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AIG Offers to Buy Back Subprime Mortage Bond Portfolio from Fed

Source: WSJ - Serena Ng

Posted on 11 Mar 2011

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American International Group Inc. (AIG)  has offered to repurchase a large portfolio of subprime mortgage bonds from the Federal Reserve Bank of New York, which acquired the securities as part of the insurer's massive bailout in 2008.

 AIG in a public filing on Thursday said that it's offering to pay $15.7 billion cash for all the securities in a company called Maiden Lane II LLC,

The New York Fed set up Maiden Lane II in late 2008 to take on roughly 800 mortgage-backed bonds from AIG and stem the insurer's cash bleed from a business known as securities lending. The regional Fed bank is currently owed about $12.8 billion on a loan it provided to Maiden Lane II, while AIG contributed $1 billion to the vehicle.

The portfolio of mortgage securities had a "fair value" of $15.9 billion at the end of 2010, according to Fed data, versus their face value of about $30 billion.

AIG said its offer, if accepted, would enable the New York Fed to be fully repaid on its loan ahead of schedule and reap a $1.5 billion profit. In a letter to the New York Fed on Thursday, AIG said it "believes this offer is in the best interest of the U.S. taxpayers, the U.S. government and AIG itself." No offer deadline was given.

A representative for the New York Fed had no comment.

The proposed deal shows how far both AIG—and the markets—have come since the depths of the financial crisis. The securities lending business caused substantial losses for AIG, whose outsized exposures to subprime mortgage debt caused its near collapse. Now the company's finances are on the mend, and AIG is seeing these same bonds as an opportunity.

AIG is hoping to use cash from its insurance units, mainly its life-insurance subsidiaries, to buy the bonds, which are earning relatively attractive yields in today's low-yield environment.

"At the proposed purchase price, the Maiden Lane II securities have an attractive risk/return profile to AIG," the company said in its letter.

Most of the bonds, which have floating interest rates, are expected to mature in four or five years. AIG executives regard these bonds as a good match for the liabilities of the insurance businesses, according to a person familiar with the matter. Insurers collect premiums that they invest to earn income before claims have to be paid out.

The mortgage bonds in Maiden Lane II were previously held by AIG's securities lending business, which suffered a liquidity crunch in late 2008 around the time the parent company nearly collapsed.

The securities lending business, which has since been wound down, previously lent corporate bonds and other securities owned by AIG's life-insurance units to Wall Street firms and banks, in exchange for short-term cash. AIG's asset-management unit invested much of the cash in subprime mortgage securities to earn additional returns for the company.

During the financial crisis, when values of those mortgage securities plunged and it became difficult to sell them, AIG had trouble raising cash to repay its trading partners when they returned the securities they borrowed and demanded their cash back.

The New York Fed in late 2008 helped AIG meet its financial obligations to its trading partners, and took over the mortgage bonds at prices representing a deep discount to their face value. Over the past two years, values of the bonds have partially recovered, but are still trading at roughly 53 cents on the dollar on average.

If the New York Fed accepts the offer, it would bring down the total outstanding amount of U.S. taxpayer assistance to AIG to roughly $72 billion, including $13 billion the New York Fed is trying to recoup from other mortgage securities known as collateralized-debt obligations that AIG previously insured. Over the past few months, AIG has used asset sale proceeds to repay nearly $40 billion of its bailout.

The regional Fed bank originally provided about $19.5 billion to Maiden Lane II in 2008. A chunk of its loan balance was repaid over the last two years from interest and principal payments from the securities. The terms governing Maiden Lane II essentially require that the Fed loan be fully repaid before AIG's $1 billion "equity" contribution is redeemed. After that, profits would be split between the New York Fed and AIG, with taxpayers getting over 83% of the upside and AIG getting the remainder.

AIG's letter to the Fed said the company "has prepared extensively over the last year to make this offer" and has closely analyzed the risks and benefits of owning the securities. It concluded that the securities are within its risk tolerance and the transaction wouldn't affect its credit ratings.