AIG: The Mark-to-Lehman Market

Ooh now this is ugly. AIG (AIG) shares are down 26% today to their lowest level in over 15 years; the firm's credit default swaps are wider than Lehman's. AIG was never known as much of a mortgage shop, but it's undoubtedly the insurer's mortgage exposure which is dragging it down -- that, and the same self-reinforcing downward spiral that can hit any leveraged financial institution in this market.

Note that AIG is not trading at zero, in the way that Lehman (LEH) and WaMu (WM) are: its market capitalization is still a substantial $35 billion or so. But the credit markets are certainly far from reassured that there's any value in the equity.

The worst sign of all for AIG? According to Bloomberg, the much-anticipated turnaround plan, which was meant to be unveiled by CEO Robert Willumstad on September 25, might be brought up to an earlier date -- just like Lehman's earnings. And we saw how much good that did.

I see very little chance that Willumstad's plan will placate the market, which now smells blood. I think the best chance for AIG now is that Lehman gets bought at a non-peppercorn price: If LEH is worth something, then AIG might be too. But if Lehman's bondholders end up being forced to take a haircut, then the prospects for AIG could be grim indeed.

Essentially, AIG bondholders and shareholders are marking their assets to Lehman, even as Lehman is trading on a worst-case scenario basis. Is there any particular reason why AIG should suffer the same crisis of confidence which is currently besetting Lehman? Maybe not -- but this market isn't rational, and AIG is just as opaque as Lehman. Right now, that's a really bad thing -- and frankly I'm surprised that Goldman isn't down more, too.

If you own shares right now in any company where you don't really understand how it makes its money, and if that company is highly leveraged, then you'd better have an iron stomach. Your shares can -- and quite possibly will -- go all the way to zero.

Comments

[Ishortyou:]

as it was point out over and over and over again the uncertainties are in the CDO's, specially those triple A rated by Moody's. It was found that a lot of them contain triple A rated JUNK or NINJA backgrounds, and no one knows not even their own owners what they have. Uncertainties and fear drive the market price down.

2008 Sep 13 06:50 AM

[BSCLossMan:]

There's a good article on Forbes today about AIG. AIG has many assets it can sell, real assets, not voodoo securities.

2008 Sep 13 07:18 AM

[Ishortyou:]

they dont need to sell the good assets they just need to get rid off the CDO-CDS.

2008 Sep 13 07:47 AM

[Gerry Sullivan:]

The real problem with AIG is the Credit Default Swaps. How much do they have outstanding on Lehman? Wamu? Merrill Lynch?
General Motors, Ford, etc?
Is AIG meeting the required marks to market?
Can AIG survive a rating cut?
Why does it cost 1200 basis points to insure AIG debt?

2008 Sep 13 08:43 AM

[bsharvy:]

Lehman has good assets it can sell too. That's not the problem. The problem is crap assets + high leverage. How does AIG do on that score?

2008 Sep 13 09:17 AM

[roy mckoi:]

Why can't they reinsure their insurance businesses to raise capital? This is all a ratings issue right? Ratings agecines are concerned about access to capital...that's anothe rmarket for insurance capital

2008 Sep 13 09:17 AM

[venividivici:]

Felix I think your final paragraph sums it up to a tee. . I just wonder when the share market is going to notice. If the financial backbone of the market is hopelessly impaired, that will bring everything down with it.

2008 Sep 13 10:24 AM

[jbortho:]

What will happen to all the 401K 's invested in AIG Valic. Are they safe?
Should I rollover my money immediately. Thanks

2008 Sep 13 10:49 AM

[E Nuff Sed:]

AIG's financial leverage is just 8:1. As to getting rid of CDS-CDO's - it cannot. There is no market. These have to be held to maturity. It can however get rid of other assets to maintain capital ratio's. It will have to sell the family silver at fire sale prices, since capital raise is no longer an option (given stock is at 40% of book).

2008 Sep 13 12:21 PM

[prescient11:]

There is an interesting article about CDS speculators essentially engaging in aggressive naked short selling TO FORCE THE DEFAULT of companies by driving their share price to the ground. Thus, they cannot raise capital because of this ridiculous low share price and most do not want to purchase the company because the shares don't stop dropping.

Now, we can argue about the merits of whether they should have raised capital when their share price was higher, but that really puts the cart before the horse, doesn't it. In other words, I find it ridiculous that if LEH has adequate capital levels, that it should be forced to dilute shareholders at $20/share to raise ADDITIONAL capital so that the "market" will feel comfortable with its business. You do see the vicious cycle that is happening here, don't you.

Banking is about trust. Assume LEH has adequate capital at $20/share, thus no need to dilute shareholders at this price or raise additional capital. Then, "rumors" about LEH's assets and losses start to percolate on the street. Hedgies with enormous assets and the ability to leverage ridiculous pressure, drive the share price down, scaring all of the investors and LEH's customers/counterparti... that perhaps LEH isn't stable. Thus, funds are removed from LEH even though they had sufficient capital, and now LEH's share price is at such a ridiculously low level and unstable that no one wants to invest. Thus, their capital continues to bleed as a result of this, and problems occur. How about that Felix, why don't any of you uber-bears ever address that frigging point.

It's so frigging obvious it's ridiculous. Look at the action in the bonds and the CDSs, to the extent one can. After BSC no fool is going to be as transparent as buying crazy out of the money put options. But I bet the real play is in the bond and CDS market. If one restored the uptick rule and banned naked shorting out right FOR ALL COMPANIES then this would cease. Cramer is absolutely right here.

And where is the damn SEC, the damn OTS, the damn Fed, the damn Treasury, our FRIGGING OFFICIALS PAID TO STOP THIS. They fiddle while Rome burns and these companies' debts are forced upon the taxpayer. My own conspiracy theory is that they want this forced consolidation of financial companies. For what purpose, who knows. But I find the fact that nothing is done about these obvious manipulations to be absurd. Naked shorting is already illegal, why has it not been stopped?

Of course, LEH must bear a bit of the blame. In this environment, diluting shareholders at $20 is much better than a forced sale at $2, given that what happens above is obvious and will continue to happen until "the Street manipulators" are satisfied. Until then, the carnage will continue. But the wealth destruction we are witnessing, and subsequent taxpayer burdens, without any intervention by regulators, is ridiculous.

As goes the famous saying, "when they came for me, there was no one left to stand to object..." True words indeed.

2008 Sep 13 01:19 PM

[PeteK:]

Just let the Korean Banker buy the whole thing, whatever they want to pay, take it !!!

2008 Sep 13 01:52 PM

[dato2020:]

Bib Laden is laughing at our lust for greed and self destruction. We play into his grand plan. If the distorting shorts are not stopped the system will collapse and the next world wide depression will be a very violent one. Americans must wake up.

2008 Sep 13 03:34 PM

[prescient11:]

Where are you at Felix? I suppose an intelligent response to your articles is too much. You were wrong with your exchange with Dear John Thain, and you are wrong now. The idea that this is just an efficient market is a lie perpetrated and repeated by fools.

Do not be one.

2008 Sep 13 04:47 PM

[williambanzai7:]

If you pretend you are an investment bank, you get whipped like one as well.

2008 Sep 14 02:44 AM

[InnocentsAb...:]

Suprised there isn't an ETF that is composed of CDOs. Perhaps American investors are so imitative that the CDOs are considered to be worth nothing at any price. An ETF for the CDOs would provide a vehicle for potential purchasers, and a potential source of liquidities for holders.

A fairly simple proxy would be an ETF composed of the senior debt of ML, Lehman, Goldman, AIG, etc. Or, potentially, a closed end bond fund with that specialty.

2008 Sep 14 05:14 PM

[E Nuff Sed:]

AIG is not a bank from where depositors can withdraw or counter-parties can withdraw in a hurry. I can understand this for Lehman which as a investment bank is facing a classic run at the banks engineered by shorts. So comp. are apples to oranges.

AIG's financial leverage is approx 14 while, quite reasonable for a financial services company.

AIG shares are going to be hammered tomorrow as the investment sheep, scared by the short wolf pack, crap & run for the hill. My advise to the longs is to sit tight - watch how the next few days unfold. There might be a buying opportunity of epic proportions.

2008 Sep 14 06:49 PM

[Ken Houghton:]

Prescient 1: Felix posts at his own site; it just got mirrored here.

I hope your knowledge of finance is better than your grasp of the internet.

2008 Sep 14 07:36 PM

[pkiula:]

AIG's leverage is 11:1, not 8:1. How do you calculate your leverage figure? Also, why after all this mess is AIG's S&P rating still at A?

2008 Sep 21 09:51 PM

[pkiula:]

E Nuff Sed, you said that a leverage ration (debt to leverage) of a financial company up to 14:1 is "quite reasonable for a financial services company."

This is precisely the kind of moron-thinking that had led AIG down the toilet. Berkshire Hathaway is also a financial company, but it's debt-to-equity is 2:1. Several other insurers around the world are between 2:1 to 4:1. Calling a leverage of 14 reasonable is colossally stupid if not ignorant. It is precisely this kind of greed that needs to be reined in by the Fed.

2008 Sep 21 09:55 PM