American International Group ( AIG) may have turned the government not only into a lender of last resort, but a buyer of last resort as well. AIG, the battered insurance giant, is reportedly facing a loss of up to $60 billion on Monday, according to several news outlets, and has received only paltry bids on several prized businesses it's been trying to sell to repay a massive government loan. A combination of factors -- a weak economic outlook, few bidders and those bidders' knowledge that AIG is desperate to sell -- have complicated the firm's efforts. In exchange for $150 billion in emergency funds last fall, the Federal Reserve Bank of New York received a nearly 80% stake in AIG in the form of preferred stock. AIG is required to pay out hefty dividends on those shares, but as it faces additional losses, AIG and the government are hammering out a new repayment plan and considering radical options to keep the struggling firm afloat.
Part of AIG's plan to repair its balance sheet and work back toward profitability was to scale down its gigantic amalgam of operations. It would hold onto its core property and casualty businesses, and some of its general and life insurance businesses abroad as well. The toxic assets that initially sent AIG to the brink of destruction -- $39.3 billion worth of residential-mortgage-backed securities and $16 billion in collateralized-debt obligations -- were placed into a "bad bank" structure to be managed by the New York Fed. Related credit default swaps were extinguished.
In theory, this plan might have worked out fantastically: The bad debt was wiped from AIG's books, and now it could sell off non-core assets for reasonable prices, repay its debt and get back to business. So far this year, AIG has closed nine transactions for subsidiaries across the globe in a range of businesses, including AIG Private Bank, which services high-net-worth clients; HSB Group, which provides insurance against equipment breakdown for industrial firms; financial subsidiaries in the Philippines and Thailand; two joint ventures in Brazil's banking industry; a gas-storage business called Tenaska; a Canadian life insurer; and other deals involving energy, infrastructure and commodities. Terms of four deals were not disclosed, though under the outlined terms AIG will receive as much as $1.8 billion for HSB Group, AIG Life of Canada, AIG Retail Bank, AIG Card Thailand, a commodity-index business and an energy and infrastructure book. While that sum is nothing to sneeze at, it doesn't go far in repaying a $150 billion loan. And unfortunately, AIG has been unable to solicit competitive bids for its remaining crown jewels on the auction block. According to several sources, those include American Life Insurance, its prized U.S. life insurance operation; American International Assurance, Asia's largest life insurer; International Lease Finance Corp., which has a fleet of over 900 planes; and a broker-dealer operation called AIG Advisor Group. While some of those crown jewels may have lost value in the downturn, they are still healthy businesses with a potential to rise back to their former glory, says Robert Hartwig, an economist and president of the Insurance Information Institute. For instance, the value of AIG's fleet may have come down as major carriers have flooded the market with their own jets, but when demand and wealth pick up, that value will return.
"The value of a franchise that specializes in aircraft leasing is going to go up or down with the cycle," says Hartwig. "But the point is, it's a large and valuable franchise." But the question is, when will those assets rebound? Time is precious for AIG, which is also looking to part with hundreds of other less-prized subsidiaries. Just within AIG Capital Corp. are 21 subsidiaries, which have 34 subsidiaries under those, and another 25 subsidiaries under that, and so forth. Joe Paduda, a former director of marketing in AIG's managed-care subsidiary, says the last time he counted, AIG was 280 different companies, but may whittle down to 50 once all is said and done. Paduda, who is now a principal at managed-care consulting firm Health Strategy Associates, was asked what AIG might look like after selling off non-core assets. "I'm not sure how to answer that because I'm not sure what AIG is," he responds. He later adds, "AIG is so convoluted and has so many cross-business relationships and intercompany transfers, it is byzantine. I was in president's meetings a decade and a half ago, and it was byzantine then. You'd have to get the big blue supercomputer to figure it out now." That dynamic adds difficulty in structuring deals that would dismantle one division, and also makes the government less interested in controlling the firm, Paduda says. In better times, AIG would have been able to sell entire blocks of business to private players, or offer ownership stakes, but unfortunately, none of those plans seem to be working out.
"The other solvent players in the industry are experiencing not the same kind of problems as AIG, but problems that are straining their capital base," says Adam Sherman, president of Firstrust Financial Resources. "So, those once-healthy suitors of AIG's businesses -- the Chubbs ( CB) of the world, the Fireman's Funds, the AXAs ( AXA) and the Prudentials ( PRU) -- are all dealing with their own capital issues and they can't pay the dollar amount that AIG would find acceptable." Sherman has been involved in the insurance business for over 15 years, and works with all the major firms to analyze product offerings for Firstrust clients. He says that while AIG wanted $4 billion for its American General unit, it only received bids in the $1 million range. CEOs of other large firms are performing due diligence for the assets AIG is shopping around, but "I don't think anybody feels comfortable buying something of that magnitude at this time, when the entire industry's
credit rating has been downgraded," Sherman says. Furthermore, buyers -- well aware of AIG's desperate situation -- are holding all the bargaining chips. "You know that your neighbor has got to sell his or her car," says David Steuber, co-chair of the Insurance Recovery practice at Howrey LLP. "It's sitting there and you know that they absolutely positively have to sell that car. What are you going to do? You're going to hold on and wait and wait and wait until you get the lowest possible price."
One industry observer, who has sat on the opposite side of the bargaining table from AIG, says buyers would be more interested if the government offered incentives, like guarantees on the firm's assets -- similar to deals structured for JPMorgan Chase's acquisition of Bear Stearns and Washington Mutual or Bank of America's ( BAC) buyout of Merrill Lynch. Otherwise, says the consultant, who spoke on condition of anonymity, AIG will have to offer its most attractive assets in the core P&C business to attract buyers. That course of action is problematic, however, because it would imply liquidation of the entire firm. Steuber also notes that while AIG is now shopping around prized assets, a big portion of the operations it needs to shed relate to financial services and asset management -- not attractive operations in the current recession. Furthermore, it may be unclear to buyers what lies beneath even a healthy-looking AIG business, as troubles have spread from residential mortgage-backed securities and credit default swaps to commercial real estate. Even AIG's "toxic" residential mortgage-backed securities portfolio now managed by the New York Fed was stuck within a business called "Life Insurance Companies," which was found within AIG's financial services arm. "They're trying to get rid of their dogs," says Steuber. "There aren't that many people out there who are in the market for big expenditures out there, nor is there anyone who's in the market for a dog." This dynamic lays out a few options for taxpayers, none of them incredibly favorable.
The Fed can exchange preferred shares for common equity, thereby halting dividend payments and giving AIG more flexibility to handle its losses. Such a move would also grant the government board seats and more control over operations, but give taxpayers a heap of penny stock instead of the cold, hard cash they were promised. Regulators may also be able to defer loan payments under revised terms, or take over some of AIG's cash-generating businesses in lieu of outright dollars. While the U.S. government may not be interested in operating life-insurance business, such a move would not be unprecedented, notes Steuber, who says state agencies have taken over bankrupt insurers in the past. While AIG's businesses may be larger and far more complex, keeping them running under the auspices of Uncle Sam will be far less difficult - and preserve more value - than letting the firm go under or selling assets at rock-bottom prices. After all, the government has the luxury of holding onto assets with greater economic value than the market is offering, until the market can repair its balance sheet and start making heady offers again. Such a deal might offer better return for taxpayers than all the money-losing businesses they have been forced to invest in so far. "If I'm Tim Geithner and I want to get the best return-on-investment," says Sherman, referring to the Treasury Department chief, "I would let AIG sit tight, repair itself and then chop off the company and sell off the healthy parts. But do it in an adequate timeline, not at these fire-sale prices." However, Paduda doesn't see this as a likely scenario. He notes that the government is handling multiple crises in the banking, auto and housing sectors, and isn't interested in running byzantine insurance operations for extended periods of time. "There's no question the feds want to get outside of this business as fast as they can," he says. "I wouldn't be surprised to see the feds tell AIG that if they get a decent offer for whatever they've got, you have to bring it to us and you have to sell."