American International Group Inc is selling most of its consumer finance unit to hedge fund and private equity firm Fortress Investment Group at a deep discount and taking a $1.9 billion pretax loss due to the sale.

AIG, majority owned by the U.S. government, said on Wednesday it will sell 80 percent of American General Finance to Fortress managed funds and affiliates as it restructures after a bailout. It will retain the rest of the business.

AIG and Fortress did not disclose terms of the transaction. But a source close to the deal said Fortress was paying a very small fraction of the equity value of the business. Last week, AIG said it valued its investment in the unit at $2.4 billion.

Fortress expects high demand for American General Finance loans amid reduced supply as some players -- under regulatory and other pressures -- exit the market for consumer loans to people with credit problems, the source said, declining to be named because the plans are not public.

With about 1,200 branches American General Finance is one of the largest consumer finance firms in the United States and difficult to replicate, the source said.

Its reach and contact with borrowers also mean its loans are faring better than its peers, the source said. American General's 60 day-plus delinquency rate on loans to people with credit problems is about 9 percent, compared with 30 percent to 35 percent for the industry, the source added.

New York-based Fortress plans to reduce the unit's leverage, including through restructuring debt and asset sales, and has the time to do so because of strong cash flows, the source said.

The companies expect the deal to close by the end of the first quarter of 2011.

Fortress, one of only a few publicly traded hedge fund groups, was involved in a similar deal earlier this year when some of its funds bought European assets from Ally Financial's Residential Capital unit.

In has made other recent acquisitions. It bought bond manager Logan Circle Partners for $21 million and announced a deal in July for loan servicing firm CWCapital.

Still, Fortress's share price has been a disappointment for investors since it debuted at $18.50 in 2007. On Wednesday, the share price fell 4.8 percent to $3.99.

AIG, once the world's largest insurer, nearly collapsed in September 2008 from credit default swaps that left it on the hook for tens of billions of dollars in payouts to some of the biggest U.S. and European banks.

It has been selling assets to repay taxpayers, to whom it still owes more than $100 billion.

American General Finance, which provides loans to people in the United States and the United Kingdom, has assets of about $20 billion and liabilities of about $18 billion.

It reported an operating loss of $11 million for the second quarter on Friday, compared with a loss of $202 million a year ago. The loss narrowed because of a drop in the provision for loan losses due to favorable trends in credit quality.

AIG's stock dropped 5.3 percent to trade at $38.08 on Wednesday.

(Reporting by Michael Erman and Paritosh Bansal in New York, and Svea Herbst-Bayliss in Boston; Editing by Derek Caney, Robert MacMillan, Phil Berlowitz)

United kingdom Aig