Last week American International Group (AIG) reported net income of $1.5bn for the first quarter of 2010 compared with a net loss of $4.4bn in the first quarter of 2009. Despite the improvement, analysts remain sceptical about AIG’s ongoing recovery.
According to Bill Bergman, senior analyst at Morningstar, the problem is the amount of the money that AIG owes relative to its capital – including government capital.
“They are still very thinly capitalised,” says Bergman. “If you look at the market capitalisation of the common equity relative to total assets, it’s just a sliver of total assets. And if you look at other relatively thriving institutions it is still significantly different.”
Bergman believes the market is still “very skittish and sceptical” about the long-term consequences to AIG’s common shareholders. It is possible the government is still facing some risk as well, he warns.
Cliff Gallant, analyst at Keefe, Bruyette and Woods, is unimpressed by the results, saying that the reported income is meaningless unless the benefits trickle down to the shareholders.
The reported adjusted operating income of $809m is “irrelevant”, says Gallant.
“They are not paying their series dividend and over the quarter they increased the amount of debt they owe to the federal government,” he told Reactions. “From my point from view the net income that they are reporting is not accruing to the common shareholder so to me it is a somewhat irrelevant figure.”
Gallant points out that over the course of the quarter AIG’s debt to the Federal Bank of New York and US Treasury actually increased. Gallant takes this as a sign that AIG is still very much dependent on the government to meet its liquidity needs. There is also a transfer of risk going from public equity owners of AIG to the federal government, he says.
He adds: “On the one hand you have a company that wants to say they are making money and financially stabilising but at the same time they are saying: ‘We can’t pay the interest we owe you.’ That’s not the degree of income, strength and stability that most people want to see from AIG.”
On a positive note, Bergman is encouraged by the performance of AIG’s general insurance operations of AIG. Chartis reported first quarter operating income before net realised capital gains of $879m compared with $710m in the first quarter of 2009, a 24% increase.
Chartis recorded also net premiums written of $7.6bn in the first quarter of 2010, a 1.1% decrease from the first quarter of 2009.
“The most important feature was the stabilisation of premium volume in their general insurance operations,” said Bergman. “That is going to be key to the company’s future viability and the ability to inspire customer and brokerage market confidence.”
However, Bergman points out that uncertainly lies in quality of the business that Chartis is underwriting and pricing. Bergman warns that insolvent or near insolvent institutions that are allowed to keep operating sometimes take greater risks in order to “gamble for resurrection or survival”.
He adds: “Hopefully that is not the case, and at AIG’s general insurance operations they are stressing that they are maintaining their discipline. But it’s more uncertainty under the surface.”
Keefe, Bruyette and Woods has an underperform rating on AIG and Gallant notes there is a lot of downside risk on the common stock.
Gallant believes there are plenty of signs that the AIG businesses are doing well, but argues that there are too many issues in the parent company for the true strength of the underlying business to come through.
Overall, Bergman at Morningstar believes AIG is facing an uncertain but increasingly positive future. A source of uncertainty remains as a result of being highly levered and so Bergman notes that inflation that is not compensated by premium for future underwriting costs has the potential to undermine recovery.
“It’s very ironic that we are getting a lesson in moral hazard from an insurance company,” says Bergman. “Hopefully we have learnt some lessons in terms of our public policy; AIG is part and parcel of a much bigger problem that we need to learn lessons from.”