American International Group offered on Thursday to buy back, for $15.7 billion cash, mortgage-backed securities the U.S. government took off the bailed-out insurer's hands during the financial crisis.

The announcement came as a surprise, though AIG -- which nearly collapsed in the fall of 2008 partly because of the securities -- said in a regulatory filing it has been preparing to make the offer for at least a year.

The company said it has set aside the cash to pay for the deal and will still have strong liquidity reserves after it closes.

AIG will pay for the residential mortgage-backed securities (RMBS) with cash from its insurance subsidiaries, which will then hold the securities in their investment portfolios, a person familiar with the situation said on condition of anonymity.

AIG and the Fed have been in talks for many months about the deal, the person said. Given the insurance units' needs to invest their capital, the source said the RMBS were an attractive investment at their current levels.

The securities have actually increased in value since, giving AIG the opportunity to profitably pay back the government and regain them for its own portfolios.

The source said AIG is hopeful the Fed will accept the offer soon, and that the company will have the cash to fund the offer ready as soon as next week.

REDUCING AID

AIG, which is 92 percent owned by the government, said the Federal Reserve Bank of New York will make a profit of about $1.5 billion on its residual equity interest in Maiden Lane II, the entity that holds the securities, if it accepts the offer.

AIG said in a U.S. Securities and Exchange Commission filing that the total outstanding assistance to it will be reduced by about $13 billion, to some $26 billion in total, if its offer is accepted.

That $26 billion figure has three parts: the government's interest in a vehicle that holds shares in insurer AIA Group <1299.HK>, a different Maiden Lane vehicle that holds interests in collateralized debt obligations and an undrawn line of credit.

Maiden Lane II was formed in December 2008 and took over about $20.5 billion of residential mortgage-backed securities in a bid to ease liquidity pressure on AIG due to its securities lending program.

At the proposed purchase price, the Maiden Lane II securities have an attractive risk/return profile to AIG, the company said in its offer letter. The source said AIG would split the securities roughly proportionally between life insurer SunAmerica and property insurer Chartis.

AIG shares rose to $37.45 in after-hours trading from a $36.48 close.

At current levels, the Treasury stands to make a profit of nearly $13 billion on AIG shares. People familiar with the plans have said the Treasury is likely to start selling off its stake in May.

The source said Thursday that the Fed deal would help AIG convince potential investors that its insurance businesses had solid opportunities to grow their investment income.

(Additional reporting by Paritosh Bansal; Editing by Tim Dobbyn, Gary Hill)

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