AIG Rescue Spared European Banks From $16 Billion Capital Raise

June 14 (Bloomberg) -- American International Group Inc.’s U.S. government rescue spared European banks from raising as much as $16 billion in capital during the depths of the global financial crisis, according to a Congressional panel. ABN Amro Holding NV and Danske Bank A/S, Denmark’s biggest bank, were among the firms that bought the most derivatives from AIG to trim reserves they held against investment losses, the Congressional Oversight Panel said last week in a report. ABN Amro may have had to raise $3.5 billion if New York-based AIG was allowed to fail in 2008, and Danske Bank would have lost as much as $2.1 billion in relief, the panel wrote.

The banks “would’ve needed to come to the capital markets in a time when it would’ve been nearly impossible to raise that kind of capital,” said Jonathan Hatcher, a Jefferies Group Inc. desk analyst and former Federal Deposit Insurance Corp. bank examiner. “This was point-blank regulatory arbitrage, AIG lending out its credit rating so institutions could hold less real capital.” The Federal Reserve Bank of New York weighed the consequences that an AIG failure would have on Europe’s largest financial institutions days before the September 2008 rescue, the panel said. The banks had bought credit-default swaps from AIG to cut the capital that regulators demanded be held against potential losses on about $250 billion in securities tied to mortgages and corporate debt, according to the report.

‘Catastrophic Market Disruptions’

The report shows which banks relied most on capital relief from the insurer. AIG had refused to disclose a list of the firms, according to the panel, which based its analysis on a document from the New York Fed with data as of Oct. 1, 2008. The insurer had named most of the banks, without disclosing the value of each firm’s coverage, in a confidential presentation to regulators as AIG appealed in early 2009 for its fourth rescue. AIG said then that its failure may lead to credit rating downgrades of the banks, which “could result in catastrophic market disruptions.”

KFW Bank and Credit Logement SA each had $1.9 billion in capital relief protected by AIG’s rescue, the panel said. Credit Agricole SA’s Calyon had $1.6 billion, BNP Paribas SA had $1.5 billion and Societe Generale SA had $1 billion. Other unidentified firms had a total of $2.4 billion. “We entered into the contracts in order to get downside risk protection on our mortgage portfolio and thereby reduce risk-weighted assets,” said Peter Rostrup, chief risk officer at Danske Bank in Copenhagen. The capital relief was about $770 million, rather than the panel’s $2.1 billion estimate, Rostrup said. He said the panel’s analysis was based on assumptions that assign too much risk and that the company would have met capital requirements even without the AIG contracts.

‘Low Risk’

KFW’s contracts with AIG involved “low-risk senior tranches” of debt, and the use of the derivatives has declined in the past two years, the bank said in a statement Mark Herr, an AIG spokesman, declined to comment, as did representatives at BNP Paribas, Societe Generale and Credit Agricole. A spokeswoman for Royal Bank of Scotland Group Plc’s Netherlands unit, wasn’t immediately able to comment. RBS bought ABN Amro’s wholesale bank.

Credit Logement Chief Financial Officer Eric Veyrent said last year that the firm “wouldn’t be directly touched by an AIG failure.” He didn’t immediately return a call yesterday outside of regular business hours. Two days before AIG’s Sept. 16, 2008, rescue, Timothy F. Geithner, then president of the New York Fed, was sent an e- mail from Alejandro LaTorre, an assistant vice president at the regulator, about the consequences a failure would have on European firms, according to the report.

‘Significant Problems’

“A bankruptcy filing had the potential to cause significant problems for numerous European banks” and could have led to their seizure by governments, said the panel, led by Harvard University law professor Elizabeth Warren. It is also possible that “some countries would have granted forbearance to their banks,” the panel said. Congress created the panel to oversee Treasury Department activities in stabilizing the economy and the $700 billion Troubled Asset Relief Program that bailed out firms including AIG. Geithner, 48, is now Treasury secretary.

Goldman Sachs

The so-called regulatory relief swaps are separate from the contracts tied to U.S. subprime mortgages that drained the insurer of cash in 2008, forcing a bailout that swelled to $182.3 billion. Goldman Sachs Group Inc. and Societe Generale were among the biggest counterparties in those transactions, which involved multisector collateralized debt obligations. As part of AIG’s third rescue, banks received payments in exchange for delivering the CDO assets linked to $62.1 billion in swaps. The securities were placed in a taxpayer-funded vehicle called Maiden Lane 3.

The total size of European bank assets AIG protected shrank to $109.4 billion as of March 31, about 60 percent residential loans and the rest largely made of corporate debt, as some of the contracts expired. The average weighted duration of the swaps protecting residential loans is 31 years, while the span tied to corporate loans is about 5 years, AIG said in a May regulatory filing. AIG has said that it doesn’t expect to make payments tied to the European swaps. Banks that continue to get regulatory benefits from the derivatives may not terminate the contracts as early as expected, AIG said in the May filing.

It will take years to unwind all of the Swaps that originated from Joseph Cassano and AIG Financial products... This really shows one how important Internal risk oversight/management is. I wonder if Robert Benmosche truly understands the contents of the items remaining on his firm's bloated balance sheet.