Monday, September 28, 2009

Bailout Bonds or The AIG Trifecta (Part I –AIG)

I got a ping on my Blackberry from a colleague/friend: “What do you think about AIG?” He was talking, of course, about AIG stock, which has been a trader's delight for much of 2009, from the short and long sides.

He might as well have asked me to tell him how general relatively is explained by string theory.

AIG is an analyst’s nightmare. Take one look at those financial statements and you can understand why the black hole that lurked within the company went undetected until it was too late.

Nowadays, even post-bailout, AIG’s 10-K (annual SEC report) is 344 pages long and its latest 10-Q (quarterly) is 221 pages strong. That’s without getting into the supplementary statements. To make matters worse, you can go through those reports with a comb and STILL not come away with an understanding of the company and much less a valuation of it.

You see, AIG is a holding company with different operating companies, all mainly in the financial area. To BEGIN to understand and value it, you’d have to go through all the main subsidiaries and drill down THEIR portfolios (now that we’re not sure of the value of anything) and businesses and add all that up.

Sorry, amigo, don’t have that kind of time. It also brings up the analyst’s conundrum: by the time the analyst has done the work, figured it out and written it up, the market has probably gone way ahead (perhaps on insider knowledge). So it’s not worth it. And as far as I have been able to find, there hasn’t been any deep research done on the company this year. Goldman Sachs, often fingered as the beneficiary of the AIG bailout lists the company as a “Not a GS-followed company”. (If someone can find a good report, send it my way, please).

I can’t say I blame them. I wouldn’t have an analyst spend time on unraveling the mysteries of the AIG universe, either.

Of course, you can read the WSJ and the Internet blogs. You’ll find outrage, opinions, conceptualizations, but very little in terms of hard numbers.

As frustrating as it may seem, sometimes you have to make use of less than perfect information and make some assumptions when investing. AIG and others like it, just stretch that reality a bit further than most.

With all those caveats, luck has it that that sometimes you can find tidbits of information that are particularly useful. Earlier this year I had been browsing through that mountain of AIG data, and I found this. LINK. Open it in a new window. Look it over, it’s important.

It is AIG’s post-bailout capital structure, explained by AIG itself. I know it may seem like Chinese to some, but basically this is the “pecking order” of AIG’s creditors, and bonds and shareholders.

First in line is the Federal Reserve Bank of NY, which basically has the first dibs on the sale/spinoff of several of AIG’s insurance businesses. AIG owes FRBNY over $40 billion.

Second is Senior Debt. Yes, Bonds. AIG has a number of senior debt issues outstanding.

Number three on the list is Junior Subordinated debt. Also bonds. A couple of these caught my eye. Will explain further down.

Four and Five is government bailout money and last on the list is the common stock.

So here’s how it works: if you were to value all of AIG’s assets (something I’m not going to do) and assign the value to the stakeholders in order of preference, there would certainly be enough for Level One. Also probably Level Two and probably Three. Levels Four or Five, not so sure. What’s more, we hear all the time that the government isn’t certain that they’ll get their money back. LINK. Well, until the gov is paid, there is nothing for level SIX.

How much is level SIX worth? No idea. If there are enough in assets and/or ongoing businesses to satisfy ONE through FIVE, level SIX is worth something. If not, it’s worthless. Right now, Mr. Market says that level SIX is worth $6 billion. Maybe it is. Maybe it’s worth 10 times that. Maybe zero.

I told my friend to trade the stock technically, if he was into that. What else can you say?

However, there is a lot to be said about Levels Two and Three. (Yeah, bonds). These guys collect BEFORE the government with its preferred stock. And so far, AIG has been making its debt payments on time and in full.

Not that this is secret to the bond market. Last year in the midst of the crisis, AIG senior bonds maturing in one year later (i.e. now) was trading at 50 cents on the dollar. Those brave enough to get in there, made their double. (Compare to those who dared to buy stock). (No, I wasn’t that brave).

Today AIG senior bonds are trading with yields mostly below 10%. They have been on a tear lately, since yields were in the high double digits only a few months ago.

Better returns are still available in the Level Three bonds, the junior subordinated ones. I’ve been able to get my hands on two different issues, the A-6, which matures in 2058 and the A-1, which runs through 2087.

The A-6 bond pays 8.175% coupon until 2038, when it changes to Libor plus 4.195%. Currently yielding about 14% until my kids inherit and something variable thereafter (which my grandkids might enjoy).

The A-1 is set up similarly, 6.25% until 2037, Libor plus 2.0568% thereafter until 2087. Trading around 50% currently, there’s some good interest payments left in those bonds until my great-grand kids collect the principal.

I was fortunate enough to get those bonds at a lower price, but would still consider buying them. AIG got its bailout, here’s a way get a bailout of your own.

As for the other two flavors of AIG. Next post. This is long already.

The Picture? Wayne Rooney. AIG used to be the sponsor of the Manchester United side. Ah, the good old days.

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