AIG's Long-Term Prospects Challenged As Industry Analysts Raise Red Flags

Washington

Analysts raised red flags about the long-term prospects for American International Group at a congressional hearing last week, despite assurances from President Robert Benmosche to the panel that AIG is on a "clear path" to repaying its debt to the government and "remaking itself into a more streamlined and focused company."

"I see substantial progress," Mr. Benmosche testified at a hearing on AIG convened by the Congressional Oversight Panel, created to act as a watchdog over government investments made through the Troubled Asset Relief Program, as well as by other Treasury Department and Federal Reserve Board programs launched to prevent a financial meltdown in September 2008.

"We are redefining our strategy, restoring our financial strength, strengthening our key businesses, bolstering our corporate governance, instilling a focus on performance management, and making strategic hires to ensure that our remaining businesses thrive," he said.

He added that in recent months, AIG has become less reliant on government aid and has been able to instead tap the capital markets.

"We are working hard to complete the sale of AIA and Alico by the end of this year, to increase profits at our remaining businesses, and to improve operating returns," he said.

At that point, he noted, "we can begin to examine the alternatives we have to address the Treasury's TARP investment and equity holdings."

However, securities analysts also testifying at the hearing warned that AIG's creditworthiness and ability to reward its shareholders going forward remain in doubt, particularly because of concern that as the company stabilizes, the government will move to act on behalf of taxpayers, not shareholders, clouding its profit outlook.

Clifford Gallant, head of property and casualty research at Keefe, Bruyette and Woods in New York, testified that AIG "may eventually need to raise significant equity capital from public markets in order to fully stand alone." He characterized the shares of AIG stock as "grossly overvalued."

He cautioned that as the risk of systemic failure of the company fades, "we view there is a risk of a shift in government priorities to favor [taxpayer] interests," adding that "without a material transfer of value from the taxpayer to the shareholder, we believe the effects of full dilution, debt/preferred repayment and stock sales will leave little value left for the stub shareholder."

He called AIG's debt levels "enormous," warning that "we see potential risks to several balance sheet items, including property and casualty reserves…the value of its international leasing unit, and other concerns, including the remaining exposures and the carrying values of facilities managed by the Federal Reserve Bank of New York and outside managers."

Rodney Clark, managing director of ratings services for Standard & Poor's, added that while S&P's outlook for the company's stand-alone credit profile is positive, "we maintain our negative outlook on the company going forward."

He said this is based in part on S&P's belief that "AIG is particularly susceptible to the broad insurance market trends, given its somewhat weakened position, and that pressure on the operating performance of its subsidiaries may build, due to market factors such as aggressive pricing and competitive pressures."

Furthermore, he said, "the negative outlook reflects uncertainty with regard to legislative risk and its potential impact on the government's ability to continue to provide extraordinary support to AIG, if needed."

Addressing the "creditworthiness" of AIG's insurance entities, Mr. Clark said "we believe those subsidiaries are to some extent insulated."

For example, he said, if AIG had been forced into bankruptcy, it would have likely included a relatively small number of AIG's non-insurance subsidiaries–such as AIG Financial Products Corp.–with "only a marginal impact" on its insurance subsidiaries because the capital in those entities is "generally insulated by state insurance laws and regulations."

However, S&P has lowered the credit ratings of AIG's insurance entities because "we believe the creditworthiness of those subsidiaries is nevertheless indirectly affected in two primary respects."

First, he said, "in our opinion," financial pressures at AIG generally make it less likely the company will be in a position to provide additional capital in the event its subsidiaries suffer investment losses of their own or otherwise require recapitalization–although he conceded this risk is "somewhat muted" by AIG's receipt of government support and because of improved capitalization.

The second issue S&P sees as affecting the creditworthiness of AIG's insurance subsidiaries "relates more generally to overall reputational risk resulting from the parent company's financial problems."

For example, Mr. Clark said, "it may be more difficult for the subsidiaries to retain and attract new customers where there is uncertainty surrounding the parent company–particularly in light of a dampened demand for insurance and, more significantly, marginal pricing."

In his testimony, Mr. Benmosche said AIG's insurance businesses have remained healthy. He cited Chartis' first-quarter operating income of $879 million compared to $710 million in the first quarter of 2009–a 24 percent increase.

"Chartis has been taking important actions to further strengthen its risk management and position its business for the future," he said.