TARP – What Has Happened? Does Anyone Care? Part 2 – AIG

Introduction

In Part 1 of this series, I detailed what has happened with the Capital Purchase Program (CPP) and the Public-Private Investment Program (PPIF). I originally intended this to be a 2-part series, with this part summarizing the other TARP elements followed by an overall assessment of the Program. But the other program components are too large and important to be briefly summarized. Consequently, this part will focus entirely on AIG with later pieces covering other TARP activities.

What Happened to AIG

 In 1987, AIG launched a new unit in London called AIG Financial Products, or AIGFP.  Operating as a semi-autonomous unit, it started insuring asset-backed securities (see Morgenson report). It became a very profitable business: in 2005, it amounted to more than 17% of AIG’s operating income. In the summer of 2008 –the global market for asset backed securities (ABS) starts drying up, with big banks increasingly reluctant to lend to each other – The Global Credit Freeze Starts. AIGFP becomes overwhelmed by insurance claims (for more on AIGFP, see Lounsbury’s excellent article on Cassano, the former head of the unit).

As a consequence of the ABS market collapse, AIG had realized capital losses of $60 billion in 2008 and 2009 while AIGFP had unrealized capital losses of $30 billion over the same period. These are significant for AIG inasmuch as its net income in a good year is in the $10-15 billion range and a significant component of its assets is used as collateral for its insurance businesses. As a result of its losses and ongoing problems, its stock price fell from a high of $1450 in 2007 to around $40 where it trades today.

The AIG Rescue Program

The AIG story does not start with TARP. As I reported in my April 19 article:

  1. On July 10, 2006, Henry Paulson left his job as CEO of Goldman to become Secretary of the US Treasury. Keep in mind that Goldman Sachs was a major client of AIGFP.
  2. In mid-September 2008, Treasury Secretary Paulson and Timothy Geithner, then head of the Federal Reserve Bank of New York (FRBNY), met with senior executives of AIG in the Bank’s headquarters in New York. The only outsider in that meeting was Lloyd Blankfein. Blankfein replaced Paulson as CEO of Goldman Sachs.
  3. As I reported in my March 18 article, Goldman had a large stake in AIG’s survival: an insurance claim for guaranteed asset-backed securities of almost $13 billion. That meeting resulted in an $85 billion credit line from the FRBNY later in September 2008.
  4. Why the FRBNY and not TARP? TARP was not enacted until October 3, 2008. Why could AIG’s bailout not be delayed one month? Ask Paulson.

AIG was effectively insolvent without the FRBNY credit. But with it, the AIG staff believed it could settle claims at 60 cents on the dollar and was prepared to start negotiating on that basis.

But the FRBNY instructed AIG to pay off claims in full and The FRBNY did everything it could to keep the names of who was getting paid off out of the AIG reports to the SEC.

The result? More than 30 financial institutions were paid a total of $93 billion by AIG, with Goldman getting the largest payment – $12.9 billion. Payment in full! At 60 cents on the dollar, the payout would have been $56 billion, a savings of $37 billion.

Government Finance of AIG – FRBNY

For the original $85 billion FRBNY credit line, AIG issued the “Series C” convertible preferred stock. This provided the FRBNY with a trust established for the sole benefit of the US Treasury with 79.8% of the voting power of AIG’s shareholders plus a claim on 79.6% of the dividend rights of all common stock plus the preferred share’s dividends. AIG pays interest on this credit of LIBOR plus 300 basis points. On November 30, 2009, AIG transferred two of its wholly owned businesses, AIA and ALICO, to the FRBNY for a $25 billion reduction of the outstanding loan balance as shown in Table 1.

Table 1. – AIG – FRBNY Position (mil. US$)

Item end July
Balance on FRBNY Original $80 Billion Credit 23,755
Assets Accepted by FRBNY to Reduce Credit
Maiden Lane II & III 38,704
AIA Aurora LLC and ALICO Holdings LLC 25,733
Total 88,192

Government Finance of AIG – TARP

In return for the TARP payments of $40 billion to AIG, Treasury was initially issued Series D preferred stock, later converted to 400,000 shares of Series E 10% non-cumulative preferred stock. In addition, in return for an additional $29.8 billion credit facility, Treasury got 300,000 shares of Series F 10% Non-Cumulative Perpetual Preferred Stock, par value $5.00 per share, and a warrant to purchase 150 shares of AIG Common Stock, par value $2.50 per share. Both Series E and F pay a non-cumulative dividend of 10%. If AIG fails to pay dividends for four consecutive quarters, Treasury can appoint two Board members which it did on April 1, 2010. As of May 31, AIG had drawn $7.54 billion from the credit facility.

Table 2. – TARP Finance (in mil. US$)

Item end July
Series E Preferred Stock 41,600
Series F Preferred Stock 29,800
Total 71,400

Treasury Holdings

The Series C preferred stock issued to FRBNY and put in a trust for the US Treasury is convertible into common stock. These preferred shares, when converted, would increase AIG’s common shares from about 135 million today to 706 million shares.  As part of the Series D preferred stock deal, Treasury got warrants convertible into 2.7 million shares of AIG common stock. The Series E and F preferred stock issued to Treasury have liquidation preferences of $41.6 billion and $29.8 billion, respectively. Series E and F shares are not convertible into common stock.

Will AIG Make It?

Obviously, a tricky and complex question.

Some facts.

  • In earlier (good) years, AIG annual revenues ran around $100 billion. With expenses $10-$15 billion less, AIG profits were in the $10-$15 billion range.
  • Its balance sheet shows assets of $864 billion, liabilities of $760 billion, and $102 billion of total equity (with 135 million common shares outstanding, equity per share is would be $755 per share; with 706 million shares outstanding, equity per share would be $144).
  • Obligations coming due by period: 2010 – $69 billion; 2011-12 – $109 billion; 2013-14 – $111 billion; after 2014 – $644 billion, of which
  • long term debt – $132 billion.

A lot of debt is coming due over the next few years, and AIG is selling off units to reduce its debt. But selling off units reduces the income stream….

What Should Treasury’s Strategy Be to Protect the US Taxpayer?

In bankruptcy, debtors have the first claim followed by preferred stockholders. Should Treasury convert its Series C preferred stock? If AIG makes it, they would have to pay LIBOR plus 3% on the Series C, and 10% on Series E and F. I guess I would hold onto all the preferred until it is clear what will happen to AIG.

Post Script on Compensation

The AIG bonus payments controversy began in March 2009, when it was publicly disclosed that the American International Group (AIG) was to pay approximately $218 million in bonus payments to employees of AIGFP – very distasteful. The Special Master for TARP Executive Compensation consequently placed significant new restrictions on the compensation of AIGFP and other AIG employees. A tremendous amount work has gone into AIG compensation issues – of the 120 pages in AIG’s 2010 proxy statement, 66 are devoted to compensation.

While distasteful, I see compensation concerns a bit of a red herring: the top five in AIG are making $35.9 million (average $7.1 million) and two have cars and drivers provided by AIG. Just remember AIG staff wanted to negotiate the bank payments down to 60 cents on the dollar and Paulson said no – pay it all. The difference? $37 billion.

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of archive.org):
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