AIG’s Unsupervised Capital Structure Conflicts
Chaos occurs when government uses private deal making to invest in corporations. AIG gives lessons in this (as William Sjostrom explores) that characterize scores of other deals the New York Federal Reserve and US Treasury have been cooking up for a year, on-the-fly and without any administrative law or other legal supervision (as David Zaring and Steve Davidoff explore).
To see some of the problems, start with the following rundown of AIG’s current capital structure, as constituted by the NY Fed and Treasury without any oversight.
Senior Debt. The NY Fed is AIG’s senior secured lender, with about $50 billion in credit extended, along with other lenders to whom the company owes another $130 billion in long-term debt.
Senior Equity. The US Treasury holds AIG’s senior equity, a series of non-voting, non-convertible preferred for which it paid $40 billion (which AIG used, in turn, to reduce borrowings from the NY Fed). The US Treasury also holds warrants to buy about 2% of AIG’s common. It says it is about to acquire another series of non-voting, non-convertible preferred for $30 billion.
Mezzanine Equity. A Trust whose sole beneficiary is the US Treasury holds convertible preferred stock which, before conversion, commands 77.9% of AIG’s total share voting power.
Junior Equity. Finally, junior equity, the common stock, is held by numerous institutional and other sophisticated investors, with 10% of that held by AIG’s former CEO Maurice Greenberg.
The presumed purpose of this unsupervised intervention is to put voting control in the Trust so that, eventually if AIG is rehabilitated, that controlling interest can be sold in an orderly transaction to private investors, perhaps along with Treasury’s senior equity, and certainly after the NY Fed’s senior debt is repaid. Trouble is, the deal for the Trust’s equity is incomplete, and the overall structure seems replete with conflicts of interest.
Incomplete Deal. The Trust’s voting control is based on convertible preferred stock that, although issued earlier this month by AIG’s board under a charter giving it carte blanche to do so, isn’t exactly convertible into a controlling position just now.
Not Enough Stock. That is because AIG’s charter authorizes it to issue only 5 billion common shares and 3 billion of those already are outstanding. That does not leave enough common shares to enable the preferred to be converted so that it would command more than 40% of the total voting power. For that, AIG’s charter has to be amended to add at least another 12 billion in authorized common shares.
Junior Equity Approval Needed. Amending AIG’s charter to increase the authorized common shares requires a vote of AIG’s common stockholders, voting as a single class under Delaware corporate law. AIG’s board will propose just that that at an upcoming shareholder meeting, probably in May.
Given that approval would massively and conclusively dilute the common holders’ interests, the odds of that happening may not be great. Potential buyers of the preferred stock will accordingly insist on a discount to buy it, absent ability actually to convert it into common.
Par Value Too High. There is also doubt about whether the common into which the Trust’s preferred is convertible would be validly issued. That is because AIG’s charter says its common stock has a par value of $2.50. Under Delaware corporate law, that sets the minimum price at which AIG’s board can sell it.
Since the Trust’s convertible preferred does not appear to require paying anything additional on conversion, the minimum price depends on what was paid for the convertible preferred. Formally, Treasury paid a mere $500,000 for the convertible preferred, earlier this month. That is far less than the $30 billion it would take to pay a minimum of $2.50 per share for 12 billion common shares.
The deal papers suggest that the parties are assuming that the NY Fed’s earlier loans, with a current balance of about $50 billion, somehow count as part of the consideration AIG received for issuing the convertible preferred. Maybe a court could be so persuaded. But it is not free from doubt.
Junior Equity Approval Sought. That explains why AIG’s board also is to ask its common stockholders this spring to amend the company’s charter to reduce the common’s par value from $2.50 per share to $.000001 per share. Again, why common shareholders would vote for such an amendment is difficult to understand and buyers of the convertible preferred will discount their purchase price in light of this legal uncertainty.
Trust Conflicts. In addition, there is a question, which I broached last week, of how the Trust, and not Treasury or the NY Fed, owns the convertible preferred. The Trust has three Trustees, appointed by the NY Fed in consultation with Treasury. They presumably owe fiduciary duties as trustees to the Trust and Treasury and should vote and make other decisions in the best interests of the convertible preferred.
Yet the Trust’s convertible preferred voting rights make it now the controlling shareholder of AIG, with duties to the minority shareholders, meaning the common shareholders, including Mr. Greenberg. Interests of the Trust and Mr. Greenberg and other common stockholders likely will come into conflict.
Indeed, they already are in conflict, as the coming votes on charter amendments attest. They likely will continue to be in conflict in innumerable matters, including dividend policy. Again, this will not be a positive factor to buyers considering buying this equity.
Debt-Equity Conflicts. Finally, there are hidden conflicts between the NY Fed and Treasury. The NY Fed is AIG’s most important creditor and the US Treasury (and the Trust) its most important equity holder. The interests of creditors and equity holders are inherently in conflict. And yet these deals are being done as if the two have absolutely co-extensive interests.
Indeed, standard talk is that the “government” has made all these investments in AIG. But it has not. The NY Fed has its own balance sheet, and interests, wholly apart from the federal government’s. Treasury is inextricably part of the executive branch of the federal government. Their interests are not necessarily or inevitably aligned, let alone uniform.
Chapter 11 may be ugly, but it may be a lot cleaner than this mess. And at least at follows a tradition of legal supervision. No one is supervising the NY Fed or Treasury as they do these deals.