AIG’s Bailout Far More Punishing than Fannie and Freddie

Finally we get the details of the draconian American International Group (AIG) bailout: “AIG SIGNS DEFINITIVE AGREEMENT WITH FEDERAL RESERVE BANK OF NEW YORK FOR $85 BILLION CREDIT FACILITY” The deal should certainly make the Fannie Mae (FNM) and Freddie Mac (FRE) shareholders feel lucky.

Funding: The GSEs will be forced to issue up to $100B each in 10% senior preferreds (12% if in arrears) to the government to cover any negative net worth. AIG is being given an $85B credit facility charging an interest rate of 3 month LIBOR plus 8.5%. All draws are conditioned on the Federal Reserve Board of New York’s satisfaction with AIG’s corporate governance, liquidity and other factors. Proceeds from asset, debt and equity sales are required to be applied to repayment of the facility, and these mandatory repayments reduce the amount available be borrowed.

The GSE agreements are like revolvers, the Treasury senior preferreds can be paid down and reissued as necessary. Unlike the GSEs, each dollar in the AIG facility can be borrowed only once. If AIG borrows $25B and repays that amount from asset sales, the open facility would still drop to $60B.

The GSE facility concludes at the end of 2009, but the senior preferreds don’t have to be paid down when the facility ends. AIG must repay all outstanding balances when the facility ends in 24 months.

Dilution: Both the GSEs and AIG will end up giving 79.9% of their common equity to the government upfront. The GSEs issued warrants. AIG starts by issuing preferreds (to be converted to common) that are granted the equivalent of 79.9% of voting rights and 79.9% of any common dividend. The GSEs’ conservator has the equivalent of 100% of their voting rights. The GSEs have eliminated both common and preferred dividends, while AIG only eliminated common dividends.

Fees: The GSEs initiation fee was $1B each in senior preferreds. AIG pays a 2% initial gross commitment fee on closing, plus an annual commitment fee of 8.5% on the undrawn balance. This makes AIG’s net cost of drawing funds 3 month LIBOR, since they have to pay 8.5% whether they draw or not. It is not clear whether the basis for the annual commitment fee is reduced by mandatory repayments.

Conclusion: Both the GSEs and AIG lose 79.9% of their common equity upfront. The GSEs initial commitment fee is 1%, compared to 2% for AIG. The GSEs sell equity, while AIG only gets loans. The GSEs facility is revolving, the AIG facility is not. The GSEs pay only for the funding they need, AIG pays nearly the same whether they use the entire facility or not.

My rough estimate is that the facility could cost AIG $20B over the 24 months, in addition to the 79.9% dilution. The biggest difference between the GSEs and AIG is that most of the GSEs cost of funding is variable while most AIG’s cost of funding is fixed.

The real question for investors is which if any of these companies will return to private shareholder control? I think there is a higher probability for AIG, but recent stock market activity is showing some life in Fannie and Freddie.

Disclosures: Author is long AIG, FNM and FRE.

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