AIG CEO Edward Liddy’s Optimistic Journey

Could American International Group (AIG) be as great a buy at $2 as Wachovia (WB) was? The market certainly has shown little faith this morning in the Federal Reserve’s new plan for AIG. AIG will be selling $40B perpetual preferred to the TARP at a 10% dividend plus warrants for 2% of the common equity, receive a 5 year $60B credit facility for 3% over LIBOR plus an undrawn fee of 0.75% and 77.9% of the common equity, and facilities to liquidate a large percentage of CDS and RMBS exposures. The onerous existing 2 year 8.5% over LIBOR Federal Reserve credit facility will be dissolved.

The most compelling statement CEO Liddy made during this morning’s conference call was that the latest changes in the Fed and Treasury’s support for AIG are just step 2 in a long journey. I take this to mean that if AIG could show that the government can profit more by even less onerous terms, AIG has further room to negotiate. Liddy implied that even the government’s 79.9% might be negotiable if a reduction in systemic financial risk could be shown.

Liddy contended that the majority of AIG borrowings in the original Fed facilities were used to support CDS collateral requirements and RMBS liquidity issues related to securities lending. The Fed will provide $30B and AIG $5B to buy up $70B face value CDOs insured by AIG at market value. Once the CDOs are acquired the related CDS will be canceled. The Fed will negotiate or strong arm AIG’s counterparties into submission. This appears to be the first source of the analysts doubt on today’s earnings call. I don’t think we should underestimate Fed influence when everyone from Goldman Sachs (GS) down is dependent upon favors from the Fed. All these counterparties benefited from cheap capital in the form of AIG’s forced collateral calls, now the Fed is saying the party is over.

AIG invested the collateral cash received from securities lending in RMBS. The values of these RMBS dropped and AIG had trouble coming up with cash to return to counterparties when the lending matured. The Fed will provide $22.5B and AIG $1B to buy these AIG RMBS at market value. AIG will share in one-third of the upside in the CDS facility and one-sixth of the upside in the RMBS facility. Analysts were also concerned about further write downs that AIG would incur prior to transferring the RMBS to the new facility.

Liddy is on target to stop the bleeding from collateral calls and securities lending, hinting that the ratings agencies are favorably considering step 2 on the journey. The Fed has time to sit on assets in these facilities while AIG’s fortunes improve. Liddy reconfirmed that AIG’s core assets include Commercial and Foreign General. I believe that the more value Liddy can provide to AIG, the more the government will reward shareholders. The government will share for its own benefit.

I don’t know if we should credit former AIG CEO Hank Greenberg for the changes or just that Liddy knew the original plan was leading to disaster. I think Greenberg was the motivator, but my confidence in Liddy is growing.

Disclosures: Author is long AIG and WB.

Comments

[User 302535:]

My question is now that Liddy has bought time so that they can sell assets/subsidiaries, when will it happen? I can't imagine national agents selling American General policies like in previous years, if at all. They need to consider a sale of this subidiary before the brand becomes completely tarnished. Any thoughts would be appreciated.

2008 Nov 20 11:54 AM