Friday, February 29, 2008

taking another look at aig

on a market day like today, it's easy to lose one's cool. it's easy to let emotions take over and to make investment mistakes that will be regretted. i want to take a look again at today's most emotional stock, aig.

awhile ago, i recommended aig. after today's sickening session, it's now a bit lower than where i recommended it, about 47 or so. judging by today's price drop in the stock, there are lots of angry aig shareholders out there - rightfully so. two months ago aig did give assurances about the super-senior cdo book; a huge portion of that analyst day revolved around the safety and, basically, the non-material nature, of their cdo book.

aig displayed some arrogance that day, and now they look foolish. obviously the company took some hits, but they are still insisting that the ACTUAL losses won't be material. i happen to believe them, even though trusting these guys at this point MAY be a foolish exercise.

the truth is that aig was insuring a tranche of paper that was senior to the aaa paper in the CDOs. in other words, aig would not have to stand by and owe actual dollars on these CDOs until several moats were crossed. however, at least as it stands today, the cdo creators were smarter than aig. the company has the seeming audacity to stress that it will all wash out; which is still entirely possible. again, we have the management credibility issue. but if that's the case, what's the point of stopping the buyback and scaring the heck out of everyone with these charges? to me, it seems like maybe a bit of prudence is seeping into management's decisionmaking.

some are calling for ceo martin sullivan, ace greenburg's chosen one, to resign. that may not be such a bad thing, if it happens. he made promises just two months ago that turned out to be unfounded. who gets to stick around after that? prince at c didn't, and that's one reason why i think c's finally on its way toward recovery. but to be clear, i don't think sullivan is nearly "as bad" as prince was. i guess time will tell on that point.

of course, one of the lessons learned from c was that corporate america lets things fester. obviously, as that's human nature alot of the time. one of the perceptions on a day like today is to think that the cdo thing is completely out of control. the so-called equity portions of these pieces of paper, the initial really bad loans that were pooled, have long since been blown out. my opinion is this: on terrible days like today, try very hard not to let emotions get the best of you; try to make smart, long-term financial decisions based on facts; or at least very-well-thought-out "hunches," for lack of a better word.

one of the crucial issues here is how to value any financial institution, if the aaa paper that aig thought would never be written down is now written down?

now, again, i'm not saying this is the perfect-world solution (but maybe at this point the best one, given the world we live in); if the feds would step in and take positions in the insurers - pmi and mtg on the personal mortgage side and mbi and abk on the structured side - then the banks that have written this stuff down to zero or are about to in the wake of these aig revelations can begin to heal and be valued at what they should be, at least in most situations. what we're living through now, in my opinion, is quite abnormal.

lots of stuff out there about why the Cs, BACs, etc. of the world aren't down more; about why c doesn't immediately need more capital - the answer may lie in the belief that the "aaa wall" will not be breached; some say it has been. but if abk and mbi keep their ratings, rightly or wrongly, has it been breached? does a non-gloomy, it's really not THAT bad perception equal reality? we'll see, i guess. one thing i've learned over the years is that on fearful days like today, irrational fear, maybe, is many times looked back upon with disgust that we didn't see the opportunities in the dust. it's my opinion that one should never let the fear make any decision for you. it will be very intersting to see how this plays out, if the seemingly-needed government intervention ever comes to pass.

not all aaa paper is created equal. is 2007 paper better than 05/06 paper, due to tighter lending standards? in my opinion, the simple truth, once again, is that without home price appreciation, or at least a lessening of the decline in value and cancellations - the banks that are being counted on to lend as rates come down may not have the capital to do so. they have to build reserves and raise capital. that's the worse case, in my opinion. again, don't let fear itself deny you a great opportunity. try to look at things from more than one angle. it just may be that things are not as bad as they seem.

fortunately, agi is well capitalized. however, it MAY not last. it MAY be in the company's best interest to raise capital now, so that the losses will be absorbed without ratings being cut. my opinion, once again, is that this latest sell-off is a huge opportunity for those with patience. it is entirely possible that a material amount of these charges will be reversed back into earnings over the next few years as the mortgage loans backing the CDOs pay down. their portfolio has a weighted average life of just over 4 years. the stock is now at about 1x book value; it's a play on the rising middle class in china, india, russia, brazil and the rest of the world. remember - do your own DD!!

disclosure: long mbi, c and bac. i am looking to get long aig asap

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