American International Group’s (AIG) underlying insurance operations show continued signs of stability, which bodes well for the troubled insurer. But analysts remain concerned about the impact of the government’s exit and the company’s recapitalisation efforts.
AIG reported a $2.7bn net loss in the second quarter of 2010 but adjusted net income, which excludes a $3.3bn goodwill impairment charge related to the sale of Alico to MetLife, was $1.3bn for the quarter.
“I think they have learned lessons so you have to be willing to give them the benefit of the doubt,” says Bill Bergman, senior analyst at Morningstar, who was sceptical of AIG’s first quarter results in May 2010. “It was helpful to see the stabilisation of incoming premiums and we haven’t seen any serious deterioration in underwriting profitability despite the fact they might have been underwriting business with more aggressive pricing in recent years.”
Bergman said that the stabilisation in results both in terms of incoming premiums and the profitability in the general insurance operations will be vital to the recovery of AIG.
On the surface it does seem that the performance of the general insurance operations is impressive and is likely evidence that AIG’s eye on a government exit can be supported by stable, core operations. However, Bergman warns: “We have learned to be respectful of the fact that the truth may be under the surface with AIG and not always on the surface with the accounting numbers.”
Chartis, the general insurance unit of AIG, reported second-quarter operating income of $955m, compared with $1bn in the second quarter of 2009. Chartis incurred around $287m of catastrophe losses in the quarter, principally related to the floods in the south-eastern US, Hurricane Alex, US hailstorms, the Deepwater Horizon oil rig explosion, and the Icelandic volcano.
The second-quarter combined ratio was 102%, compared with 98.2% in 2009. Net premiums written of $7.8bn declined 1.6% compared to the same period last year.
Included in the second-quarter results was a statement from CEO Robert Benmosche that demonstrates that AIG is actively planning separation from the government.
“In accordance with our longstanding commitment to repay our obligations to the US government, in recent weeks, we have commenced discussions with the Federal Reserve Bank of New York (FRBNY), the Department of the Treasury and the trustees of the AIG Credit Facility Trust with respect to a proposed strategy to repay the FRBNY Credit Facility and allow the government to exit its owner relationship with AIG," Benmosche said.
As of June 30, AIG had outstanding net borrowings under the FRBNY Credit Facility of $20.5bn, plus accrued interest and fees of $6.0bn. Net borrowings under the FRBNY Credit Facility decreased by $1.2bn from June 30 2010 to July 28 2010. At the end of the second quarter, the remaining available amount under the Department of the Treasury Commitment related to Series F Preferred Stock was $22.3bn.
Benmosche also reiterated his plans to close the sale of Alico to MetLife in the fourth quarter and proceed with an AIA IPO. “These two transactions are expected to allow the company to substantially reduce its obligations to the FRBNY and take significant steps toward a sustainable capital structure,” he said.
Earnings from AIG’s foreign life operations – Star, Edison and American International Assurance – were $820m, reflecting strong sales and investment income which has caused the market speculate on what this might mean for AIG’s intention to sell parts of its business.
MarketWatch reported that based on Star and Edison’s generated pre-tax operating profit of $216m, Sterne Agee insurance analysts have calculated that the life operations might be able to generate annual pre-tax operating earnings of $800m to $850m. Therefore, a deal price for Edison and Star in the range of $4 to $6bn would not be unrealistic, the Sterne Agee analysts said.
Commenting on the speculation Bergman told Reactions that it is likely “all options are on the table” and that he is sure “there is a lot going on behind the scenes that we don’t know about” with regards to creative solutions for selling subsidiaries.
Another promising result came from International Lease Finance Corporation (ILFC), the aircraft leasing unit, which produced a profit of $182m, despite higher interest costs, analysts at Keefe, Bruyette and Wood (KBW) pointed out.
MarketWatch also reported that ILFC intends to offer up to $900m of senior secured notes due 2014, $800m of senior secured notes due 2016 and $800m of senior secured notes due 2018 to repay a portion of its outstanding secured loans from AIG Funding.
In addition, United Guaranty Corporation (UGC) reported a profit for the second consecutive quarter, as residential mortgage trends showed signs of improvement and American General Finance (AGF) benefitted from lower loan losses.
Lastly, AIG’s Financial Products division continued to make progress on its wind-down and de-risking activities. “At the appropriate time, we plan for AIG to directly assume the management of the investment and debt portfolios, leaving only the derivatives portfolio within Capital Markets,” said Benmosche.
But while things are looking up for many of AIG’s operations there is still a long way to go. Bergman at Morningstar warns that AIG must remain transparent and credible in the future as it is going to take time to rebuild market perception, while KBW maintains its view that changes in the capital structure and specifically, generous exit terms by the US government, will be required to salvage value for AIG’s common shareholders.
“The underlying insurance operations have a tremendous franchise with a lot of earnings potential. The challenge is the parent’s capital structure, debt burdens, the Series E preferred stock and the impact of the eventual exercise and sales of the warrants,” said KBW.
Bergman at Morningstar adds: “The leverage there is so high. There is a range of outcomes that it is difficult anticipate any one of them, but there is a lot of work going on behind the scenes that hopefully will come into fruition both for taxpayers and shareholders.”