Email | Print    Type Size  -  +

Fed's price: AIG must shrink

A reprieve comes from the Fed, but the insurer's future is surely going to be very different.

By Roddy Boyd, writer
Last Updated: September 17, 2008: 11:17 AM EDT


NEW YORK (Fortune) -- The Federal Reserve's ninth inning rescue of AIG may soothe capital markets and keep the company's bondholders from taking a beating, but the financial services titan's future will look very different, and likely much narrower.

AIG (AIG, Fortune 500) has secured an $85 billion bridge loan from the Federal Reserve in exchange for a stake in the company that could reach 80%. But the deal comes with the provision that AIG sell off businesses to raise capital and repay the debt. It's likely to have to sell any number of insurance units that were long-time cornerstones of its franchise to raise funds.

Also likely to be in the offing is a substantial downsizing of its once-vaunted AIG Financial Products unit, a group that has brought in billions in revenue, but whose insurance guarantees on risky credit default swaps tied to the mortgage market has led to writedowns that have helped destroy the insurance giant's equity capital and its credit rating and led to the government's intervention.

AIG's management had already been discussing a vast restructuring and downsizing of the firm. The Federal Reserve's involvement now gives the firm time to proceed in orderly fashion.

Also likely on the auction block is International Lease Finance Corp., a unit that several weeks ago AIG's CEO, Robert Willumstad, declared a "core" holding. According to company filings, its book value is $7.4 billion and in ordinary times, would appear able to fetch a handsome premium. But these are no ordinary times.

ILFC has long been a money-maker for AIG - last year it booked $604 million in net income - but its $27 billion in debt requires a big sized buyer with a strong credit rating and healthy balance sheet.

A bitter pill

AIG started out as an insurance company and under former CEO Hank Greenberg grew into what was one of the world's most important financial companies, with a $180 billion stock market capitalization and operations in over 100 countries.

The notion that chunks of the company will now go at fire-sale prices is surely a bitter pill for shareholders, who have seen the value of their holdings decline by more than 90% this year, and that's before the dilution of their stake that will come with federal involvement.

AIG's general insurance subsidiaries are broadly considered the world's finest. In a good year, these units can make upwards of $20 billion in pre-tax profit. In the past 12 months, according to regulatory filings, they've made $6.6 billion.

It is impossible to believe that large rivals aren't pondering a bid for at least the international sections of the insurance unit.

But again, having to sell under pressure is going to be difficult. There's at least one buyer, however, willing to take a plunge. According to Reuters, longtime AIG rival Munich Re has indicated some (unspecified) AIG businesses are attractive.

An Australian hedge fund analyst, John Hempton, made an argument on his Bronte Capital blog earlier today that "a wise independent 'multi-trillionaire'" might be inclined to loan AIG the $70 billion it is seeking to meet collateral demands and replenish its equity capital.

He reasoned a loan of $70 billion to AIG makes sense since the insurance units throw off so much income. At an interest rate of 8%-10%, the payoff could be handsome, he argued.

Hempton's opinion seems to be in the minority, leaving the lender of last resort to step into the breach. To top of page

Company Price Change % Change
Bank of America Corp... 16.13 -0.26 -1.59%
Facebook Inc 59.72 0.63 1.07%
Yahoo! Inc 36.35 -0.02 -0.06%
Intel Corp 26.93 0.16 0.60%
Alcoa Inc 13.42 0.37 2.84%
Data as of Apr 16
Index Last Change % Change
Dow 16,424.85 162.29 1.00%
Nasdaq 4,086.23 52.06 1.29%
S&P 500 1,862.31 19.33 1.05%
Treasuries 2.64 0.01 0.34%
Data as of 5:49am ET
More Galleries
8 CEOs who took a pay cut in 2013 Median CEO pay inched up 9% in 2013 to $13.9 million. But not everyone got a bump last year. Here are eight CEOs who missed out. More
7 businesses Amazon wants to shake up From industrial supplies to educational software, Amazon is about more than just retail and books. More
Don't miss these Tax Day deals From massages and paper shredding to cookies and queso, celebrate the end of tax season with these Tax Day freebies and discounts. More
Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.