Standard and Poor's slashes AIG rating, bankruptcy more likely

American International Group (AIG), the world's biggest insurer with over US$1 trillion in assets, moved one step closer to bankruptcy on Tuesday when Standard and Poor's slashed its credit rating by three notches from AA minus to A minus. Fitch also cut its rating on AIG to A from AA minus. The collapse of AIG would have even bigger ramifications for global financial markets than the collapse of Lehman. AIG has sold other banks and other investors protection on US$441 billion of bonds and securitised mortgages, including US$57.8 billion of bonds tied to sub-prime mortgages. It is widely expected to write down the value of its mortgages by US$30 billion, yet has a market value of less than US$15 billion and saw its share price fall almost 90% in the last two days. S&P cited a "combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses." The downgrade effectively signals a deathknell for AIG because AIG has previously said it would have to put up an extra US$13.3 billion of collatoral when its credit rating is cut by such an amount. AIG tried on Monday to get a US$40 billion loan from the US Federal Reserve to avoid such a credit rating downgrade. The Federal Reserve rejected the request and instead asked JP Morgan and Goldman Sachs to lend AIG US$70-75 billion. Those discussions are continuing. Here is the full statement below from Fitch on why it downgraded AIG.

The rating actions reflect Fitch's view that AIG's financial flexibility and ability to raise holding company cash is extremely limited due to recent declines in the company's stock price, widening credit spreads, and difficult capital market conditions. The rating actions also reflect benefits derived from a plan announced by New York's governor today that grants certain AIG operating company subsidiaries the authority to exchange up to $20 billion of assets with AIG in order to promote the company's liquidity. Fitch believes that AIG's ability to fund collateral requirements and replace capital lost due to the company's on-going exposure to the U.S. residential mortgage market is now largely dependent on accessing assets provided under the plan outlined by New York's governor and by asset sales. AIG's collateral requirements and liquidity needs rise from several sources, including the company's AIG Financial Products (AIGFP) subsidiary's portfolio of credit default swaps written on collateralized debt obligations backed by structured finance CDOs. In the second quarter 2008 AIG posted approximately $8.2 billion of collateral related to this portfolio, bringing the total collateral posted at July 31, 2008 to $16.5 billion. Given current difficult market conditions Fitch believes that AIG is likely to face additional material collateral calls on this portfolio. Further, as of July 31, 2008, AIG estimated that it could be required to post $10.5 billion of additional collateral if the company's ratings are downgraded one notch from current levels by the other major rating agencies and $13.3 billion of collateral if downgraded by both of the other agencies. AIG's also has potential liquidity needs derived from 2a-7 put contracts the company sold that Fitch estimates at $6 billion as of June 30, 2008. Fitch believes that AIG is likely to pursue other steps to raise cash and capital and that the company may pursue the sale of various operating units. Fitch believes that these measures will take time to develop and thus while they are likely to provide AIG with long-term benefits they are unlikely to provide benefits in the short-term. Notwithstanding, Fitch believes the accommodations being provided by AIG's insurance regulators has eased the potential liquidity strain being experienced at the holding company level. Fitch has downgraded the following ratings and kept them on Rating Watch Negative: American International Group, Inc. -Long-term IDR to 'A' from 'AA-''; --Senior debt to 'A' from 'AA-; --Junior subordinated debentures to 'A-' from 'A+'; --Short-term IDR to 'F1' from 'F1+'.