Crunching Numbers: Why I'd Buy AIG 40 comments
-
Font Size:
-
Print
- TweetThis
In view of the wide range of loss estimates that have been put forth for AIG's (AIG) insured portfolio of super senior CDS, I thought I would try my hand at developing my own estimate. In common with Ambac (ABK) and MBIA (MBI), AIG publishes a detailed disclosure on its web site, listing the individual insured transactions and considerable information about the type of collateral, vintage, and ratings. I located the information on their website as an appendix to their second quarter conference call credit presentation. Using this disclosure, line by line, I created an 11 page Excel workbook to estimate losses, along the lines of Ackman's so-called Open Source document.
AIG classifies the Transactions as either High Grade or Mezzanine, based on the collateral. For each type of transaction, they provide a one-page listing of the transactions and a percentage breakdown of the collateral among Prime RMBS, Alt-A RMBS, Sub-Prime RMBS, Non US RMBS, CMBS, Other ABS, CDO, and Non ABS. Then they provide eight pages of information on Prime RMBS, Alt-A RMBS, Sub-Prime RMBS and CDOS, providing percentage information by Rating and by Vintage.
In order to get a clearer picture of the quality of the underlying information, I would suggest you take a look at the actual disclosure (.pdf).
Here is the summary showing my assumptions and the resulting losses (click chart to enlarge):
There were two possible routes to developing the estimates – one relied on ratings only, the other relied on a combination of asset class, vintage and structural considerations. In either case, I developed my assumptions as to cumulative losses by adapting material from outside documents located on the internet. For the asset class/vintage approach I used Standard & Poor's “Detailed Results of Subprime Stress Test of Financial Guarantors” published 2/25/2008, available on MBIA's website. I used their stress case assumptions for Direct RMBS, treating 2004 as being the same as 2005 and Prime as being 80% of Alt-A. AIG says nothing about any HELOCS or CES, so I used an average of Sup-Prime, HELOCS and CES in lieu of Sub-Prime, which raised my Sub-Prime assumptions.
Ambac(ABK) noted that it experienced extreme problems with internal CDO collateral, writing off about 50% of such collateral in their book of insured CDOs. That gives credibility to my assumptions for CDO collateral, which I also derived from the “Detailed Results...”
For the ratings based approach, I used S&P's “Default, Transition, and Recovery: 2007 Annual Global Corporate Default Study and Rating Transitions.” Basically I doubled the 15 year cumulative average default rate by rating modifier for Corporate bonds. I averaged all rates under BB, which gave me a cumulative loss assumption of 72.4% for anything rated below BB.
Mezzanine collateral has been one of the big problems in that it performs very poorly under stress. In order to allow for this, I introduced a multiplier which I applied to my asset class/vintage assumptions for mezzanine collateral. Because the ratings should include a consideration of structure, I used a multiplier of a little bit over 1 for mezzanine collateral when working with the ratings based approach. In all cases I capped losses at amounts somewhat under 100%. The numbers with the tan background are ratings based: the yellow background is asset class/vintage based.
The agencies have been extremely active in downgrading collateral. I suspect we are nearing the end of that phenomenon and as such the doubling of the long term corporate rates accounts for the prospect of further downgrades.
The numbers with the light blue background are where the results became very sensitive to the assumptions used – much of the collateral is 2004-2005 sub-prime RMBS, and much of the mezzanine collateral has been severely downgraded. The severity of the losses on the Below BB collateral is one of the main issues – my best guess is that there would be some salvage, hence the 72.4% loss assumption.
In any event, using what I consider to be very conservative assumptions I got to $4 billion of losses by either method. This is quite a bit less than the mark to market losses of $26 billion reported by the company. It is also less than the low end of the $5 to $8.5 billion range of stress case losses provided by the company. I experimented with various assumptions, and as far as I'm concerned the $26 billion mark to market losses is just not related to reality. To get into the stress range requires extremely severe assumptions. I am using the $4 billion losses as a maximum in making my investment decisions.
AIG's actual business problems are manageable: the considerations that are more difficult arise from the negative publicity fostered by the distort and short set, as well as the potentially unpredictable actions of the ratings agencies. Jim Cramer was on AIG Thursday night on TV – his suggestion was that the Federal Government should dismember it as part of his trillion-dollar solution to the bank problem. AIG is an insurance company, not a bank. Jim obviously had not done any research into the possible size of the losses or he would have been talking responsibly. Regretfully, mark to market accounting has been seized on by the distort and short set as an easy way to attack any business that is complex and difficult to understand.
Based on my analysis of maximum probable losses for the Multi-Sector Credit Derivative Portfolio, I consider AIG a buy and see a target of 40 per share within two years.
There are two risks that need to be acknowledged. The first is further dilution caused by the threat of a rating agency downgrade, leading to a capital raise in the midst of a torrent of short-selling. AIG is a DOW component and widely owned: Perhaps they could do something with institutional investors rather than expose themselves to what Ambac (ABK) and MBIA (MBI) went through trying to placate the agencies. The rating agencies are unpredictable: There is no telling when they will move the goalposts again. Willumstad rightfully declined to rule out a capital raise – rightfully so because it is still economically feasible.
The second lies in Willumstad's review, due on 9/25 [if not moved up], and expected to result in some restructuring. Thursday night on TV someone was suggesting he was going to do the surgery with a sledgehammer. The primary issue arises from the fact that both sides of the balance sheet are heavily influenced by the perceived risk in MBS. Mark to market exaggerates AIG's liabilities and understates its assets.
Thus far, AIG has been able and willing to hold mis-priced positions to expiration. I listened to the last conference call (see transcript) and could not make a decision at the time whether Willumstad was suffering from deer in the headlight syndrome or was simply being deliberate in his decision-making process. I now vote for the latter, and expect that he will do a workmanlike job in making his plan and demonstrate patience and resolve in carrying it out. AIG has the resources to make a good plan work.
Because this situation will be playing out under a relentless distort and short attack, I plan to enlarge my position gradually and monitor the news closely.
Disclosure: I am long AIG.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 40 comments:
Isn't it possible this entire meltdown is a preconceived plan because, at this point, there is more money to be made on the downside. Has anyone considered this?
In fact AIG, Lehman, and others could actually be cooperating with this. They will continue to be powerful forces in the financial world yet sharesholders will be left with nothing. Where does the money go? To those in the know about the plan which is to maximize return just like they did when building up these institutions.
Ponder that for me and I encourage your comments. I may be wrong and I hope so... but what if I am right?
AIG problems are mainly ratings agency driven.
At this price level, management may find it advantageoues to use its cash to buy back common stock rather than pay a nearly 8% dividend.
I could say alot more, but no time to do so!
Thanks.
Ever think of that?
Plus I think your math is faulty.
As I see it, AIG is expecting a negative return on about $80 billion in assets of about 7.5%-8% a year for at least five years, including what we can roughly refer to as "financing". That looks like about $26 billion to me.
Moreover, an analysis without liquidity data is unreasonable. The assumption such an analysis rests on is that not only do you have deeper pockets than the market, but that someone else will have deeper pockets than you when you want to sell.
Would you buy the underlying real estate right now? No. Then why is it a good idea to buy it with leverage?
It's unsurprising to the point of un-noteworthy that models using historical performance data would say that these securities are a buy. Those are the models that created the situation in the first place.
What people can't accept is that the MBS market is now a game of musical chairs with 20-30% of the chairs taken away. Somebody will most assuredly get stuck with MBS they cannot sell and all their talk of returns will be meaningless because their principal will be gone.
When institutions holds collateral nobody wants, liquidity dries up.
Even if you think you can find the floor, you're going to have to get somebody to go down there with you. Why bother?
Long AIG.
On Sep 13 08:25 PM E Nuff Sed wrote:
> Distressed investing can be very profitable. Look at Ambac as an
> example (up 800%). I was lucky enough to get in right at the bottom.
> No luck so far with AIG. However I think at this stage the upside
> is much more than the downside.
>
> Long AIG.
everyone talks about the value of the assets, which is good, to a point. Remember though that if there is no market (ie, no one wants or no one is large enough to buy your assets), then what is the value of those assets?
2. Liabilities
The assets are there to provide for the Liabilities... so what happens when
(a) AIG need to pay out claims??? They use their cash, which in effect increases the % of total assets which are less liquid.
(b) policyholders start to cancel their contracts which have significant surrender (cash) values??
Two quick comments on the analysis:
1. we are in a new era going forward ... historical assumptions not so applicable (though government could intervene to attempt to change assumptions)
2. when calculating Present Value, the interest (discount) rate used should be the rate that you as a investor demand as a return on your investment. If you are happy with 4.5%, then ok, but other investors want something like 15%.... try inputing 15% and see those PVs decline rather significantly !!
On Sep 14 06:48 AM peter6 wrote:
> According to Bloomberg, even before Friday AIG's CDS liabilities
> were traded as if they were rated B1, four levels below investment
> grade and 10 levels under their actual rating. AIG was concerned
> about further downgrade according to IHT. So the jittery is about
> their CDS liabilities increasing, not assets diminishing as calculated
> by Tom. Unless I miss something here.
On Sep 14 02:23 AM abcde_98 wrote:
> 1. Assets, Market, Liquidity
> everyone talks about the value of the assets, which is good, to a
> point. Remember though that if there is no market (ie, no one wants
> or no one is large enough to buy your assets), then what is the value
> of those assets?
>
> 2. Liabilities
> The assets are there to provide for the Liabilities... so what happens
> when
>
> (a) AIG need to pay out claims??? They use their cash, which in effect
> increases the % of total assets which are less liquid.
>
> (b) policyholders start to cancel their contracts which have significant
> surrender (cash) values??
>
>
> Two quick comments on the analysis:
> 1. we are in a new era going forward ... historical assumptions not
> so applicable (though government could intervene to attempt to change
> assumptions)
>
> 2. when calculating Present Value, the interest (discount) rate used
> should be the rate that you as a investor demand as a return on your
> investment. If you are happy with 4.5%, then ok, but other investors
> want something like 15%.... try inputing 15% and see those PVs decline
> rather significantly !!
On Sep 13 11:48 PM peter6 wrote:
> You have done some calculations about the value of their assets.
> But have you done any calculations about their CDS liabilities? Would
> somebody care to comment?
AIG 1,2,3,4,$ no clue!
I think it would be irresponsible for rating agencies to downgrade based on a massive short surge (where there was no news on AIG), which would cause it to destroy a bit of long-term value by posting additional collateral.
Ton of money to be made long AIG if you don't soil your pants... look for a huge short-covering rally soon.
From: media.corporate-ir.net...
• AIGFP is required to post collateral on the majority of the credit derivatives that are part of the multi-sector CDO and corporate arbitrage portfolios.
– The amount of collateral required for posting is primarily based either on the replacement value of the derivative or the market value of the reference obligation.
– The amount required for posting is affected by AIG Inc.’s credit rating and that of the reference obligation.
Can’t this collateral requirement have the same effect as a “run-on-the-bank” if the market drives their MTM to even sillier valuations?
That's what WEBISKING said, and I agree, this is a good trade. On Monday, we may see further downside in Merrill and AIG due to whatever happens later today with Lehman. So this AIG put sale will perhaps fetch an even higher premium about an hour after the open on Monday.
My comment on the Lehman fiasco and ramifications -
Once the investing/gambling crowd realizes that LEH went out for chump change on the equity side, they will be pretty fearful about MER in particular, and to a lesser extent AIG. It's really not clear if there actually is any appreciable equity value left at LEH - it is tiny at this point.
Dick Fuld blew it bigtime - he could have done a recap at $35 in May - instead, he tried to 'look tough and bluff' which by the way, is a strategy that has already been PROVEN TO BE A FAILURE at every stage of this equity meltdown, and for EVERY FIRM that has tried it!
Think back to the subprime mortgage originators (New Century, CFC) and the rating agencies and Thornburg Mortgage and the mortgage insurers and Indymac and Fremont General and Bear and dozens of others nobody even remembers at this point. They all looked into the camera, spoke clearly with an assuring, measured tone, and then imploded. EVERY one of them.
So, I give Fuld an F minus for his handling of this - he is just another grossly overpaid Wall Street Capo who is blind to his own reality. He runs an extremely-highly-lever... gambling house. It's really that simple - and that's all it is. And when his pile of chips was rapidly shrinking, and he was looking at really bad cards, he tried to bluff his way out of the hand, and got called.
Now his firm is basically worthless, and he personally lost over $500 million.
Dick Fuld wouldn't last two hours at the poker tables in Vegas - what the hell is he doing running a multi-billion dollar financial firm???
Now back to AIG. Assuming they survive this latest short attack and run on their assets, they are in a much better position to ride it out than MER, for example. Although John Thain is a very well-connected insider in the Wall Street rackets, he is not a magician, as far as I know. Merrill has very serious problems, and I suspect will announce massive layoffs over the next year. Most of the money they've made in recent years has been through milking suckers, and running a piece of the fraud-tainted securitization, CDO, auction-rate, and hedge fund games that Wall Street has been running.
Most of this is disappearing or under investigation at this point. The investing public is sick to death of the lies, fraud and dirty dealings of the banks, the admin, and corporate America. Therefore, I think Merrill's basic business is in serious trouble, and that is on top of massive and growing losses on their asset book. So I think MER could go to single digits very easily here, and stay there for a while.
I doubt that AIG will be in the $10 range for long, although I must admit, it surprised me how rapidly it sank this past week. It was a stunner.
I was steeling myself against the urge to jump in and buy AIG - now I am sure I will wait until LEH is resolved, and we see if there are any other "surprises" that float out of that cesspool. The delays in putting the rescue together tell me that there is some bad news that has not yet been fully revealed.
But at some point, unless there is just a whopper of a fraud announced at AIG, I will be a big buyer, as I feel that the upside here is really strong, and could be a quick double before year-end. Call Options trades could be a five bagger if timed right, and with a bit of luck.
The result will probably be zero or negative.
Imho AIG's debt is secure and safe and a buy here.
AIG last price : 5.50 - Down 55% within 2 days after the posting of this article.
Watch out for Master card and Visa in which banks have major stakes. They may have to unload them to raise capital apart from both of them having their own problems.
Today's move explains why all the pundits were pushing financial sector etf (XLF) on TV shows for past month and the run up.