|Shares Out. (in M):||1,728||P/E||3.3x||8.4x|
|Market Cap (in M):||53,513||P/FCF||N/A||NA|
|Net Debt (in M):||73,779||EBIT||5,788||9,500|
We recommend establishing a long position in the equity of AIG, which is in the later stages of its exit from government assistance and making progress in improving the profitability of its core insurance franchises.
With the sale and equity buyback announced following Q1 2012 results,USgovernment ownership fell to 61% of outstanding shares in May 2012. We estimate that by the end of the year AIG, through disposal of non-core assets, will generate $15-$20b in cash, which it can use to repurchase significant additional shares from the Treasury. At the current pace of share disposal by the government and repurchase by AIG, we believe AIG will be less than 50% owned by the government later this year, and completely free of Treasury ownership by end of 2013.
We believe that once Treasury ownership falls to 30%, this will remove a significant overhang on the share performance, as the market turns its attention to its de-risked and gradually improving business model. We expect AIG to hit $40 by the end of this year. Share repurchases in connection with government divestitures will push AIG book value per share to $75 by the end of 2013, and we expect a $50 stock price in 2013 as improvements in AIG core insurance businesses translate to a higher ROE. If expectations are that ROEs will improve to 10-12%, then valuations should approach book value in 2014.
AIG has made great strides in extracting itself from the several forms of financial assistance which it was forced to take during its $150b+ bailout in the fall of 2008. Specifically, in 2011 and early 2012 AIG repaid and terminated the $21b line of credit from the Federal Reserve and the $26b non-controlling interests in certain special purpose vehicles holding stakes in former subsidiaries AIA and ALICO. This year AIG also fully paid down the $20b Maiden Lane II SPV which held distressed mortgage backed securities. Later this year the final portion of the $24b Maiden Lane III SPV which holds CDOs, is expected to be repaid. In the past year, the Treasury has sold 596 million of the 1,655 million shares it received in connection with the bailout (36% of its stake). Thus, as of May 2012 the only government assistance is comprised of an approximately $30b common equity stake and a liquidating interest in Maiden Lane III. This represents significant progress in repaying the $150b+ bailout in 2008, and within the next year, AIG should be completely free of US government assistance or ownership. In May 2012, the GAO reported that the government expects to make over $15b profit on its bailout of AIG.
Near Term Capital Management
AIG is in the process of divesting three noncore assets which will generate over $15b in deployable cash.
AIG has used $5b total of cash to purchase shares from the Treasury simultaneous with the two most recent sales of Treasury’s stake in March and May of this year. We expect AIG continues to purchase 50% of the stock to be sold by Treasury (currently worth approximately $33b). The proceeds from the three assets sales set forth above, together with AIG’s $1b+ per quarter earnings power, will give AIG ample resources to effect such future buybacks.
A De-Risked and Steadily Improving Business
AIG’s core insurance operations are comprised of three businesses: Chartis (global property and casualty insurer), Sun America Financial Group (SAFG) (aUSlife insurance and investment services provider) and United Guaranty (Mortgage Insurance).
Chartis is one of the world’s leading providers of property and casualty insurance, offering a diverse mix of consumer (41% of premiums for MRQ) and commercial (59%) lines. It offers insurance in US andCanada(47%) as well as Asia Pacific (primarilyJapan) (28%) and Europe, Middle East andAfrica(25%).
Chartis’s financial performance since the financial crisis has been uneven. Its combined ratio (loss ratio plus expense ratio) has been elevated, in part due to catastrophic losses such as the Japanese Tsunami but also due to poor product pricing in prior years. Moreover, Chartis has had to strengthen its reserves by over $6 billion during 2009 and 2010 for certain long tail lines (excess casualty, asbestos, and workers comp). This poor performance led to doubts about Chartis’s earnings power as well as the sufficiency of its reserves.
Most recent data from Chartis has shown improvement in pricing (North American pricing up 5% in Q1) and business mix as Chartis is de-emphasizing its less profitable longer tail lines. Last year, Chartis sold off its asbestos exposure to Berkshire Hathaway, further reducing its tail risk. In the past four quarters prior year loss reserve development has been de minimis (less than 1/10 of 1% of total reserves), giving support to AIG’s claim that the reserves (at over $67b as of Q1 2012) are adequate and will not see the multibillion reserve adjustments seen in 2010 or 2009.
Company management has set forth aspirational goals for Chartis, that by 2015 its combined ratio will be between 90 and 95 and its unlevered return on equity will be 10-12 percent. The company repeated on its most recent earnings call that it is on track to achieving these goals, driven by the aforementioned improved pricing and tactical shift in business mix, but with combined ratio at a still elevated 102, it will take several more quarters for this improvement to flow through to the bottom line.
The current low interest rate environment is also a drag on the earnings power of Chartis, and for the P&C sector as a whole. Low interest rates constrain the ability of Chartis to earn an attractive return on its investment portfolio, which, with a combined ratio at around 100, represents all of the profit from the division. A higher interest rate environment would be a catalyst to Chartis more quickly hitting its aspirational ROE target, which likely cannot be met with pricing increases alone.
SAFG sells a variety of life insurance and retirement products. Its life insurance division American General has historically been relatively stable and slow growing, with operations focused on term and universal life. SAFG’s retirement services offerings are sold by its VALIC, Western National and SunAmerica Retirement Markets subsidiaries. The key drivers of profitability for SAFG are the spread on its investment portfolio, and the mortality and surrender rates versus actuarial assumptions in the life business and investment flows in the retirement services business. A low interest rate environment has been the major headwind for the division, as this reduces the ability of SAFG to generate positive spread on its investment book, and also is a negative to investment flows in the retirement business. Nevertheless, SAFG has been able to weather this challenging operating environment well, with relatively stable investment yield and profitability and steadily increasing AUM. SAFG represents close to $35b in book value for AIG.
United Guaranty is AIG’s mortgage insurance guaranty business. It covers mortgage lenders for first loss on high LTV mortgages; it previously provided insurance for second lien It represents a small (2%) portion of AIG’s book value at $2.4b and was profitable in its most recent quarter.
It should be noted that AIG has nearly completely exited the financial products business which necessitated the bailout. In 2008, AIG had $1.8 trillion in notional derivatives exposure from over 35,000 positions, including $305b in credit derivative liabilities. As of the end of 2011, AIG had fewer than 2,000 open derivative positions, representing a notional derivative exposure that had fallen below $200 billion, the bulk of which is fully hedged and in wind down.
AIG has a book value of $59 per share after the recently announced share repurchase. Assuming AIG repurchases half of the remaining Treasury ownership of approximately 1 billion shares at an average share price of $35 (above its more recent purchase at $30.50 per share), AIG’s book value per share would be $70. Adding in the approximately $8b in earnings AIG should generate through middle of 2013 (when we expect the Treasury divestiture and share repurchase program to be completed), AIG’s book value per share will be over $75.
AIG’s current ROE (stripping out 1 time items) is 6%; given a 10-12% cost of equity this can support a $40 share price within the next year. A “sum of parts” analysis of its various businesses, assigning a 0.8x multiple to the book value Chartis ($22) and a 0.7x multiple to the book value of SAFG ($14), together with its $16 billion deferred tax asset (expected value of $6), can also support a $40+ per share price (value of noncore assets offsets debt and other liabilities, to complete the “sum of parts”). The 0.8x multiple for Chartis represents a discount to the 1.0x P&C peer group (note that industry leader Chubb trades above 1.25x book). The 0.7x multiple for SAFG is in line with the average of its Life Insurance peers.
However, we believe AIG is making substantial progress towards eventually achieving its aspirational goal of 10%+ ROE (in line with most large cap insurers). Under a scenario where AIG is able to lift its ROE above 8%, a $50+ share price is clearly achievable, which we expect to occur by the end of 2013. Note that an ROE lift will be assisted by the company’s repurchase of 25-30% of its outstanding shares at a 50%+ discount to book. The investor paying $50 in 2013will be investing in an insurance company with a book value of $80+ per share within the year and a higher interest rate environment, supporting a further improved ROE.
Delayed turnaround for Chartis
Health of CEO Bob Benmosche
Persistently low interest rates
|Subject||RE: maiden lane|
|Entry||05/17/2012 12:52 PM|
The sale was a small piece of Maiden Lane. It is a structured product with multiple tranches so I think it is just quite complex and the people on the street who did all this type of structured work have long been let go. But who knows. The delay does not mean much to me either way given the asset sale is small and complex. Top part of structures are strong and bottem part are complex. Over all in the world of RMBS these aassets are just fine.
|Subject||comments and questions|
|Entry||07/10/2012 02:36 PM|
Thanks for posting this. I'm surprised there hasn't been more discussion.
Regarding Chartis performance, one thing to keep in mind is that the expense ratio is a bit elevated right now due to some investments in IT for underwriting. that's supposed to taper off in FY13 i believe.
Just curious if you happen to know when the bad underwriting occurred at Chartis' P&C operations - i.e. the stuff that was showing up in prior-year loss development in 2009 and 2010. Obviously the asbestos issue dates way way back, but what about the rest. I just read a book on AIG called "fallen giant" which came out around 2005. the author claims Greenberg was adamant that underwriting should generate a profit, so i thought maybe they were underpricing in the martin sullivan years. on the other hand, greenberg pushed his managers pretty hard to generate growth (15% a year on average). one can imagine how that could create bad incentives especially on long-tail lines. also, i should note the author worked for greenberg for 10 years ... might be biased.
What do you expect for timing on the share buybacks? As you say, there's ~$1B/quarter of cash flow, the AIA shares come unlocked 9/4/12 and ML3 is progressing nicely (note that next $5.6B of proceeds will flow 100% to AIG). So absent any action with ILFC, I could see them having access to over $18B of cash by yearend. So that would be great. But I'm still trying to understand what SIFI status means as far as how much how fast they can spend it on shares. Note Peter Hancock's comment at a 5/31/12 conference:
"the complexity of consolidating hundreds of legal entities around the world, the systems challenges of Fed reporting on a timely basis, will provide a reason, from an operational risk point of view, for the Fed to urge caution before we are as aggressive as perhaps some might want us to be in capital management"
Interesting he talks about operational complexity and not capital adequacy. I find that strange. what do you think?
|Subject||RE: comments and questions|
|Entry||07/17/2012 07:11 PM|
Regarding your question on when Chartis may have mispriced its long-tail policies, AIG disclosed that the bulk of its reserve strengthening was from accident years 2005 and prior. Beyond that we don’t have any additional color.
In terms of the timing for the share buybacks, AIG is likely to continue to buy back shares in connection with further dispositions by the government, with announcements of the Treasury Sales/AIG buybacks to be following earnings releases as per recent practice.
AIG has just announced full repayment of the Maiden Lane III loan, which amounts to $5.6b, and should realize up to an additional $1b this year from the disposition of the remaining assets in MLIII, of which AIG has a 33% equity interest. The AIA interest, worth over $8b, will be free from the lockup in less than two months. The ILFC IPO is likely to be a 2013 event.
We estimate that AIG will have the firepower to repurchase at least 100mm shares in connection with 200mm+ share offerings by the Treasury each of the next two quarters. This assumes less than half of the cash generated above will be used in capital management. Treasury selling 200mm/AIG Repurchasing 100mm shares each of the next two quarters will get Treasury ownership down to just over 50% after the next sale/buyback and just over 40% after the next following.
We would not expect AIG to repurchase shares on a pace faster than this in 2012, given that AIG will wish to repurchase shares in connection with dispositions by the Treasury, and Treasury will not wish to sell shares more rapidly than the market can absorb. The Treasury should be fully divested of AIG by the middle of 2013.
Hancock’s comments around the timing of capital management we read as encouraging and reinforcing the thesis. It is not a matter of if, but when the buybacks will occur. It is not surprising that the Fed will want to be fully comfortable with AIG’s controls before permitting “aggressive” capital management. As Bob Benmosche noted on the Q1 earnings call, AIG needs to show and demonstrate to the Fed that they have the proper processeses in place, but AIG’s leadership “don’t see any significant impact” on AIG’s ability to do capital management. Given the cash coming in the door, aggressive capital management will happen . . . but over the next several quarters.
|Subject||i will ask the obvious question|
|Entry||09/12/2012 05:22 PM|
why do you think they didn't sell more AIA to buy more AIG in the recent Treasury sale?
given that they placed the AIA shares at a premium, i'm guessing it wasn't due to lack of demand in Hong Kong. I can only surmise that AIG is already under de facto regulation by the Fed and - for reasons I can't surmise - the Fed told them not to shrink their equity by more than $5b for now.
|Subject||RE: i will ask the obvious question|
|Entry||09/13/2012 09:30 AM|
I do not know. My guess is it was demand. The other theory is that maybe they wanted to keep firepower to be able to get the governmnet fully out as ultimately getting rid of the Gov't overhang may be more beneficial then getting the a couple more billion of aig repurchase done at a few dollars cheaper. I think they will have a tough time monetizing ILFC so AIA is all they have left to buy back more. Another theory would be that the UST did not want them to buy more than $5 billion for appearances. Alot of theories but I do believe they want the Treasury out. Getting rid of the overhang even if the market buys the rest will provide a pop to the stock.
There is a chance that teh FED will not be as invasive as people think but who knows. It is a risk. The good news is that book value is $65 now and they are raising prices in P&C as are others. I am not sure why the FED would worry about AIG so much when they let some of the large much more risky banks buy back stock and pay dividends. AIG's credit risk and bad management is way behind them at this point.
|Subject||RE: RE: i will ask the obvious question|
|Entry||09/13/2012 10:28 AM|
DB just put out a favorable detailed report. Good read.
They think management said $5 bill and did it. Sounds like they want to have flexibility.
|Subject||Shares vs. warrants|
|Entry||02/01/2013 03:12 PM|
What is your view on the shares and warrants at current prices?
|Subject||RE: Shares vs. warrants|
|Entry||02/01/2013 07:14 PM|
I worry about market risk given the recent move. I think longer term it will move toward book value as they operate their businesses better and ROEs improve. It is a fairly long term story but management is gaining significant creds with investors so they may be getting credit for some of that. There have been rate increases, almost all non-core is sold, strong balance sheet, and a roll-off of poor business underwrtitten in 2009 and 2010 when they were in bad shape and had to cut price. BV is about $68 now can be $75+ in two years. I do not see alot of business risk. CAT risk will come and go but insurance shoud be a boring business. Big upside to investment income if rates go up over time. Chubb trades for 1.35x a clean book value with a 11% ROE. Obviously a much better company but a big gap if AIG can operate better. I think a good long term bet. Trade around the market moves if you are inclined to.