American International Group (AIG) Reports 2Q12

American International Group (AIG) reported 2Q12 earnings after the market close 8/2/12 and held their conference call on 8/3/12. It is an excellent report and our investment thesis remains on track and is ahead of schedule.

You will recall our investment thesis is centered on the recapitalization of the company
since the financial and credit crises. As this recapitalization unfolds, underlying operations of the company must do sufficiently well to: 1) continue financing the recapitalization, and 2) demonstrate the ongoing future earnings power of the company to realize the full intrinsic value.

Progress is being made on all fronts in a significant way:

Source: AIG Conference Call Presentation

Restructuring is ahead of our thesis estimates:

  1. In June 2012 the outstanding loan by the Federal Reserve Bank of New York to Maiden Lane III was fully repaid. Through 8/2, AIG received proceeds of $6.1 billion on the Maiden Lane III interest with an additional $1.9 billion expected mid-August for a total of $8.0 billion. This compares favorably to our thesis estimate of $6.0 billion total and $3.0 during 2012.
  2. Insurance company distributions of $1.3 billion were made from the insurance subsidiaries (Chartis and SunAmerica) to AIG during the 2Q for a total $3.9 billion year to date. This compares favorably to our thesis estimate of $3.0 billion for 2012 and expected annual payments of $4-5 billion ongoing.
  3. AIG repurchased 66 million shares in May from the U.S. Treasury during the 2Q12 for $2.0 billion bringing the year to date total to $5.0 billion. Our thesis 2012 estimate was $12.7 billion with six months remaining in the year.
  4. Book value increased 5 percent during the second quarter of 2012 to $60.58 per share. This compares favorably with our thesis 2012 year end book value estimates of $60.89-63.33/share with six months to go.
  5. During the 2Q12 AIG issued $1.5 billion of senior unsecured notes and ILFC raised $753 million in secured debt to refinance existing secured debt and to purchase aircraft.
  6. In a filing on 8/2 (after the close of the 2Q) AIG announced that MetLife Inc. agreed to release $950 million held in escrow from a 2010 transaction sooner than previously planned.

On 8/1 the Wall Street Journal reported “AIG is looking to buy back a large amount of its shares from the government, according to people familiar with the company’s thinking…The U.S. will be permitted to sell more shares this week, after AIG reports second-quarter results Thursday.” Last week, Treasury Secretary Timothy Geithner said the government plans to sell “as much [of AIG] as we can, as soon as we can, because we want nothing more than recovering that taxpayer’s money.”

The spinoff of ILFC (original estimated proceeds of $5.5 billion) is waiting for improved market conditions according to CEO Bob Benmosche. AIG still retains a stake of 19% in Asian insurer AIA (original estimated proceeds of $8.1 billion) and likely to sell in early September when a lockup expires.

Expect more activity on the restructuring soon!

Update: Wow, that didn’t wait long, just after posting AIG announces Treasury to sell $4.5 billion of AIG common stock and AIG will purchase $3 billion. See news release here.

Operations were solid during the 2Q12:

  1. AIG earned $2.33 billion, or $1.33 a share during the 2Q12 compared to $1.84 billion or $1.00 a share during 2Q11 for a 33% increase.
  2. Excluding one-time items AIG earned $1.06 a share almost double Wall Street Analysts view of 57 cents.
  3. During the quarter Chartis operating income increased 19.5% to $936 million with improvement in the accident year loss ratio, business mix to higher value lines, global rates up 5.5% and U.S. rates up 8%.
  4. SunAmerica operating income increased 22.5% to $933 million with improvement in base yields and investment spreads and a 20% sequential increase in variable annuities.
  5. Interestingly the two insurance subsidiaries purchased $7.1 billion of the Maiden Lane III assets auctioned by the Federal Reserve with an average yield of 9.7% in a low yield environment.
  6. Mortgage insurer United Guaranty increased operating income sequentially from $8 million in 1Q12 to $43 million in 2Q12; the primary delinquency ratio fell sequentially from 11.4% to 10.3% and new insurance written increased sequentially from $3.1 billion to $8.5 billion. United Guaranty is becoming a core part of AIG’s business as it gains market share over damaged competitors.

Source: AIG Conference Call Presentation

Winding down Legacy Assets from AIG Financial Products:

AIG continues to wind down these assets from $46.9 billion in 2008 to about $1.8 billion 2Q12.

Source: AIG Conference Call Presentation

But what about this Wall Street Journal Headline on 8/3/12?  “AIG Spent $9.9B Buying Assets That Once Helped Hasten Collapse.” Sensationalism: it is just not true. AIG did
purchase about $2.8 billion of residential mortgage-backed securities (MBS) from Maiden Lane II. These MBS are mortgage bonds that yield an average of 10.4% (when
30 year Treasury bonds yield 2.5%). They also purchased $7.1 billion of collateralized debt obligations (CDO); basically mortgages bonds divided up into different risk categories yielding 9.7%. The MBSs and CDOs are assets AIG had to give to the government in return for the needed cash infusion during the liquidity crises.

The cause of AIGs liquidity crises was collateral calls by primarily banks on credit default swap (CDS) that AIG sold to financial institutions.  CDS are insurance policies insuring owners of MBSs and CDOs against losses in the event of a default on those bonds. During the housing crises those bonds went down in value requiring the insurer (AIG) to post more collateral for the insurance it wrote (the CDSs) even if the bonds did not default. This led to the need for the cash infusion to AIG to avoid further write downs at the banks. Owning bonds is a lot different than insuring someone else’s bonds against default.

AIG is performing well on both the restructuring and operational fronts. It is interesting listening to the conference call compared to last quarters call. The analysts are now more focused on core operations and seemingly less skeptical of the outcome of the restructuring. Investors are coming around to our point of view.

You can find the Earnings Press Release in its entirety here; the Financial Supplement here; and listen to the conference call here.

Disclosures: I am long AIG and AIG warrants.

The information contained herein is provided for informational purposes only, is not comprehensive, does not contain important disclosures and risk factors associated with investments, and is subject to change without notice. The author is not responsible for the accuracy, completeness or lack thereof of information, nor has the author verified information from third parties which may be relied upon. The information does not take into account the particular investment objectives or financial circumstances of any specific person or organization which may view it. Nothing contained within may be considered an offer or a solicitation to purchase or sell any particular financial instrument. Any investment can be very risky and is not suitable for everyone. You should never enter into an investment unless you can afford to lose your entire investment. Always complete your own due diligence. Before making any investment, investors are advised to review such investment thoroughly and carefully with their
financial, legal and tax advisors to determine whether it is suitable for them.

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