A second look at the AIG deal

By Felix Salmon
October 1, 2010
Kid Dynamite for doing the math on the way that we taxpayers are swapping our AIG debt for equity in the company.

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Well done to Kid Dynamite for doing the math on the way that we taxpayers are swapping our AIG debt for equity in the company. There are three big problems here:

  1. The fact that we’re doing this conversion in the first place. The preferred stock we currently own pays a regular coupon, while the equity we’re swapping it for was described as worthless by AIG itself not so long ago.
  2. The fact that as part of the deal we’re giving current AIG shareholders free warrants to buy stock at $45 per share. Which is very generous of us, but what have they done to deserve this?
  3. Most importantly, the fact that the stock we’re swapping into is worth less, at current valuations, than the preferred stock we’re swapping out of. To the tune of about $6.6 billion.

KD has a query in with Treasury about all this; it’ll be interesting to see how they respond.

The only thing I’d note here is that there isn’t a secondary market for the preferred stock we’re swapping out of. So while its face value might be $72.1 billion, its actual market value might well be 10% or more below that figure. In which case it can be argued that the government is getting a good deal here, assuming that it’s actually able to sell its stock into the secondary market at something approximating current levels.

Still the government strategy here does seem to be based on the theory that “the market can remain irrational longer than you can remain insolvent” — that Treasury will be able to monetize all the weird theoretical value that AIG’s current shareholders are ascribing to the company, if only it first gives up any claim to regular coupon payments from AIG.

I hope they’re right, but it is a risky strategy, especially when it seems, from the published conversion rates, that Treasury’s willing to admit that its preferred stock isn’t worth as much as AIG says it’s worth.

8 comments

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If the Preferred (which is senior to common) isn’t worth as much as AIG says, what does that say for the stock into wich they’re swapping?

(I can’t be the only one who LOL’d when all the headlines–from the FT on down–declared that going from 85% to >90% was “an exit strategy,” can I?)

The free warrants put a de facto cap on the return from the bailout–and since the original bailout structure was designed to give the taxpayers who are footing the bill equity appreciation in the recovered, repentant (stop laughing, Felix!) company, giving a large chunk of those rights to current shareholders really is a great example of privatizing the gains.

Posted by klhoughton | Report as abusive

I put a comment at the Kid’s blog. Basically he is ignoring that some preferred ( the c perpetual) were not paid for but received as a condition to get loans i.e AIG was obligated to give up 80% of the company to be rescued.
the value of these c preferred is booked by AIG at $23 bln vs 0 cost to treasury i.e the sale of these preferreds is pure profit ($21.9 bln at current prices).

Posted by alea | Report as abusive

Alea –

We have warrants. we got them as a condition for the other loans. so what? Would it be ok for us to sell them for $1B? They have value.

I’m talking about the series E/F conversions – they were done at the wrong price. Do you disagree with that?

I said in my piece that the series C was the least of the problems (probably not a problem at all – we did a deal – the deal was for 80% of the common – that’s what we got for the series C – I’m cool with that!)

Posted by KidDynamite | Report as abusive

It is irrelevant that they were done at the wrong price. Net net treasury is in the money. Why exactly do you think you should count only the losses and not the profit. Fact: Treasury got free warrants now worth $21.9 bln.

Posted by alea | Report as abusive

Alea,

my blog post is not about the PnL sheet for the Treasury’s investments. I’m surprised you’re finding that detail hard to understand. Felix even summed the points up nicely with three bullet points at the top of this post.

Treasury got the series C pref warrants as a result of the extraordinary bailout they gave AIG. Those warrants are currently worth $21.9B. Great. That’s a good thing.

It doesn’t excuse the fact that Treasury exchanged some assets (preferred stock) worth $49B for some assets further down the cap structure with a lower value ($42.5B). That’s money that should be flowing to taxpayers/Treasury, which will instead accrue to AIG and its non-gov’t shareholders.

The “in the money” debate is another one entirely, and one with many uncertainties still to be seen. But the Congressional Oversight Panel estimated at the end of june that the AIG hole would be $36B deep…

http://cop.senate.gov/reports/library/re port-061010-cop.cfm

so let’s not start high fiving yet.

Posted by KidDynamite | Report as abusive

KID:
I understand your point, what you seem to miss is that it makes no sense to maximize the conversion ratio on the preferreds (E and F) when you own de facto 80% of the equity, unless you want to shoot yourself in the foot, since the higher the conversion ratio the less valuable the equity.

Posted by alea | Report as abusive

Alea, if you build yourself a spreadsheet which assumes that the market will assign post-conversion AIG a $69.7B market cap (which is what it has assigned it), you’ll find, not surprisingly of course, that the government does better in every case with a lower conversion price. precisely because we own only 80% of the equity, and not 100%.

Posted by KidDynamite | Report as abusive

Alea – I get your point – you’re saying that if we used a $39 conversion price instead of a $45 conversion price, the net “loss” to the gov’t is not $6-odd Billion.. it’s more like $450MM… right? (assuming the post-conversion market cap is the same as today’s price implies: $69B – you can back into post-conversion share prices (lower), Gov’t ownership % (higher), and Gov’t owner value (higher) – but only higher by $450MM)

Posted by KidDynamite | Report as abusive