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Fairholme buying AIG stock, converts & debt


dcollon
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What puzzles me is that previously, Berkowitz stated these financials were way too complex to figure out. Now it seems with AIG and C that the fog has cleared for him. Is there anything anyone can find where he explains why the complexity is no longer an issue? I am not tryng to be critical, I am just trying to see what he now sees or at least how he now sees it.

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To his credit Aig is the ultimate contrarian investment, I mean the smart risk taking culture, shareholder oriented management and margin of safety, this company has none of it.  The debt might get paid but the common is a lottery ticket.  

 

Last 10 years worth of reserve adjustments (deficiency):

(16,016) (20,711) (24,606) (23,071) (19,556) (11,425) (4,286) (2,409) (2,601) (2,771)

Based on the current size of their reserves,Aig is a typical zombie insurer, that has only retained business because they've been competing on price...they still have 150 billion in notional credit default swap exposure thats currently marked to expire worthless but as we know could have interesting surprises.   

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Either he is making a big bet on inflation . . . the value of assets and earnings at C and AIG will outpace the value of their debt, or I have no idea what's going on.

 

I haven't seen a credible explanation for why AIG is solvent, much less worth anything.  I was surprised by his big equity investment in GGWP. 

 

He certainly seems to have been right about Sears, no matter how bad the stores look and their reputation may be, they are a cash flow machine . . . Sears wasn't hugely leveraged though.

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http://whereiszemoola.blogspot.com/2008/12/bruce-berkowitz-tips-pfizer-and-sells.html

Or take American International Group. If you looked at an AIG annual report six or seven years ago, you saw one paragraph on derivatives. You look at an AIG annual report today and you see 15 pages on derivatives. I don't think company insiders fully understand what's going on, let alone outsiders. So if I don't understand something, I've learned to walk away.
The AIG annual reports are just as complicated as when he said the above.

 

Maybe Berkowitz is going to prove everyone wrong again, but I simply can't see why he's so bullish on trash.

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It actually does not surprise me that Berkowitz has taken a position in AIG, especially given his stakes in Citi and GGP.  Underlying the investment is Berkowitz's determination that the AIG common is probably worth a lot more than what it’s trading at if there is a recapitalization of the company.  But note that Berkowitz is investing across the entire capital structure of AIG, not just in the common.

 

Remember when Bill Ackman briefly took a position in AIG after the bailout?  Why did Ackman take a position only to back out very quickly afterwards?  I think the reason is because he probably believed that AIG's subsidiaries were worth more than its liabilities and that even after the massive dilution caused by the government's stake, the common would have been worth more than what it was trading at given a recapitalization of the company or given an orderly discharge/conversion of liabilities within bankruptcy.  In fact, Ackman actually tried to get several large shareholders (and WEB) to recapitalize AIG after he took a position in the common. 

 

But nobody wanted to participate in a recapitalization in September 2008.  On top of that, the government’s plan turned out to be to completely dismantle the company and sell off its various subsidiaries at fire sale prices, which would definitely have made the common worthless.  After Ackman saw these two things happening, he immediately sold out.

 

Hank Greenberg, the man who built AIG into what it was and who knows the company better than anyone else, has consistently argued that AIG had a liquidity issue, not a solvency issue.  According to Greenberg, the problem with AIG was that the ratings downgrades forced AIG to post massive amounts of cash collateral on the credit default swaps that AIG FP had written, which caused liquidity issues, which caused further ratings downgrades, which required more collateral to be posted, and so on.  Basically, the derivatives death spiral that Buffett described in his 2002 letter (talking about Gen Re Securities, which could just as well have been named Gen Re Financial Products) happened to AIG.  I suggest that everyone read that description again very closely -- it basically tells you exactly what happened to AIG. 

 

Note that at the time of the AIG bailout, the underlying collateral on which AIG FP wrote credit default swaps was not in default.  But the Fed nevertheless made AIG buy the CDOs back from Goldman, Credit Suisse, and others at par in order to do a backdoor recapitalization of the U.S. and European investment banks.  We do not yet know whether the underlying collateral is totally worthless.  As of September 2009, the Maiden Lane III portfolio is still worth over $20 B (according to the NY Fed). 

 

In late 2008 and early 2009, Hank Greenberg also expressed disbelief at the government's plan to essentially dismember AIG.  He argued, rightfully I think, that AIG the global insurance company -- not including AIG FP and any other non-insurance subsidiaries -- was stronger as a whole than in parts.  If you disagree, then you should be thinking long and hard about whether it’s a good idea for Berkshire or Fairfax to continue to diversify their claims exposure abroad. 

 

So there is definitely a case to be made that AIG is solvent.  Now the question is: What has changed that has made AIG more attractive over the last two months?

 

First, the government has obviously changed its mind about completely dismantling AIG.  Although some of its crown jewels are being sold (at fair prices), the plan is to keep the company a global P&C company (Chartis) with a U.S. life insurance and retirement business. 

 

Here are excerpts from an article in the WSJ on January 4:

 

American International Group Inc. (AIG) will use shares of AIG common stock in the compensation packages of some of its top employees rather than stock units reflecting a "basket" of AIG companies, as it previously planned.

 

.  .  .

 

Chartis' spinoff was put on hold as Robert Benmosche, who became AIG's CEO in August, decided to focus on rebuilding the value of AIG units, according to a Wall Street Journal report.

 

It’s very telling that the “top employees” were willing to take common stock instead of a basket of stock units in the “crown jewel” companies.  They clearly believe that there is value in the much smaller AIG that will result from its latest divestitures. 

 

The second thing is that the capital markets environment has changed completely from 2008.  AIG could very well obtain enough capital from the markets in order to pay off some of its major creditors and be put on a more sound footing.  And there could be a number of debt holders who would be willing to convert debt to equity.  Like Fairholme for one.

 

I believe that Berkowitz is talking about his investments in C, GGP, and AIG in order to make sure that there is healthy interest in the institutional investor community to participate in recapitalizations of these company.  He is using some of his reputational capital . . . very much like a Buffett would . . . to demonstrate to the institutional investors that there is value to be had in these companies if they would only help shore up these companies' balance sheets.

 

We are potentially looking at a win-win-win situation, where senior creditors are either paid off or participate in a debt to equity swap, where taxpayers are eventually paid back, and where shareholders are not wiped out.

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to me, it comes down to the fact that bruce berkowitz runs a very concentrated portfolio while pushing $15B in assets. This really narrows down his universe of opportunities and makes plays like AIG/C which are contrarian but offer tremendous amounts of liquidity.

 

I have to disagree here with respect to his universe of investments being very narrow at this time because I think you are not taking into account that FAIRX is now a "go anywhere there is value" fund.  Bruce Berkowitz is smart enough to be trusted to use shareholder funds to invest up and down the capital structure of U.S. companies; he has the ability to invest in the equity markets and the debt markets, and he can help recapitalize companies by purchasing new issues or converting debt he owns to equity.  In an environment where many companies are overleveraged, this gives him plenty of places to put his money.

 

In fact, by being a big fund and having large amounts of capital at his disposal, he can influence the margin of safety in companies that would normally present no margin of safety for the outside passive minority investor.  He can also limit the size of these special situation investments to a reasonable percentage of his portfolio.  There are very few other people who I would trust with my money to make these sorts of outside the box investments -- those others would be Buffett, Wilbur Ross, and HWIC to a lesser extent.

 

This is an important discussion because it goes to the heart of the question of whether FAIRX is too big and should be closed at this time.

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txlaw,

 

I view Fairholme in much the same way as you.  Bruce has publicly said that it has been helpful to have more money as it expands their ability to look at different classes of ownership (ACF, GGP, FUR, etc...).  In the public funds world I think it is very hard to find managers who look across the capital structure and for individuals I think this is critical point since we all know that any asset can become overvalued or undervalued.  I want my manager looking at all potential opportunities and with more capital you get "invited" to be in those discussions more frequently.

 

I'm also excited to watch what he does with the fixed income fund they have recently launched.  

 

 

 

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txlaw,

 

I view Fairholme in much the same way as you.  Bruce has publicly said that it has been helpful to have more money as it expands their ability to look at different classes of ownership (ACF, GGP, FUR, etc...).  In the public funds world I think it is very hard to find managers who look across the capital structure and for individuals I think this is critical point since we all know that any asset can become overvalued or undervalued.  I want my manager looking at all potential opportunities and with more capital you get "invited" to be in those discussions more frequently.

 

I'm also excited to watch what he does with the fixed income fund they have recently launched.  

 

 

Right on.

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http://www.morningstar.com/cover/videocenter.aspx?id=324901

 

Bruce talks about Citi in the video above.  His basic premise is that Citi essentially went through bankruptcy without going through bankruptcy, courtesy of the Fed (I think).  The bad loans are working through the pipe, and the newest loans are their best loans.  Interesting point of view.  Not sure about AIG though..

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He didn't mention (but I find significant) that Citi only has 3% exposure to CRE and something like 50% of it's business is done in the so-called "emerging markets" (and I believe only 25% or so is done in the US).  There has been some pessimism about shrinking pie for the big banks as the US consumer delevers, but that wouldn't really hold back Citi to a great extent.

 

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The plot thickens . . . Hank Greenberg's company is selling AIG stock . . .

 

AIG American International Group holder Starr In'tl enters variable pre-paid forward sale agreement for up to 10M shares of AIG common

On 17-Mar, Starr entered into the agreement for the pre-paid forward sale of up to 10M shares, pursuant to 4 stock purchase agreements, each between Starr and UBS. The agreements provide for stock to be delivered to UBS at various anniversaries of 17-Mar-10. Starr will receive aggregate proceeds of $278.2M under the transaction

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  • 2 months later...

Recent comments from Bill Berkley about AIG's reserving are worrisome:

 

Chairman Berkley said at the media lunch that AIG is charging commercial customers "prices that are clearly uneconomic" as it works to retain clients.

 

"AIG continues to be one of the most aggressive participants in the marketplace," he said, while saying the company is "a little less aggressive" than it was a year ago. Still, he said, the company is no longer setting aside enough money to pay claims on the policies it's selling.

 

"AIG has reserving issues, in my opinion," Berkley said. "AIG's reserves are, at best, optimistic," he said, while allowing that he didn't have as much information about the bailed-out insurer's business as AIG does. "No one knows AIG's reserves as well as AIG does."

 

Berkley's comments seem to echo those of others, including CEO Ted Kelly of Liberty Mutual and Chubb Corp. (CB) CEO John Finnegan, who said AIG has been cutting prices to keep customers. AIG has vigorously denied the charge, and a study by the Government Accountability Office found no evidence after an earlier round of accusations from rivals a year ago.

 

http://english.capital.gr/news.asp?id=977783

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On the other hand, Benmosche sounded pretty optimistic at the hearing today, and the Treasury's restructuring officer basically said that the government will do what it takes to make sure that AIG has an investment grade rating without government support.

 

From the restructuring officer's testimony:

 

The mechanics of the restructuring plan itself are relatively straightforward in concept: sell sufficient assets at fair prices to pay off AIG’s obligations to the FRBNY, streamline AIG’s business portfolio, and recapitalize AIG’s balance sheet to support investment grade status without the need for ongoing government support. At that point, the Company will be a simplified life, property and casualty insurer with solidly capitalized insurance subsidiaries, adequate liquidity, and a stable balance sheet. Executing this plan will enable the government to sell its equity interests in the Company as soon as market conditions permit.

 

I only own AIG indirectly via FAIRX, but for those of you who actually own AIG common, you'll want to take a look at the testimony.  See http://cop.senate.gov/hearings/library/hearing-052610-aig.cfm 

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Couple of possibilities:

 

All CDS's have a maturity date, most don't go more than 6 yrs, they still have the TARP funds, its getting on 2 yrs since the bailout. If 1/3 of the exposure has matured the remaining 2/3 now has 50% more liquidity coverage - significantly reducing the overall risk.

 

MTM's are materially better today than they were when TARP funds were released, even post Euroland disruption. Much of the difference is quasi-permanent, & effectively additional equity; not part of the leverage formula, but acting as though it were - significantly reducing the overall risk.

 

Sell an asset at its MTM, there is no impact on BV - but the remaining assets have more equity backing them, & leverage declines. Swapping debt for an asset spinoff, is the same thing but cheaper. A $ of operating loss produces less of a NI loss - significantly reducing the overall risk.

 

If Katrina II shows up tomorrow what really happens. TARP 'maturities' get pushed out, additional $ get injected, the payout drain essentially flows up to the US Fed  - significantly reducing the overall risk.

 

What's left? Lots of potential gain for comparitively little risk - if you have the tolerance. 

 

SD

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It appears Steve Eisman is short AIG.  He appears to be one of the few guys that understood the subprime crisis (according to the big short).  He blew away Bill Miller with Bear Stearns and says AIG is either worth 0 or will be diluted down to about 7 when all the gov't dilution takes place.  Their aggressive pricing plays into this narrative.  With gov't backing they will write policies to keep the lights on.

 

Packer

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I agree but given how in hock AIG is, it appears that Berkowitz' IV may require some gov't generosity.  You can read Eisman's thesis on the web but it appears sound.  It looks there are multiple was to lose (bankruptcy & dilution) and one to win.  If AIG was in such good shape, and we know there is a "soft" market, then why is it discounting premiums?

 

Packer

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