The outlines of a deal to prevent the world’s biggest insurer from filing for bankruptcy may be emerging. In concept, the outline of provisions is about as good as the government could likely extract, absent taking control, which runs the risk of loss of talent (and having considerably lost by various “helpers” as Warren Buffet calls them, pulling fees out as they pick over the remains) The terms bandied about would have the Fed having a secured loan (which in simplified terms means they could seize specific assets in the event of non-payment) and equity warrants, so if the company recovers, the Fed gets the upsisde.
So whether the deal is a good one depends on the details, namely, the quality and amount of assets securing the loan, and the amount of warrants. Given that the Fed is the only game in town, it ought to be able to drive a tough deal. But whether it will remains to be seen.
From the Wall Street Journal:
The Federal Reserve is considering an $85 billion rescue for embattled American International Group that could leave the government in control of the firm, according to a people familiar with the matter, though the structure of a deal remains unclear.
The plan under consideration late Tuesday involved the Federal Reserve providing AIG with a secured bridge loan in return for warrants, the people said. AIG would commit to sell a basket of assets within a certain timeframe and offer incentives to buyers to complete the sales quickly.
In return, the government would get warrants for most of AIG’s equity, diluting existing shareholders.
I’d like to know what “most” means. AIG will no doubt need to raise new equity, which would be senior to the warrants.
With the government support, AIG’s favorable credit ratings would likely be restored, allowing the firm to avoid bankruptcy,,,
AIG shares, which fell 61% on Monday, closed down 21% at $3.75, with trading volume during the day at more than 10 times the average. AIG, whose shares fell as low as $1.25 Tuesday, has lost more than $25 billion in market capitalization since the start of trading Monday….
An AIG bankruptcy would take the financial crisis to another level, given the company’s size and wide reach. The New York-based company is used by many companies around the world to manage a range of risks, including exposure to investments in subprime mortgages.
Update 8:20 PM The New York Times weighs in (hat tip reader Dwight):
In an extraordinary turn, the Federal Reserve was close to a deal Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people briefed on the negotiations.
All of A.I.G.’s assets would be pledged to secure the loan, these people said, and in return, the Fed would receive warrants that could be exchanged for an ownership stake. Stock of existing shareholders would be diluted, but not wiped out.
Wow. They have a $100 billion investment portfiolio in their Japan/Korea operations alone, Query how the Fed might stand relative to policyholders, since the loan is at the parent level and the assets are (presumably) in regulated subsidiaries. But rules vary by jurisdiction. So what they have is a priority position against parent assets (which have other claims against them against which the Fed might not want to assert its priority position) and (one assumes) the parent’s equity in the subs. Nevertheless, on first blush, this is WAY overcollateralized,. Addition at 9:25 PM: I needed to clarify one bit of the logic: you’d have thought that AIG would have been able to get a loan at the parent level if the collateral was sufficient, that is, it was a liquidity rather than a solvency problem in that entity. However, some parties were thinking about a last minute bid because they were convinced that there was enormous value in the company as a whole. And the requirement to sell assets means that some of the value in the subs will be extracted,
If the Fed takes a controlling stake, it is likely that it would want to replace A.I.G.’s board as well as its chief executive and chairman, Robert B. Willumstad….
Attending the meeting on the Capitol Hill were Democratic Senate leaders that included Charles E. Schumer of New York, Richard Durbin of Illinois, Christopher J. Dodd of Connecticut and Kent Conrad of North Dakota A contingent of Republicans was led by Mitch McConnell of Kentucky, the minority leader, and included Richard Shelby of Alabama, John Kyl of Arizona and Judd Gregg of New Hampshire. House leaders included John Boehner of Ohio, the Republican leader; Spencer Bachus, Republican of Alabama; and Barney Frank, Democrat of Massachusetts. Members of the leaders’ staffs were asked to leave the meeting shortly after it began.
Update 8:35 PM: The Journal reports AIG’s board has approved the plan, except the plan is in flux. Talk about fire, aim, ready:
The U.S government moved toward an emergency rescue of American International Group Inc. — one of the world’s biggest insurers — signaling the intensity of its concerns about the danger a collapse could pose to the financial system.
The board of AIG approved a government-led rescue plan late Tuesday….
he precise details of the government’s plans were still being formulated. The primary option being hammered out involved the Fed providing AIG with a short-term loan of $85 billion, according to people familiar with the situation. In exchange, the government would receive warrants in AIG representing the right to buy its as much as 80% of its stock under certain conditions, according to one person familiar with the matter.
That could put the government in a position to potentially control of a private insurer, a historic move, especially considering that AIG isn’t directly regulated by the federal government.
Update 10:00 PM. Reader Jesse pointed to the Fed press release. The juicy bits not covered above are 24 month term, interest rate Libor plus 850 and the right to veto dividends on common and preferred. Other verbiage:
The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers…..
The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets.
A reader noted on an earlier AIG post:
Neither the Fed nor Treasury had the power to impose a conservatorship. The Fed does, however, have the power to make collateralized loans.
That said, anyone who is clever should have realized (or is probably starting to realize) that a limitation to making “only” collateralized loans is not much of a limitation at all.
For example, a good lawyer can write what is basically an “equity” investment with loan documents (like a participating subordinated loan or a thinly collateralized loan with warrants like what the Fed is doing). In much the same way, a lawyer can also write what is basically a “debt” investment with equity documents (a joint venture agreement where the money provider gets all its “equity” back plus a preferred return prior to any other distributions (and you could also include a guarantee)).
My point is that this smells very much like a senior preferred equity investment. And this shows how saying the Fed can “only” make collateralized loans is really meaningless. The Fed can make any investment it wants and just slap a “loan” label on it.
Originally published at Naked Capitalism and reproduced here with the author’s permission.