AIG Debt Reduction Plan Approved by Fed

(Update adds stock movement.)

American International Group(AIG Quote) entered into a deal to reduce debt owed to the Federal Reserve Bank of New York.

In the process, the bedraggled financial services operation will also make an initial public offering of its international life insurance divisions -- American International Assurance and American Life Insurance Co. All told, the transactions will help slash AIG's debt owed under a Fed credit facility by $25 billion. AIG has a current $40 billion balance under the facility.

In a bid to prepare the franchises for the IPOs, AIG said it has entered into a deal with the Fed that will hand over equity to AIA and ALICO into different special purpose vehicles. According to a press release, AIG will get preferred and common interests in the SPVs, while the Fed will get preferred interests representing $16 billion in the AIA special purpose vehicle and $9 billion in the ALICO special purpose vehicle.

The deal is expected to close in the second half of 2009, though the spinoffs will depend on market conditions.

"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," AIG CEO Edward Liddy said in the press release.

"The agreements further the goals of enabling AIG to fully repay the assistance that it has received from U.S. taxpayers and advancing the company's global restructuring process," the Fed added. "The exchange of senior secured debt for preferred equity interests reduces AIG's financial leverage and facilitates the independence of these two key subsidiaries."

Immediately after the opening bell, shares in the company were trading up by 1.4%, at $1.43.