Fitch Drops AIG's P-C Ratings A Peg

Chicago-based Fitch said it perceives a decline in the subsidiaries' "competitive positioning derived from the organization's financial difficulties, along with the effect this stress is likely to have on AIG's near-to-midterm operating results."

The rating firm commented that it believes AIG has taken "reasonable steps to protect its competitive positioning and franchise value in light of these difficulties."

It mentioned the formation of AIU Holdings Inc. to serve as part of a rebranding campaign and said it views the necessity of such measures as "symptomatic of the deterioration of the franchise and inconsistent with the 'double-A' category ratings."

The downgrades, Fitch said, also reflect AIG's property-casualty subsidiaries' recent operating trends, the results of which Fitch generally views as "lagging those of their peers."

Fitch said it believes AIG's foreign general insurance unit's operating trends have been less affected by the organization's difficulties.

Fitch said a concurrent decision to downgrade the ratings of AIG's domestic life and retirement services insurance subsidiaries to "A-minus" reflects ongoing concerns about the entities' asset quality as well as the effect of AIG's well-publicized difficulties on new sales trends and sustainability of in-force business.

It noted that in 2008, the parent made significant capital contributions to help offset investment losses primarily from the company's securities lending business as well as operating losses from increased reserves related to equity-linked products.

But the rating firm found that despite the impairments recognized in 2008, "unrealized loss position in the life unit's bond portfolio remains high."

Fitch's downgrade of AIG's foreign life units, AIA Bermuda and ALICO, by one notch to "A-plus" reflects ongoing exposure to broader AIG issues including securities lending operations, the firm said.

These ratings remain on Fitch Rating Watch Evolving "as the company has put AIA and ALICO on a path toward separation from AIG. These businesses are expected to ultimately be divested, possibly through an initial public offering in the near term if market conditions allow. Therefore, Fitch may upgrade the ratings if stand-alone profile and capital structure support a higher rating."

But Fitch warned it may downgrade the rating if the divestiture plan is not favorably executed.

Fitch said it believes U.S. government support of AIG currently remains strong. However, the agency believes that once systemic risks abate, the U.S. government would likely not provide additional funding, if needed, simply to support ratings at the former levels.

Further, with recent downward rating migration in the insurance sector, Fitch said it believes the AIG insurance organization that emerges from the restructuring could be viable and competitive at lower rating levels than the organization held historically.

The affirmation of the "F1″ commercial paper and short-term IDRs, it said, reflect the "very strong near-term liquidity profile provided by the continuing U.S. government support." Over time, Fitch explained, it expects the short-term ratings to migrate downward to more closely align with the long-term ratings.

The Evolving Rating Outlook on AIG holding company as well as all insurance subsidiaries other than foreign life reflects a view that AIG and subsidiaries could emerge from the organization's restructuring with a credit profile supportive of higher ratings if the restructuring goes as planned, said Fitch.

But it noted "significant execution and market risks persist which could lead to downward rating migration if the restructuring is unsuccessful."

Fitch said removing AIG's domestic and retirement services insurance subsidiaries from Rating Watch Evolving reflects Fitch's belief that given market conditions, a sale of AIG's domestic life and retirement services subsidiaries will be difficult to accomplish for the foreseeable future.

AIG said it had no immediate comment on Fitch's action, but might respond later.