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Saturday, February 16, 2008

Great Find Buy AIG For Long Term Play

AIG's Selloff: A Huge Opportunity
By JON

ATHAN R. LAING
UNTIL LAST WEEK, THE INSURANCE GIANT American International Group looked relatively immune from the subprime mortgage paroxysm that has swept through so many banks and other financial institutions around the world. Though its stock had fallen to the mid-50s from about 70 in October, that was mainly because of worries about the impact that falling premium rates would have on AIG's commercial property and casualty business and how falling stock-market prices and declining interest rates would hurt the company's annuity sales.
New CEO Martin Sullivan
But that all changed on Feb. 11, when AIG (ticker: AIG) was hit by a selling panic that sent the stock plummeting 12% to a five-year low of $44.10. The selloff was triggered by AIG's disclosure in an SEC filing that its outside accountants had found "material weakness" in its accounting systems and were forcing AIG to boost its fourth-quarter write-down of the value of its credit insurance on a large mortgage security portfolio from $1.6 billion to $5.2 billion.
Even worse, this mark-to-market charge would cover AIG's results only through Nov. 30 of the yet-unreported fourth quarter of 2007. It was well known in the marketplace that the value of the mortgage securities, or collateralized debt obligations, that AIG had guaranteed had only taken more gas during December and January. So AIG was likely looking at even bigger mark-to-market hits in both the fourth quarter and the first quarter of 2008. Analysts rushed to chop their earnings forecasts -- to $5.60 a share, down from last year's $5.88. That's hardly befitting a company that has long prided itself on delivering double-digit annual earnings gains.
Hold on. Despite the palpable consternation that AIG currently evokes in the investment community -- a Citigroup report last week described AIG as a "black box hard to see in or out of" -- we would suggest that last week's stock convulsions were much over done.
For one thing, the mark-to-market write-downs, whatever their eventual size, are likely temporary. In fact, most if not all of these charges will be reversed back into AIG earnings over the next few years as the mortgage loans backing the CDOs pay down. The portfolio itself has a weighted average life of just over four years.
AIG tried to accentuate the latter point last week when it implied that the underlying CDO portfolio, despite its gruesome price levels, was performing just fine and was expected to yield no "material losses" to AIG. In other words, an accounting change isn't the same as actual losses.
The risk of actual loss is, in fact, quite contained. In a December analyst confab, AIG subjected this $63 billion insured portfolio to a doomsday scenario in which all the subprime mortgage collateral from the really bad years of 2006 and 2007 was completely written off, along with all "mezzanine" debt (rated triple-B or below) from the second half of 2005 and all CDOs rated single-A or lower, regardless of vintage or collateral backing. Even after this ultimate stress test, the pretax losses on the portfolio would come to just $590 million.
That would be a mere pittance compared with AIG's Sept. 30 shareholder net worth of $104 billion, which yields a book value of around $42 a share. Nor would a loss like that dramatically dent the eventual recovery into earnings of the minimum $5.2 billion mark-to-market charge anticipated for the fourth quarter. And, of course, the $590 million loss estimate was used for mere illustrative purposes. The company obviously feels the portfolio credit losses, if any, will be materially smaller.
AIG certainly appears to be a screaming value at its current trading level of around 45. This puts the stock at around 1.1 times third-quarter book value per share. Merrill Lynch's Jay Cohen figures that even with all the announced write-downs, AIG's book value will be $46.87 a share by year-end 2008. At that level, the stock could sustain negative pretax mark-to-market hits of $48 billion and still trade at a reasonable 1.35 times book value.
For a time in the late '90, AIG traded at more than four times its book value. The company was then run by its longtime, hard-charging chief, Maurice "Hank" Greenberg, who retired in 2005 after an accounting scandal erupted at AIG that cost the company $1.64 billion in regulatory settlements.
AIG'S FUNDAMENTAL STORY hasn't changed much from its salad days under Greenberg. The company is a financial behemoth with operations in 100 countries around the world. It's a play on the burgeoning middle class in China, India, Russia, Brazil and the rest of the developing world, which will have a growing need for insurance and retirement products. We think that AIG still has the entrepreneurial, disciplined culture that it has always possessed under its new chief executive, Martin Sullivan, despite Hank Greenberg's recent petulant assertions to the contrary.
"Look, AIG's stock could be under pressure for a while because of temporary factors like the current subprime mortgage crisis and frayed investor perceptions, but its global franchise hasn't been tarnished and the company retains a diversity and scale difficult to replicate," observes UBS insurance analyst Andrew Kligerman, who was presciently cautious in his assessment of AIG's prospects in recent months. He still has a Neutral rating on the stock.
Perhaps the best measures of analyst perceptions are the 12-month targets prices that many have placed on the stock; even in the wake of revisions prompted by last week's dust-up, they remain at fairly elevated levels. Kligerman, for example, now has a target for the stock of 67 while analysts at Bernstein Research, Citigroup and Fox Pitt Kelton Cochran have targets of 79, 69.50 and 83 respectively.
The $63 billion portfolio at the center of the latest crisis consists of multi-sector CDOs, with nearly half the underlying assets made up of subprime mortgage paper. AIG has guaranteed the credit of this portfolio by issuing derivatives called credit default swaps rather than conventional bond-insurance policies. Thus, under special derivative accounting, it must mark to market its credit-default-swap position, whereas functionally equivalent bond insurance would require no such adjustments.
Other esoteric accounting conventions lay behind AIG's accountants' insistence that the company boost its most recent mark-to-market charge by $3.6 billion. AIG had held that the value of its synthetic-guarantee contracts hadn't deteriorated by nearly the amount that the insured CDOs had. But since there's no real trading market in its highly customized swap paper, the insurer couldn't offer sufficient evidence of that contention. And these days, accountants are leery of accepting mark-to-model pricing that many financial institutions have used in the past to reduce valuation hits to earnings.
Yet there appears to be some validity to AIG's argument that the mark-to-market charge pushed on the company by accountants was far too draconian. Insurers like AIG don't have to put up capital and incur margin debt like banks or other holders of CDOs and other debt instruments. In fact, insurers receive annual premiums for extending their guarantee.
Nor in the normal course of events does the insurer suffer any outlay of cash at all. That occurs only if the insured debt instrument goes into default. And even then, the insurer's payout is effectively far smaller than its stated total obligation. That's because an insurer is on the hook only to make timely payments of interest and principal, which for CDOs involves payouts over literally decades.
Also, AIG's swap contracts are larded with high "attachment points." In other words, the upper-level, super-senior, triple-A layer of the CDOs that AIG insures have a number of layers that sit below it in the capital structure that must be wiped out first before the insurer incurs one dollar of loss. Special trigger provisions in the contracts also divert all the principal repayments from the underlying mortgages in the lower tranches to the AIG layer if certain performance tests of cash flow and the like aren't met.
Mark-to-market requirements are necessary for banks and brokerage houses since they're heavily leveraged and subject to "runs on the bank" if a sharp decline in their asset holdings threatens their solvency. Bond guarantors don't inhabit the same world of daily financial settlement that requires constant mark-to-market accounting.
The Bottom Line
Last week's plunge was way overdone. The stock could jump nearly 50%.
In its December presentation to analysts, AIG ticked off a number of characteristics of the $63 billion portfolio that ought to give investors comfort with the company's exposure. First, AIG sensed that the quality of subprime mortgage underwriting was deteriorating rapidly several years back and refrained writing guarantees on the badly adulterated 2006 and 2007 vintages. Likewise, its mezzanine CDO exposures are well protected, with some 37% of capital structure lying below AIG's insured layer.
Of course, perception influences the price of a stock as much as reality. Investors will likely be rattled by the earnings-shredding mark-to market hits that AIG is likely to suffer over the next quarter or two. But if the charges are mere temporary accounting events, as we suspect, long-term investors will have little to worry about -- and perhaps much to celebrate.

7 comments:

Anonymous said...

Dink, like to throw around big words? Pretty careless of you to rec this as a huge buy before the earnings come out. How high do you get listening to yourself talk??

Anonymous said...

You don't know jack shit about stocks. First off, your "web page" is horrible. Red background with black font, at least make the thing bold moron. Copying articles and throwing out a few words does not make you a trader. I only read a few pages of your nonsense and could tell you are just another amateur. Stop the blogging and read a book for a change.

Anonymous said...

I agree, this site is a joke!

Chus said...

This is what I think: AIG stock

Anonymous said...

Well Guru:
If you had any real money to bet where would you be? My guess is that you already have a new screen name, and you're out there still telling people how smart you are.
As the others have said I can read the yellow on red, But black on red? Did you think you were being cool? At least you didn't add a mouse follower.
By the way here is the chart for AIG since your recommendation. Pretty much straight down.
http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=aig&sid=0&o_symb=aig&freq=1&time=7

Bitcoin Mining Fund ( BMF ) said...

Anonymous , ( Of Course )
If u Dont like it dont keep visiting my blog, and for the record i never stated i am smart and telling others that i am ?? what are u talking about , this blog is for average home investers that are looking for info and to chat about stocks !! at least i am not anonymous , and state things on record , tuff guy hiding behind the computer ! new screen name ??? what afre u talking about !!??

Get a life and dont visit this site again !!

Thanks,
Mad Money Renato !

Anonymous said...

Nice. Hope you bought AIG at 40. I'm buying at 2.