Understanding AIG’s financial problems

I think Prof. Rogoff was slightly quick to say US government is letting wall street firms fail and calling it a good sign.

Fed is providing upto USD 85 billion of liquidity support (capital) and US government will now own 79.9% of AIG’s equity.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility. 

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all 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. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

Loan is expected to be repaid after from sale of assets?? I think that is too much of optimism. Even in AIG’s press release similar optimism is shown.

Fed had to again reach out to an exigent clause to bail out AIG. After Lehman’s analysis (bankruptcy and source of problems), it is time to take a peek at AIG’s financial mess.

I just took a look at AIG’s Q2 2008 financial statement. Its business is divided into 4 segments (see this for details):

• General Insurance
• Financial Services
• Life Insurance & retirement services
• Asset Management

The income/loss in each division in Q2 2008 is as follows (in billions):

• General Insurance :  $ 0.8
• Financial Services : $ (-5.9)
• Life Insurance & retirement services: $ (-2.4)
• Asset Management : $ (-0.3)
• Total: $ (-5.4)

So total losses are USD 5.4 billion in Q2 2008 and losses are a staggering 13.2 billion in the 6 months ended June 2008.

The main troubles are in 2 divisions: financial services and Life Insurance & retirement services and they continue to bleed. Fin services losses also includes $ 5.6 billion of unrelaised market valuation loss on CDS portfolio:

Capital Markets reported a $6.24 billion operating loss in the second quarter of 2008, due to $5.56 billion of unrealized market valuation losses related to AIGFP’s super senior credit default swap portfolio and a $518 million credit valuation loss. In addition AIGFP experienced low transaction volumes due to challenging market conditions.

I am not one bit surprised over this CDS. Eurointelligence points:

AIG was a huge Credit Default Swap writer, and that insurance required collateral to be posted, depending upon such factors as credit rating and credit spreads;

The recent crisis has posted numerous concerns over CDS market. I had posted number of times about the problems in these markets.

What I don’t understand is huge losses in the Life Insurance & retirement services. I was seeing Nouriel Roubini’s commnets on CNBC in the morning and he was critical of the investments done by AIG. He said this money should have been invested in safer securities as it is for retirement and life insurance. But it was invested in all kinds of exotic (he called it toxic) financial instrumnets. I could not get much clarity from AIG’s press release and would have to look more into details

Addendum:

IRDA has issued a statement saying AIG’s insurance venture with Tata is safe

Big Picture points more links

 

RBI measures post Lehman bankruptcy

RBI has taken certain measures post Lehman bankruptcy. 

Lehman Brothers has 2 outfits in India -

• Lehman Brothers Capital Pvt. Ltd. (NBFC)
• Lehman Brothers Fixed Income Securities Pvt. Ltd. (a primary dealer)

RBI has asked Lehman Brothers Capital Pvt. Ltd. to take permission from RBI before taking any direct/indirect liability from any institution in India or making any forex remittance. It has asked Lehman Brothers Fixed Income Securities Pvt. Ltd not to undertake any transactions in G-sec market.

As I posted a while back, Barclays has only brought North American operations. The other worldwide businesses are still in Lehman. So, till Lehman finds a buyer for its worldwide businesses as well, we might expect these measures in other economies as well.

Barclays buys Lehman’s broker-dealer unit

I had indicated that Barclays is in talks with Lehman to buy its broker-dealer business. The deal has been executed and press release from Lehman tells about the deal. The features are:

• Barclays Agrees to Acquire Lehman Brothers’ North American Investment Banking, and Fixed Income and Equities Sales, Trading and Research Operations, Including Approximately 10,000 Employees
• Discussions to Acquire Lehman Brothers’ Select Operations Outside of North America
• Barclays Agrees to Purchase Lehman Brothers’ Headquarters Office Building and  Two Other Facilities
• Barclays Enters into Support Agreement with Lehman Brothers to provide;
  - $500 Million DIP-Financing to Lehman Brothers Holdings Inc.
  - A Substantial Interim Credit Facility to Lehman Brothers Inc.

So, both capital markets division and i-banking division have been bought. Basically, Barclays capital, the i-banking arm has brought the lehman assets.  

 The total amount of deal has not been disclosed. So, Lehman Holding company has three remaining businesses:

• I-managment division (worldwide)
• Capital markets (worldwide minus North America)
• i-banking operations (worldwide minus North America)

I loved the statements from the officials of both Barclays and Lehman:

Robert E. Diamond, Jr., Barclays President, said, “This is a once in a lifetime opportunity for Barclays. We will now have the best team and most productive culture across the world’s major financial markets, backed by the resources of an integrated universal bank. We welcome the opportunity to add Lehman’s people and capabilities to the Barclays team.”

“This is a wonderful outcome for a great number of our employees that will preserve and strengthen our terrific franchise,” said Richard S. Fuld, Jr., Chairman and Chief Executive Officer of Lehman Brothers.

I am sure Barclays must have got it a fraction of a price but it is too early celebrate. It will still have to assume Lehman’s division losses and financial markets are still extremely panicky.  About Fuld, less said the better.

Assorted Links

If there is one prediction which has been true and perhaps better than the expected it is events in this week. Before this week started it was said that it would be an eventful week. It has truly surpassed the prediction

1. FOMC maintains rates. WSJ Blog comments that there were no dissents this time. It points NY Fed chief Geithner skips the meeting to stay in New York. WSJ Blog says inflation is still a worry for Fed.

2. There is another bailout  of AIG. WSJ Blog says Fed invokes another exigent clause.

3. Meanwhile there are also suggestions to set up a new govt. entity to deal with fallouts in financial crisis. WSJ Blog points

4. Mankiw points to a Rogoff article on bailouts

5. Rodrik on capital flows conundrums

6. PSD blog on creative destruction and emerging markets

7. As Bankruptcy gains steam, it is time to see how much creditors can get. DB points to a study

8. TTR says higher capital for i-banks is not a bad idea