Government Prays a Bigger Sucker Is Out There: Jonathan Weil

AIG's Robert Benmosche

Look through the footnotes in American International Group Inc.’s latest annual report, and you will see a long section analyzing the company’s ability to use past losses to offset future income-tax obligations.

The gist: AIG’s executives have gazed into their crystal ball and concluded that the company’s prospects don’t look good. That dim outlook may help explain why the U.S. Treasury Department seems so anxious to begin reducing its 92 percent stake in the bailed-out insurance company, after a 36 percent drop in AIG’s stock price this year.

The disclosures to watch here have to do with an item known as deferred-tax assets. Typically these consist of tax-deductible losses and expenses carried forward from prior periods. Companies can use these to lower future tax bills.

Under generally accepted accounting principles, such carry-forwards are valuable only to companies that are profitable and paying income taxes. If a company doesn’t expect to fully use these assets, it’s required to record what’s called a valuation allowance on its balance sheet to reduce their carrying amount.

In AIG’s case, the company has set up a full valuation allowance against its deferred-tax assets. AIG said it did so based on management’s conclusion that the assets “more likely than not” won’t be used. Forward-looking indicators don’t get much more bearish than this.

Here are the numbers: AIG said it had net deferred-tax assets of $24.5 billion as of Dec. 31, before factoring in the allowance. With the allowance, which was $25.8 billion, AIG finished last year with a $1.3 billion net deferred-tax liability -- in effect, a future tax obligation.

Wipe Out

In other words, the allowance more than wiped out the net assets. This wasn’t the case a year earlier. At the end of 2009, AIG showed net deferred-tax assets of $5.9 billion, including the allowance. AIG hasn’t disclosed what its tax assets were as of March 31, and a company spokesman, Mark Herr, wouldn’t say.

The footnotes also show a breakdown of the different types of AIG’s carry-forwards on a tax-return basis. For example, as of Dec. 31, AIG said it had $11.3 billion of net operating loss carry-forwards that expire from 2028 to 2030. It would need about $32.3 billion of taxable income from its operations over 20 years to fully reap those benefits, assuming a 35 percent tax rate. AIG concluded it likely won’t realize any of them.

“The implication is there are significant questions about future profitability,” says Charles Mulford, an accounting professor at Georgia Institute of Technology in Atlanta, who reviewed AIG’s disclosures at my request. “It should give investors pause.”

Going Bust

A full allowance is something you normally see only at companies in huge trouble. Over the past decade, Delta Air Lines, Bethlehem Steel and General Motors, among others, all took big charges to earnings to boost their deferred-tax allowances -- before filing for bankruptcy. Other companies, such as Citigroup, have drawn criticism for taking the opposite approach: Even when they were on death’s door, they still hadn’t recorded any such allowance.

AIG executives lately have been spinning the company’s tax assets as a good thing. The company is trying to complete a big stock sale, after all.

During a May 6 conference call with investors, AIG Chief Executive Officer Robert Benmosche called the company’s deferred taxes a “source of funds” that the company could use to buy back stock someday. David Herzog, AIG’s chief financial officer, referred to the company’s tax assets as “very valuable.” In a slide-show presentation for investors this month, AIG said it has “substantial deferred tax assets that are available to offset future tax obligations.”

No Change

Yet for these assets to be valuable, AIG will need an opportunity to use them. Chances are it won’t be able to, if we’re to believe what the company said in its annual report. That position hasn’t changed. In the prospectus it filed May 11 for its stock offering, AIG said it still holds a full valuation allowance on its balance sheet.

It’s conceivable that AIG’s forecasts might prove too conservative, reflecting an overabundance of caution. In that case part of the allowance might be reversed later, boosting net income. Yet we probably should take management at its word that the full allowance is needed. This isn’t the kind of stance a company would adopt unless it had to.

Public Offering

This month AIG and the Treasury Department said they plan to offer 300 million common shares to the public, two-thirds of which would come from the government. Most companies that repaid their taxpayer-bailout funds, such as JPMorgan Chase & Co. and Bank of America Corp., did so in cash. Not AIG.

AIG paid back the $47.5 billion that the Treasury injected into the company by converting its stake into common stock. Those shares were worth about $51 billion based on AIG’s $30.83 closing price yesterday.

It stands to reason that AIG would have repaid Treasury in cash if it could have afforded to do so. That its executives, at least for accounting purposes, hold such a gloomy view of the insurer’s prospects only reinforces the notion that AIG still is an unhealthy company. Anyone looking to buy the stock now had better hope they know something management doesn’t.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

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