The New York Times
written by Steven M. Davidoff
October 7, 2010
The federal government’s exit plan from the American International Group involves one of the largest corporate reorganizations in history. It contemplates the conversion and sale of $49.1 billion in the government’s preferred share ownership interests, the $15.5 billion sale of A.I.G.’s Alico subsidiary to MetLife, the approximately $15 billion initial public offering of the company’s American International Assurance subsidiary and the repayment of a $20 billion loan to the Federal Reserve.
This is an example of how the government has employed a deal-like approach to its investments and used corporate finance tools to meet its goals. This restructuring also involves a rejiggering of the government’s ownership and control position in A.I.G., one that will bring the insurance giant under the direct control of the Treasury Department.
As part of the restructuring, the A.I.G. trust that formally held the insurer’s shares on behalf of the government will be dissolved. Instead, the Treasury Department will obtain direct ownership of 1.655 billion A.I.G. shares, giving it 92.1 PERCENT of the outstanding common stock. These shares will be issued in exchange for the conversion of the $49.1 billion in preferred shares held by the Treasury.
This is a Rubicon that the government had previously been unwilling to cross. In January 2009, the Federal Reserve had placed its preferred share interests into a trust. These shares held a 79.9 percent voting interest in A.I.G., so therefore whoever held these shares controlled the company. The A.I.G. trust, directed by three trustees, thus had complete control over the government’s voting interest in the company. The Fed stated that this step was taken at the time to “avoid possible conflicts with the New York Fed’s supervisory and monetary policy functions.” In truth, it was likely because of political reasons and fears that the government would be accused of trying to directly run A.I.G. – in other words, the usual “socialist” tag.
With the change in its stake, the government will now be able to directly vote and remove A.I.G. directors. This is a significant step since the investments in General Motors, Chrysler, GMAC (now Ally Financial) and initially A.I.G. were structured so that the government had more limited control, either by intentionally limiting the Treasury’s ability to appoint and remove directors or deliberately circumscribing Treasury’s ability to appoint a majority of directors in, for example, the case of GMAC. (I outlined all of these arrangements in a recent paper.)
In truth, this is likely just formalizing and simplifying in part the informal power the Treasury already wielded. The A.I.G. trustees have reconstituted the company’s board to include five newly appointed independent directors, while the Treasury has appointed its own two independent directors, a right it gained when A.I.G. missed dividend payments on the preferred stock issued to the Treasury. The Federal Reserve Bank of New York has also monitored A.I.G. and its compliance with its covenants under its loan agreement with the Fed, while a five-person team at the Treasury headed by Jim Millstein, its chief restructuring officer, is working to unwind the government’s investment in the company. Mr. Millstein, a former restructuring expert and investment banker at Lazard, has worked with the A.I.G. trustees to monitor the company and he recently discussed his efforts with Andrew Ross Sorkin of DealBook.
It appears that two years into the financial crisis, the Treasury has become much more comfortable with the idea that it could own and control directly a significant public company. This does not mean that Treasury officials will now sit on the A.I.G. board. The government will still run A.I.G. in accordance with the principles announced at the time of the G.M. restructuring. These include a statement that:
After any upfront conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.
Even so, the Treasury will now have the legal authority to deviate from these principles if things go awry. With luck, the Treasury will be able to sell down its position before any such significant issue ever comes up, if it ever does.
I spoke with Mr. Millstein and others at Treasury about this change of position. They cited some of these facts and also said the structure allowed all of the government’s A.I.G. stake to be held in one place in order to facilitate its eventual sale as well as to put the risk of equity where it really belonged, at the Treasury. If you are selling more than a billion of shares, you do not want multiple sellers. Additionally, this is really a problem that should be dealt with not by the Fed, but directly by Treasury now that it has the tools to do so.
This is in part why, as part of the restructuring, A.I.G. is drawing down $22 billion, the remainder of its money from the Troubled Asset Relief Program, authorized on the eve of the program’s expiration, to pay back a loan from the Federal Reserve Bank of New York. In exchange, the Treasury will be repaid from the sale of Alico, the initial public offering of American International Assurance and other asset sales, again simplifying the structure and making the Fed whole. This is in essence an exit for two entities — A.I.G. and the Fed. The Treasury will become the sole government creditor as part of this restructuring.
The restructuring is significant because it also puts the government over the 80 percent threshold in ownership, giving it 92.1 percent of A.I.G. It was previously thought that the government was limited from exceeding 80 percent, and in fact the bailouts of Fannie Mae, Freddie Mac and initially A.I.G. were structured so that the government owned approximately 79.9 percent of the companies. At the time, I wrote about possible reasons for this limitation and said that the main one was most likely an accounting reason: an interest exceeding 80 percent would require under accounting rules that the companies be consolidated onto the federal balance sheet, said Mr. Millstein at the Treasury. This would be significant, as Fannie and Freddie have about $5 trillion in liabilities, while A.I.G. still has approximately $750 million in liabilities and $860 million in assets, according to its last quarterly filing with the Securities and Exchange Commission.
I also spoke with Mr. Millstein of the Treasury on this point. He said the initial thinking on the A.I.G. bailout (which was done in a terrible rush) was to mimic those of Fannie and Freddie and avoid the consolidation issue. During this most recent restructuring, however, the government’s accountants grew more comfortable with the fact that this A.I.G. interest did not need to be consolidated since it was in connection with the bailout and only temporary. <=== BULLSH*T
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