Fitch Discusses Rating Rationale Behind AIG Downgrade

Business Wire,  May 8, 2008  

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CHICAGO -- Earlier today Fitch Ratings downgraded American International Group, Inc.'s (NYSE: AIG) Issuer Default Rating (IDR) and senior debt ratings to 'AA-' from 'AA', as well as its other holding company and subsidiary debt ratings, including those of AIG Capital Corp., International Lease Finance (ILFC) and American General Finance (AGF). The ratings remain on Rating Watch Negative pending the completion of the company's capital raising plan announced earlier today. A full list of rating actions is detailed below.

Additionally all AIG-rated ratings that were not previously on Rating Watch have been placed on Rating Watch Negative pending the completion of the capital raising plan. If capital raising is completed, Fitch will remove all ratings from Rating Watch Negative and affirm AIG with a Negative Rating Outlook. Failure to complete the capital raising in a timely manner would likely result in a one-notch downgrade of the listed ratings.

The rating actions follow the release of AIG's first- quarter 2008 financial results as well as the preliminary conclusion of Fitch's evaluation of estimated economic expected and stress losses related to AIG Financial Products Corp. (AIGFP) credit default swaps on collateralized debt obligations backed by structured finance (SF CDOs) collateral. AIGFP's obligations are guaranteed by AIG.

First-quarter 2008 results were adversely affected by AIG's relatively large exposure to the current U.S. residential mortgage crisis. Fitch believes the area of AIG most exposed to this market is $61 billion of SF CDOs collateralized mainly by subprime U.S. residential mortgage-backed securities (RMBS), that are included within its broader $469 billion notional credit derivatives portfolio.

For the second straight quarter, the company recognized a significant FAS 133 unrealized market valuation loss on the credit derivative portfolio. The $9.1 billion pre-tax loss in the first quarter brings the cumulative market value loss to over $20 billion. However, Fitch has stated that from an analytical perspective, the more important ratings consideration is AIGFP's exposure from an economic and stressed loss perspective, especially during periods of market stress when market values may become disconnected from underlying fundamentals.

Fitch has completed its detailed analysis of the underlying SF CDOs, including those not rated by Fitch, to evaluate the potential range of economic and stress scenario losses. Fitch estimates economic expected losses on a present value discounted basis of between $1.6 billion and $5 billion on this portfolio. Applying a 'AA' rating category ratings stress (AIG's current rating level), estimated losses on a discounted basis rise to between $8.8 billion and $11.7 billion. It should be noted that economic expected losses reflect an estimate of future losses Fitch ultimately expects AIG to incur, whereas 'AA' stress losses reflect what Fitch views as reasonable target capital guidelines to support AIGFP's SF CDO exposure.

As AIGFP's credit derivatives business was historically underwritten to a zero loss assumption, these estimated losses are material and imply performance outside of Fitch's previous expectations for the rating. Fitch believes further deterioration in the U.S. residential mortgage market could increase these estimates.

Unlike monoline financial guarantors that have similar types of exposure, AIGFP is required under many of its credit derivative contracts to post collateral for adverse market movements as well as for changes in its own rating. As of April 30, 2008, AIGFP had posted collateral against its credit derivatives portfolio of $9.7 billion. Further deterioration in credit markets could lead to additional collateral posting requirements. Separately, per contract terms, downgrades of AIG's ratings by Standard & Poor's or Moody's Investors Service would also lead to collateral posting requirements. Fitch believes AIG has adequate liquidity to fund these requirements under most reasonable scenarios.

The company also recognized significant realized and unrealized capital losses in its investment portfolio during the quarter. AIG realized other than temporary impairments of $6.1 billion on a pre-tax basis including $4.1 billion related to market severity. In addition, AIG had unrealized capital losses during the quarter of $10.8 billion on a pre-tax basis. The after-tax unrealized capital losses are a direct charge to shareholders equity and do not run through the income statement.

Overall, these charges as well as lower than expected run-rate earnings led to a $16.1 billion decline in stated shareholders equity for the quarter. This follows a fourth-quarter 2007 decline of $8.3 billion. Cumulatively, shareholders equity has declined by 23% since Sept. 30, 2007.

Positively, AIG has announced a capital-raising initiative to replenish some of the decline in shareholders equity. Fitch expects the capital raise to include a mix of pure equity, mandatorily convertible securities and hybrid securities. A successful capital raise will both strengthen leverage and capital ratios, and also aid liquidity.