AIG’s $30bn alternatives business hangs in balance

As the US insurance giant struggles to raise capital, the fate of the firm’s substantial private equity business remains uncertain. AIG Investments has not been placed for sale as part of its parent’s capital raising measures.

As American insurance giant AIG scrambles to raise capital to stave off a potentially lethal credit downgrade from ratings agencies, the fate of the company’s $29.5 billion (€20.7 billion) private equity business hangs in the balance.

Unlike Lehman Brothers, which solicited bids for a stake in its asset management unit as it has sought to raise capital prior to filing for chapter 11 bankruptcy protection earlier today, AIG has made no mention of whether it would put its asset management business, AIG Investments, up for sale as a last-ditch effort to raise capital. As a result, should AIG fail to secure additional capital, the fate of its investment management division will be closely tied to that of its parent.

A spokeswoman for AIG Investments declined to comment.

Along with the International Lease Finance Corporation (ILFC), AIG’s plane leasing business, AIG Investments forms a relatively bright spot in the parent company’s portfolio. For the second quarter of 2008, as AIG posted a net loss of nearly $5.4 billion, its asset management division posted operating income before net realised capital gains/losses of $150 million. However, its institutional asset management division, which includes its private equity activities, reported a $27 million operating loss stemming from lower carried interest revenues, real estate investment gains and partnership income.

Despite the loss, AIG Investments’ private equity business ranks among the largest in the industry, having been ranked 19th in the PEI 50, Private Equity International magazine’s PEO proprietary ranking of private equity firms by size. Since inception, it has raised at least $45.6 billion in private equity capital and today boasts more than 200 private equity professionals in 24 offices worldwide. New York-based Steven Constabile heads the division’s fund of funds group, whose current portfolio investments stand at more than 250.

AIG Investments’ private equity group has also been expanding its Latin American activities in recent months. In April it closed its second Brazil-focused special situations fund on $692 million. In connection with this, it will be opening an office in Colombia in the last quarter of 2008 to pursue investments in Colombia and Peru from the fund, PEO previously reported.

AIG Investments’ parent company has been under extraordinary pressure to raise capital as losses mounted within its insurance investment portfolio, which is heavily exposed to various residential mortgage-backed securities as well as credit default swaps collateralized by structured finance vehicles such as collateralized debt obligations (CDOs). The resultant collateral posting and capital needs of holding such instruments put pressure on the company to raise capital, which was exacerbated by the fact that the firm has nearly $50 billion of debt that may need to be rolled over in the next 12 months.

These short-term liquidity pressures intensified when Fitch said on 22 August that it may put AIG on watch for a further downgrade in its corporate debt ratings. A the time, its issuer default rating stood at AA-. Shortly thereafter, analysts at Credit Suisse estimated that a one-notch ratings downgrade from both Moody’s and S&P would require AIG to post up to $13.3 billion of additional collateral at a time when the company is already cash-strapped.

Among the alternatives that the world’s largest insurer considered was a capital infusion of between $10 billion to $20 billion from financial sponsors JC Flowers, Kohlberg Kravis Roberts and TPG. JC Flowers, which focuses on financial services firms, reportedly offered $8 billion in preferred shares to AIG but the company turned down the offer since it also included an option to buy the entire insurer for a discounted price in the future.

Had an $8 billion dollar capital infusion into AIG by JC Flowers materialised it easily would have represented one of the largest ever private equity-sponsored deals in the insurance sector. To date, the largest financial sponsor buyout in the insurance sector on record is last year’s takeover of Tennessee-based insurer Asurion Corporation for $4.2 billion by Madison Dearborn Partners, Welsh Carson Anderson & Stowe and Providence Equity Partners, according to data from Dealogic.

As for KKR and TPG, the firms withdrew their offers to buy preferred shares in the company after it became clear that the Federal Reserve would not help underwrite their investments in the troubled insurer.

Other reported liquidity measures considered included asset sales of up to $20 billion for divisions such as AIG’s Transatlantic Holdings, its NYSE-listed reinsurance business, as well as ILFC and its consumer finance business. The company previously considered selling ILFC but in June decided against doing so.

Mid-day Monday New York State Governor David Paterson announced at a press conference that the state would relax insurance regulations to let AIG shift up to $20 billion of less liquid assets between its subsidiaries and the parent company to cover its day-to-day operating needs while it continues to look for fresh sources of capital. Additionally, he called for the Federal Reserve to provide short-term liquidity for AIG.

“If the Fed responds positively to the Governor’s request and gives AIG the liquidity it needs, some level of confidence may be restored,” New York State Comptroller Thomas DiNapoli said in a statement.

Later in the day, the Wall Street Journal reported that the Federal Reserve asked investment banks Goldman Sachs and JPMorgan to make available between $70 billion to $75 billion in loan financing to AIG.

AIG shares on the NYSE ended the day down 61 percent at $4.76.