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AIG Is Resuming Securities Loans

Source: WSJ - Serena Ng & Erik Holm

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Posted on 04 Nov 2011

Seeking to boost income, American International Group Inc. is creeping back into the business of securities lending—just three years after missteps there helped push the insurer to the brink of collapse.

The disclosure came in the New York company's third-quarter regulatory filing, which showed a $4.1 billion net loss for the quarter. AIG also unveiled a surprise $1 billion share buyback program aimed at supporting its stock price, which has languished since a stock offering in May.

The buyback program isn't expected to change the Treasury Department's plans to sell down its 77% stake in AIG over time. Government officials were notified of the buyback but didn't have to approve it, a person familiar with the matter said.

The Treasury is waiting for better market conditions before trying to sell more shares and still intends to dispose of its stake at above its "break-even" price per share of $28.73, according to other people familiar with the matter.

AIG said that during the third quarter it lent $1.2 billion in municipal bonds to banks, brokerages and others in exchange for collateral such as Treasury securities or cash, also receiving interest payments and a fee. Its insurance units are likely to lend more securities to generate income or bolster liquidity, the company said.

The new lending activity is just a fraction of the $90 billion in corporate bonds and other securities that AIG's insurance units lent to banks and brokers before the last financial crisis. To juice returns at the time, a division of AIG took much of the temporary cash it received for the securities and invested the money in subprime-mortgage bonds.

When credit markets froze during the housing downturn and AIG's trading partners returned the securities and asked for their money back, the insurer had difficulty coming up with the cash and used taxpayer money to meet its obligations in late 2008. AIG ultimately realized a roughly $20 billion loss from its precrisis securities lending activities.

This time around, AIG's filings indicate there are arrangements to avoid a repeat of what happened during the last crisis. The municipal bonds were lent by Chartis, AIG's property and casualty insurance business. Banks and brokers that borrowed the securities posted collateral amounting to at least 102% of the securities' value. The collateral cannot be reinvested by Chartis and is being held on the insurer's behalf in a third-party custodial account.

Chartis currently owns more than $35 billion in municipal bonds whose interest payments are tax-exempt. The insurer earlier pared its holdings of such debt, in part because it currently doesn't need the tax benefits that municipal bonds provide. Because of AIG's large losses from 2007 to 2009, the company and its units have large deferred tax assets that can be offset against income it generates.

Banks and brokers that borrowed Chartis's municipal bonds are paying the insurer the bonds' coupons plus a fee, which is at least 0.2%. In essence, the returns from the bonds would become similar to that on taxable bonds, but Chartis wouldn't have to pay taxes on the income.

AIG's life insurance business, SunAmerica Financial Group, is also planning to lend securities in exchange for short-term cash that can be an additional source of liquidity for the insurer when it has to fund life-insurance policy payouts, withdrawals or surrenders, the company's filings said.


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