If AIG Is Downgraded, It Needs to Post Collateral

UPDATE: New York governor David Paterson, working in concert with superintendent of insurance, Eric Dinallo, has given AIG permission to borrow up to $20 billion from its subsidiaries. This should alleviate some of the urgency but AIG still needs to unload its valuable assets.

UPDATE 2: I also added a quick word clarifying that the situation faced by AIG is similar to what the monolines faced with their investment portfolio, which is a side business that has nothing to do with their insurance business. Monolines did not have to post collateral upon downgrades for their insured portfolio.


AIG's stock is off quite a bit today:



It is following a path that is very similar to what the monoline bond insurers faced. AIG, however, is massive and is the largest insurer in the world. What is haunting AIG is the performance of mortgage bonds and mortgage derivatives (such as CDOs.) The latest problem--monolines faced this problem about 3 months ago with their investment portfolios (not to be confused with thier insurance portfolios)--is the need to post collateral for their investment contracts if they are downgraded. Ambac and MBIA were downgraded and they ended up collateralizing their investments and MBIA actually took a $400 million loss (or thereabouts.) AIG's business is much larger so their losses would be bigger.

What probably killed the stock today is word that AIG was seeking a $40 billion loan from the Federal Reserve. Market thinks that losses are going to be this big but I believe that the loan is to post collateral upon a downgrade and is not indicative of a loss.

AIG can probably raise $20 billion from asset sales so it better get moving. It will probably have to sell off its assets to foreigners and I'm not sure if the US government will block some of those deals. For instance, I'm not sure if the aircraft leasing business can be sold at will.

Comments

  1. UnknownSeptember 15, 2008 at 1:21 PM

    Hello Mr Velauthapillai,

    I'm an associate producer at CBC national radio news, and I'm helping a reporter with a story about what's happening in today's US markets. We're looking for a regular investor (ie someone who doesn't work in the financial industry) to talk to about how this is affecting them, and I was wondering if you might be available. The only thing is we would need to do the interview in the next few hours, before 3 pm today. I'm at 416 205 6209 if you're interested.

    Karin Marley

    ReplyDelete
  2. AnonymousSeptember 15, 2008 at 1:53 PM

    AIG’s CDS exposure is different from that of MBI and ABK. AIG, unlike MBI and ABK, has to post collateral as the CDS MTM’s go against them.

    From: http://media.corporate-ir.net/media_files/irol/76/76115/FinalConf_revised_08-13-08.pdf

    • AIGFP is required to post collateral on the majority of the credit derivatives that are part of the multi-sector CDO and corporate arbitrage portfolios.
    – The amount of collateral required for posting is primarily based either on the replacement value of the derivative or the market value of the reference obligation.
    – The amount required for posting is affected by AIG Inc.’s credit rating and that of the reference obligation.

    This makes it much harder for them to ride out this storm.

    RIV

    ReplyDelete
  3. Sivaram VSeptember 15, 2008 at 2:10 PM

    Thanks for the offer Karin but I have to decline. I don't believe I'm representative of the average investor and I'm also unavailable during that tight time slot. Thanks...

    Sivaram

    ReplyDelete
  4. Sivaram VSeptember 15, 2008 at 2:17 PM

    Anon,

    Thanks for pointing that out. I am not familiar with AIG but my feeling is that AIG's CDS is similar to the INVESTMENT PORTFOLIO of the monolines. The monolines have a side-business (an investment management business) that is separate from their insurance business, and this is what required them to post collateral. Similar to AIG, the monolines also had to post collateral or pay out losses based on ratings. The main insurance portfolio (as opposed to this investment portfolio) does not require collateral posting. So the damage was limited for the monolines. In contrast, based on your comments, it seems that AIG is very vulnerable due to its massive CDS portfolio (something like $500 billion notional if I'm not mistaken.)

    ReplyDelete
  5. ng2000September 15, 2008 at 3:52 PM

    Valuable resource of aig stock news summaries: http://www.ng2000.com/fw.php?tp=aig-stock

    ReplyDelete

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