There once was a time when Goldman Sachs and AIG Financial Products ruled the roost on Wall Street. Times are changing though as the vultures go for each other's jugular. Their weakness is PM's gain.
Regards - VHF
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Calling All Cash: please report to AIG FP
Financial Times
Sam Jones
April 19, 2008
Bloomberg on Monday:
"The one financial industry that seems to be dodging the subprime bullet is insurance. Only a handful of companies have had their safety ratings knocked down because of an excessive exposure to Wall Street’s toxic waste. The vast majority has enough capital to withstand the known problems on their balance sheets, the rating companies all say."
Turns out: not so much.
At least, not so much for AIG. The world’s largest insurer.
AIG is, in fact, a trainwreck, and the market is only just waking up to this.
A note from Goldman analysts this morning might just be the wake up call investors need. For an idea of tone, let’s flash through some of the headers:
Don’t buy AIG.
A dangerous balance sheet posing as an inexpensive entry point.
There’s nothing to be feared except fear itself…and mortgages.
Raising capital: Ultimate number too difficult to quantify.
The “base case” scenario for AIG under Goldman’s analysis is a further $9bn in losses on their CDS contracts. That widens to $20bn under the more likely “stressed” scenario.
As the note makes clear, $20bn isn’t the end of it either: there are so many unknowns, particularly given the physical settlement nature of AIG’s CDS contracts:
The idea of physical settlement in AIG’s CDS is often overlooked. Given the very substantial amount of cash AIG could be forced under the terms of its contracts to purchase protected securities at par, we are concerned with the lack of discussion around this topic by the firm and the rating agencies. Our understanding is that if AIG provided protection on a $1,000 security with an event of default, AIG would have to pay $1,000 to the holder of the security and then take physical possession of the security. Thus, a $1,000 security with a $100 loss does not imply a $100 cash outlay - in fact, it implies a $1,000 cash outlay in receipt of $900 of collateral. Given the “securities” in this example are
mostly CDOs and the “collateral” is largely mortgage-based, we suspect the regulators and the rating agencies will not look kindly on AIG’s swapping cash for mortgage assets. Of even more concerning relevance, the majority of the CDS written on CDOs require this form of physical settlement.
A $25bn loss on CDS alone isn’t out of the question. With that then, in mind, rating agency downgrades become an inevitability. And if AIG is downgraded, then the rest of its business will falter and its business model will come off the rails.
The rating agencies themselves are behind the curve. As Goldman note:
The central tenet of our “Don’t buy AIG” argument is simple: the intricacies of AIG’s business are so complex that management may not even know the extent of the company’s ultimate exposures, let alone losses… Thus, if management cannot accurately assess its ultimate exposures or losses, then how can one expect the rating agencies to do so?
Is any of this ringing any bells?
After another surprisingly negative quarter, it appears that investor confidence in AIG is damaged. We believe the stock may continue to drift down as investors remain wary of the possibility of a dilutive capital raise, the potential for ratings downgrades, and the corresponding effects on the underlying business. Put simply, we have seen this credit overhang story before with another stock in our coverage universe, and foresee outcomes similar in nature but on a much larger scale.
Goldman won't say it, but we will. AIG is going the way of the monolines... but on a much larger scale.
