Sorkin’s AIG math

By Felix Salmon
October 5, 2010
Andrew Ross Sorkin talks to Treasury's Jim Millstein and makes a valiant attempt to explain the AIG deal, explaining step by step how the company's debt to the government is going to be repaid.

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Andrew Ross Sorkin talks to Treasury’s Jim Millstein and makes a valiant attempt to explain the AIG deal, explaining step by step how the company’s debt to the government is going to be repaid. But I’m afraid I still don’t understand it. Especially not this bit:

Now the tally is down to $71 billion.

At this point, A.I.G is going to pay down the Fed’s remaining $20 billion stake in two special-purpose vehicles, which hold the rest of Alico and A.I.A, he explained. In doing so, and this is where things get a little tricky, A.I.G. will be using money from the Treasury Department’s credit facility. In some ways, the government is moving money from one hand to another.

If all of that works — and if you’re still with me — A.I.G. will be left owing us, the taxpayers, about $49 billion.

No, Andrew, I’m not with you. If Treasury is lending the money to buy out the Fed’s $20 billion stake, then the total debt either goes up or stays the same. I don’t see how it goes down — and I certainly don’t see how it goes down by more than $20 billion. The official AIG press release helps a bit, though. If I’ve got this right — and it certainly isn’t presented in a transparent manner — then the plan is essentially that AIG will borrow money from Treasury to buy its SPVs back from the Fed, and will then sell the contents of those SPVs to repay Treasury.

So OK, let’s grant that. But the next bit really doesn’t add up.

Now, you’re probably asking, how can A.I.G., or what’s left of it, which is currently worth $26 billion, become a $49 billion company?

As part of the restructuring, Treasury is going to exchange its preferred shares for common shares, expanding the total number of shares of the company and diluting the current investor base. Treasury will own 1.6 billion shares, or 92 percent of the company. At A.I.G.’s share price on Monday, the government’s stake would be worth about $62 billion, a $13 billion profit. That’s if, of course, shareholders do not send shares tumbling because of the dilution.

Mr. Millstein is betting that investors will be bullish on the stock once they understand the government’s plan to exit its investment over time.

It seems to me that before the exchange, the government will have $49 billion in debt, as well as an 80% stake in a company valued at $26 billion. So call it $49 billion in debt and $21 billion in equity, for a total of $70 billion.

After the exchange, Treasury will own nothing but equity — and that equity is forecast to be worth only $62 billion. You can call that a $13 billion profit if you like. But you can equally well think of it as an $8 billion loss.

So maybe Mr Millstein is right to bet that investors will be bullish on the stock once they understand the government’s plan to exit its investment. Because a large part of that plan seems to involve swapping a $70 billion stake in AIG, most of which is made up of senior, interest-bearing securities, for a $62 billion stake which is junior and pays no interest at all.

Think about it this way: before the exchange, the government and private shareholders between them will have securities valued at $75 billion — $49 billion in debt and $26 billion in equity. The government will own some $70 billion of that $75 billion, or 93%.

After the exchange, the government and private shareholders between them will have securities valued at $67 billion: somehow, the exchange will have erased $8 billion of value. And the government will own only $62 billion of that $67 billion.

The whole idea behind this column is that AIG has value after paying off its debts to the government at 100 cents on the dollar. But that doesn’t seem to be what’s going to happen. Instead, Treasury seems to be paying itself $41 billion in equity for $49 billion in debt, valuing those debts at less than 84 cents on the dollar.

Which would help to explain why AIG’s current shareholders might be rather bullish: it looks as though Treasury is happy to forgive a good $8 billion of the debt they owe taxpayers.

I can see why Treasury might want to do that, in its rush to exit AIG as quickly as possible, just so long as it can extract at least as much money as it put in along the way.

But Treasury placed a significant interest rate on its loans to AIG for a reason. If AIG is incapable of paying those loans back in full, with interest, then the value of the non-government stake in AIG should be zero. Instead, it’s $5 billion. And that’s the bit which, to me, doesn’t add up.

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