Fed Loans $37.8 B to AIG; Prudential Falls

123jump.com Staff
09 Oct, 2008
New York City

The New York Fed was forced to lend additional $37.8 billion to the fallen insurance giant AIG after its securities lending division faced a barrage of cash calls. Of the $85 billion loan issued by the Fed, $61 billion has already been used and more money may be needed to meet cash requirements.

[R]1:15PM New York – The New York Fed lent additional $37.8 billion to the recently nationalized insurer AIG.[/R]

The Federal Reserve Board authorized the New York Fed to assist regulated insurance subsidiaries of AIG with additional capital injection. The new loan of $37.8 billion will be in addition to $85 billion loan facility set by the Fed for AIG of which $61 billion has been already spent.

AIG continues to burn cash at a rapid rate, faster than expected by regulators. During the Congressional hearing, former chief executive of AIG Robert Willumstad confirmed that $61 billion of the $85 billion. The bulk of the original loan, the largest U.S. government intervention has been already spent in settling counterparty obligations and more money is needed to support the cash requirements in its securities lending business.

AIG Financial Products, the unit based in London, UK is at the heart of the current troubles at AIG. The division headed by Mr. Joseph J. Cassano, former investment banker with Drexel Burnham Lambert, helped to build speculative and risky credit default swap business, was fired after AIG declared its first quarterly loss this year. The House members were outraged to learn that AIG has hired Mr. Cassano with $1 million a month contract after the government takeover.

AIG FP is wound down by the Federal regulators but it holds mostly illiquid securities and contracts that have values that are hard to measure. The securities lending business where AIG leveraged its considerable financial strength and lends and trades securities to various parties including hedge funds. The insurance company also leveraged many of these securities and took risk in bond markets trading. AIG borrowed money in exchange of various securities that are illiquid and falling in values and now investors are returning these securities and demanding cash.

The out flow of cash at AIG has accelerated since September 15. Many of these returned securities have lost considerable value and are nearly impossible to sell. If these securities are allowed to mature, it may take anywhere between three to five years to collect the cash from the underlying collateral from counter parties who are also on shaky grounds.

The New York Fed will lend $37.8 billion in exchange of these illiquid securities to the insurance division of AIG that has liquidity calls from these lenders. AIG has at least $200 billion in these obligation spread across various units and if all the lenders demanded money, AIG potentially may need additional $80 billion.

While AIG is burning cash, the House hearing revealed that the company spent $440,000 for a marketing event at a California resort where employees stayed at $428 a night suite and spent $10,000 in drinking at the expense of the company. AIG conference was organized last month at St. Regis resort in Monarch Beach. A similar conference that was planned at a resort this week was cancelled after heavy criticism from Congressional members, Presidential candidates and the White House.

The today’s move by the New York Fed will alleviate the temporary needs of the capital from various lenders but the demand for cash has overwhelmed the insurance business. The $85 billion loan approved as a part of the bailout in the mid-September was intended to help AIG to wind down its risky credit default swaps unit originated at its London office. That money has been used to meet obligation of its securities lending division which was not expected.

AIG bleeding continues as creditors, clients and lenders lose confidence in the insurance company. The weakness of AIG has also affected the insurance sector and market volatility has lowered earnings at MetLife, Hartford Financial Services and worries of earnings meltdown at Prudential Financial have dragged the stock to a five-year low.

MetLife completed its secondary offering on Wednesday and sold 75 million shares at $26.50 a share. Hartford was forced to raise capital by issuing preferred shares to the German insurance giant Allianz SE.

Allianz agreed to purchase $750 million in convertible preferred stock at $31 a share and $1.75 billion of 10% junior subordinate debentures. The debentures are callable at par after ten years. Allianz was also issued warrants that expire in seven years that can be exercised to buy up to $1.75 billion in common stock at a price of $25.32 a share. The company also lowered its dividend 40% to 32 cents a share and indicated a large loss for the third quarter.

Prudential Financial, Inc ((PRU)) dropped 9.2% or $4.18 to $39.11 and is down from its peak of $101 in mid-October 2007. The insurance company is expected to announce earnings shortfall and may have to raise capital to shore up its balance sheet.