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Tim Travis is CIO of www.optimitrading.com and is CEO of T&T Investment Management L.L.C. Tim currently possesses the series 3, 7, 63, and 65 licenses, and he works actively in the field of investment management. Both Optimi Trading and T&T Investment Management L.L.C are investment... More
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  • AIG Bond Investment Recommendation 0 comments
    Jul 2, 2010 12:32 PM | about stocks: AIG
      Buy the (NYSE:AIG) 6% Due 12-1-16 

    From: optimitrading.com ;

    Yield to Maturity: 12.68%

     Investment Rationale: AIG has been in the news the last 3 years for all of the wrong reasons. Clearly the company lost reality with proper risk management and rightly or wrongly was coerced into a government takeover which virtually wiped out the majority of the equity holders in the stock. Unlike some of the other government brokered deals AIG was unilaterally penalized with onerous terms with high interest rates. Fortunately for AIG the government backing has really resolved any issue of counterparty risk that dominated the short term focus of market participants during the financial crisis. AIG has been profitable three of the last four quarters and revenues are starting to recover as market participants are gaining confidence in AIG’s financial strength. AIG is also in the process of divesting some of their larger businesses in Asia to Metlife and they did a great job securing a fair price. Another deal with the British insurer Prudential fell through, but it is safe to say that they aren’t done divesting businesses, and the primary place where that cash will be going to is paying off the company’s debts to the government. Currently the US government owns about 80% of AIG. The next biggest shareholder is the Fairholme Fund which is managed by the famed value investor Bruce Berkowitz. The Fairholme Fund has posted a cumulative 10 year return of 237.17% versus a negative 7.86% return through the period of (6/1/00-5/31/10).

    The beauty of buying the debt in AIG is that due to bankruptcy laws AIG’s debt is senior to the equity in the capital structure. Typically the equity would have to be wiped out for the bondholders to lose a single penny and we think that this is very unlikely given the government’s significant stake. Companies go bankrupt for a variety of reasons. Financial companies like AIG typically either have a liquidity crunch where they lose their access to capital like a Lehman Brothers, or due to the heavy regulation in the industry some type of government action occurs. AIG had both due to their Financial Products division which was forced to keep providing collateral as securities insured by the division kept getting downgraded to the point where they no longer could access the capital they needed to stay in business. The government got involved due to the systemic risk in a manner similar to Freddie Mac and Fannie Mae where the equity was virtually wiped out. Now AIG has the implicit backing of the Federal Government so it seems highly unlikely that there will be any liquidity risk whatsoever, and I can’t imagine the government wiping its own equity stake out.

    Even in a worst case scenario which would be some type of government forced bankruptcy the AIG debentures would likely be converted to equity in a better capitalize and reorganized insurer with a drastically reduced debt load. We believe the bonds have a 90% probability of remaining performing bonds, and it is difficult for us to envisage a scenario in which an investor at these prices could lose as these bonds come to maturity. Short term mark to market losses are very possible so we only recommend this for long term bond buyers.

    Investment Strategy: Buy the bonds below 82. This gives us an equity-like return, with a yield to maturity upwards of 12% with significantly less risk.

    Primary Risk Factors: Extensive government interference and a double dip recession could stress this investment. There is likely to be a lot of headline risk over the next couple of years which could affect mark to market pricing.



    Disclosure: Long AIG Bonds
    Stocks: AIG
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