AIG Slashes Munis by $5 Billion as Benmosche Builds Mortgage Bond Holdings

American International Group Inc. (AIG) cut municipal-debt holdings by about $5 billion and added mortgage bonds as Chief Executive Officer Robert Benmosche reshapes the insurer’s $249.4 billion fixed-income portfolio.

The municipal-bond portfolio fell to $39.3 billion on June 30 from $43.8 billion three months earlier, led by declines in holdings tied to New York and California, AIG said in a regulatory filing yesterday. Residential mortgage-backed securities jumped 21 percent to $31.4 billion.

Benmosche, 67, is seeking to boost annual returns on New York-based AIG’s portfolio by as much as $700 million as he attracts private investors to replace the U.S. Treasury Department’s majority stake. The insurer has said it has less use for tax-exempt municipal bonds after losses helped it accumulate deferred tax assets, which may be used to cut obligations to the government.

“They can sell the bonds and buy another instrument which yields higher,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. AIG’s trades are large enough to alter the balance in fixed-income markets, he said. “Munis have been suffering from a lack of supply.”

AIG had $4.9 billion of New York municipal bonds on June 30, compared with $5.5 billion on March 31, the filing shows. Holdings in California dropped by 10 percent to $5.2 billion.

About half of the $661 million in realized gains from bond sales in the quarter came from reducing munis. Mark Herr, a spokesman for AIG, declined to comment.

Munis Rally

AIG locked in gains from a market rally, said Howard Cure, New York-based director of municipal research for Evercore Wealth Management LLC, which has $2.8 billion in assets.

Muni bonds had their best second quarter since 1992, returning 4.45 percent, according to Bank of America Merrill Lynch’s Municipal Master Index. The securities outperformed corporate debt and Treasuries in the period.

AIG’s general-obligation New York holdings are concentrated in local governments. Governor Andrew Cuomo’s budget cut school aid by $1.3 billion and capped Medicaid, the federal-state health-insurance program for the poor, at $15.3 billion. Local governments that would otherwise have relied on property taxes to bridge those cuts will have trouble raising them because of a tax cap approved in June, Cure said.

“Local issuers are a little more vulnerable because the state has balanced its budget on the backs of local governments,” he said.

California Debt

California, with the lowest credit rating of any state from Standard & Poor’s, is typically the largest issuer of U.S. municipal debt. It didn’t sell any general-obligation bonds in the second quarter as legislators debated solutions for a $26 billion deficit.

“California is a good sale because they haven’t been issuing a lot of extra bonds, and the state has richened up,” said Chris Ryon, who co-manages $6.5 billion in municipal bonds at Thornburg Investment Management in Santa Fe, New Mexico. “It makes sense to sell that.”

Budget pressures facing states and municipalities are forcing governments to raise taxes, cut spending and tap reserve funds, AIG said in the filing. The insurer “does not expect any significant defaults in its portfolio holdings of municipal issuers in the foreseeable future.”

Unrealized gains on AIG’s municipal bond portfolio widened to $1.59 billion from $1.16 billion on March 31. Residential mortgage-backed securities widened their unrealized loss to $156 million from $142 million on March 31.

Fair Value

The insurer cites fair values for fixed-income securities, which reflect fluctuations in market prices. The reductions in the municipal portfolio included “approximately $5 billion in sales,” according to the filing.

Yields on benchmark 10-year top-rated tax-exempt municipal debt are at about 2.5 percent, their lowest since November, according to data compiled by Bloomberg.

AIG set a goal of boosting annual returns on its portfolio after the Federal Reserve Bank of New York rebuffed Benmosche’s $15.7 billion offer to buy back a pool of mortgage bonds. The insurer had built up cash at the end of last year to buy the bonds, part of a pool called Maiden Lane II that was created to take the assets off AIG’s books after its 2008 bailout. The Fed began to auction the bonds in April.

Maiden Lane

Benmosche said in May that he had invested about a third of the cash slated for buying back Maiden Lane II at yields between 8 percent and 9 percent, without specifying asset classes. The company purchased some of the Maiden Lane II assets after the Fed decided to auction them, according to the filing.

Residential mortgage-backed securities purchased in the second quarter had “experienced deterioration in their credit quality since their issuance,” according to the filing. It’s “probable” that AIG won’t collect all required interest and principal payments on the bonds, the insurer said.

About 9 percent of AIG’s bond portfolio was rated below investment grade as of June 30, compared with 7 percent three months earlier, according to the filing. AIG said that 3 percent of its portfolio was unrated.

Subprime Securities

Subprime-mortgage securities have declined about 15 percent to 20 percent this year, JPMorgan Chase & Co. analysts said last month. The Fed’s since-halted sales of the securities once held by AIG and Europe’s sovereign debt crisis have helped drive down the market.

Losses in prior quarter helped the insurer rack up more than $25 billion in deferred tax assets through Dec. 31. To use them, the company must generate profits. The insurer posted second-quarter net income of $1.84 billion yesterday on investment income from its stake in AIA Group Ltd., the Asian business it sold last year in an initial public offering as part of a plan to repay the government.

The insurer declined 19 cents to $26.21 at 9:46 a.m. in New York Stock Exchange composite trading. The company has fallen about 46 percent this year, compared with the 3.9 percent decline of the Standard & Poor’s 500 Index.

AIG was first rescued in September 2008 after losses on housing-market bets by the Financial Products unit. The bailout was revised at least four times, swelling to $182.3 billion, to extend more credit and lower the interest charged.

AIG repaid the last $21 billion it owed the New York Fed and the Treasury converted its preferred stake into 92 percent of AIG’s common stock in January. That holding was reduced to 77 percent in May when the government and AIG raised $8.7 billion in a share sale.

-- With assistance from Brook Sutherland and Jody Shenn in New York. Editors: Dan Reichl, Pete Young

To contact the reporters on this story: Noah Buhayar in New York at nbuhayar@bloomberg.net; Sarah Frier in New York at sfrier1@bloomberg.net;

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net

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