The Rescue of American International Group Module C: AIG Investment Program

By September 2008, wholesale credit markets in the US, which has been under stress most of the year as a result on effects from the subprime mortgage crisis were showing significant signs of strain, which would only worsen when on September 15, the investment bank Lehman brothers filed for bankruptcy. (FCIC 2010, 349).  The effects of the bankruptcy were felt throughout the fincial system and created additional severe lending stresses as companies hoarded their cash.

For months, American International Group (AIG), a trillion dollar insurance and financial products company had been experiencing liquidity strains. Although its balance sheet was huge,  most of its  liquid assets and cash were held in its regulated insurance subsidiaries whose regulators would not permit the cash to flow to the holding company or other non-insurance subsidiaries. (FCIC 2010, 344). In the days prior to the Lehman bankruptcy AIG sought a loan from the Federal Reserve Bank of New York (FRBNY). (FCIC 2010, 345).

On September 16, 2008, the Board of Governors of the Federal Reserve, utilizing its emergency lending powers under Section 13(3) of the Federal Reserve Act, announced, with the full support of the Treasury Department, that it had authorized the FRBNY to lend up to $85 billion to AIG (FRBd 2008b; FRBd 2016). The FRBNY would enter into the  Revolving Credit Facility (RCF) with AIG, which offered AIG an immediate liquidity cushion to address funding strains some due to collateral calls from trading partners and counterparties of the AIG Financial Products (AIGFP) division (GAO 2011, 25). (See Buchholtz and Lawson 2021a for more details on the terms of the RCF.)

The RCF was the first federal assistance provided to AIG. However, it quickly seemed insufficient to alleviate AIG’s worsening capital and liquidity woes. The company drew $72 billion on the RCF by early November (FRBd 2016). Credit rating agencies continued to express concerns about AIG’s poor capital position and the size and stringency of the company’s debt to the FRBNY (GAO 2011, 8). The US government was also worried that investors would react badly to the upcoming announcement of major third-quarter losses. Negative news could adversely affect investor confidence and damage the value of subsidiaries that the company was trying to offload (GAO 2011, 52–53). The FRBNY even considered asking the rating agencies to take a “ratings holiday,” that is, to refrain temporarily from downgrading the company (GAO 2011, 53). To satisfy rating agencies and stabilize AIG’s financial condition, the government decided to restructure the terms of the RCF and provide further financial assistance to AIG (GAO 2011 , 52–53).

The funding to assist AIG was available through the $700 billion Troubled Assets Relief Program (TARP), authorized by Congress under the Emergency Economic Stabilization Act of 2008 (EESA) on October 3, 2008 (EESA 2008). Administered by the Treasury, TARP made available a variety of asset purchase and capital injection facilities “aimed at stabilizing the financial system and restoring liquidity, enabling the flow of credit consumers and businesses, and restoring economic growth” (Treasury 2009b, Summary).

Among them, the Systemically Significant Failing Institutions (SSFI) program aimed “to provide stability and prevent disruption to financial markets in order to limit the impact on the economy and protect American jobs, savings and retirement security from the failure of a systemically significant institution” (Treasury 2008c, 3). The SSFI  was later renamed the AIG Investment Program, as AIG was the only company to  benefit from the program (See Appendix A more information on the SSFI program.)

The AIG Investment Program, as the SSFI investments ultimately came to be known, was comprised of two components: the initial Nov 2008 TARP investment and, when that proved insufficient to alleviate AIG’s woes, the March 2009 investment.

November 2008 TARP Investment

On November 10, 2008, the Fed and Treasury announced that Treasury would invest $40 billion into AIG via the SSFI program, in part to facilitate repayment of a portion of the debt owed by AIG under the FRBNY’s RCF and in part to provide a cash buffer on AIG’s balance sheet (FRBd 2008b; Webel 2017,14). Since FRBNY’s RCF was extended prior to the passage of TARP, the preferred stock obtained in connection with the RCF loan was issued to an independent Trust established by the FRBNY, and managed by three independent trustees, appointed by the FRBNY, for the benefit of the US Treasury (Webel 2017, 9,11).  The original $40 billion, as well as any subsequent capital investments, were made possible through EESA, which gave Treasury, through TARP, the ability to invest in the equity of banks and other institutions, a power it did not have before.

AIG and Treasury signed a Securities Purchase Agreement on November 25, 2008, pursuant to which, in exchange for its investment, Treasury received 4 million shares of AIG Series D fixed-rate cumulative perpetual preferred stock (Series D preferred stock) and a warrant to purchase 2% of AIG’s outstanding common stock (Series D warrant) (Treasury 2008f, 6). Treasury transferred the investment directly to the FRBNY on November 25 on AIG’s behalf (Treasury 2008e, 8). The Series D preferred stock came with an aggregate $40 billion liquidation preference, adjusted to $10,000 per share, with a par value of $5.00 per share and a perpetual life span (Treasury 2008a, pdf 223). Treasury was to receive cumulative dividends on the preferred stock at a rate of 10% per annum paid quarterly when AIG’s board of directors declared dividends (Treasury 2008a, pdf 223). Any unpaid dividends were to compound quarterly. In addition, the Series D preferred stock ranked senior to all other series of preferred stock and AIG common stock (Treasury 2008a, pdf 223).

Dividends and Directors

If AIG did not pay dividends to Treasury for four quarters, consecutive or not, Treasury could nominate and elect the greater of two new directors to AIG’s board of directors or the number of directors equal to 20% of AIG’s board of directors (Treasury 2008a, pdf 111). Treasury would be able to elect its choice of directors as a separate class from all other AIG share classes (Treasury 2008a, pdf 111). Following four consecutive quarters of dividend payments, thereafter, any Treasury-elected director would have to resign. (Treasury 2008a, pdf 111).

Beyond the election of directors associated with unpaid dividends, the Series D preferred stock was non-voting except in the following cases (Treasury 2008a, pdf 111–112):

1. Any authorization or issuance of shares other than convertible preferred stock ranking senior or pari passu to the Series D preferred stock;
2. Any amendment that adversely affects the rights of the Series D preferred stock;
3. Any merger, exchange, or similar transaction unless the Series D preferred stock remains outstanding or is converted into or exchanged for preference securities of the surviving or resulting entity.

Warrant

The Series D warrant allowed Treasury, upon exercise, to purchase 53,798,766 shares of AIG common stock—then 2% of outstanding AIG common stock—at an initial strike, or exercise, price of $2.50 per share (Treasury 2008b, pdf 228). The strike price could be amended based on the market price of the common stock on the day of exercise (Treasury 2008a, pdf 136). The warrant had a duration of 10 years and could be “exercisable upon issuance, in whole or in part” (Treasury 2008b, pdf 136). However, Treasury agreed not to exercise any voting power of the common stock received from the exercise of this warrant at any point (Treasury 2008b, Sec. 4.6, pdf  39).

Executive Compensation

Since the November 2008 investment was made through TARP, AIG was required to change its compensation structure, bonuses, incentives, benefit plans, and other arrangements with senior executive officers to conform to Section 111 of EESA (Treasury 2008g). Section 111 included an “anti-abuse rule” aimed at preventing executives and top officers at institutions receiving TARP aid from reaping the benefits of federal assistance (EESA 2008). EESA provided Treasury the ability to change AIG’s executive compensation and corporate governance standards, including the compensation for senior executive officers; rules on bonuses, retention awards, or other incentive compensation provided to officers and other highly compensated employees; and the prohibition of “golden parachute payments” to the most senior executive officers, among other regulations (GAO 2009, 60).

Table 1, compiled by the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), summarizes the executive compensation and bonus pool terms included in the government’s November 2008 investment in AIG.

Source: SIGTARP 2009b.

Corporate Governance

In terms of lobbying restrictions, AIG had to adhere to a new “comprehensive written policy on lobbying, governmental ethics, and political activity,” wherein any changes to the existing terms required approval by Treasury (Treasury 2008f, 4). EESA rules also mandated that AIG create a new plan for corporate spending to be approved by Treasury. (Treasury 2008g).

The initial term sheet required AIG to create a risk management committee that would “oversee the major risks involved in [AIG’s] business operations and review [AIG’s] actions to mitigate and manage those risks” (Treasury 2008f, 5). The term sheet required AIG to create such a committee within 30 days of the investment, and it would have to be active, at the minimum, until Treasury no longer owned any shares of Series D preferred stock or common shares purchased through the Series D warrant (Treasury 2008a, pdf 45; Treasury 2008f, 5). Last, the term sheet stipulated that AIG was subject to the same reporting requirements that it had to follow under the FRBNY’s Revolving Credit Facility (Treasury 2008f, 4).

March 2009 TARP Investment

Despite the earlier government assistance, AIG’s woes continued and it worried about  another ratings downgrade; the ratings agencies were concerned about a number of factors, including the impact of the RCL on AIG’s leverage ratio. (FRBd 2008c) In March 2009, Treasury announced a second investment under the AIG Investment Program in the form of a $30 billion funding commitment, sometimes referred to as the Equity Capital Facility (ECF), which had a duration of five years, until April 17, 2014 (AIG n.d., 11). In return for the new funding commitment, Treasury received the right to purchase 300,000 shares of Series F fixed-rate non-cumulative perpetual preferred stock (Series F preferred stock) in AIG, as well as another warrant (Series F warrant), this time to purchase 1% of AIG common stock as of the date of the warrant ((Treasury/FRBd 2009; Treasury 2009 2–3). The ECF went into effect on April 17, 2009 (GAO 2009, 35).

The Series F preferred stock had a par value of $5.00 per share, with its liquidation preference beginning at $0 upon issue to Treasury (Treasury 2009d, 8) The stock’s liquidation preference increased by the amount drawn on the new commitment (Treasury 2009d, 5–6). According to SIGTARP, “the shares had no value until cash was disbursed from Treasury,” or drawn upon by AIG (SIGTARP 2009c, 62). For example, if AIG drew $1 billion from the March 2009 investment, the overall value of the Series F preferred stock would increase to $1 billion, reducing the available amount of the Treasury’s investment by an equal amount.

As part of the restructuring, the Treasury also exchanged its Series D cumulative preferred stock for 400,000 shares of Series E non-cumulative preferred stock. The new shares had characteristics closer to common stock are were intended to boost AIG’s balance sheet.

Commitment to make retention payments

 Treasury provided AIG $165 million of the total $30 billion commitment to make retention payments to AIG Financial Product employees (Treasury 2009d, 1). The ECF agreement required AIG to repay Treasury for its commitment via three installments of $55 million  each from its operating cash flow: on December 17, 2010. August 17, 2012, and April 17, 2014 (Treasury 2009d , 2).

Dividends

Under the Series F purchase agreement, AIG could not make dividend payments on any basic common stock or redeem any shares of common or other capital stock, without the consent of Treasury, prior to the termination of the March 2009 investment. The Series F preferred stock became the most senior of all AIG preferred stock (Treasury 2009a, 2). Treasury would receive non-cumulative dividends “at a rate per annum equal to the applicable dividend rate [10% per annum] on the applicable liquidation amount per share of the Series F preferred stock,” payable quarterly, in arrears on February 1, May 1, August 1, and November 1 every year, and payable when declared by AIG’s board of directors (Treasury 2009a, A-2).

As shareholders of the Series F preferred stock, Treasury had the right to nominate and elect the greater of two new directors to AIG’s board of directors or the amount of directors equal to 20% of AIG’s board (Treasury 2009a, A-7). However, unlike the Series D preferred stock, this right would become exercisable if dividends were not paid for any four quarters, whether consecutive or not (Treasury 2009a, A-7).

Warrant

Treasury’s purchase of the Series F warrant on April 17 enabled the government to purchase 1%, or 3,000 outstanding, unissued shares of AIG common stock (Treasury 2009e, 2). The warrant had an initial strike, or exercise, price of $2.50 per share and a 10-year limit “exercisable upon issuance, in whole or in part” (Treasury 2009f, 5). Moreover, Treasury agreed not to exercise any voting rights of AIG common stock acquired upon exercising the Series F Warrant (Treasury 2009f, 7).

Executive Compensation

Executive compensation restrictions were broadened with the passage of the American Recovery and Reinvestment Act of 2009 (ARRA) in February of 2009. Bonus restrictions from EESA that applied exclusively to senior executive officers (SEOs) extended to SEOs and the 20 next highest paid employees (ARRA 2009, 518). AIG was allowed to issue “long-term, restricted stock” to those same employees in lieu of now-prohibited bonuses, retention awards, and incentive payments, so long as the stock did not vest while AIG had TARP funds outstanding and the grant would not be more than one-third of total compensation to the employee receiving it (ARRA 2009 , 518). Prohibitions on golden parachute payments, likewise, were extended to SEOs and the five next highest paid employees.

Corporate Governance

There were no significant changes with respect to corporate governance in the March 2009 restructuring. After the March 2009 investment, Treasury issued additional guidance on these issues, summarized in their Interim Final Rule on TARP Standards for Compensation and Corporate Governance, released on June 10, 2009 (Treasury 2009c).

This rule was designed to implement the ARRA provisions and consolidate all of the executive-compensation-related provisions directed at TARP recipients into a single rule. The rule (1) limited executive compensation for certain executives and highly compensated employees at companies receiving TARP funds, (2) appointed a special master to review compensation plans at such firms, (3) implemented and expanded earlier Treasury proposals regarding the need for shareholders and directors to work together on compensation issues, (4) set additional compensation and governance standards for firm to improve accountability and disclosure. (Treasury 2009c).

For an overview of the two TARP investments in AIG in November 2008 and March 2009, see Table 2.

November 2008 Investment

On November 10, 2008, the Board of Governors, Treasury, and AIG announced a restructuring plan for AIG (which closed on November 25, 2008) (COP 2010b; Treasury 2008f). The November 2008 investment enabled AIG to repay some of the amount that it had drawn on the FRBNY’s RCF; the amount of available credit under the RCF was also reduced from $85 billion to $60 billion (FRBd 2016, 6).

The November 2008 investment helped to restructure AIG’s balance sheet, thereby avoiding any downgrades from the major credit rating agencies. It also contributed to a restructuring of the terms of the RCF under the Credit Agreement (YPFS 2018a). The AIG common stock into which the Series C preferred stock issued pursuant to the RCF could be converted was adjusted to 77.9% of AIG outstanding common stock to accommodate the 2% conversion under the Series D warrant, keeping the total conversion amount at less than 80% for accounting reasons (Treasury 2008f, 6) . Generally Accepted Accounting Principles (GAAP) standards, if the government’s ownership was 80% or greater, it would be deemed to control the company and would be required to consolidate AIG”s balance sheet with the government balance sheet, something the government sought to avoid, although ultimately, it would have to consolidate the company. (See Buchholtz and Lawson 2021a for more information on the changes implemented to the terms of the RCF and the preferred stock.)

With the expectation that 2008 fourth-quarter losses would be greater than $40 billion and that credit agencies would further likely downgrade AIG, the US government sought to provide additional aid to the insurance firm (COP 2010b, Sec. 1[D][1]).  In March 2009, the US government announced a second restructuring plan for AIG, which included exchanging the 4 million shares of Series D preferred stock worth $40 billion  for 400,000 shares of Series E preferred stock worth $41.6 billion^FNThe 400,000 shares of Series E preferred stock were valued at $104,011.44 per share, up from the $10,000 per share of the Series D preferred stock. The higher proportional value per share for Series E shares also includes about $1.6 billion in cumulative unpaid dividends that was due to Treasury on the Series D preferred stock (GAO 2011). (SIGTARP  2009c,  62). The Series E preferred stock provided for non-cumulative dividends, unlike the cumulative dividends of Series D, and limited AIG’s ability to redeem the preferred stock except with the proceeds from the issuance of equity capital” (SIGTARP 2009c, 62). The Series E preferred stock also permitted Treasury to elect new directors to AIG’s board of directors if dividends were not paid for four quarters, consecutive or not (SIGTARP 2009, 61).

The Series E preferred stock was also subject to a Replacement Capital Covenant, which stated that AIG could not repurchase the Series E preferred stock from Treasury prior to April 17, 2012, unless AIG replaced the Series E preferred stock with “qualifying equity replacement capital securities” (Treasury 2009d, 1). Eligible qualifying securities included common stock, qualifying warrants, qualifying non-cumulative preferred stock, or mandatorily convertible preferred stock (Treasury 2009d, 1).

In their initial report to Congress, Treasury and the Federal Reserve Board stated that the new Series E preferred stock would “more closely resemble common equity and thus improve the quality of AIG’s equity and financial leverage” (Treasury 2009b, 8–9). The Series E shares were seen as more like common shares because their dividends were non-cumulative, meaning the company was under no obligation to pay past dividends; the Series D preferred shares had been cumulative (GAO 2011, 10–11). This idea proved successful as credit rating agencies viewed the new Series E preferred stock more favorably than the Series D preferred stock when assessing AIG’s financial situation at the time (GAO 2011, 10– 11).

During AIG’s 2009 Annual Meeting of Shareholders, AIG stockholders voted to conduct a 20-to-1 reverse stock split, which affected the total amount of stock available for purchase under the Series D warrant, but nonetheless allowed Treasury to purchase 2% of the outstanding AIG common stock upon exercise (SIGTARP 2011, 61). Another vote during the meeting increased the exercise price of AIG common stock from $2.50 to $50.00 per share (SIGTARP 2011, 61). (See Buchholtz and Lawson 2021a for more information on the events of the 2009 shareholder meeting.)

In September 2010, Treasury, the FRBNY, and AIG, designed a Recapitalization Plan (Recapitalization) for all of the federal assistance provided to AIG (AIG et al 2010a). As part of the Recapitalization, Treasury converted the 400,000 shares of Series E preferred stock to 924,546,133 shares of AIG common stock, on January 14, 2011, representing 51.4% of all outstanding AIG common stock (AIG et al 2010a, 2).

Executive Compensation Controversy

In March 2009 it became public knowledge that AIG planned to pay $218 million in retention bonuses  to more thana 400 employees of its AIG Financial Product Division, which  had contributed to AIG’s near-failure . While the payments provoked public outcry, legal opinions from private parties and government counsels all concluded that the retention plans for those employees were contractually binding (SIGTARP 2009a, Summary). More specifically, because AIG agreed to the payments prior to the passage by Congress of the American Recovery and Reinvestment Act of 2009 (ARRA) on February 11, 2009, the payments were not subject to executive compensation restrictions enacted by EESA, ARRA, or related Treasury guidelines. (SIGTARP 2009a, 400).^FNFurther, Treasury’s interim final rules on ARRA compensation guidelines for financial institutions receiving federal assistance, published on June 15, 2009, also reiterated that restrictions did not apply to payment agreements agreed upon prior to the guidelines (SIGTARP 2009a, 30). In late March 2009, Treasury Secretary Timothy Geithner requested that the Department of Justice (DOJ) conduct an investigation into the retention payments and determine if there was a “legal basis to recoup the retention awards” (SIGTARP 2009a, 17). However, the DOJ concluded there were no alternatives to paying the bonuses that had legal merit (SIGTARP 2009a, 17).

March 2009 Investment

At the 2009 Annual Meeting, shareholders passed a resolution to reduce the par value of AIG common stock, which reduced the Series F warrant’s exercise price from $2.50 to $0.00002 per share (SIGTARP 2011, 63).

Prior to recapitalization, AIG had drawn about $7.5 billion of the $30 billion March 2009 investment (GAO 2011, 33). However, the March 2009 investment played a large role during the January 2011 recapitalization of AIG. Of the $7.5 billion drawn on the commitment, Treasury exchanged $2 billion of the Series F preferred stock for 20,000 shares of Series G preferred stock (AIG et al 2010; AIG 2011, 11). Treasury exchanged the remaining $5.5 billion of Series F preferred stock for approximately 167.6 million shares of AIG common stock at $2.50 per share (AIG et al 2010a, 1). Last, AIG drew down the remaining amount of $20.3 billion under the March 2009 investment to purchase from the FRBNY preferred interests in two special purpose vehicles established by AIG (AIA Preferred Interests and ALICO Preferred Interests). AIG had transferred such preferred interests to the FRBNY in partial payment for amount outstanding under the RCF. (AIG et al 2010, 1-2); AIG 2011, 10).

Treasury’s Stake in AIG after Recapitalization

The Office of Financial Stability (OFS), which was created with the passage of TARP to manage the program, was used to manage the shares that Treasury held directly. Treasury gradually sold the AIG common stock converted from the Series E and the Series F preferred stock during recapitalization to the public, with the final sale of the remaining stock coming on December 10, 2012. Treasury received $38.2 billion in net proceeds from the sales (Treasury 2013, 14). Treasury never exercised the Series D and Series F warrants, and in March 2013 sold both warrants back to AIG for approximately $25 million, in aggregate (Treasury 2013, 14).

2010 Shareholder Meeting

By the beginning of February 2010, AIG had not reinstated dividend payments to shareholders, which AIG’s board of directors had originally suspended to all share classes on September 23, 2008 (AIG 2008, 137). Therefore, on February 1, 2010, following more than four quarters without dividend payments, Treasury exercised its right to elect new directors to AIG’s board of directors granted by the Series E and Series F preferred stock (GAO 2011; Treasury/FRBd 2009). At the time of the 2010 Annual Meeting, since 11 directors held seats on AIG’s board, Treasury was able to nominate and elect the number of members equal to 20% of the board, or in this case, two new directors, increasing the total numbers to thirteen. (AIG 2010, 19).

According to the terms of the Series E and Series F preferred stock, any directors elected by Treasury would step down from AIG’s board of directors when dividends had been paid for four consecutive quarters following their election (Treasury/FRBd 2009). However, following the execution of the recapitalization, AIG’s Nominating and Corporate Governance Committee decided that it would be in the best interest of AIG and its shareholders to keep the two Treasury elected directors on AIG’s board of directors.