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AIG’s Plan to Exit U.S. Control is Misleading and a Questionable Deal for Tax Payers

September 30th, 2010

09.30.2010 original publish date
10.01.2010 update
03.18.2011 repaired broken links

AIG’s Plan to Exit U.S. Control is Misleading and a Questionable Deal for Tax Payers

original article written by Net Advisor

EXCERPT:
One of the most mismanaged companies in U.S. history is seeking to reinvent itself after taking in record tax payer bailouts. The company has sought various methods to reduce its liability to taxpayers but such methods are highly questionable as to whether they really are a benefit to taxpayers or not. Read the 6 page report that has summarized some relevant key events up to now. Learn how government may not exactly be representing the taxpayer’s best interest with AIG; and yet government is trying to persuade Americans in an election year that AIG is ‘paying us back.’ The truth may surprise you with over 40 linked references from major sources.

Part I: The Bailout
On or about September 16, 2008, the U.S. government decided to implement an $85 Billion bailout of what was then the largest insurance company in the world, AIG. At the time the U.S. took a 79.9% stake in AIG and issued these loans for 2 years with an interest rate at LIBOR plus 8.5% (Source: Wall Street Journal).

What many people may have not been aware of is that AIG had required a lot more than $85 billion for a bailout. If you guessed $100 Billion, keep going — double $85 billion? — keep going — try $182.3 Billion (Source: Reuters).

AIG had issued insurance policies, specifically called credit default swaps which essentially guaranteed payments in the event a counter party failed to pay or went bankrupt, such as Lehman Brothers. In exchange, AIG collected an insurance premium for issuing the policy. The problem was that AIG assumed that no major defaults could ever occur and thus didn’t bother to keep capital in reserve to pay off potential big insurance claims.

In September 2009, the Federal Reserve (The FED) who is one part of AIG’s lender along with the U.S. Treasury decided (or may have been encouraged) that AIG didn’t have to repay $25 Billion of its debt in exchange for two other AIG assets.

We’ll, it’s now 2 years later and those loans are now maturing and apparently AIG cannot or the U.S. will not refinance their own AIG debt.

Part II: The Blame Game
In 2009, the American public got very upset over AIG receiving bonuses (Source: NY Times). Keep in mind that this was done under the Obama Administration, and when the Obama government controlled (at that time) 79.9% of AIG.

Obama blames “Wall Street” for receiving bonuses (Source: NY Daily News). Mr. President, one can’t blame a 3rd party for alleged “bad behavior” then make it OK for the government’s chosen few (AIG) to be OK with receiving bonuses. The result of this is that some bonuses were returned from top management from public outrage of AIG’s taxpayer funded bailout.

AIG plans to pay out another $100 million in bonuses in 2010 (Source: Washington Post). Obama’s Pay Czar indicated that legal contract issues may pay prevent the Obama Administration from limiting bonuses to a taxpayer funded AIG.

If the government allowed AIG to fail (file bankruptcy, Chapter 11 in September 2008) and at the same time said that once they file, the government would step in to stabilize any ramification government deems necessary in order to stabilize the economy or similar rhetoric, Then, that move would allow the government to break all AIG contracts, AIG debt, other AIG obligations, etc., and any such contracts, obligations, etc, could then be renegotiated in bankruptcy court.

Instead, the government sought to just save all of AIG, and anything and everything it was liable for, and that is what has cost $182 Billion to tax payers not to mention the $100 Billion in losses it took in 2009 alone (Source: Reuters)

I understand why the government argued the AIG bailout as necessary, but the action put to U.S. government into a total obligation defensive instead of taking control and evaluating what must be “fixed” and what can be renegotiated in bankruptcy. The government allowed the power to go into the wrong side of the equation and issued a blank check. That is not the brightest business decision for the level of talent the government has at its for its resources.

Part III: Artificially Inflate the Stock Price
AIG was looking at a stock price under $5.00 a share. On September 16, 2008 AIG stock fell as low as $1.25 per share (pre 1-20 stock split). There is this old Wall Street adage that says stocks that fall to $10 tend to go to $0.00 This of course assumes that there is not a bailout waiting. By the Spring 2009, AIG decided to do what normally risky low priced, pink sheet, near worthless or worthless stocks dare to do, they issued a reverse stock split.

On June 30, 2009 effective 5:00PM (EST), AIG issued a one-for-twenty reverse stock split. The ONLY reason to do a stock split is to in my professional view is to artificially prop up a stock’s price. It seemed to work, but a stock split does not change the value of a company’s stock.

Investors and institutions who have held on to AIG from 2008 or earlier have likely not done too well.

In order to get AIG’s stock price up, AIG’s stock would have to go from current split-adjusted $39/ share to about $95.20 to reach its September 15, 2008 pre-bailout level.

AIG is still down 98% (ninety-eight percent) as of 09-30-2010 from its split-adjusted all-time high of $1,947.48 made back on December 8, 2000. I think its pretty safe to say, that this the odds of AIG reaching its split adjusted highs or anywhere close is not likely to happen for as long as humans inherit the Earth.

Earlier this month (September 14, 2010) I argued that the AIG repayment plan is “a Farce.” This is the same strategy that the players in the General Motors bailout ran. Since they apparently can’t or won’t pay back the loan, they will issue stock instead. Try that one with your bank.

Part IV: Deceive the Voters Two Months Before an Election
If anyone has been watching the news on this story, or paying attention to just the headlines, the story is that it makes AIG sounds as if it is going to payback tax payers the $182 billion it owes, less the side deals. This could not be further then the truth.

The way AIG is going to “repay” taxpayers is not with cash, but with paper – shares of stock. Now the U.S. gov et al already own 79.9% of AIG before all this. The result is that the U.S. government will effectively own now 92.1% of AIG’s stock.

“The Treasury will convert some of its AIG securities into common shares, raising its stake in the insurer to 92.1 percent from nearly 80 percent.”

— Source: Reuters

Question:
How much stock do you have to own in order to control a company?

Answer:
Many times with Fortune 500 companies, with 5% or more ownership of the outstanding stock one often can take control. But technically, to have total control in a company, one generally needs 50.1% of the outstanding stock. So the U.S. government will control 92.1% of AIG, but the headlines seem to suggest that AIG will be out of government control?

If you owned 92% of something would, how is it then one release control of that? We’ll, this is a another case of Obama semantics.

In an election year where voters are upset about government’s inability to produce any real “change” or results from the $787 Billion+ stimulus, except more U.S. debt and more lost jobs, the Obama Administration is trying to show that they were successful having AIG “repay its debt” to the U.S. gov just like it did with General Motors, both would be highly misleading and false statements.

“A new Rasmussen Reports national telephone survey shows that 75% of likely voters now say they are at least somewhat angry at the government’s current policies.”

— Source: Rasmussen Reports (Poll)

Part V: Shuffle the Deck of Cards
Now here is the funny part. Remember the $25 billion that AIG didn’t have to repay the FED, and where the FED took interest in two of AIG’s subsidiaries? Well, guess who is now going to own the two subsidiaries? You guessed it, the U.S. tax payers.

Question:
Are the tax payers getting these AIG subsidiaries for free, we basically own AIG right?

Answer:
Yes, we, the tax payers (via the Treasury) basically own AIG; but no, these two AIG subsidiaries we are talking about are currently and technically owed by the FED.

Now, for whatever (insert political reason), the FED is going to be exiting their interest in AIG, making this sound as if the AIG bailout is winding down from at least the FED’s view point, right? We’ll sort of. Yes, the FED should effectively be out of AIG, but in order to make this happen, the U.S. Treasury is going to BUY those two AIG subsidiaries from the FED – key word, “BUY.”

Yes folks the taxpayers are going to pony up more money to help the FED get out of AIG and put that unknown multi-billion dollar bill on the taxpayers. Recall that the FED forgave AIG $25 Billion in exchange for these two subsidiaries, thus the in order for the FED to break even, they need $25 Billion from the US Treasury.

“The Treasury will also effectively buy out the Fed’s interest in two large AIG units that are being sold.”

— Source: Reuters

Question:
Why does the Treasury have to buy these AIG subsidiaries?

Answer:
They don’t. But apparently some people in Washington want Americans to think they are doing something positive with AIG right before an election.

Question:
How is buying AIG subsidiaries positive for the Treasury?

Answer:
It won’t be unless the Treasury can turn a profit.

Question:
Why doesn’t the FED just hold the assets them self? The FED took on the risk, why does the Treasury (tax payer) have to take on more risk by purchasing two more AIG subsidiaries?

Answer:
Good question. That answer has not been provided by government or anyone else.

Part VI: Analysis: AIG “Repayment” Plan Not in the Best Interest of U.S. Taxpayers
Arguably, the U.S. gov has a fiduciary interest to taxpayers in managing this AIG asset.

This move to convert debt into stock will result in taxpayers giving up a lot, and taking on more risk, not less risk with AIG.

The Treasury (tax payers) will be giving up its preferred stocks that pays dividends in exchange for common stock that pays nothing. The Treasury will also be giving up its position as a potential creditor, the senior creditor, the largest creditor, if in the event AIG defaults on future debt or files for bankruptcy.

I’m not saying AIG is going bankrupt anytime soon, or that they may in the future. AIG already was technically insolvent in September 2008 when the government “had to” take AIG over.

But what taxpayers and government officials, who tend to be lawyers by profession, need to know or be reminded of is that in a corporate bankruptcy, amongst the first people who are paid (aside from employees, and the IRS) are the bondholders, senior creditors, then the preferred stock holders. The last people who are paid are common stockholders. The U.S. government is going from senior bondholder, senior creditor, preferred stock holder, and dumping all this into becoming a common stockholder.

“In most instances, the company’s plan of reorganization will cancel the existing equity shares. This happens in bankruptcy cases because secured and unsecured creditors are paid from the company’s assets before common stockholders. And in situations where shareholders do participate in the plan, their shares are usually subject to substantial dilution.”

— Source: The Securities & Exchange Commission (SEC)

Bottom-line, why would anyone increase their risk in this AIG transaction and move from a senior position to last in line as a common stock holder? Did we tell you the government (Obama Administration) is in charge of these decisions?

Part VII: Losing Money 101
The deal the Obama Administration is working out with AIG is not only a poorly negotiated deal for taxpayers, especially when the government is the owner, and just negotiated themselves a deal worse than they had in the first place. To top it off, the stock deal is also dilutive.

What is dilutive mean? According to Investopedia, a “dilutive stock is any security that dilutes the ownership percentage of current shareholders.”

What did you say? Yes, as if the Obama government could not only structure taxpayers a worse deal on AIG, they also managed to help existing AIG investors by decreasing the value of their own stock. This is accomplished by issuing more stock. In other words, if you currently own AIG stock, your stock will be worth less than it was before the new government-AIG “deal.”

Part VIII: Just When You Thought It was Safe to End the Bailouts
Diluting stock is clearly a not a benefit to current AIG stockholders. So the Obama Administration has come up with a plan to try and stop current AIG shareholder from dumping their stock before it loses any more value when the government converts their shares into common stock: Offer AIG stockholders a bailout-guarantee of their own.

The plan is that AIG will issue warrants (basically giving rights) to existing AIG stockholders to buy even more AIG shares (75 million more common shares to be exact), at a fixed price of $45 per share valid over the next 10 years.

“For AIG shareholders, the conversion will mean dilution as a flood of new common stock is created. To stop investors from dumping the stock, AIG said it will issue warrants that give existing shareholders the right to buy up to 75 million AIG shares at $45 for 10 years.”

— Source: MarketWatch

Basically, AIG is issuing a 10 year option to buy AIG at $45.00 If the stock goes above $45 within the next 10 years, and you exercise or sell the warrant, you make money. If the stock does not go above $45, the warrant expires worthless.

Never mind the part that issuing warrants is also potentially dilutive to existing common stockholders (Source: Professor Paul Zarowin – NYU Stern School of Business). We (AIG and or the Obama Administration) don’t need or want to talk about that. All we want is you (the public) to know is, that AIG is giving AIG common stockholders warrants. ‘Don’t try and figure out what this means, just accept what we tell you and that its good,’ seems to be implied sound bite.

Question:
So….does this mean the tax payer’s who own over 90% of AIG will get some warrants too?

Answer:
— No, we don’t count. The tax payers who bailed out AIG don’t get any 10 years warrants. In fact, we’re giving up our exclusive $49.1 billion of preferred AIG stock that pays quarterly dividends, and our senior creditor status because the borrower (AIG) just can’t seem to pay us back and operate profitably.

“Warrants, stock options, convertible preferred shares, etc. all serve to increasing the number of shares outstanding. As a shareholder, this is a bad thing.”

— Source: Investopedia

How dilutive will this government conversion into common AIG shares impact existing AIG shareholders?

We’ll current AIG shareholders will see their ownership in AIG drop from 20% to 7.9%.

“The company’s common shareholders, who hold about 20 percent of the company, will have their stake diluted to about 7.9 percent, AIG said.”

— Source: Bloomberg

As I listened to some people talk about this today, I heard them call this a 12% reduction in value to AIG shareholders. That’s not exactly correct. In percentage terms, to calculate this, the formula is not simple subtraction such as 20 – 7.9 = 12.1;

 

Here is the formula:

20% – 7.9% = 12.1%; then 12.1% divided by 20% = 0.605 or 60.50% (sixty and one-half percent).

Thus, after the U.S. converts its stake into common AIG stock, current AIG common stock shareholders will have seen a 60.50% dilution rate.

As if AIG stockholders have not been whacked enough over the last 3 years (2007-2009) let alone the last 10 years (2000-2009)! The government is here to help you, or so they want us to believe.

Also never mind that it is more than likely to take more than 2 years to sell the government’s new total of 92.1% share stake in AIG. The stock could remain under pressure from the government’s ongoing sales for many years, maybe up to a decade to basically turn the entire company back to the public market.

The good news is that the preferred shares may yield a profit IF IF IF sold at the conversation rate ABOVE $29 (break-even price) per share (Source: Bloomberg) The bad news is it may take two years or more to sell the shares, and assumes the stock does not go below $29, and does not count the other shares owned in this equation. Thus, the Treasury will convert and attempt to sell $49 billion worth of its preferred stock, and change it into common, but please don’t ask about the other $133 billion loaned to AIG.

Part IX: Why Are We Doing This “Stock Conversion” in the First Place?
We’ll the reason is that arguably, AIG simply cannot afford to ever repay the $182 Billion. AIG has sold off tons of assets over the last two years, and is a much smaller company now. AIG simply cannot generate the kind of future revenue it needs to repay the loans. It also cannot generate enough revenue to also pay the quarterly dividends to the Treasury as effective interest on the loan.

“The conversion will relieve pressure on AIG because preferred securities have to be repaid and often come with large dividend obligations.”

— Source: MarketWatch

Part X: “Could:” The New Hope Trade
The Obama Administration somehow has comes under the impression that they will make money on AIG. This is what the Obama administration has said:

“A senior Obama administration official said the (AIG) plan could yield a profit of around $16.5 billion for taxpayers, compared to a previously estimated loss of about $45 billion.”

— Source: CNBC

I have a stuffed animal I won at the town fair, and would like to sell it on eBay. I could make a profit of $500,000, even thought the item is probably near worthless in the secondary market. I could also win the lottery.

The Obama Administration may be assuming that they “could” make $16+ billion profit based on converting the preferred stock into common at today’s AIG’s stock price. The fact is that the Obama Administration has yet to put a single share up for sale.

The Obama Administration then hedges its optimistic forecasts using math that is not publicly known then cautions the public that they may not make money, or at least as much money if AIG’s stock prices goes down.

“The administration official cautioned, however, that any declines in AIG’s share price could reduce taxpayer profits.”

— Source: Reuters

Oh? Do they mean if a stock price goes below the price they paid for it, then they could actually have a chance for a loss? I thought that we are looking at a $16+ Billion profit 30 seconds ago; now they tell us we could lose money? That’s a slight discrepancy. Why bother making a rosy forecast with some arbitrary number for a profit, when they really have no clue what the ultimate outcome will be?

Why? Did we tell you that an election is coming up in November?

As Obama’s 20-year pastor has said:

“Politicians say what they say and do what they do because of electability.”

— Rev. Jeremiah Wright (ABC News)

There’s One More Slight Problem.
The entire AIG-US stock conversion deal is contingent on AIG being able to (1) get money from new private investors, (2) show that AIG is a strong company again, and (3) get their credit rating up.

“The deal… can’t be completed until AIG proves its strength by displaying its ability to raise money from private investors and regain a top rating from credit agencies” (Source: CNBC).

See you in Fantasyland.

AIG-U.S. Exit Plan Summary.
So the government decides to help AIG get back on its feet by giving up their creditor interest in the company; then the government reduces its interest down to a common stockholder; government then increases their risk in AIG’s ownership from 79.9% to 92.1% of outstanding common shares; during this the process, the government decreases the value of existing AIG stockholders by over 60%; AIG then issues warrants to protect existing stockholders from the government who will be diluting their AIG shares; the problem is warrants are in them self also dilutive to common stock; then the government thinks that they will make a $16 Billion profit, but forgets its needs $182 billion to break even on the bailout; then the government thinks it may not make money; and somehow AIG and the Obama Administration thinks all of this is a good deal. For whom? Certainty not for tax payers. And the caveat is the whole deal is contingent upon AIG getting new private investors, demonstrate AIG’s stability, and get its credit rating up like it once was. Hint to AIG’s Board: Diluting your stock, does not get your credit rating up, and who is their right mind would jump into AIG knowing that they are going to see a 60.5% immediate dilution? No thanks.

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