AIG Posts Record Loss, As Crisis Continues Taking Toll

AIG Posts Record Loss, As Crisis Continues Taking Toll
By LIAM PLEVENMay 9, 2008; Page A1
In a sign that crisis continues to reverberate through the financial sector, American International Group Inc. reported multibillion-dollar losses Thursday. The giant insurer also announced that it would raise $12.5 billion in capital to replenish its balance sheet.
AIG's results show that while the credit crunch may be easing on Wall Street, it appears to be tightening elsewhere. In the past week, U.S. regional banks have reported big losses and announced plans to raise fresh capital. Sovereign Bancorp, one of the nation's largest savings and loans, is looking to raise $1 billion after suffering rising loan delinquencies, people familiar with the situation said Thursday.
The AIG news comes even as some on Wall Street are saying the financial crisis, touched off last year by the fall in housing prices and rising foreclosures, is winding down. Earlier Thursday, James Dimon, chief executive of J.P. Morgan Chase & Co., said in a speech that the cleanup from the subprime-mortgage mess is 75% to 85% complete. "We know about most of the bad stuff now," he said.
Following the market's close Thursday, AIG reported its record $7.8 billion loss, eclipsing the $5.3 billion loss it recorded in the fourth quarter. AIG said credit-market woes, weakness in housing and stock-market volatility "had a substantial adverse effect" on its results. "The severity of the unrealized valuation losses and decline in value of our investments were beyond our expectations," said AIG Chief Executive Martin Sullivan.
The New York-based insurance behemoth took a $9.1 billion write-down for the first quarter on credit derivatives designed to protect against losses on a variety of investments, including subprime mortgages. It booked an additional $6.1 billion in losses in its investment portfolio.
The results increase the pressure on Mr. Sullivan, who took over as CEO in 2005 after the departure of Maurice R. "Hank" Greenberg, who built AIG into a globe-spanning giant over four decades. The company's shares have fallen by just under 40% in the past year. After falling 2% Thursday to close at $44.15 on the New York Stock Exchange, shares fell a further 5% in after-hours trading, priced just above a 10-year low.
Strong-Willed Executives
As it sputters, AIG is looking increasingly like other huge businesses built by strong-willed executives. Sanford Weill's successor at Citigroup Inc., Charles Prince, struggled to manage the unwieldy company and was ultimately forced out because of huge losses on subprime mortgages. Asset manager Legg Mason posted its first loss ever earlier this week as its new CEO tries to manage a decentralized firm created by Raymond "Chip" Mason.
AIG said it was looking for a new chief financial officer to replace Steven Bensinger, who was named vice chairman of financial services. Some members of AIG's board have felt that Mr. Sullivan hasn't moved fast enough to hire better finance executives and get rid of weak executives, said a person familiar with the matter. An AIG spokesman said: "Under Steve Bensinger, AIG has made tremendous strides in bringing on board terrific financial talent."
AIG also disclosed a dispute with the Internal Revenue Service over a cross-border tax transaction. The matter has potentially far-reaching implications for the company and other firms on Wall Street that were involved in similar deals. The company said it had received a notice from the IRS asserting it owes $329 million in back taxes and penalties, a portion of which related to "the disallowance of foreign tax credits associated with cross-border financing transactions."
The financial results prompted ratings agency Standard & Poor's to downgrade AIG's credit rating by one notch. S&P cited the loss, but also pointed to weaker performance in several of the company's businesses. S&P also said it was lowering the credit rating of several AIG subsidiaries, including its airplane-leasing unit, International Lease Finance Corp.
The challenge to Mr. Sullivan, whose background is not in finance, is to run an immensely complicated company built by his dominant predecessor. So far investors have had patience with Mr. Sullivan, arguing that investment decisions that caused the losses were made before he took control. But as the struggles continue, the question will become whether Mr. Sullivan is the right person to navigate the crisis.
The AIG spokesman said Mr. Sullivan has already led the company through crisis, including the accounting problems that led to Mr. Greenberg's departure and a subsequent $1.6 billion settlement with authorities. "Any CEO of any corporation is always under pressure to perform," the AIG spokesman said.
AIG plans to raise $7.5 billion in capital through both a common-stock offering and "equity units" that combine contracts to make future stock purchases and junior debt. AIG said it expects to issue hybrid securities "at a later date" to raise an additional $5 billion.
"Just a few months ago, management seemed to think they had an excess capital position," said Cliff Gallant, an analyst at Keefe Bruyette & Woods, who owns shares of AIG and called the results "a very disappointing quarter." For the same quarter a year ago, AIG earned $4.1 billion.
One reason AIG could need capital is that the firm has to post collateral to banks under the credit-default swap agreements it wrote. That has forced AIG to fork over cash as the prices of their credit-default swaps fall.
The S&P downgrade could allow counterparties to demand that AIG post up to $1.8 billion in collateral, according to an SEC filing. AIG says it still has $2.5 billion to $7.5 billion in excess capital.
Raising Dividends
Also on Thursday, AIG said announced its 23rd consecutive year of dividend growth, saying it was raising its dividend by 10% to 22 cents a share. That's about half of the 20% annual dividend increases AIG said last year it planned "under ordinary circumstances."
In addition to the losses associated with derivatives and investments, Mr. Gallant said he was concerned by some of the results in AIG's main insurance businesses. For each dollar AIG brings in as premiums, it is paying out a greater amount on losses and expenses in its property and casualty operations. That percentage, known as the combined ratio, rose from 87.5% in the first quarter last year to 96.9% in the first quarter of this year.
The tax dispute between AIG and the IRS involves cross-border financing transactions that were popular for years on Wall Street. In general, such transactions have permitted U.S. companies to shift assets overseas, pay foreign taxes and then split credit for paying those taxes with lenders that in turn will lower their financing costs.
Such transactions were the subject of testimony by former IRS Commissioner Mark Everson in 2006, who called them "abusive." The IRS issued proposed regulations last year that have effectively shut down new transactions, according to a person who has worked on such deals.
The IRS challenged transactions dating from 1997 to 1999. AIG indicated in its SEC filing that it expects the IRS to challenge similar transactions from later years, although it gave no indication of the potential size of those disputes. The company said it plans to contest the notice. While AIG may soon be writing a large check to the government, the company said it believes that it "is adequately reserved for any liability that could result from the IRS actions."