S&P Lowers AIG’s Ratings; On CreditWatch/Negative

May 9, 2008

American International Group’s whopping $7.81 billion first quarter loss (See related article) brought an immediate reaction from Standard & Poor’s Ratings Services. S&P has lowered its counterparty credit ratings on AIG, and several of its subsidiaries with ratings that are based on AIG guarantees, to ‘AA-/A-1+’ from ‘AA/A-1+’.

S&P also lowered its rating on AIG’s indirect subsidiary, International Lease Finance Corp. (ILFC), to ‘A+/A-1’ from ‘AA-/A-1+’. “The ILFC rating reflects support from AIG and is currently capped at one notch below the rating on the ultimate parent,” the bulletin explained.

The rating agency then announced that it has “placed these ratings as well as the ‘AA+’ counterparty credit and financial strength ratings on AIG’s core insurance operating subsidiaries on CreditWatch with negative implications.”

S&P credit analyst Rodney Clark said the rating actions were a direct result of the $7.81 billion loss. “The loss includes charges of $5.9 billion (after taxes) for market-valuation losses on AIG Financial Products Corp.’s (AIGFP) super senior credit default swap (CDS) portfolio and $3.6 billion of other-than-temporary impairments on investments, largely related to U.S. residential mortgage-backed securities (RMBS),” said S&P. “When combined with charges taken in 2007, this brings the cumulative after-tax charges to more than $13 billion on the CDS portfolio and to $6.7 billion for impairment of investments.”

Clark noted: “Although we expected that AIG would have some losses in the first quarter, the level of the additional losses exceeds these expectations.” In addition S&P pointed out that “AIG guarantees AIGFP’s obligations, so the potential strain of the losses to the parent contributed to the downgrade.” S&P also cited the fact that “weaker operating performance in several units and unrealized investment losses somewhat reduce the ability of subsidiaries to provide dividends to AIG. The increased notching (to two notches from one) between the primary operating companies and the holding company now reflects treatment similar to other large diversified insurance organizations.”

AIG’s intention to raise about $12.5 billion to cover a portion of the accounting losses prompted the CreditWatch placement. Clark stated that the ratings would remain on CreditWatch “pending the completion of the capital raise and Standard & Poor’s evaluation of whether the amount raised is sufficient to justify the current ratings.”

He added that “a higher amount would likely result in the ratings being affirmed and removed from CreditWatch, while a lower amount could result in the ratings being lowered by one notch. If AIG were to raise no capital, which we consider unlikely, we could lower the ratings by two notches.”

However, S&P also indicated that even following any capital increase, “the outlook is likely to be negative because of continued uncertainty in the investment markets. We expect that AIG’s earnings for the year will improve but will still to be short of those of 2007. Further significant deterioration in mortgage market performance or in AIG’s relative performance or capital could result in further downgrades. If significant recoveries of asset losses begin to emerge, we could assign a stable outlook, but that would not be likely for at least two quarters.”

Source: Standard & Poor’s – www.standardandpoors.com

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