American International Group (AIG) Reports 2Q14 Results; Thank you Mr. Benmosche!

American International Group (AIG) reported 2Q14 earnings [Source]. This is CEO Robert Benmosche’s last earnings report as he retires and assumes an advisory role with the company effective September 1, 2014. Under Bob Benmosche’s leadership AIG has recovered from its near collapse and has made amazing progress bringing focus back to the core insurance businesses, repaying the $182 billion bailout and selling non-core assets. He will be succeeded by Peter Hancock who currently serves as Executive Vice President of AIG, and Chief Executive Officer of AIG Property and Casualty unit.

Bob Benmosche sums up his last quarter this way: “AIG’s results in the second quarter were solid. Overall, our businesses demonstrated our continued discipline and resilience, underscoring our focus on improving the results of our core insurance businesses. In many ways, this quarter, my last as President and CEO of AIG, was punctuated by two significant milestones: the completion of our sale of ILFC to AerCap, which marks the last disposition of AIG’s non-core businesses, and the appointment of Peter Hancock to succeed me as AIG’s next President and Chief Executive Officer.”

Financial Highlights:

AIG 2Q14 Financial Highlights

 

1) Computed as Annualized Net income (loss) attributable to AIG divided by Average AIG Shareholders’ equity, excluding AOCI. AIG Second Quarter Conference Call Presentation [Source]

AIG reported net income of $3.1 billion for the 2Q14 compared to $2.7 billion for the 2Q13 for a 12.5% increase. After tax operating income was $1.8 billion for 2Q14 compared to $1.7 billion for the 2Q13. Diluted earnings were $2.10/share for 2Q14 compared to $1.84/share for 2Q13 and after tax operating income were $1.25/share compared to $1.12/share in 2Q13. These results include the $1.4 billion gain on the sale of the aircraft leasing unit AerCap Holdings NV.

Book value was $75.71/share up 15% from 2Q13 and book value excluding accumulated other comprehensive income (AOCI) was $67.65/share up 10% percent over the year ago period 2Q13.

Capital Plan:

The capital plan remained on center stage during the past quarter.

With AIG shares trading at about 30% below book value it’s hard to think of a better allocation of capital than share repurchases. Accordingly, the company repurchased 18.1 million shares of AIG Common Stock for approximately $1.1 billion in the 2Q14; including initial delivery of 1.7 million shares as part of a 3.8 million shares of an accelerated share repurchase agreement which settled in July 2014. Approximately $1.5 billion remains available under repurchase authorization. This is the most aggressive share buyback since AIG purchased its’ shares from the U.S. Treasury.

The company completed the sale of ILFC to AerCap Holdings N.V. for approximately $7.6 billion including a $1.4 billion after-tax gain on the sale or $0.96/share.

AIG still holds certain assets and liabilities of AIG Financial Products (AIGFP), the division cited at the center of the company’s financial crises. This portfolio referred to as the direct investment book or DIB is residual exposure that remains until completely wound down in 2018. AIG announced during 2Q14 they made further progress and reduced DIB debt through a redemption of $750 million principal amount notes due 2015 using cash allocated to the DIB. In July AIG further reduced DIB debt by approximately $2.0 billion through redemption of $790 million principal amount of notes due 2016 and redemption of $1.25 billion principal amount of notes due 2017 using cash allocated to the DIB.

In July 2014, AIG repurchased, in tender offers, high coupon hybrid and senior notes issued or guaranteed by AIG Parent, for an aggregate purchase price of $2.5 billion, and also issued $1 billion of 2.300 % Notes due 2019 and $1.5 billion of 4.500% Notes due 2044.

AIG Parent liquidity sources were $18.5 billion at June 30, 2014, including $14.1 billion of cash, short-term investments, and unencumbered fixed maturity securities, up from $15.6 billion from 1Q14.

Dividend:

AIG announced [Source] that its Board of Directors declared a dividend of $0.125 per share on AIG common stock. The dividend is payable on September 25, 2014 to stockholders of record at the close of business on September 11, 2014.

Separately AIG Announced:

On July 16 the company announced [Source]  it reached a global resolution of its residential mortgage related disputes with Bank of America. AIG will receive $650 million in cash plus a pro rata share of whatever amount is ultimately paid out to investors in connection with the Countrywide repurchases settlement.

Operating Performance:

AIG’s core businesses are now AIG Property and Casualty (P&C), AIG Life and Retirement (L&R) and the mortgage insurance business, Mortgage Guaranty (MG).

After the initial recapitalization of the company in early 2011, management developed enterprise wide “aspirational goals” to be achieved by the year 2015 for the key operational metrics of the company [Source]. We continue to use these goals as a measure of progress for AIG’s core businesses because they are believed to be the key to unlocking the intrinsic value of the company.

Return on Equity:

Insurance companies make money from writing profitable insurance policies (underwriting) as measured by the combined ratio; and from returns on the invested premiums (float) as measured by return on investments until the premiums are paid out as claims. Both sources of earnings are reflected in the return on equity the primary measure for shareholders of how much the company is earning on our investment in the company.

AIG has shown improvement in the return on equity over the past three quarters with the 2Q14 increasing to 7.7% from 7.5% in 1Q14. But they still lag their peers and consequently the share price to book value multiple also lags their peers. Performance matters and AIG needs to demonstrate that a 10% ROE (the aspirational goal) can be achieved to command a 1.0X book value multiple.

AIG 2Q14 ROE

Improving ROE has the potential result of a $75/share price or an additional 40% appreciation over the current price. For every $1 spent on share repurchases at about $52/share management is acquiring assets worth about $75.71/share (the book value per share) for a 45% return on that equity dollar spent. So it is good to see available cash being used for the share repurchase program at these discounted prices.

Combined Ratio:

The key metric for the AIG Property and Casualty (P&C) is the combined ratio a measure of how well management is pricing risk. A combined ration below 100 reflects profitable insurance policy underwriting and above 100 reflects underwriting losses. Management’s original aspirational goal was a level between 90 and 95.

During the quarter, the P&C combined ratio improved significantly from 101.2 in the 1Q14 to 98.8 in the 2Q14 for first profitable underwriting quarter in over a year. Although not yet to the goal of <95 it is another step in the right direction. Perhaps this quarters positive operating leverage is an indication that the 4 ½ years of investments by new CEO Peter Hancock in managing risk and underwriting discipline are paying off.

AIG 2Q14 P and C Combined Ratio

Return on Investments:

Returns on the invested premiums (float) as measured by return on investments contributes to return on equity until the premiums are paid out as claims. AIG Life and Retirement (L&R) aspirational goals were set for return on investment at 7.4% and assets under management (AUM) at $320 billion. Investment yields declined to 5.48% during 2Q14 quarter from 6.09% in 1Q14 on lower alternative investment returns and lower income on investments accounted for under fair value. However AUM increased $8.4 billion and exceeds the 2015 goal of $320 billion.

AIG 2Q14 AUM

Life Insurance in Force:

Another key metrics for AIG Life and Retirement (L&R) is Life Insurance in Force. It ultimately determines assets under management and investment earnings. Although revenues increased modestly up 0.4% from 1Q14 level of $915.3 billion to 2Q14 level of $918.6 billion the Life Insurance in Force lags considerably below what was once thought possible by 2015. However if this is an indication of L&R disciplined underwriting where quality is chosen over volume to reduce risk and eventual losses, it is well worth the tradeoff.

AIG 2Q14 LIF

Mortgage Guaranty Combined Ratio:

The Mortgage Guaranty (MG) unit is the smallest core business unit with AIG shareholders’ equity of $2.5 billion or about 2.4% of the company. MG reported pretax operating income increased from $73 million in 2Q13 to $210 million in 2Q14 or 188%. This company’s performance has been outstanding but unfortunately is too small to have a material impact on AIG.  The key metric for the MG unit is the combined ratio a measure of how well management is pricing risk and the performance has been outstanding.

AIG 2Q14 MG Combined Ratio

AIG’s book value reached our 3-5 year target early but the share price is lagging considerably due to low returns on equity resulting in a low price to book value multiple.

2Q14 AIG Thesis Progress

Second Quarter Key Themes:

AIG 2Q14 Key Themes

AIG Second Quarter Conference Call Presentation [Source]

Summary:

AIG is focused on the key priorities of operations improvement and capital management. Operations and share repurchases continue to improve return on equity. At these accretive values share repurchases continue to be a nice option to leverage ongoin operation improvements. Our investment thesis is on track.

Disclosures: Long AIG common stock

 

 

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