American International Group, Inc. (AIG) executives are being pressured by well-known activist investor Carl Icahn to break the company up into three parts: one for Property and Casualty (P&C) insurance, one for Life insurance and the third backing mortgages. Icahn argues that the breakup would improve AIG's financial position by theoretically removing the company's systemically important financial institution (SIFI) designation (along with related capital requirements and regulations), as well as reducing costs and expense ratios.
However, Moody"s Investors Service warns that such a move would have unintended consequences of the credit-impairing kind, and has released an official comment on the proposed breakup.
Among the many considerations both pro and con to such a breakup is the effect on AIG's credit rating, Moody's says, as well as the potential rating for each of the three new companies. In its Nov. 2 Credit Outlook, Bruce Ballentine, vice president and senior credit officer, and Christian Plath, vice president and senior credit officer, expressed the opinion that a breakup of AIG and loss of SIFI status (assuming this would actually result) would be "credit negative" for the company, removing the diversification benefit of the multiline insurance operations and the capital and risk management oversight that the U.S. Federal Reserve applies to nonbank SIFIs. "A step-up in share repurchases would be credit negative to the extent that it reduced the capital adequacy of the ongoing businesses," the outlook says.
AIG's credit profile
When determining a company's investment-grade credit profile, Moody's factors in leading market positions in the company's major industry segments, diversification across products and geographic regions and liquidity. With a worldwide property casualty network, Ballentine and Plath describe AIG as "one of a handful of carriers that can serve multi-national accounts with complex insurance needs."
They observe further that AIG's life operations rank among the largest in the U.S., offering a full suite of products through multiple distribution channels. On the downside, they note, "These strengths are tempered by the company's record of weak profits and volatile reserves in property/casualty insurance, its above-average exposure to structured and alternative investments, and the challenge of risk management across its diversified business portfolio."
Under the Dodd-Frank Act, the U.S. Financial Stability Oversight Council (FSOC)is authorized to determine that a nonbank financial company's material financial distress—or the nature, scope, size, scale, concentration, interconnectedness, or mix of its activities, even when not in distress—could pose a threat to U.S. financial stability. Such companies will be classified as SIFIs and subject to consolidated supervision by the Federal Reserve and enhanced prudential standards.
In June 2013, the FSOC classified AIG as a nonbank SIFI, which subjects the company to regulation by the Federal Reserve, in addition to other regulators such as the U.S. Securities and Exchange Commission and government insurance regulators wherever the company does business. Ballentine and Plath point out that "The Fed is still developing criteria and rules for nonbank SIFIs, which will likely include rigorous capital adequacy and liquidity tests, plus extensive requirements for risk management structures and processes. The Fed's group-wide regulation is credit positive, although it may limit the company's ability relative to non-SIFI peers to manage its operations and capital structure."
Balancing interests of creditors and shareholders
Since the financial crisis of 2008-09, AIG has pursued a strategy of simplifying its business portfolio, divesting itself of assets and business lines, for more than $70 billion, Ballentine and Plath note. "In applying these proceeds, AIG has balanced the interests of creditors and shareholders, leading to significant debt reduction and improving financial leverage and fixed charge coverage metrics."
For the remaining businesses, they say, AIG has shifted its focus toward higher-value offerings, such as insurance for multi-national accounts and certain consumer lines, from relatively volatile product lines, notably long-tail U.S. casualty insurance. In addition, the company has made significant investments in its people and systems to improve risk selection, claims practices and operating efficiency. The transition in business mix and processes has led to elevated expenses, which Ballentine and Plath expect AIG to reduce over time. Splitting the group into three separate companies would not necessarily facilitate or accelerate the reduction in aggregate expenses, they conclude.
Given Icahn's contentious history with other large corporations in which he was a major shareholder, the debate over the proposal is likely to continue for some time. Stay tuned.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.