AIG and the Bailout of the Government Bailout

The government is apparently about to provide AIG with access to another $30 billion.  As part of that deal, the government will convert previously issued preferred shares to a new class of Series E Non-Cumulative Preferred Shares on decidedly less advantageous terms for the government.  The main difference was that the preferred shares originally provided for a 10% dividend that would "cumulate," that is would accrue yearly if not paid.  The cumulated (unpaid) dividends must be paid before common stock holders can ever receive a dividend.  The new Series E shares do not cumulate.  If the 10% dividend is not paid in any year, the obligation disappears. 

Moreover, the term sheet pretends that the new Series E shares will pay a 10% dividend but that is highly unlikely to ever occur.  If AIG does not pay a dividend for any four quarters, even if not consecutive, it must cede to the government two positions (or 20%) of the board.  Even if that occurs and directors are inserted onto the board, they must resign whenever a dividend is paid "for four consecutive dividend periods following commencement of such right."

If by chance the dividend is not paid during a four quarter period, it is not clear that the government directors will ever actually get on the board.  The term sheet merely provides that the government gets the right "to elect" two directors.  This suggests the need for a shareholder meeting.  Since the term sheet does not say anything about the government's right to call a meeting, this presumably means the government must wait until the annual meeting of shareholders at which directors are elected.  This could be as long as a year away.  Moreover, the government's right to positions on the board terminates after four consecutive payments from the "commencement of the right" not the actual election of directors.  Thus, AIG could conceivably make the four dividend payments before the government actually elects the directors. Presumably once the right is terminated, AIG can then miss four more dividend payments before again having to worry about the directors. 

This effectively means AIG could pay no dividend one year (it then wouldn't cumulate), triggering the government's right to board seat then pay the dividend the next four quarters (eliminating the government's right to board seats).  The pattern could repeat, effectively meaning that preferred shareholders receive a 10% dividend every other year.

In addition, it is not good governance to provide that directors may sit on the board for a brief time and then resign automatically once certain dividend payments are made.

This aspect of the bailout means that the government is giving more and getting less.

Comments

[Bill Sjostrom]

FYI: The director right is triggered for failure to pay for four quarters, whether or not consecutive.

[Inge]

What governance principals are governments following when providing financial bailouts to banks? The world as a global village also requires a system by which it is controlled in order to ensure successful capital markets. Has there been sufficient consideration as to how the bailouts may effect future inflationary risks?