Sunday, October 18, 2009

Naftogaz Defaults, Bondholders Rejoice

A little update on my post a few weeks back on Naftogaz. As "kind of" expected, the company failed to make the principal payment on its $500 million bond issue back on Sep 30, generating what the rating agencies called a "technical default".
They did come up with the interest coupon, however. LINK

Since then, and also as expected, the company held a bondholder vote, and with an overwhelming majority (92%), holders of Nafto paper agreed to swap their "defaulted" paper for the to be issued 9.5%, 5 year, govenment-backed bond that Naftogaz was offering in exchange. Even the dissident group went along. LINK

A few lessons here. One is that despite the showdown and drama that played out in the press, there was no real interest in any other outcome. Bondholders weren't necessarily obsessed with collecting their money, just getting a decent deal in the exchange (which they did). It's not like there are ton of better opportunities elsewhere.

The next lesson is that not all defaults are created equal. There is a huge difference between this "pseudo-default" (although it was defined as such for effects of making good on CDS), and defaults such as the Argentine default in 2001 and the recent Ecuadorian default. No one's going to lose money on this one, and I wouldn't be surprised if the new Naftogaz bonds were trading above par in less than a year.

Finally, if Ukraine wants to be a player in the capital markets, they really have to get their act together. This back and forth about paying or not paying and letting everything go down to the last minute (and beyond) was totally unnecessary and counterproductive. A little professionalism and foresight go a long way towards reducing country risk (and hence interest expenses). Ukraine could certainly take a lesson from Russia in this aspect, as much as it may pain them to do so.

Saturday, October 10, 2009

The AIG Trifecta Part III – American General Finance

Now, the last part to the seemingly endless AIG trifecta, brought to you by this blog, chock full of ideas that may or may not make you money. (Now you know why I never went into sales).

American General Finance. I wonder, who came up with that catchy name? In any case, its subsidiary of AIG and it also has bonds out in the markets with double digit yields on them.

Should you buy?

First of all, understand that AGF is a consumer loan company. They will give people loans to buy a refrigerator or send their kid to college or (drumroll) to buy a house. The get their money from the same “wholesale” model that we discussed here with CIT and ILFC. For those who haven’t been reading, that means they issued commercial paper and mid-term bonds to the market. They would then lend that money to individuals (as opposed to businesses for CIT and ILFC).

I’ll link to the 10-Q, but here are the basic numbers: a loan portfolio of about $20.7 billion, of which (yikes) $15.5 billion are real estate loans. On the other side about $20.9 billion of long and short term debt.

AGF has the same problem that CIT faces: they don’t have access to capital markets right now to roll over debt as it matures. They also have the additional problem that their real estate portfolio -well- is not great. About a third is “sub-prime” (FICO less than 619), another 20% is “non-prime” (FIC0 between 619 and 660) and the rest is “prime” as defined by these guys (FICO over 660). (Nowadays, TRY getting a loan with a 660 FICO score…)

Delinquency rates are up and the average yield on the portfolio (about 10%) is high, but can’t support higher funding costs.

Trying to not get too numeric, there is a real problem here.

Fortunately for AGF, there are some things they can do. First, liquidity. They are in “collection” mode, as in collecting more than they lend out, so they are generating some cash. They are cutting costs by closing branches, etc. Plus, consumer loans and mortgages, as maligned as they may be are still “pseudo commodities” and they can be packaged and sold or securitized and used as collateral for lower cost loans (and AGF has done so). As long as AGF can collect and sell assets, they can service debt as it matures (until they run out, but that could take a while).

Second there is support. This year, AIG came up with over $750 million in fresh equity for AGF. That’s money AGF does not have to pay back (unlike the money AIG lent to ILFC). A “bailout”, if you will. AGF could need more in the future. How much? I’d say about $2 billion tops.
Additionally, AGF has “lent” its parent AIG over $1.5 billion at low (Libor plus 50 bp) rates, but at an interest rate nonetheless.

The idea is not to dwell on these transactions between parent and subsidiary, but to understand that as AIG and AGF become more intertwined, they also become less separable. AIG has only formally committed to supporting AGF until Aug 15, 2010. But how do they cut loose, once they have intermingled the finances of parent and subsidiary? It’s not that simple.

So the credit holder in AGF is basically watching a game of chicken with the government “supporting” AIG (can they really cut loose?) and AIG supporting AGF. Methinks that if all it takes is another $2 billion of equity infusion in AGF, AIG (and the government) will prefer to pay it than deal with the public opinion consequences of an AGF failure.
And frankly, who is going to know? Like anyone noticed when AIG put $750 million into AGF to shore it up this year. Two billion is a drop in the bucket in the whole AIG mess.

So there you have it, your “bailout” opportunity number three. AGF bonds are available in a number of flavors. Here are a few options:

I’m not particularly partial to this particular AIG flavor (AGF), but if you understand the risks, well that’s what its all about. Potential double-digit returns do not come without some risks these days, even if a government bailout is involved.

Psst. If you ask me, I’d get the short dated paper (May 2010), at least AIG has committed to support through that date.

And so ends the AIG trifecta. Yes, there is still more to AIG, like AIGFP, which was an integral part of the financial meltdown mainly due to the CDS it wrote on CDOs, like RMBS and CMBS, leading to TARP, TALF and many, many more acronyms.
But no.

Monday, October 5, 2009

The AIG Trifecta Part II – ILFC

As promised, the rest of the AIG trifecta. Part II is ILFC or International Lease Finance Corporation, an AIG subsidiary.

This part of AIG has been quietly “discovered’ by the mainstream press over the past year. So many of you may have read about it. LINK. LINK. (Very alarmist, not particularly insightful).

ILFC leases airplanes. Over 1,000 of them. They are the leaders in the business, which is dominated by themselves and GE Capital Aviation Services (a division of GE Capital).
Before you sigh and say “Oh no, the airlines are such terrible businesses, o dear me”, try to remember when they WEREN’T such terrible businesses. You can’t, can you? (unless you are really old, of course).

That’s why leasing exists and is so big for ILFC and GE. If the airline goes broke (as they periodically seem to do), the lessee takes its airplane back home and goes to play with someone else.

This has historically been good business. ILFC has been doing it since 1973, so they’ve been through ups and downs. This isn’t their first recession. The business is profitable: the company booked profits of $440 mm in the first half of 2009 and hasn’t registered a losing quarter as far as I looked back. LINK to 10-Q (if can you read these things).

So what’s the problem? Funding is the problem. ILFC would basically fund its operations two ways: commercial paper and notes (mostly medium term). It made sense, a typical airplane lease is three to five years, and so funding the purchases the same term is what would seem to be logical.
ILFC mid-term notes were even distributed on a retail basis as ideal investments for income-seekers looking for a bit more than the local bank offered (nothing strange with this, Ford, GMAC, GE, Dow and others do the same thing).

But when both the commercial paper and bond markets dried up, ILFC found itself in a bind. Notes were maturing at a quick pace and to boot they were a “part’ of AIG which was and to a point continues to be, financial caca (no touch!). The company was prepared (with credit lines) for temporary disruptions in the market, but this was and is and ongoing business. There were/are airplane orders in the pipeline, with which ILFC had to comply. These planes have airlines wanting them, but there is a cash imbalance in the process.

Mama AIG, now in government hands (kind of) has been both helpful and hurtful. On one hand AIG Funding lent ILFC $1.7 billion so it could keep up with maturing debt obligations and the purchase orders for new aircraft. (Taxpayer money? Not really, but the talking heads complain).

And AIG hasn’t been requiring dividend payments. But on the other hand AIG has been trying (unsuccessfully so far) to sell or otherwise dispose of this unit and that has undermined ILFC’s possibilities of obtaining stable (and inexpensive) sources of funding. Who is going to lend ILFC money (i.e. buy bonds), if they’re not sure what is going to happen to the company?

So there’s a kind of catch-22 going on with this. The press is focusing on the upcoming maturities as some kind of “impending doom”. Which I guess it could be. The notes are coming due constantly, as will the credit line (in 2010 and 2011).

However, if there is any rationality left in the market, this company should be able to come up with a solution, even if it is more stand-by financing by Mama AIG or even the government. AIG has committed to fund ILFC through August 2010.

A restructuring “a la CIT”, in which debt is capitalized wouldn’t seem necessary, since ILFC is far better capitalized than CIT. Not that it couldn’t happen, though. The ideal would be a return to the credit markets, which are thirsty for new paper. That return, however has been running into the concerns raised above about ILFC’s ownership.

The investment opportunity here is, of course, in ILFC notes and bonds, of which there many different options. The maturities are from now through 2013 and the yields currently around 11-13%. There are some large liquid issues, plus those retail “notes” that can sometimes be snapped up on the cheap, but which probably don’t have a good secondary market (so, you’ll have to hold them to maturity).

I’ve been a buyer, because frankly I can’t see a scenario where a Chap. 11 or a forced restructuring of this company makes sense. More likely they’ll come back to the credit markets sooner or later (as did Ford Credit) and get back to business.

It would be a shame that those shiny new 787 Dreamliners that Boeing is making should gather dust in the showroom.