AIG Ratings Nullify Govt. Quotient

The latest $20.7 billion sale of American International Group Inc.’s (AIG - Analyst Report) stock by the US Treasury has inclined the ratings agencies to subtract the government support from the company’s credibility status.

Yesterday, the Treasury further reduced its stake in AIG to 15.9% from the prior 53.4%, by selling 553.8million shares in the open market, at $32.50, a share for $18.0 billion, of which 153.8 million shares were bought back by the company for $5.0 billion. The Treasury also raised an additional $2.7 billion by selling 83.1 million extra shares to the underwriters.

The share price of $32.50 also came in quite above the Treasury’s break-even of $28.73 per AIG share. Meanwhile, the Treasury expects to earn about $15.1 billion from the $182.3 billion government bailout loan, which it had granted to AIG in 2008. However, following the latest sale, the Treasury holds about 234.2 million shares of AIG, which constitutes the remaining 15.9% stake.

As AIG’s consistent deleveraging and restructuring efforts, taken over the past few years, have started showing positive results. Yesterday Fitch Ratings upgraded its issuer default rating (IDR) of AIG to “BBB+” from “BBB”. Even its subordinated debt and junior subordinated debentures were upgraded to “BBB-” and “BB+” from “BB+” and “BB”, respectively. However, the rating agency affirmed the company’s senior unsecured debt at “BBB”. The outlook for all remains stable.

Concurrently, Standard & Poor's Ratings Services (S&P) affirmed its long-term counterparty credit rating of “A-” on AIG. Additionally, its senior unsecured debt, subordinated debt and junior subordinated debentures were affirmed at “A-”, “BBB+” and “BBB”, respectively. However, S&P has raised some caution by demoting its outlook to negative from stable.

Nevertheless, Moody’s Investor Service of Moody’s Corp. (MCO - Analyst Report) asserted the company’s financial strength and senior debt ratings by affirming the senior unsecured debt of AIG at “Baa1” along with a stable outlook.

Basis of Ratings

The ratings agencies have not only confirmed the substantial improvement in AIG’s capital and operating leverage, but also expect it to be strongly competitive going forward. This optimism is based on the company’s consistent deleveraging efforts and business restructuring, by shedding off redundant assets, to repay the government debt and focus on its core insurance operations.

Additionally, the sooner-than-expected wipe-off of Treasury’s stake also injects confidence among the ratings agencies and investors, thereby expecting AIG to liberate itself entirely before the end of 2012.

While S&P’s revised outlook casts concern over AIG’s weak fixed-charge, it also projects this metric to advance more than 4.0x in 2012 from 3.0x in 2011. The rating agency believes that the company’s earnings strength is still inferior to its debt obligations and that a similar trend in the next couple of years may warrant a ratings downgrade.

Conversely, Fitch remains confident of the company’s debt leverage that strikingly reduced to about 21% now from 77% at the end of 2010. Even AIG’s total financial commitment (TFC) ratio improved to 1.3x currently from 2.5x at 2010-end, and is further expected to be in line with peer group at below 0.7x in the near future.

AIG has shown stark improvement in its financial results so far in 2012, given lower catastrophe losses, reducing interest expenses and superior performance from its primary businesses – Chartis and SunAmerica. The ratings agencies also appear quite optimistic about the company’s core earnings and underwriting profitability for the rest of 2012.

The simultaneous improvement in the company’s credit curve and earnings potential from Chartis and SunAmerica should provide the required buoyancy for long-term growth. The overall enhanced outlook is also highlighted by management’s anticipation of initiating dividends in 2013, thereby boosting investors’ confidence.

We believe that amidst the macro-economic factors and interest rate volatility, AIG has the potential to liberate itself from the clutches of the government, and maintain a strong and competitive business profile in the future. Currently, AIG carries a Zacks Rank #2, which implies a short-term Buy rating although the long-term recommendation remains Neutral.