AIG May Not Be as Healthy as It Looks
American International Group has come a long way since its record $182 billion government bailout in the financial crisis. It has been buying back its stock from the Department of the Treasury, helping to reduce Washington’s stake in the company to 70 percent from a peak of 92 percent. It posted a profit of $21.5 billion for the fourth quarter of last year, a showing that helped push the stock price up 40 percent this year through April 24, to $32.40 a share. Analysts for Wells Fargo and Bernstein Research are recommending the shares to investors as the company nears what they believe will be a complete exit from government ownership within a year.
Still, AIG may not be as healthy as it seems. Critics including Neil Barofsky and Elizabeth Warren, who helped oversee the government’s Troubled Asset Relief Program, contend AIG is benefiting from favorable treatment from Washington that amounts to a “stealth bailout,” in Warren’s words. And some analysts, including Morningstar’s Jim Ryan, say the insurer’s underlying businesses are struggling.
One point of contention is Treasury’s decision to allow AIG—along with TARP recipients Citigroup and Ally Financial—to use operating losses from previous years to eliminate taxes on current income. The allowance, which typically does not apply to bankrupt or acquired companies, added $17.7 billion to AIG’s fourth-quarter earnings and will allow the company to shield profits from taxes for many years to come. “It’s important to remember that a substantial portion of AIG’s recent earnings were attributable to Treasury’s unilateral decision to preserve AIG’s net operating losses,” says J. Mark McWatters, a law professor at Southern Methodist University who was a Republican appointee to the TARP oversight committee.
Treasury explained its decision on the tax waiver in a March 1 statement: “The government reluctantly” invested large amounts “of taxpayer dollars to prevent corporate failures from causing a collapse of the financial system and resulting in even more severe harm to Americans. Allowing those companies to keep their net operating losses made them stronger businesses, helped attract private capital, and further stabilized the overall financial system.” Mark Herr, an AIG spokesman, said executives could not comment because the company is in a quiet period in advance of announcing earnings on May 3.
Treasury’s rationale doesn’t fly with Warren, the former chairman of Congress’s TARP oversight panel who is now a Democratic candidate for the U.S. Senate from Massachusetts. “That kind of bonus wasn’t necessary to protect the economy,” she said in a joint statement with three other former committee members on March 12. “It also gives AIG a leg up against its competitors at a time when everyone should have to play by the same rules—especially when it comes to paying taxes.”
Barofsky, TARP’s former inspector general, believes the government is doing AIG—and itself—another favor by permitting the company to repurchase its shares at $29 each. Selling at that price allows Treasury to claim a profit on the government’s investment, based on its cost of $28.72 a share. The department calculated its cost by dividing the $47.5 billion in TARP funds AIG received by the 1.66 billion AIG shares it held before winding down its stake. Matthew Anderson, a Treasury spokesman, says the price is appropriate because it covers the government’s cost in acquiring the shares.
Barofsky calls the price “a political manipulation of numbers.” He argues the calculation shouldn’t include 563 million AIG shares that Treasury received from the Federal Reserve in January 2011 because the shares were not acquired as part of the TARP program. Removing those shares from the calculation would lift Treasury’s per-share cost to $43.53, which means TARP would show a $16 billion loss if Treasury sold the rest of its holdings at $29. “Treasury is misleading the market on TARP doing better than it actually is,” says Barofsky, who now lectures at New York University’s law school. “If I were an AIG investor, I’d think if they were being manipulative on this, then what else?”
Joshua Stirling of Bernstein Research sees the government’s eagerness to prop up AIG as a reason to buy the stock. “It seems clear that by allowing AIG to buy shares from the government ‘at cost,’” Treasury is helping AIG boost its earnings, he wrote in an April 4 report in which he changed his rating on AIG to buy from hold. “I’m thinking of this from the shareholder perspective,” he says. “The government and AIG all want it to end. Some of it, of course, is political; you don’t want the Tea Party to keep bringing it up.”
Morningstar analyst Ryan sees weakness in AIG’s basic businesses. He says the company’s property and casualty unit, which accounts for half its revenue, is “not making money selling policies and is having a very difficult time just earning its cost of capital.” Analysts at Sandler O’Neill + Partners expect AIG’s return on equity this year to be 5.1 percent, lagging large property-casualty peers’ average of 8.9 percent and life insurance peers’ 10.3 percent. The problem was made worse, Ryan says, when AIG sold a majority of its high-growth Asian life insurance business in October 2010 to help pay back the government. Keefe Bruyette & Woods analyst Clifford Gallant concurs. “Their insurance profits aren’t high enough,” he says. His price target for the stock: $25.
Treasury takes a “passive hand” when it comes to AIG’s operations, says Anderson, the Treasury spokesman. “We’re not saying ‘sell life insurance in this county, but not the other county,’” he says.
With its basic businesses struggling, Ryan says, “so much of AIG comes down to what it can earn on its investments.” In press interviews in March, AIG Chief Executive Officer Robert Benmosche indicated he wants the company to return to investing in mortgage securities—the very assets that helped take the company down in 2008. Meanwhile, 12 percent of AIG’s fixed-income portfolio is in junk or nonrated securities, according to company filings. That’s almost quadruple the level at Travelers, another big property and casualty insurer. “It concerns me that Benmosche says they want to be more aggressive in their investments,” says Ryan. “That’s what hammered them in the crisis.”