increase the annual interest expense by almost US$1.1bn, or $0.30 per share net of tax,” predicted Shanker, despite only replenishing the capital it lost. Things are only likely to get worse if the US economy continues to deteriorate as some predict.

The problems afflicting AIG are illustrated by its renegade business unit International Lease Finance Corp, which is seeking a split from its parent. But should a split occur, AIG will at least be in line for some level of compensation.

Moody's downgraded AIG to Aa3 in the wake of the news that the unit might go it alone, while confirming ILFC's A1 rating. Investors were also wary as ILFC itself entered the market with a benchmark-sized offering of 5.5-year notes in late May.

“We continue to believe that AIG's solvency remains sustainable in the long term given its global and diversified platforms,” concluded Shanker, though in the short and mid-term the road could be bumpy. “Pressure in core operations does not allow them to offset the volatile and adverse results elsewhere.”

But there are optimists out there. "AIG is a company that has some problems, but it is very diversified and a market leader in its businesses," said one portfolio manager. "For a large deal, the AIG hybrid offering drew a lot of demand and was well placed."

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