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American International Group Inc. (AIG - Analyst Report) reported third-quarter 2012 operating earnings per share of $1.00, significantly beating the Zacks Consensus Estimate of 85 cents as well as year-ago quarter’s loss of $1.58 per share. Consequently, operating net income surged to $1.64 billion from a loss of $3.0 billion in the year-ago quarter.

On a GAAP basis, AIG reported a quarterly net income of $1.86 billion or $1.13 per share as compared with a net loss of $3.99 billion or $2.10 per share in the year-ago quarter. The reported results primarily included net realized capital loss of $387 million against $430 million in the year-ago quarter. Additionally, gain from discontinued operations was recorded at $1 million versus a loss of $221 million in the year-ago quarter.

The reported quarter also included non-qualifying derivative hedging gains of $5 million against $62 million in the year-ago quarter and deferred income tax valuation allowance release of $229 million as against a charge of $1.16 billion in the year-ago quarter. It also included gain from changes in benefit reserves worth $393 million against $102 million in the year-ago period.

Results reflected a robust top-line growth driven by higher investment income along with reduced claims and expenses. Additionally, escalated fair value of Maiden Lane III LLC and AIA along with significantly high growth in the insurance, aircraft leasing and other operations boosted the earnings growth. These were partially offset by reduced premiums growth and higher underwriting expenses. Volatile equity markets, widening credit spreads and reduced interest rates were other dampeners.

Nevertheless, the positive factors also drove the bottom line, operating cash flow, book value per share and return on equity (ROE). The company also managed to reduce the interests held by the Treasury during the quarter, thereby enhancing capital efficiency.

Total revenue spiked 38.8% year over year to $17.65 billion during the reported quarter and substantially exceeded the Zacks Consensus Estimate of $12.29 billion. Additionally, total benefits, claims and expenses fell 11.4% year over year to $15.05 billion.

Segment Details

AIG’s Chartis (general insurance) business – conducted through Commercial & Consumer Insurance – reported operating income of $949 million, up 72.2% from $551 million in the year-ago quarter. The year-over-year upside primarily resulted from improvement in pricing trends, higher investment income and growth from higher value business, partially offset by higher underwriting expenses that led to underwriting loss of $441 million. This complemented with a year-over-year reduction of 8.6% in claims and adjusted expenses that reduced to $6.25 billion.

Subsequently, combined ratio improved marginally to 105.0% compared with 105.9% in the prior-year period, reflecting reduced catastrophe losses although adverse reserve development was high. However, premiums earned edged down 3.2% year over year to $8.75 billion on the back of unfavorable currency, risk selection, business mix and retention. While growth decelerated in commercial insurance segment, improved results were witnessed in the consumer insurance segment.

Operating income at SunAmerica (life insurance services) escalated 75.4% year over year to $826 million, based on higher net investment income, positive equity market performance and disciplined management of interest crediting rates. These were partially offset by lower base yields and interest crediting rates. As well, AUM climbed 5.1% year over year to $275.5 billion as of September 30, 2012, while net flows remained positive for the seventh consecutive quarter.

Nevertheless, premiums, deposits and other considerations declined 18.6% year over year to $4.8 billion, primarily driven by significant decline in fixed annuities amid the low rate environment. Conversely, group retirement products, individual variable annuities and retail mutual funds witnessed modest improvement.

Aircraft Leasing– conducted through International Lease Finance Corp. (ILFC) – recorded operating income of $3 million against a loss of $98 million in the year-ago quarter. Rental revenues remain unchanged on a year-over-year basis at $1.1 billion, given the re-lease of older aircraft at lower rates.

The Mortgage Guaranty – conducted through United Guaranty Corporation (UGC) – recorded operating income of $3 million against $12 a loss of $98 million in the year-ago quarter, driven by increased mortgage originations and higher private mortgage penetration. Consequently, net premiums written rose 6.3% year over year to $219 million.

The Other Operations – conducted through AIG Financial Products Corp (AIGFP) and other non-aircraft leasing – reported operating income of $844 million versus a loss of $4.2 billion in the year-ago period.

In addition, AIG’s Direct Investment book (DIB), consisting of the Matched Investment Program (MIP) and the non-derivative assets and liabilities of the previous AIG Financial Products Corp. (AIGFP) portfolios, recorded operating income of $428 million against $119 million in the year-ago period.

Global Capital Markets, consisting of AIG Markets Inc. and the remaining AIGFP derivatives portfolio, recorded an operating income of $190 million, significantly improving from a loss of $174 million reported in the year-ago quarter.

During the reported quarter, the fair value of the AIA ordinary shares increased by about $527 million from the prior quarter. Additionally, the fair value on AIG’s interest in Maiden Lane III also improved by $330 million compared with a decrease of $931 million in the prior-year period.

Financial Update

AIG exited the reported quarter with total assets of $550.7 billion, down from $552.4 billion at 2011-end. Shareholders' equity totaled $101.7 billion at the end of September 2012, up from $101.5 billion at the end of 2011. Meanwhile, operating cash flow surged to $1.27 million from cash outflow of $4.47 billion in the prior-year period.

As of September 30, 2012, AIG’s book value per common share, including accumulated other comprehensive income, escalated by 61.7% year over year to $68.87. Further, operating ROE improved to 7.0% for the reported quarter against a negative return recorded in the year-ago period.

Government Loan and Credit Update

During the reported quarter, the U.S. Treasury raised about $26.5 billion, of which AIG repurchased shares worth $8.0 billion. The remaining booty was raised through open market operations and sale to underwriters. The total stock sale, in turn, reduced Treasury’s stake in the company to 15.9% with about 234.2 million shares.

On October 5, 2012, AIG entered into an amended and restated 4-year syndicated credit facility which provides for $4.0 billion of revolving loans, which has been increased from $3.0 billion in the previous facility. It also includes a $2.0 billion letter of credit sublimit.

In September 2012, AIG sold approximately 600 million ordinary shares of AIA by means of a placement to certain institutional investors, for about $2.0 billion.

In July 2012, AIG also received the full repayment of $5.0 billion against its equity interest in Maiden Lane III along with contractual and additional distributions of $1.1 billion. Henceforth, AIG will continue to receive 33% of proceeds generated by future sales of Maiden Lane III assets.

Peer Take

Earlier this week, MetLife Inc. (MET - Analyst Report)  reported third-quarter 2012 operating earnings per share of $1.32, comfortably beating both the Zacks Consensus Estimate of $1.28 and year-ago quarter’s earnings of 91 cents. Operating earnings surged 47% year over year to $1.42 billion.

The upbeat results were primarily due higher net investment income, as well as lower-than-expected operating expenses. This was partially offset by significantly reduced top-line growth driven by unfavorable impact of foreign exchange rates and low interest rate environment that led to underperformance across Europe, Middle East and EMEA as well as generated higher derivative losses.

Meanwhile, another close competitor, Prudential Financial Inc. (PRU - Analyst Report) is slated to release its third quarter financial results after the market closes on November 7.

Currently, AIG carries a Zacks Rank #3, which implies a short-term Hold rating although the long-term recommendation remains Neutral.

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