AIG Sells Shares to Fed: Papa’s Little Dividend?

The New York Fed has agreed to get involved in the life insurance business by investing $25 billion in two special-purpose vehicles.

In a move aimed at cutting American International Group’s $40 billion debt to the Federal Reserve Bank of New York by $25 billion and setting up two AIG life insurance giants as initial public offerings, the N.Y. Fed has agreed to a debt-for-equity swap done via special-purpose vehicles.

Under the agreement announced today, AIG will place the equity of American International Assurance Company and American Life Insurance Company in separate SPVs in exchange for preferred and common shares of the vehicles. The New York Fed will get all the preferred shares in the two SPVs, amounting to $16 billion in the AIA unit and $9 billion in the ALICO vehicle.

The New York Fed will be paid a 5 percent dividend on its shares, which it will get at a fairly hefty discount, until September 2013. For shares that aren’t redeemed by that date, the SPVs would start paying a 9 percent dividend.

The face value of the preferred shares represents a percentage of the estimated fair-market value of AIA and ALICO. With the IPOs looming, the parties aren’t saying what that value is. But the New York Fed, which will hold all the preferred shares, will get a majority stake in the economic value of the companies.

For its part, AIG will hold all the common equity in the two SPVs and “will benefit from the fair market value of AIA and ALICO in excess of the value of the preferred interests as the SPVs monetize their stakes in these companies in the future,” AIG said in a release issued today.

The dates of the closing of the deal and the IPOs aren’t tied to each other. The AIG-New York Fed transaction is expected to close late in the third quarter of this year. AIA, which has already launched its IPO process, is expected to start the offering in 2010. While ALICO hasn’t started the process of its offering just yet, it has announced its attention to do so.

As for the SPVs, they will structured as limited-liability companies in Delaware. Until they’re spun off, AIA and ALICO will remain wholly owned subsidiaries of AIG, consolidated in the company’s reported financial statements.

“Placing AIA and ALICO into SPVs represents a major step toward repaying taxpayers and preserving the value of AIA and ALICO, two terrific life insurance businesses with great futures,” said Edward Liddy, AIG’s chairman and chief executive officer said in the release. “Operating AIA’s and ALICO’s successful business models in the SPV format will enhance the value of these franchises as we move forward with our global restructuring.”

Asked why the company chose to structure the arrangement by means of the much stigmatized method of setting up SPVs, AIG spokesperson Christina Pretto told CFO that since the vehicles were on-balance-sheet entities they wouldn’t be the target of disapproval.  

AIA has one of the biggest books of life insurance in Asia, and ALICO has a large presence in Japan. While both are profitable, AIG has found it impossible to achieve its goal of selling the companies-at least partly because they are so large.

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