AIG Could Miss Recovery if it Takes on Too Little Risk

Of all the too big to fail institutions to reach notoriety in recent years, AIG’s (NYSE:AIG) is perhaps the most enduring. Shortly after the subprime mortgage crisis of 2008 began, the company found itself short on cash largely due to the declining value of its credit default swaps (CDSs) and collateralized debt obligations (CDOs). Its fourth quarter loss of $61.7 billion set a record for the largest quarterly loss in corporate history. While AIG was far from the only, and certainly not the biggest, financial institution to need government funds (see: Citigroup (NYSE:C), Bank of America (NYSE:BAC) it is still struggling more than most to break free from its dependence on government bailouts. It also has not been able to return to profitability, with a net loss of $4.11 billion ($2.16 a share) in Q3 2011. This is an increase of 64% over last year, when its third quarter losses reached only $2.5 billion. See our article AIG Struggles to Grow Core Business Amid High Impairment Charges.

With the firm continuing to lose money, investors have to ask themselves if it will regain its luster, and when will it return to profitability? Our analysis suggests that the firm has a long way to go before it can repay its taxpayer bailouts and even longer before it can return to sustained profitability and growth. For now, expect AIG to get smaller as it rapidly streamlines and becomes more risk averse.

See the full Trefis analysis of AIG here

AIG’s Allergy to Risk

With many homeowners struggling to pay back their mortgages while interest rates reach record lows, it would seem to be a perfect time for a refinancing bonanza. The White House certainly thinks so and is encouraging the financial sector and insurance companies to get on board with a massive refinancing plan that would help thousands get into lower-cost mortgages.

Many banks and insurance companies are beginning to comply but AIG isn’t. AIG balked at President Obama’s plans to expand the Home Affordable Refinance Program (HARP) to more homeowners. The president’s plan was to make cheaper credit more widely available, which would allow homeowners to refinance and take advantage of record low mortgage rates. Despite the U.S. Treasury‘s majority stakeholder position in AIG, the government has little control over the insurance firm’s business operations. ^[1]

AIG is resisting because it feels that “lenders with fraudulent or poorly documented or undocumented mortgages want to use the HARP program to relieve themselves of the risk tied to their bad lending decisions,” according to Mark Herr, a spokesman for the company. After AIG suffered well over $100 billion in losses since the subprime mortgage crisis began, it has had reasons to be skittish about taking on future risk. ^[1]

Less Activity Equals Less Income

However, AIG’s resistance to take on future risk also means it is resisting future business and making it more difficult for mortgage-holders to repay their debts. Such a sudden allergy to risk is surprising considering the expectations of moral hazard that the American bailout has produced. If an insurance company is too scared to sell insurance, it cannot expect to see increases in revenues and resulting increases in net profits.

While the company has ensured its shareholders, including the U.S. taxpayer, that it is restructuring to reduce operating costs and repay U.S. government loans (largely through selling off assets), it has not shown any legitimate plan for growth. In fact, its recent asset sales and share buybacks suggest that the company will continue to shrink in the short and medium term. Even more devastating from an investor’s perspective, the company has made reducing risk exposure a key component of its post-crisis business model. This means less activity, which can only result in a smaller company.

AIG’s Future Operations

The insurance giant’s market price is struggling to hover around the $21-22 mark, and more struggles might be on the way. The firm’s Trefis price of $20 may be a reality soon, considering that the firm is winding down its largest operation, property and casualty insurance.

While there is a demand for consumer insurance, especially in emerging markets, the firm is too heavily divested in life insurance, retirement solutions and financial services for growth in these sectors to help offset the company’s shrinking operations in property insurance. Likewise, because the firm has a relatively small international presence and is not currently able to expand in foreign markets, it is in no position to capitalize on foreign markets.

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1. AIG Resists Concessions to Banks for Obama Refinancing Plan, Bloomberg [↩] [↩]