AIG Wagers on Subprime Betting Second Time is Different
American International Group Inc. (AIG), the insurer that needed a $182.3 billion bailout from the U.S. government in 2008 after failed mortgage investments, is betting this time it’s different.
Chief Executive Officer Robert Benmosche has increased non- government-guaranteed residential and commercial-mortgage backed securities holdings by $11.1 billion since 2010 to $28.4 billion at the end of March, according to regulatory filings. The New York-based insurer has acquired debt sold by the Federal Reserve that the central bank acquired from AIG when the company was rescued, including $600 million of CMBS last month.
AIG, which is also bolstering its unit that insures home loans with low down payments, is wagering that a more than 35 percent plunge in property values, cheaper prices for the securities and fewer competitors justify returning to investments that four years ago required the government to step in when it was unable to meet margin calls to banks.
“This is massively illiquid, under-loved asset risk that’s actually really attractive,” Josh Stirling, an analyst with Sanford C. Bernstein & Co. said. “The one thing this doesn’t do for AIG is help simplify the story.”
Jim Ankner, an AIG spokesman, declined to comment.
Benmosche is targeting debt that may yield in excess of 10 percent as the Fed pledges to hold interest rates near zero through the end of 2014 to bolster the economy and help lower the 8.1 percent jobless rate.
Fed policy makers and Europe’s debt crisis have pushed down benchmark bond yields to below 1 percent, weighing on returns at insurers and forcing them to buy lower-rated or longer-duration securities to maintain profits. AIG has put more cash to work after repaying most of its bailout funds, regaining access to capital markets through debt and equity sales and having its outlook lifted by ratings company A.M. Best.
It reported pretax investment income of $7.1 billion in the quarter ended March 31, a 28 percent increase from a year earlier. That was the most AIG earned from its holdings since 2007 before the financial crisis.
Pressure to generate profit from bonds held to back claims has increased as the company’s property-casualty insurer Chartis posted underwriting losses in 2010, 2011 and for the first quarter of this year, meaning the business spent more on claims and expenses than it earned in premiums.
Chartis, which sells coverage in the U.S., Europe and Asia, is AIG’s largest unit, followed by the SunAmerica life insurer.
AIG, which held its annual shareholder meeting in New York today, fell 51 cents to $30.45 at 4:15 p.m., trimming its return this year to 31 percent. The shares may rise 24 percent to $37.77 in the next 12 months, according to the average of 13 analyst estimates compiled by Bloomberg.
“AIG today is far different from the risky pre-crisis AIG,” according to a May 7 presentation from money manager Whitney Tilson of T2 Partners LLC. He estimates the shares may be worth as much as $75 and will rise as the Treasury reduces its stake.
AIG has sold more than $50 billion in assets including non- U.S. life insurers and American General Finance Inc., which originated residential mortgages, to raise cash to repay the government.
The insurer was forced in September 2008 to take a bailout after it was unable to meet collateral calls from banks including Goldman Sachs Group Inc. (GS) and Societe Generale SA. An AIG unit in London led by Joseph Cassano sold protection to banks against defaults on collateralized debt obligations, which are pools of assets such as home loan bonds or CMBS. Values decreased after property prices began to fall in 2006 and mortgage delinquencies rose.
Maiden Lane Rescues
The Fed and AIG later agreed to create Maiden Lane III to purchase $62.1 billion in CDOs and Maiden Lane II to buy about $39 billion in residential mortgage-backed securities owned by AIG. The securities were purchased at about half their face value, reflecting markdowns AIG had already taken. Under the agreement, AIG can share in profits once the Fed is repaid.
AIG offered to pay $15.7 billion for Maiden Lane II in March 2011 when debt prices were rising. The Fed rejected the offer and began auctioning the securities piecemeal, fueling a selloff in credit markets that worsened as Europe’s sovereign fiscal crisis erupted. The central bank halted sales in June.
The Fed resumed disposals in January and February when it sold $19.2 billion of home-loan bonds to Credit Suisse Group AG (CSGN) and Goldman Sachs, helping the central bank unwind Maiden Lane II at a profit of $2.8 billion for taxpayers.
“It was a very successful sale,” with AIG buying $600 million, Benmosche said on a May 4 conference call discussing first quarter results.
The most junior types of originally AAA rated CMBS, among the debt underlying the MAX CDOs, typically offered yields about 17 percentage points over Treasury rates as of last week, according to a Morgan Stanley index.
AIG didn’t seek to purchase these CDOs before its bailout. It became involved through an option that Cassano’s unit issued to Deutsche Bank in 2005, which allowed the Frankfurt-based lender to create CDOs the insurer would be obligated to buy, according to a 2008 regulatory filing. Deutsche Bank exercised those options in 2007 and 2008, after the types of top-rated CMBS that would fill the CDOs had tumbled in value, the filing shows.
AIG’s more than $250 billion bond portfolio increased its CMBS holdings to $8.3 billion on March 31 from $7.3 billion at the end of 2010. Home loan bonds without government backing climbed to $20.1 billion from $10 billion over that period, according to regulatory filings. The largest additions were prime debt, with subprime securities rising $900 million to $2.2 billion.
Hedge funds and insurers have been buying property debt, including subprime bonds, which sparked the worst financial crisis since the Great Depression, as the U.S. housing market recovers from the worst slump in seven decades. Builders broke ground on more home than anticipated in April with housing starts rising 2.6 percent to a 717,000 annual rate, Commerce Department figures showed today.
With some bonds trading for as little as 30 cents on the dollar, senior securities tied to subprime home loans with expected lives of more than seven years will yield about 8 percent after accounting for projected losses, according to JPMorgan Chase & Co. (JPM) data.
AIG’s investing “obviously doesn’t make any sense if the world relapses and there’s a massive recession and unemployment goes to 30 percent,” said Sanford C. Bernstein’s Stirling.
Protocols created by the National Association of Insurance Commissioners starting in 2009 have also enabled greater buying of mortgage bonds by insurers. Under the rules, their capital requirements are no longer tied to credit ratings on the securities, which have mostly fallen to speculative grades.
Instead, regulators compare loss estimates from Pacific Investment Management Co. and BlackRock Inc. (BLK) against the values at which the debt is being carried.
AIG has also added to its business that guarantees home loans against default. Its United Guaranty Corp. unit said last week it hired Donna DeMaio, the former head of MetLife Inc. (MET)’s bank, to be chief operating officer.
United Guaranty has become the second-largest U.S. private mortgage insurer, according to industry newsletter Inside Mortgage Finance with a 23.7 percent market share in the first three months of 2012. That’s up from 14.6 percent a year earlier. Radian Group Inc. (RDN) is the largest.
The unit is “putting very good business on the books as we grow,” Benmosche said on a May 4 conference call with analysts.
While AIG is having to move out of traditional investment- grade bonds for yield, they’re not taking so much risk they’ll “blow themselves up again,” said Rob Haines, an analyst at debt research firm CreditSights Inc. in New York. “If they get a bloody nose again, the company will be punished very severely in terms of their stock price and their credit spreads, and I think they’re very cognizant of that.”
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