U.S. Treasury to Buy $40 Billion AIG Preferred Shares

By Craig Torres and John Brinsley

Nov. 10 (Bloomberg) -- The U.S. Treasury will buy $40 billion in American International Group Inc. preferred shares, and the Federal Reserve will open two new emergency loan units to finance the company's securities, the government said today.

The new terms of the government's assistance are less costly than the Fed's first loan to AIG on Sept. 16, a statement released in Washington said. The New York Fed gave the original loan to prevent widespread default against AIG creditors in the same week that Lehman Brothers Holdings Inc. collapsed.

``These new measures establish a more durable capital structure and resolve liquidity issues,'' as well as ``protect the interests of the U.S. government and taxpayers,'' the statement said.

The Fed and the Treasury are restructuring AIG's bailout so the company will survive credit market turmoil that has worsened in the two months since the company's first loan. A government report Nov. 7 showed the U.S. economy lost 524,000 jobs in September and October and unemployment rose to a 14-year high of 6.5 percent.

The Treasury, in a separate statement, called AIG a ``systemically important company.'' A Treasury official, speaking to reporters on a conference call on condition of anonymity, said Treasury Secretary Henry Paulson and Fed Chairman Ben S. Bernanke late yesterday briefed members of President-elect Barack Obama's transition team on the matter.

Separately, the insurer said today it lost a record $24.5 billion, or $9.05 a share, in the period ended Sept. 30, compared with profit of $3.09 billion, or $1.19, a year earlier.

Smaller Loan

Today's government announcement indicates the Fed will reduce its original credit line to AIG to $60 billion from $85 billion. The interest rate on the facility will be reduced to the three-month London interbank offered rate plus 3 percentage points, from a previous spread of 8.5 percentage points, the statement said. AIG's assets continue to secure the loan.

Under the deal, AIG must comply with the limitations on executive compensation for its top five senior executive officers as required under a bailout package signed into law last month, the Treasury said. Also required are ``golden parachute'' restrictions and a freeze on the size of the annual bonus pool for the top 70 company executives, the government said.

The Fed also invoked emergency authority to set up two new emergency loan facilities.

`Liquidity Pressures'

``These facilities are designed to alleviate capital and liquidity pressures on AIG associated with two distinct portfolios of mortgage-related securities,'' the Fed said.

In one new facility, the New York Fed will lend as much as $22.5 billion to a new limited-liability company to fund the purchase of residential mortgage-backed securities from AIG's U.S. securities lending collateral portfolio. AIG will make a $1 billion subordinated loan to the LLC and bear the risk for the first $1 billion of any losses, the Fed said.

The second lending facility lets the New York Fed lend as much as $30 billion for collateralized debt obligations of AIG.

``The loans will be secured by all of the assets of the LLC and will be repaid from the cash flows produced by these assets as well as proceeds from any sales of these assets,'' the central bank said. ``The New York Fed and AIG will share any residual cash flows after the loans are repaid.''

Treasury's TARP

The capital injection into AIG will come from a $100 billion pool authorized by Congress for Treasury to use at its discretion, rather than the $250 billion allocated to purchase stakes in the country's banks, a Treasury official said. The government will get a 10 percent dividend for its preferred shares in the insurer, the Treasury official said.

A Fed official said on a conference call with reporters that they have been negotiating with AIG since September and that central bankers hired outside consultants to value the assets to be pledged to the facilities.

The modeling assumes that the Fed could recover value over a six-year lending period, a Fed official said, adding that restructuring should reduce their overall risk to the company.

The Fed will loan to the two facilities at the one-month London interbank offered rate plus 1 percentage point, providing the firm with a low-cost way to fund the assets, the official said, speaking on condition of anonymity. The securities that will be moved to the Fed facility were marked to market on Oct. 31, the official said.

The Treasury is working on lobbying restrictions for AIG, the Fed official said.

The Treasury's purchase of $40 billion in newly issued preferred shares from the New York-based insurer uses the agency's $700 billion Troubled Asset Relief Program, a financial rescue package that Congress passed in early October.

``This restructuring will improve the ability of the firm to execute its asset disposition plan in an orderly manner,'' the Treasury said in a statement, calling the insurer a ``systemically important company.''

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; John Brinsley in Washington at jbrinsley@bloomberg.net