Behind AIG's Nasty Surprise

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Tom Kersting, an analyst at Edward Jones in St. Louis, went as far as to say there needs to be a change in leadership at AIG, not limited to Martin Sullivan, the chief executive, but the entire management team. "They have come out time and time again on earnings calls and at analyst day [presentations] saying losses will only be this much, and they continue to go up and up," says Kersting. "At this point they have lost most of their credibility."

He lowered his rating on the stock to hold from buy on May 9 after assessing the latest results. "I'm not sure they had or have a complete handle on what's going on with some of their riskier investments," he says.

Dividend Hike Disappointment

The latest results were hurt by a pretax charge of about $9.11 billion for a net unrealized market valuation loss related to super senior credit default swaps held by AIG Financial Products Corp. Another weight on earnings stemmed from $6.09 billion in pretax net realized capital losses, mostly for other than temporary impairment charges in AIG's investment portfolio, which dwarfed $70 million in similar losses recorded in the first quarter of 2007.

Some analysts expressed dismay at the company's plan to raise its quarterly dividend by 10% to 22¢ per share at the same time that it's saying it needs to raise fresh capital. On the May 9 conference call with analysts and investors, Sullivan said the dividend hike reflects "the board and management's long-term view on the strength of AIG's business, earnings, and capital-generating power." The dividend increase will amount to about $200 million in annual expenses, small compared to the amount of capital AIG is trying to raise, the company said.

In a research note that Goldman Sachs (GS) put out on May 8, analyst Thomas Cholnoky said he expected the market to react negatively to the nearly 16% decline in book value and the need to raise capital, which is sure to dilute future earnings per share.

Reacting to Credit Ratings?

"The focus will be on the implications of the capital raise, especially given the company's belief that it has $2.5 billion to $7.5 billion of 'excess economic capital,'" Cholnoky wrote. (That's sharply lower than the $15 billion-$20 billion range prior to the onset of the credit crunch.)

He concluded that the capital-raising effort is primarily a defensive move prompted by Fitch Ratings' downgrade of AIG's claims-paying ability, S&P Ratings Service's downgrade of AIG's debt, and the possibility that AIG may now have to post collateral on its AIG Financial Products exposures. (Goldman Sachs has received compensation for investment banking services from AIG in the past 12 months.)

On the call, Steven Bensinger, AIG's chief financial officer, denied that the plan was directed by rating agencies and said management "felt this was the absolute right thing to do," and should be viewed as a proactive move to be prepared to respond to potential further turbulence in the financial market.

He conceded that the equity offerings would initially lower earnings per share, but said that over the longer term "it is something we hope we can offset by the use of net capital in very productive ways as opportunities manifest themselves over the course of the next few quarters."

Bogoslaw is a reporter for BusinessWeek's Investing channel.