Benmosche 9% Yield Hunt May Mean AIG Got Junk, Mortgage Bonds
American International Group Inc. CEO Robert Benmosche
Andrew Harrer/Bloomberg
American International Group Inc. Chief Executive Officer Robert Benmosche.
American International Group Inc. Chief Executive Officer Robert Benmosche. Photographer: Andrew Harrer/Bloomberg
American International Group Inc. (AIG)’s hunt to boost investment income may have steered the bailed-out insurer toward junk bonds and securities backed by home loans.
Chief Executive Officer Robert Benmosche is working to lift annual returns on AIG’s portfolio by as much as $700 million as he seeks capital in a public share offering after posting insurance underwriting losses. Benmosche is getting yields of 8 percent to 9 percent on about $5 billion invested this year after the Federal Reserve rejected AIG’s bid to repurchase mortgage bonds turned over in its bailout, he said last week.
“He’s either going out really long duration or really buying some suspect stuff,” said Paul Howard, director of research at Solstice Investment Research in Glastonbury, Connecticut. Benmosche’s target may have required buying high- yield corporate debt or mortgage-backed bonds in a “pretty big leap of faith” that higher interest rates won’t erode returns.
AIG needs to attract private investors to a stock offering that will reduce the U.S. Treasury Department’s 92 percent stake in the company. The New York-based insurer and Treasury plan to sell 300 million shares, according to a regulatory filing last week. AIG has dropped 36 percent this year through yesterday in New York Stock Exchange composite trading.
Yields on corporate bonds, which comprise more than half of AIG’s $238.3 billion fixed-income portfolio, are near record lows as the Fed keeps benchmark interest rates in a target range of zero to 0.25 percent. That’s forcing investors to buy lower- rated or longer-duration bonds to maintain returns.
‘Diverse Mix’
Warren Buffett, who competes against AIG selling insurance through his Berkshire Hathaway Inc., said in March that investors should avoid long-term, fixed-income bets in U.S. dollars as inflation may erode the value of returns.
AIG is buying a “diverse mix of assets to achieve attractive risk-adjusted rates of return in relation to insurance liabilities,” Mark Herr, a spokesman for the company, said in an e-mail without providing specifics on the purchases. The holdings are typically rated among the safest by the insurer’s regulators, he said.
AIG had about $21 billion in investible cash available as of Dec. 31 and had to broaden its search for investments after the Fed rejected Benmosche’s $15.7 billion offer to buy back a pool of mortgage bonds called Maiden Lane II. The Fed chose in March to auction the securities in blocks, rather than sell the entire pool back to the insurer, which had expected a yield of as much as 9 percent on the bonds.
‘Many Other Sources’
“We are, in fact, making very good progress investing” funds that had been earmarked for Maiden Lane II, Benmosche said May 6 in a conference call with analysts after AIG announced that first-quarter profit fell 85 percent on earthquake claims.
“Some of the investment is bidding on aspects of ML II,” Benmosche said. “However, we’ve found many other sources, and so approximately a third of that money has now been invested. Generally, the yields are between 8 percent and 9 percent.” He reiterated the yield range at AIG’s annual meeting on May 11.
The average high-yield bond, rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s, yields 7.19 percent, according to Bank of America Merrill Lynch index data. That compares with about 15 percent two years ago.
In order to achieve a yield of at least 8 percent on a corporate bond, an investor would typically have to move below BB, the highest-rated tier of junk, the index data show.
“In this world, there’s just no way he gets 8 or 9 percent without taking on significant risk,” said Marc Gross, a money manager in New York at RS Investments who helps oversee $3 billion in fixed-income funds. AIG was forced to take a bailout in 2008 after bets on mortgages brought the company to the brink of collapse.
‘More Business Risk’
The only corporate bonds yielding 8 percent or more are “crappy things,” said Lon Erickson, a money manager at Thornburg Investment Management Inc. in Santa Fe, New Mexico, who oversees $9 billion. “You’re getting some goofy structures as well with more business risk with some of the companies.”
About 7 percent of AIG’s bond portfolio was rated below investment grade as of March 31, according to a regulatory filing. That compares with 4.7 percent at Hartford Financial Services Group Inc. and about 5 percent at Lincoln National Corp., the other two insurers to take U.S. bailouts. Both have repaid their rescue funds. AIG said about 3 percent of its portfolio was unrated.
AIG added corporate bonds and residential mortgage-backed securities, while cutting state and municipal debt in the first quarter. Corporate holdings increased to $131.2 billion on March 31 from $126.4 billion three months earlier, while the RMBS portfolio expanded to $25.9 billion from $19.8 billion. AIG also scaled back investments in the debt of European nations whose ratings have been downgraded or placed under review.
Maiden Lane
AIG said it expects a 4 percent to 5 percent return on the larger pool of $21 billion in cash it had as of Dec. 31, including Benmosche’s higher-yielding bets.
The Fed’s decision to auction the Maiden Lane II bonds was a “huge problem” for AIG, Benmosche told the New York Times in March.
AIG may need to focus on boosting investment returns after taking charges related to its underwriting, said Meyer Shields, an analyst with Stifel Nicolaus & Co. The company put aside more than $4 billion in the fourth quarter to bolster reserves for policies sold in prior years.
To contact the reporters on this story: Noah Buhayar in New York at nbuhayar@bloomberg.net; Sapna Maheshwari in New York at sapnam@bloomberg.net
To contact the editors responsible for this story: Dan Kraut at dkraut2@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net
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