AIG deal may reap rewards

The Star-Ledger, September 21st, 2008

The Star-Ledger Archive COPYRIGHT © The Star-Ledger 2008

Date: 2008/09/21 Sunday Page: 001 Section: BUSINESS Edition: FINAL Size: 846 words

Series: THE BIG MELTDOWN

AIG deal may reap rewards

Large windfall possible if federal plan works out By SAM ALI STAR-LEDGER STAFF

How many times have you grumbled and griped that the big money on Wall Street has all the advantages?

Rich people with very deep pockets always seem to have sole access to money-making opportunities.

And ordinary investors usually can't afford a lick of it. Or share in any of the spoils.

Well, to all you "ordinary investors" who have long dreamed of playing in the private-equity sandbox, your time has arrived.

You're in it, baby.

Although critics have blasted Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke for socializing America's financial system when they stepped in to rescue American International Group this week, on the face of it, taxpayers didn't do too badly.

Craig Noell, managing director and chief executive at Sherman Oaks, Calif.-based hedge fund Signature Capital Partners, buys distressed loans for a living, and he likes what he sees.

"This is the kind of loan we love to do," Noell said. "We go into a situation where, either because of timing or bad press or other things swirling around the company, it's crashing against the rocks."

The way the deal is structured, the Fed is lending up to $85 billion to AIG, and the U.S. government will effectively get a 79.9 percent equity stake in the insurer in the form of warrants, called "equity participation notes."

That doesn't mean the government owns 80 percent of AIG – at least not yet, explained Jeffrey Lipshaw, an associate professor of law at Suffolk Law School.

Lipshaw said warrants are options to buy the stock – a right to own stock in the future, not present ownership.

The equity participation notes are another way of saying the government has an option to acquire an 80 percent equity stake in AIG down the road if the company for whatever reason does not pay back this really big loan.

On Friday, the Wall Street Journal reported some of AIG's shareholders were trying to rally to pay off the $85 billion loan early as a way to prevent the federal government from taking a majority control in the world's largest insurer. News sent AIG's flailing stock soaring $1.16, or 43 percent, to end the day at $3.85. Earlier this week, AIG teetered on the brink of collapse when it couldn't come up with enough capital to shore up its balance sheet.

Lipshaw said the government deal is structured like the "vulture capital" deals he used to do back in the late 1980s.

"This structure of a deal, where you loan money and then you take an option for equity, is very common in the vulture capital or venture capital industries," Lipshaw said.

In the meantime, AIG is paying taxpayers – you and I – a nice chunk of change for the privilege of borrowing all this money.

The two-year loan carries an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

That means the government is lending AIG the money at about 11.5 percent.

So, while the prospect of government ownership may smack of socialism to some – face it, it's hard to sniff at an 11.5 percent return on your investment.

In Goldman parlance, there's nothing wrong with taxpayers being "long-term greedy" for a change.

For years, these kinds of private-equity deals where investors swoop in, buy distressed assets, make some improvements and then sell them off for huge gains have been the purview of hard-core capitalists and high rollers such as George Soros and his ilk.

Simply put, the goal is to make a profit from companies that have failed to do so on their own and are on the brink of bankruptcy.

When done right, vulture investors can reap huge total returns, historically as much as 30 percent or more. On the flip side, they also can lose their shirts, if they guess wrong about the value of a business.

"There is a lot of similarities, because a lot of people would look at the value of the underlying units of AIG that are serving as collateral for the loan and say, that's a pretty interesting play," Noell said.

If everyone involved is to be believed, AIG should be able to sell or spin off some very profitable assets – some think AIG's lucrative commercial airline leasing business alone could fetch upwards of $20 billion – to cover the government's loan.

Jeremy Garvey, an attorney at the Pennsylvania law firm Buchanan Ingersoll & Rooney, which focuses on private capital financing, said taxpayers are lucky to have someone with Paulson's credentials – he is the former chief executive at Goldman Sachs – acting as their investment adviser.

"He obviously comes from the right kind of business background to understand these kind of deals and make these decisions quickly and understand what makes things tick," Garvey said. "These folks are deal folks, and they come from world-class organizations."


Sam Ali may be reached at sali@starledger.com.

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