Behind AIG's Nasty Surprise

The insurance giant's far larger-than-expected first-quarter loss rouses investor ire and renews fears the credit crisis may still have a way to go

American International Group CEO Martin Sullivan. Munshi Ahmed/Bloomberg News/Landov

by David Bogoslaw

American International Group's (AIG) financial results took a sharp turn for the worse in the first quarter and sent a shock wave through the equity markets, renewing concerns that there's likely to be more fallout from the credit crisis.

After the market close on May 8, the world's largest insurance company reported a net loss of $7.81 billion, or $3.09 per share, in the first quarter, vs. a profit of $4.13 billion, or $1.58 per share, in the year-earlier period. Excluding mark-to-market writedowns and other asset impairment charges, the company had an operating loss of $3.56 billion, or $1.41 per share, in the latest quarter, compared with adjusted net income of $4.39 billion, or $1.68 per share, a year ago.

The bulk of those writedowns was related to credit default swaps, the complex credit derivatives used either by debt owners to hedge against credit events or by speculators to bet on changes in credit spreads. New York-based AIG said the loss included the impact of successful hedging activities that didn't qualify for hedge accounting treatment or for which hedge accounting wasn't used, including related foreign exchange gains and losses.

Seeking Fresh Capital

AIG also said it plans to raise about $12.5 billion in capital to shore up its balance sheet and provide greater financial flexibility to be able to respond to future events in the turbulent financial markets. First, it will raise roughly $7.5 billion through a common stock offering and an equity-linked offering, to be followed later by an offering of hybrid securities made up of debt and equity.

The loss far surpassed the per-share loss of 76¢ that analysts had expected, prompting AIG shares to tumble 8.8% to close at 40.28 on May 9.

Hank Greenberg, AIG's former chief executive, who has been very vocal in his public criticism of AIG's current management in recent months, told BusinessWeek that he was "stunned as a shareholder, and very disappointed and very upset" at the extent of the losses in the latest quarter.

He says he was surprised by the size of the impairment charges not only in AIG's Financial Products business but also in its partnership and equity investments, as well as how funds were allocated to various asset classes, which he wouldn't elaborate on. The increase in the expense ratio from about 19% a few years ago to the current 26% is also distressing to him.

Downbeat Assessment from Analysts

An AIG spokesperson wouldn't respond to Greenberg's remarks except to say that the motivation behind them should be considered given the multiple lawsuits Greenberg is facing. Among those, AIG is seeking to recover losses that resulted from writedowns and settlements due to accounting irregularities under Greenberg, and the insurer has also sued Greenberg and six other former AIG executives, claiming that after they left AIG in 2005 they illegally seized control of Starr International, an affiliated company that owns $20 billion in AIG shares.

Analyst Cathy Seifert at Standard & Poor's Equity Research said she expected to see weakness in AIG's "outsized" mortgage-related exposures but was "troubled by what we view as a pretty significant deterioration in a number of core insurance underwriting lines." She reaffirmed her hold rating on the stock and stuck to her 2008 earnings estimate of $2.50 per share, but said this forecast assumes underwriting results improve. She also said she believes the company is long overdue for a major restructuring. (Like BusinessWeek, S&P is a division of the The McGraw-Hill Companies (MHP).)