Where to start with this one. First I have to say I am disappointed in BW on this. The article is totally slanted and if I am really looking at it, IMO a bit misleading (we will get into that as we go through the piece). This belongs in an opinion section, not a “news” site.There is some stuff here that those responsible for writing it had to know was….let’s say… in a gray area? I debated how to do this and decided rather than be accused of cherry picking sections in an attempt to make my point, I’ll just put it all up right here and then go point by point and let readers decide.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
AIG May Not Be as Healthy as It Looks
American International Group, Inc. (NYSE:AIG) has come a long way since its record $182 billion government bailout in the financial crisis. It has been buying back its stock from the Department of the Treasury, helping to reduce Washington’s stake in the company to 70 percent from a peak of 92 percent. It posted a profit of $21.5 billion for the fourth quarter of last year, a showing that helped push the stock price up 40 percent this year through April 24, to $32.40 a share. Analysts for Wells Fargo (WFC) and Bernstein Research (AB) are recommending the shares to investors as the company nears what they believe will be a complete exit from government ownership within a year.
Still, AIG may not be as healthy as it seems. Critics including Neil Barofsky and Elizabeth Warren, who helped oversee the government’s Troubled Asset Relief Program, contend AIG is benefiting from favorable treatment from Washington that amounts to a “stealth bailout,” in Warren’s words. And some analysts, including Morningstar’s (MORN) Jim Ryan, say the insurer’s underlying businesses are struggling.
One point of contention is Treasury’s decision to allow AIG—along with TARP recipients Citigroup Inc. (NYSE:C) and Ally Financial—to use operating losses from previous years to eliminate taxes on current income. The allowance, which typically does not apply to bankrupt or acquired companies, added $17.7 billion to AIG’s fourth-quarter earnings and will allow the company to shield profits from taxes for many years to come. “It’s important to remember that a substantial portion of AIG’s recent earnings were attributable to Treasury’s unilateral decision to preserve AIG’s net operating losses,” says J. Mark McWatters, a law professor at Southern Methodist University who was a Republican appointee to the TARP oversight committee.
Treasury explained its decision on the tax waiver in a March 1 statement: “The government reluctantly” invested large amounts “of taxpayer dollars to prevent corporate failures from causing a collapse of the financial system and resulting in even more severe harm to Americans. Allowing those companies to keep their net operating losses made them stronger businesses, helped attract private capital, and further stabilized the overall financial system.” Mark Herr, an AIG spokesman, said executives could not comment because the company is in a quiet period in advance of announcing earnings on May 3.
Treasury’s rationale doesn’t fly with Warren, the former chairman of Congress’s TARP oversight panel who is now a Democratic candidate for the U.S. Senate from Massachusetts. “That kind of bonus wasn’t necessary to protect the economy,” she said in a joint statement with three other former committee members on March 12. “It also gives AIG a leg up against its competitors at a time when everyone should have to play by the same rules—especially when it comes to paying taxes.”
OK. Lets stop here. Let’s address the “stealth bailout” gibberish. Treasury has made several statements on the tax situation including the following not mentioned above:
“The Treasury earlier this month said the tax provision “originally was intended to prevent trafficking in tax losses” by private companies, and didn’t apply to companies in which the government ended up owning a majority stake as a result of a bailout. At one point, the Treasury owned more than 90% of AIG; it has since fallen to about 70% and the government plans to sell the rest of its stake over time to recoup roughly $37 billion in federal aid.
“It would have been counterproductive–and perhaps irresponsible–to undermine the stability of those same institutions, at the height of the financial crisis, by imposing a tax code provision that was never intended to apply in this context,” the Treasury said. The federal government “is not a taxpayer and has no interest in sheltering taxable income.””
What is lost on Warren, Farzad et all is the concept of ownership. A stock certificate is a share of ownership in a company. When Treasury made the ruling in 2009, it in all reality owned $AIG. In essence, what these folks are saying is that they wanted (and continue to want) $AIG and by its near complete ownership stake the US Treasury, to then (and now) pay taxes to itself. To what point? To delay the exit from $AIG longer? To further weaken the business and perhaps in the end force a loss on taxpayers? Think about the logic. They want $AIG, now 70% owned by Treasury to pay ~$1B in taxes (estimating 30% of the ~$3.7B profit excl tax benefit). So then those funds come out of the profits & available cash that is being used to pay back the Treasury so they can then be paid to Treasury in the form of taxes. Brilliant!!
What is the goal here for taxpayers? To allow the Gov’t to exit the $AIG bailout/rescue at a profit as expeditiously as possible. Right? Wasn’t that the whole idea? Stabilize it and get out fast at a profit? So why slow it down with this tax scheme that is nothing more than a financial circle-jerk?
The real joke of it is that $AIG is using the money they are “saving” from not paying taxes to the US Gov’t, to buy shares from and to pay back….the US Gov’t. The worst part is everyone here knows that. Warren is just playing politics in her run for office…sad but true. She made her name trashing everything the Treasury and Fed did in ’08-’09 despite never having to make, you know, a decision that actually mattered and that horse has gotten her to this point. She is going to ride it to the end no mater how twisted it gets…
Barofsky, TARP’s former inspector general, believes the government is doing AIG—and itself—another favor by permitting the company to repurchase its shares at $29 each. Selling at that price allows Treasury to claim a profit on the government’s investment, based on its cost of $28.72 a share. The department calculated its cost by dividing the $47.5 billion in TARP funds AIG received by the 1.66 billion AIG shares it held before winding down its stake. Matthew Anderson, a Treasury spokesman, says the price is appropriate because it covers the government’s cost in acquiring the shares.
Barofsky calls the price “a political manipulation of numbers.” He argues the calculation shouldn’t include 563 million AIG shares that Treasury received from the Federal Reserve in January 2011 because the shares were not acquired as part of the TARP program. Removing those shares from the calculation would lift Treasury’s per-share cost to $43.53, which means TARP would show a $16 billion loss if Treasury sold the rest of its holdings at $29. “Treasury is misleading the market on TARP doing better than it actually is,” says Barofsky, who now lectures at New York University’s law school. “If I were an AIG investor, I’d think if they were being manipulative on this, then what else?”
Stop….Barofsky is playing semantics. He is making two separate arguments. The Gov’t WILL, make a profit on the $AIG bailout…a significant one at that and he knows that to be true. He is playing games by parsing TARP with all of the Gov’t actions. This is like me having a portfolio of two stocks. One up 50% and one down 10% (equal weighted). I would say “my portfolio is up 40%” and what Barofsky is essentially doing is saying that I am playing games since part was down 10%. We can say the Gov’t will take a small loss on the TARP action with $AIG but make a killing on the Fed action……bottom line? The Gov’t will turn a profit on $AIG and ALL the actors here know that and if they don’t…..oye….
Let’s also not forget Barofsky was saying in ’10 that taxpayers were likely to lose $40B on the $AIGbailout. Maybe the longer we can confuse the issue of the actual gain/loss the Gov’t will see the less wrong he will have looked in the past? I don’t know but…
What I find even more odd is no one here is talking about the ML portfolios that the Fed is liquidating at a very healthy profit. William Dudley said just yesterday of the sale of part of ML III, “I am pleased with the level of interest and the results of this process, especially with the strength of the winning bid, which represents good value for the public and significantly exceeds the original price ML III paid for these assets…
I’m guessing Warren will want the Fed to pay taxes on these profits also since she seems to want Treasury to pay them????
Joshua Stirling of Bernstein Research sees the government’s eagerness to prop up AIG as a reason to buy the stock. “It seems clear that by allowing AIG to buy shares from the government ‘at cost,’” Treasury is helping AIG boost its earnings, he wrote in an April 4 report in which he changed his rating on AIG to buy from hold. “I’m thinking of this from the shareholder perspective,” he says. “The government and AIG all want it to end. Some of it, of course, is political; you don’t want the Tea Party to keep bringing it up.”
Morningstar analyst Ryan sees weakness in AIG’s basic businesses. He says the company’s property and casualty unit, which accounts for half its revenue, is “not making money selling policies and is having a very difficult time just earning its cost of capital.” Analysts at Sandler O’Neill + Partners expect AIG’s return on equity this year to be 5.1 percent, lagging large property-casualty peers’ average of 8.9 percent and life insurance peers’ 10.3 percent. The problem was made worse, Ryan says, when AIG sold a majority of its high-growth Asian life insurance business in October 2010 to help pay back the government. Keefe Bruyette & Woods (KBW) analyst Clifford Gallant concurs. “Their insurance profits aren’t high enough,” he says. His price target for the stock: $25.
Treasury takes a “passive hand” when it comes to AIG’s operations, says Anderson, the Treasury spokesman. “We’re not saying ‘sell life insurance in this county, but not the other county,’” he says.
With its basic businesses struggling, Ryan says, “so much of AIG comes down to what it can earn on its investments.” In press interviews in March, AIG Chief Executive Officer Robert Benmosche indicated he wants the company to return to investing in mortgage securities—the very assets that helped take the company down in 2008. Meanwhile, 12 percent of AIG’s fixed-income portfolio is in junk or nonrated securities, according to company filings. That’s almost quadruple the level at Travelers (TRV), another big property and casualty insurer. “It concerns me that Benmosche says they want to be more aggressive in their investments,” says Ryan. “That’s what hammered them in the crisis.”
The bottom line: AIG’s stock is up 40 percent this year, thanks in part to a tax benefit worth $17.7 billion awarded by the Treasury.
With Noah Buhayar
Seriously? Can’t find one guy out there who is positive on the stock save for the one guy with a Tea Party conspiracy theory? Really?
Regarding the ratios and how they “lag peers”. We can’t forget when Benmosche took over in Aug 2009 $AIG was in run off mode. Those in charge before he got there were liquidating the business. Everyone thought it was dead. He stopped that process and began to run it as a business again. What Farzad does not tell you is that $AIG underwriting results and profitability have IMPROVED since Benmoshe has been there and Q1 2012 will continue that trend. He also omits American International Group, Inc. (NYSE:AIG) insurance operations (Chartis/Sun America) had a net operating profits of ~$3.6B in ’11 vs ~$2.5B in ’10. Nice improvement?
Someone also should Inform Morningstar, Inc. (NASDAQ:MORN)’s Ryan and BW’s Farzad what happened to $AIG in the crisis (I suggest Roddy Boyd’s fantastic book on it) and their “concerns” over Benmosche saying he wants to be “more aggressive” . It wasn’t $AIG buying mortgage bonds that got them into trouble, it was insuring virtually every CDO written on those bonds held by every bank that did it. That is more than a little different and both ought to know that…..and I think they do….which is why the omission of it pisses me off.
What Ryan also omits is that ex catastrophe’s $AIG did earn its cost of capital at Chartis in ’11 and even if we include them, their combined ratio dropped from 116 to 109. More improvement.
I will say contrary to the title of the BW piece, $AIG is in fact healthier than it seems. $AIG trades at ~60% of its BV. That in no way implies Wall St or investors think it is a healthy vibrant company…if they did, it would be a $60 stock.
As for the “bottom line”? The tax benefit the Gov’t gave itself has NOTHING to do with $AIG’s stock rise this year. Nothing at all. It does have everything to do with the billions they have coming to them from the ML II & III sales, Met Life sale, AIA sale, IFLC IPO and the basic improvement in their insurance operations. Wall St has realized that with all those billions they will be able to take a huge chunk out of the Treasury’s ownership stake and remove that final cloud hanging over the company. They now see a company that was absurdly undervalued in the $20?s….and still is in the $30?s
THAT, is the reason for the price rise…..
I have no qualms with people taking a contrary opinion on any investment and in fact I debate them on twitter about it all the time. Further I enjoy reading them and seek them out as it makes me dig harder to reinforce my thesis. My problem with this piece is it reeked of a pre-determined agenda that was backed by the opinions of those sought out to simply parrot it. In no way was this an attempt to paint a clear picture for potential or current investors. Am I to believe there is not an analyst or investor out there who could have countered the claims of those mentioned above? I would expect that BW would strive to do that…..right?……..am I wrong to assume that?